[Merrill Lynch Logo] Merrill Lynch Laurence A. Tosi
Finance Director
Merrill Lynch & Co., Inc.
World Financial Center Fl 31
New York, NY 10080
Tel: (212) 449-5203
Fax: (212) 738-3996
September 19, 2006
BY HAND
Ms. Sharon Blume
Reviewing Accountant
Securities and Exchange Commission
100 F Street, NW
Washington, DC 20549
Re: Merrill Lynch & Co., Inc.
Form 10-K for the Fiscal Year Ended December 30, 2005
Forms 10-Q for the Fiscal Quarters Ended June 30, 2006 and 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"), Forms 10-Q for the fiscal
quarters ended June 30, 2006 and March 31, 2006 contained in your letter dated
September 5, 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
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Management's Discussion and Analysis
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Liquidity Risk Management, page 48
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Comment 1:
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In future filings please explain why you had negative cash flows from
operating and investing activities for the periods ending December 31, 2005
and 2004.
Laurence A. Tosi
Merrill Lynch & Co., Inc.
September 19, 2006
Page 2 of 9
Response 1:
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Merrill Lynch will include this disclosure in future filings.
Consolidated Statements of Cash Flows, page 72
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Comment 2:
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We have reviewed your response to comment 2 of our letter dated July 6, 2006.
As the impact of the net cash flows associated with loans you originated and
acquired with the intent to sell appears quantitatively and qualitatively
material to cash flows from operating and investing activities, please amend
your December 31, 2005 10-K and applicable Forms 10-Q to restate your
Statements of Cash Flows to present these cash flows as operating activities.
Please include a financial statement footnote describing and quantifying the
correction of an error.
Response 2:
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We respectfully request that you reconsider our materiality assessment of this
error and the related conclusion as to the need to amend previously issued
financial statements. We submit the following enhanced discussion for your
review, and would welcome an opportunity to discuss our analysis with you
further.
As we have previously included in our response, we agree that the
classification of cash flows associated with loans originated or acquired with
the intent to sell should be reported in cash flows from operating activities.
We further agree that the financial statements should be corrected for this
misstatement, and have taken steps in this respect. 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 corrected the prior
period to conform to this proper 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.
Laurence A. Tosi
Merrill Lynch & Co., Inc.
September 19, 2006
Page 3 of 9
To the extent that the Staff believes that we should expand or modify this
disclosure, we would welcome your recommendations and can address such in
future filings.
With respect to previously issued financial statements, it is our judgment
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 ("SAB"): No. 99-Materiality ("SAB
99"), and guidance recently issued in SAB No. 108.
As it relates to cash flow activities of the Company, the below is an analysis
of the impact of the misstatement on the Consolidated Statement of Cash Flows:
Year to Date
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2003 2004 Q105 Q205 Q305 2005 Q106
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(dollars in millions)
Cash Flows From Operating Activities:
Loans, notes, and mortgages held for
sale - reclassification amount ($ 1,395) ($ 1,332) ($ 299) ($ 528) ($ 967) ($ 3,300) ($ 867)
Cash Provided by (used for) Operating
Activities before reclassification 8,656 (14,941) 5,842 (3,173) (15,459) (25,658) (7,173)
Cash Provided by (used for) Operating
Activities after reclassification 7,261 (16,273) 5,543 (3,701) (16,426) (28,958) (8,040)
Cash Flows From Investing Activities:
Loans, notes, and mortgages held for
investment before reclassification ($12,625) ($ 2,234) ($ 3,289) ($ 6,541) ($ 8,377) ($12,977) $ 463
Loans, notes, and mortgages held for
investment after reclassification (11,230) (902) (2,990) (6,013) (7,410) (9,677) 1,330
Change from current presentation 1,395 1,332 299 528 967 3,300 867
Cash Provided For (used in) Investing
Activities before reclassification (10,408) (4,370) (4,658) (6,053) (4,571) (3,938) 299
Cash Provided For (used in) Investing
Activities after reclassification (9,013) (3,038) (4,359) (5,525) (3,604) (638) 1,166
We acknowledge that if it were necessary or appropriate for the materiality
analysis to be performed solely on a quantitative assessment of the impact on
the individual line items and subtotals affected in this one financial
statement, the amounts may be viewed as significant in relation to certain
subtotals or periods. However, we believe that this approach or analysis is
not necessarily valid from two very important perspectives:
1) Materiality is based on the Consolidated Financial Statements taken as a
whole.
Even if a purely quantitative materiality assessment approach is taken, such
analysis should be made in relation to the consolidated financial statements
taken as a whole, and not on an individual financial statement or individual
disclosure item. This would appear to be especially critical if the analysis
is being performed in order to determine if previously issued financial
statements should be amended.
Laurence A. Tosi
Merrill Lynch & Co., Inc.
September 19, 2006
Page 4 of 9
In this regard, we note that the misstatement impacts only the Consolidated
Statements of Cash Flows and does not impact any of the other financial
statements or disclosures. Net income, earnings per share, equity, nor any
balance sheet amounts are impacted by the misstatement. In addition, there is
no impact on liquidity, capital or cash balances of Merrill Lynch as a result
of this misstatement. Therefore, from an earnings and financial condition
perspective, the misstatement is not material in any respect.
