CONFIDENTIAL TREATMENT HAS BEEN REQUESTED BY MERRILL
LYNCH & CO., INC. PURSUANT TO 17 C.F.R. ss. 200.83. THIS LETTER OMITS
THE CONFIDENTIAL INFORMATION INCLUDED IN THE UNREDACTED
VERSION OF THE LETTER DELIVERED TO THE DIVISION OF
CORPORATION FINANCE OF THE SECURITIES AND EXCHANGE
COMMISSION AND ASTERISKS DENOTE SUCH OMISSIONS.
Laurence A. Tosi
Finance Director
[COMPANY LOGO] Merrill Lynch
Merrill Lynch & Co., Inc.
World Financial Center Fl 31
New York, NY 10080
Tel: (212) 449-5203
Fax: (212) 738-3996
August 24, 2006
VIA ELECTRONIC DELIVERY
Ms. Sharon Blume
Reviewing Accountant
Securities and Exchange Commission
100 F Street, NE
Washington, DC 20549
Re: Merrill Lynch & Co., Inc.
Form 10-K for the Fiscal Year Ended December 30, 2005
Form 10-Q for the Fiscal Quarter Ended March 31, 2006
File No. 1-07182
Dear Ms. Blume:
This letter provides the response of Merrill Lynch & Co., Inc. ("Merrill
Lynch") to the comments from the staff of the Securities and Exchange
Commission (the "Commission") on the Annual Report on Form 10-K for the year
ended December 30, 2005 ("2005 Annual Report") and form 10-Q for the fiscal
quarter ended March 31, 2006 contained in your letter dated July 6, 2006
addressed to Mr. Jeffrey N. Edwards. For your convenience, we have included
your comments in bold type along with our responses thereto.
10-K for the Fiscal Year Ended December 30, 2005
- ------------------------------------------------
Consolidated Statements of Earnings, page 67
- --------------------------------------------
Comment 1:
- ----------
We have reviewed your response to comment 1 of our letter dated June 1, 2006.
We believe that Rule 5-03 of Regulation S-X requires you to present cost of
services and selling, general and administrative expenses separately. However,
you state that you do not track costs related to separately presented revenue
line items and that your current presentation is consistent with how you
manage your business; therefore, please revise your financial statements to
disclose how you manage and analyze your
Laurence A. Tosi
Merrill Lynch & Co., Inc.
August 24, 2006
Page 2 of 11
financial results including how you determine the prices for your services,
determine the proper cost structure and manage the overall profitability of
your business. If you believe that providing this information would involve
undue cost and burden, please provide us with support for your determination.
Response 1:
- -----------
Please see our response in our letter dated July 19, 2006. In addition, in
order to change Merrill Lynch's income statement structure to present cost of
services and selling, general and administrative expenses separately, a
theoretical framework would have to be established for this alternate view of
profitability. The majority of Merrill Lynch's financial systems would need to
be reconfigured. This effort would cost tens of millions of dollars and would
involve thousands of employees globally. This effort would put an undue burden
on Merrill Lynch and would provide financial information that would not be
useful for management as Merrill Lynch does not measure its financial results
under such a framework.
Consolidated Statements of Cash Flows, page 72
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Comment 2:
- ----------
We have reviewed your responses to comments 2 and 3 of our letter dated June
1, 2006. We note in your response that you have historically classified cash
flows related to loan activities as investing activities, regardless of
whether a loan is classified as held-for-sale or held-for-investment at
inception or subsequent to origination. Paragraph 9 of SFAS 102 requires that
cash flows resulting from originations, acquisitions and sales of loans should
be classified as operating cash flows if those loans are acquired specifically
for resale. Please amend your December 31, 2005 10-K and applicable Forms 10-Q
to revise your Statements of Cash Flows to present as operating activities the
cash flows related to the origination, acquisition and sale of loans for which
you had the intent to sell when the loan was originated. If you do not believe
this would result in a material change to your Statements of Cash Flows,
please provide us with a comprehensive analysis of the impact, including the
applicable gross and net cash flows.
