Merrill Lynch’s Greg Fleming: Sources Say No Legal Trouble Ahead

There are gray storm clouds hanging over Wall Street this February but Merrill Lynch’s Greg Fleming appears to be weathering the storm. The Securities and Exchange Commission has initiated a formal investigation into whether the brokerage knew more than it revealed to shareholders about the value of its subprime investments prior to announcing the giant write-downs with its third-quarter results. Federal prosecutors have opened a preliminary investigation, leading to speculation that criminal charges could possibly brought against some Merrill executives. But sources at Merrill Lynch say Fleming, who continues in his role as president of the bank after the losses forced the departures of a co-president and the chief executive, was not involved in the businesses reportedly being scrutinized and they do not expect him to be a subject of the investigation.

In early October of last year, Merrill warned investors that it expected to write down about $5billion in the third quarter relating to collateralized debt obligations and loans to back leveraged buyouts. A few weeks later, Merrill upped the write-down for the period to $8.4billion write-down. This left the bank with a quarterly loss of $2.2 billion, making the third quarter the worst ever for Merrill. That record was broken, however, the very next quarter, when Merrill recorded more than $16 billion in write-downs, for a loss of $9.8billion for the period. The Justice Department is now reportedly asking who knew what about the size of these losses and when they knew it.

Merrill’s loss-making performance led to the departures of former chief executive Stan O’Neal and former co-president Ahmass Fakahany. But many thought the changes at Merrill would go further. Peter Sorrentino, who helps manage a $12 billion fund that has invested in Merrill told Bloomberg that: ``The whole executive suite needs to change. It wasn't one person's bad decisions -- there are a lot of fingerprints on this murder.'' At the time of O’Neal ouster, the Wall Street Journal’s Dana Cimilluca pointedly asked on the Deal Journal blog why Fleming had been permitted to keep his job.

So how did Fleming manage to hold on? Fakahany was in charge of risk at Merrill, and the circumstances that led to his and O’Neal’s departures arose from failure of risk management. As co-president Greg Fleming would likely have attended the meetings discussing the losses that are likely the subject of the governmental investigation but control and assessment of those risks did not fall directly under his mandate. And just as he survived the earlier trouble, Fleming, whose skill at investment banking is widely admired, is well-positioned to avoid the latest storm—and particularly any legal fallout—according to people familiar with the situation.

Although the initial wave of ‘off with their heads’ panic on Wall Street has passed, the recent revelations of investigations by SEC, the New York State Attorney General’s office and the Justice Department have set off a wave of paranoia. (Federal prosecutors and state officials are far more feared than the SEC, which can bring only civil lawsuits and which Wall Street views as manageable.) This has fueled speculation that Fleming might find himself in the hot-seat, although this seems far-fetched at this point. Conversations with sources close to the situation say Fleming has not been questioned and it is ‘extremely unlikely’ that the investigation would point in his direction.

Last week, DealBreaker reported on the growing culture of fear that these investigations have created. At Merrill Lynch, some fear that even if no criminal charges are forthcoming, the investigations could prove a distraction at a time when the firm is attempting to recover its reputation and its bottom line. The fear of criminal investigations—and the perception that prosecutors can be over-zealous when responding to headline making business scandals—is particularly sharp at Merrill. In the aftermath of Enron’s accounting scandal and collapse, four top Merrill executives—including the heads of the investment bank division and of the leasing finance group—found themselves targeted by prosecutors. They were convicted at trial received multi-year sentences. Later a federal appeals court overturned the convictions of the executives, saying the charges were flawed.

But lawyers experienced with investigations into Wall Street scandals say that at this early stage any such concerns are overblown and premature. Sources at Merrill say that some of this speculation likely arises from critics and rivals of Fleming. As we stressed last week, no-one has indicated any wrong-doing on the part of Fleming and DealBreaker.

Fleming led Merrill's push into private equity, a business that contributed billions to Merrill’s bottom line when the going was good but proved costly when the bank had to write-down leveraged loans left on its books when investor appetite dried up. He is praised for arranging the deal that allowed Merrill's to acquire 49.8 percent stake in BlackRock. But Fleming had a role in the controversial plan to merge with Wachovia, a move that many within Merrill believe would have been disastrous. O’Neal’s conversations with Wachovia chief Ken Thompson, conducted without getting the approval of Merrill’s board, is considered a “a major breach of corporate protocol” according to the New York Times. It is thought that this lead to his ouster.

The bottom line is that while Fleming’s reported role in the Wachovia deal and his position as the last of Stan O’Neal’s gang has led both allies and enemies alike speculate about his fate, there’s no sign that he has been singled out by prosecutors—federal or state—for special attention in the current investigations.