Response 2:
- -----------
We believe that this misstatement does not constitute a material change to our
Consolidated Financial Statements which would require an amendment of our
previously filed December 31, 2005 10-K and applicable forms 10-Q. In reaching
our conclusion, we considered both quantitative and qualitative analyses as
required by SEC Staff Accounting Bulletin: No. 99-Materiality ("SAB 99"), in
relation to the Consolidated Financial Statements. We
Laurence A. Tosi
Merrill Lynch & Co., Inc.
August 24, 2006
Page 3 of 11
note that the misstatement only impacts the Consolidated Statements of Cash
Flows and does not impact net income, earnings per share, equity, or the
balance sheet; therefore, from an earnings and financial condition
perspective, the misstatement is not material in any respect. As it relates to
cash flow activities of the Company, we have evaluated the impact that this
misstatement has on the Consolidated Statement of Cash Flows and the
individual line items affected, and again believe that the changes are not
material as to require a reissuance of previously issued Consolidated
Financial Statements. Below we have provided an analysis of the impact of the
misstatement on the Consolidated Statement of Cash Flows:
===================================================================================================================================
Year to Date
-------------------------------------------------------
2003 2004 Q105 Q205 Q305
-------------------------------------------------------
(dollars in millions)
Cash flows From Operating Activities:
Loans, notes, and mortgages held for sale - reclassification amount ($1,395) ($1,332) ($299) ($528) ($967)
Cash Provided by (used for) Operating Activities before reclassification 8,656 (14,941) 5,842 (3,173) (15,459)
Cash Provided by (used for) Operating Activities after reclassification 7,261 (16,273) 5,543 (3,701) (16,426)
Cash Flows From Investing Activities:
Loans, notes, and mortgages held for investment before reclassification ($12,625) ($2,234) ($3,289) ($6,541) ($8,377)
Loans, notes, and mortgages held for investment after reclassification (11,230) (902) (2,990) (6,013) (7,410)
Change from current presentation 1,395 1,332 299 528 967
Cash Provided For (used in) Investing Activities before reclassification (10,408) (4,370) (4,658) (6,053) (4,571)
Cash Provided For (used in) Investing Activities after reclassification (9,013) (3,038) (4,359) (5,525) (3,604)
===================================================================================================================================
====================================================================================================
Year to Date
------------------------
2005 Q106
------------------------
(dollars in millions)
Cash flows From Operating Activities:
Loans, notes, and mortgages held for sale - reclassification amount ($3,300) ($867)
Cash Provided by (used for) Operating Activities before reclassification (25,658) (7,173)
Cash Provided by (used for) Operating Activities after reclassification (28,958) (8,040)
Cash Flows From Investing Activities:
Loans, notes, and mortgages held for investment before reclassification ($12,977) $463
Loans, notes, and mortgages held for investment after reclassification (9,677) 1,330
Change from current presentation 3,300 867
Cash Provided For (used in) Investing Activities before reclassification (3,938) 299
Cash Provided For (used in) Investing Activities after reclassification (638) 1,166
====================================================================================================
Given that the total of cash provided by or used in operating and investing
activities represent the sum of individually large positive and negative cash
flows which, when combined, can net to relatively small net balances, we do
not believe that changes in these net amounts are a meaningful measure of
materiality to users of our financial statements. It is important to note that
for broker dealer companies, the individual components within operating and
investing cash flow categories can fluctuate significantly from period to
period based on management decisions with respect to certain core operating
activities such as the purchase and sale of securities and lending activities
including loans, notes, mortgages and repurchase and resale agreements.
Accordingly, we do not believe the total amounts are significant indicators of
any particular business activity which is meaningful to users of cash flow
information for a broker dealer or financial services company.
Laurence A. Tosi
Merrill Lynch & Co., Inc.
August 24, 2006
Page 4 of 11
Therefore, on a quantitative basis, we do not believe that the misstatement is
such that it is probable that the judgment of a reasonable person relying upon
the financial statements would have been changed or influenced by the
correction of the cash flow amounts.
We also considered whether or not the misstatement would be material from a
qualitative perspective. In order to make this determination we looked to the
indicators specified in SAB 99. These indicators largely focus on whether or
not the misstatement impacts earnings, segment reporting, covenants and
contractual requirements, management compensation or concealment of an
unlawful transaction. The misclassification on the Consolidated Statement of
Cash Flows would not be considered material within any of the qualitative
indicators specified in SAB 99 as discussed below:
1) Does the misstatement arise from an item of precise measurement or
from an estimate with a significant degree of imprecision inherent
in the estimate?
The misstatement is not the result of amounts that require significant
judgment in their measurement. The amounts relate to the classification
of cash advanced and cash received on loans.
2) Does the misstatement mask a change in earnings or other trends?
No. As noted above, this misstatement does not impact Merrill Lynch's
net income, nor mask any other trends. Specifically, we note that the
trend in the Company's cash flows related to activities from loans,
notes and mortgages held for investments is consistent with the trend
prior to the change in presentation.
3) Does the misstatement hide a failure to meet analysts' consensus
expectations for the enterprise?
No. The misstatement does not impact net income and therefore does not
impact analysts' consensus expectations for Merrill Lynch. Further, we
do not believe that analysts view the cash flow statements or the net
amounts impacted by this misstatement as a basis for consensus
expectations.
4) Does the misstatement change a loss into income or vice versa?
No. The misstatement does not change a loss into income or vice versa as
the misstatement does not impact net income. Additionally, the
misstatement does not change a source of cash flow to a use of cash flow
or vice versa.
Laurence A. Tosi
Merrill Lynch & Co., Inc.
August 24, 2006
Page 5 of 11
5) Does the misstatement concern a segment or other portion of the
registrant's business that has been identified as playing a
significant role in the registrant's operations or profitability?
No. The misstatement does not impact segment reporting as cash flows are
presented on a consolidated basis.
6) Does the misstatement affect the registrant's compliance with
regulatory requirements?
No. The misstatement does not affect our compliance with any regulatory
requirements. We do not have any regulatory requirements which are based
on the net cash flow items nor the individual line items in the cash
flow statement which are being restated. Our regulatory requirements are
generally based on capital levels.
7) Does the misstatement affect the registrant's compliance with loan
covenants or other contractual requirements?
No. The misstatement has no impact on any loan covenants or other
contractual requirements. We do not have any covenants or other
contractual requirements which are based on the net cash flow items nor
the individual line items.
8) Does the misstatement have the effect of increasing management's
compensation?
No. The misstatement would not have affected management's compensation.
Management compensation is not based on any cash flow measures.
9) Does the misstatement involve concealment of an unlawful
transaction?
No. The misstatement relates to the grouping of discreet cash flow
movements for presentation in the Consolidated Statement of Cash Flows.
It does not pertain to any particular transaction or involve an
intentional misstatement or a concealment of an unlawful activity.
In addition, the misclassification did not impact liquidity, capital or cash
balances of Merrill Lynch. Further, it is our view that since this
misstatement does not affect earnings, cash flow trends or business trends, it
would not have resulted in our investors, securities analysts, rating agencies
and other constituents changing an existing published view of our results.
Laurence A. Tosi
Merrill Lynch & Co., Inc.
August 24, 2006
Page 6 of 11
As discussed in our June 14, 2006 response, beginning with the second quarter
of 2006 10-Q filing, we disclosed the cash flows associated with loans held
for sale within cash flows from operating activities and cash flows associated
with loans held for investment within cash flows from investing activities and
reclassified the prior period to conform to this presentation. We provided the
following disclosure in Note 1 to the Condensed Consolidated Financial
Statements:
During the second quarter of 2006, Merrill Lynch reclassified cash flows
from loans held for sale to operating activities, whereas in prior
periods, these loans were classified as investing activities. Merrill
Lynch believes that classifying cash flows from loans held for sale as
operating activities correctly presents the cash flows associated with
these loans as they have been acquired primarily for resale. All prior
period amounts have been reclassified to conform to the current period
presentation.
Notes to Consolidated Financial Statements
- ------------------------------------------
Note 1. Summary of Significant Accounting Policies
- --------------------------------------------------
Accounting for Derivatives, and Hedging Activities, page 79
- -----------------------------------------------------------
Comment 3:
- ----------
We have reviewed your response to comment 4 of our letter dated June 1, 2006.
For each type of hedging relationship you describe in your response, please
specifically tell us how they met each of the criteria for hedge accounting
pursuant to paragraph 20, 21, 28 and 29 of SFAS No. 133.
Response 3:
- -----------
Fair Value Hedges
When the hedged item is a financial asset or liability, pursuant to paragraph
21(f)(2) of SFAS 133, Merrill Lynch's primary risk management objective is to
hedge against the risk of changes in fair value attributable to changes in the
designated benchmark interest rate by entering into interest rate swaps. When
the hedged item is a physical commodity, Merrill Lynch's primary risk
management objective is to hedge against the risk of changes in fair value
attributable to changes in price of the physical commodity. For each type of
hedging relationship described in our letter dated June 14, 2006, Merrill
Lynch satisfies the requirements as described in paragraphs 20 and 21 of SFAS
No. 133 to qualify for fair value hedge accounting:
Laurence A. Tosi
Merrill Lynch & Co., Inc.
August 24, 2006
Page 7 of 11
Requirement 1: Designate the hedge instrument, hedged item, and risk being
hedged
Merrill Lynch Debt - Merrill Lynch routinely issues debt in a variety of
maturities and currencies and frequently enters into interest rate swap
agreements that convert fixed rate interest payments into variable payments.
Due to the volume of these types of transactions, Merrill Lynch has
established specific hedge codes to formally document the designated hedging
relationship. Merrill Lynch designates hedging relationships by documenting a
hedge code in its trade capture system. A hedge code is assigned to every
hedging relationship and documented appropriately.
Each hedge code corresponds to a hedge code memorandum that describes the type
of hedge, the type of risk being hedged and the method of assessing hedge
effectiveness. These memoranda serve as formal hedge designation
documentation for SFAS 133 purposes and are supplemented by trade
notifications or other documentation as required including copies of the trade
confirmations and related derivative term sheets.
Marketable Securities - Merrill Lynch enters into interest rate swaps to hedge
the changes in fair value attributable to changes in the benchmark interest
rate associated with fixed rate marketable investment securities. Each hedging
relationship is documented using an individual hedge designation form. Each
form includes a detailed description and identification of the hedged item and
hedging instrument including notional amounts, inception date, maturity date,
interest rate, frequency of coupon and other features if applicable. The form
identifies the risk being hedged and the method of assessing hedge
effectiveness.
Resale Agreements - Merrill Lynch enters into interest rate swaps to hedge the
changes in fair value attributable to changes in the benchmark interest rate
associated with long-term fixed rate resale and repurchase agreements. Merrill
Lynch documents each hedging relationship on an individual hedge designation
form. Each form includes a detailed description and identification of the
hedged item and hedging instrument including notional amounts, inception date,
maturity date, interest rate, frequency of coupon and other features, if
applicable. The hedge designation form identifies the risk being hedged and
the method of assessing hedge effectiveness.
Commodities - Merrill Lynch enters into futures and forwards contracts to
hedge commodity price risk associated with its physical inventory. Merrill
Lynch documents its hedging relationships on hedge designation forms at the
inception of the hedge. The form identifies the risk being hedged and how
effectiveness will be assessed at inception and on an on-going basis.
Attachments to the form identify the hedged items by location and the hedging
instruments by third party trade identification.
Laurence A. Tosi
Merrill Lynch & Co., Inc.
August 24, 2006
Page 8 of 11
Requirement 2: Assess hedge effectiveness at inception and on an ongoing basis
and measure ineffectiveness on a quarterly basis
Merrill Lynch Debt - Merrill Lynch documents how effectiveness will be
assessed at inception and on an on-going basis and how ineffectiveness will be
measured. Each hedge code that corresponds to a hedge code memorandum
describes whether the hedging relationship qualifies for shortcut treatment or
whether effectiveness testing under the "long-haul" method is required.
Documentation of whether the hedge qualifies for shortcut treatment or
"long-haul" is maintained in the trade capture system. The hedge code
memorandum lists the requirements to be met for a hedging relationship to
qualify for shortcut treatment. If the hedge does not meet all the criteria
required for the shortcut method, the hedge code memorandum describes how
hedge effectiveness will be determined at inception of the hedge and on an
ongoing basis. For prospective testing, Merrill Lynch applies a dollar value
of a one basis point change ("DV01") test. DV01 measures the sensitivity of an
instrument to an instantaneous 1 basis point parallel shift to the yield
curve. The DV01 test is assessed at the inception of the hedge relationship
and at the beginning of each subsequent testing period by looking at the ratio
of DV01 of the hedge to the position being hedged. To capture the potential
non-linearity of interest rate risk being hedged, Merrill Lynch uses
positive/negative 10 and 50 basis point parallel shocks to the interest rate
curve and calculates DV01 based upon both parallel shocks. Based upon the
parallel shocks to the curve a change in fair value for both the derivative
and the hedged item is obtained and assessed for effectiveness. The resulting
ratio must fall within a range of 80% to 125% to be deemed an effective hedge.
A retrospective test is performed at the end of each month, based on a dollar
offset methodology. The hedge must pass both the prospective and retrospective
tests to qualify for hedge accounting in that particular accounting period.
Any hedge ineffectiveness is recorded in earnings.
Marketable Securities - Merrill Lynch uses DV01 to assess whether the
relationship between the underlying securities and corresponding hedge will be
highly effective in offsetting changes in fair value attributable to the
hedged risk. This test is performed at inception of the hedge relationship and
documented in the hedge designation form. Subsequent prospective tests using
DV01 are performed at least monthly. A retrospective test is performed at the
end of each month based on a dollar offset methodology. Any hedge
ineffectiveness is recorded in earnings.
Resale Agreements - Merrill Lynch uses DV01 to assess hedge effectiveness on a
prospective basis and the dollar offset methodology to assess hedge
effectiveness on a retrospective basis. Subsequent prospective tests using
DV01 are performed quarterly. A retrospective test is performed at the end of
each month based on a dollar offset methodology. Any hedge ineffectiveness is
recorded in earnings.
Laurence A. Tosi
Merrill Lynch & Co., Inc.
August 24, 2006
Page 9 of 11
Commodities - Merrill Lynch assesses hedge effectiveness prospectively and
retrospectively using a regression analysis of past changes in the historical
spot prices of the hedging instrument and the hedged item by location. This
includes an analysis of R(2), the slope, and the F and t statistics. The test
is performed at inception and at the end of each month.
Paragraphs 20c, 21a1, 21a2, 21c, 21d of SFAS 133 are not applicable as Merrill
Lynch does not employ such hedging strategies.
Cash Flow Hedges
The impact of cash flow hedging activity is not material to Merrill Lynch's
Consolidated Financial Statements. In limited circumstances, Merrill Lynch may
designate interest rate swaps as hedging the exposure to variability in
expected future cash flows related to variable rate loans and variable rate
securities. Each hedging relationship is individually documented using cash
flow hedge designation forms. The form includes a description of the
underlying hedged item and hedging instrument including notional amounts,
interest rate, payment period, inception and maturity dates. The form further
identifies the hedge objective and the method of assessing hedge
effectiveness. Hedge effectiveness is demonstrated using the change in
variable cash flows method.
Comment 4:
- ----------
We have reviewed your response to comment 5 of our letter dated June 1, 2006.
Please tell us the following related to your short-cut fair value hedges:
o the specific terms of the hedging instruments and hedged items and
how those terms match; and
o specifically how these hedges met each of the criteria in
paragraph 68 of SFAS 133 to qualify for shortcut accounting.
Response 4:
- -----------
The particulars of our discussion of short-cut fair value hedges is contained
in a separate letter of even date hereof.
* * * *
Laurence A. Tosi
Merrill Lynch & Co., Inc.
August 24, 2006
Page 10 of 11
Laurence A. Tosi
Merrill Lynch & Co., Inc.
August 24, 2006
Page 11 of 11
We hope that this response satisfies your concerns. As always, we
look forward to continued dialogue on financial reporting issues. If you have
any questions concerning this response, please do not hesitate to contact me
at (212) 449-5203 or our Global Controller, Kathleen Skero, at (212) 449-0173.
Sincerely,
/s/ Laurence A. Tosi
Laurence A. Tosi
Finance Director
Principal Accounting Officer
Cc: Mr. Dave Irving, Staff Accountant
Mr. Jeffrey Edwards, Chief Financial Officer