The question we then addressed is: Do the amounts misstated in the
consolidated cash flow statements impact the overall consolidated financial
statements in such a way as to render such previously filed consolidated
financial statements misleading to users of our financial statements?
We believe that neither the statements of cash flows nor the information
impacted by this misstatement are of equivalent importance or relevance as the
Income Statement or Balance Sheet are to users of financial statements for
financial services companies. The significance which is typically ascribed to
net cash flow streams resulting from total operating and total investing
activities in the statement of cash flows is arguably less meaningful for
financial services companies where, for example, 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. These net total amounts (or changes in
these amounts from period to period) are not a meaningful measure of
materiality nor are they significant indicators of any particular business
activity which is meaningful to users of cash flow information for a financial
services company. 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.
Furthermore, we believe that in our industry the split between the cash flows
related to loans, notes and mortgages which are available for sale and those
that are held for investment is arguably less relevant, and not necessarily
more useful than the combined cash flows associated with this business where
management's intentions with respect to these investments can change as a
result of market conditions.
Additionally, industry analysts who follow and review companies in this
industry generally do not rely on cash flow information for developing
earnings' expectations or in analyzing the company's results of operations or
financial health. To fully understand and support this view, we have discussed
the relevance of the cash flow statement and cash flow information to the
users of our financial statements with Guy Moszkowski, a Merrill Lynch analyst
who is a prominent industry analyst within the securities industry, who has
stated that:
Laurence A. Tosi
Merrill Lynch & Co., Inc.
September 19, 2006
Page 5 of 9
"In general, very rarely, if at all do we rely on the Statements of Cash
Flows in analyzing Investment banking and Brokerage companies; the nature
of the business is generally that U.S. GAAP earnings are a good enough
approximation of true cash flow. Furthermore, generally speaking, the
classifications of the various line items on the cash flow statement into
categories (operating, investing and financing) are, in our view, simply
not relevant in providing useful input to the investment-decision-making
process of a reasonable person. The individual line items can be very
useful, but the categories most certainly are not.
In a previous report on a large financial services company (our initial
report on Citigroup dated September 18, 2003), we specifically commented
on the fact that using cash flow statements for a financial company is
far less straightforward than doing the same analysis for an industrial
company. For an industrial, the categorization of sources and uses of
cash into operating, investing and financing components is reasonably
straightforward. For a financial company, the distinctions are not so
clear cut given that what could be categorized as investing activities
(for example, the purchase and sale of large amounts of securities) is
likely to be part and parcel of the company's core trading operations;
"financing" activities like the raising of funds via deposits could also
be viewed as operating. Therefore, we often re-cast cash flow data of
financial institutions to better reflect a company's cash flows. For
example, such re-categorizing of U.S. GAAP information would help us
reflect the fact that activities such as trading of securities, capture
of deposits, and granting of loans, are all part of the operating
activities of the institution."
Therefore, we do not believe that there are any reasons to give the
consolidated statement of cash flows, nor the information misstated therein,
any special prominence with respect to the materiality assessment performed
for the consolidated financial statements taken as a whole for the purpose
being discussed herein. In fact, we believe the opposite is more appropriate,
in that the statement is generally viewed as less relevant to users of our
financial statements.
2) Materiality is an assessment based on quantitative and qualitative factors.
SAB 99 has historically required a robust analysis of misstatements in order
to determine if such errors are deemed to be material; such analysis is to
weigh relevant qualitative assessments based on the specific facts and
circumstances. This perspective on determining materiality has been recently
reinforced in SAB 108, which references FASB Concepts Statement No. 2,
Qualitative Characteristics of Accounting Information:
Laurence A. Tosi
Merrill Lynch & Co., Inc.
September 19, 2006
Page 6 of 9
"In describing the concept of materiality, FASB Concepts Statement No. 2,
Qualitative Characteristics of Accounting Information, indicates that
materiality determinations are based on whether "it is probable that the
judgment of a reasonable person relying upon the report would have been
changed or influenced by the inclusion or correction of the item".
While we appreciate that SAB 108 is intended to address the different methods
of quantifying financial statement misstatements, it also addresses when such
misstatements, now evaluated under this new guidance, would result in
amendments to previously issued financial statements.
Accordingly, we believe that this new guidance provides further support to
supplement the quantitative assessment and to carefully consider and weigh the
qualitative indications 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. Based on our review of each indicator, as noted below,
we believe that the misstatements 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.
Laurence A. Tosi
Merrill Lynch & Co., Inc.
September 19, 2006
Page 7 of 9
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.
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.
Laurence A. Tosi
Merrill Lynch & Co., Inc.
September 19, 2006
Page 8 of 9
For all of the reasons enumerated above as well as our assessment of the
relevant importance of the consolidated statements of cash flows and the
information misstated in relation to the consolidated financial statements
taken as a whole, we do not believe that it is probable that the judgment of a
reasonable person relying upon the previously issued financial statements
would have been changed or influenced by correction of these cash flow
amounts.
Comment 3:
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We note your disclosure on page 95 regarding your accounting policies for
retained interests in securitized loans. Please tell us how you classify cash
flows related to retained interests in securitized loans and your basis for
that treatment. In your response, please distinguish between the retained
interests classified as trading securities and available-for-sale securities.
Describe how you separate the actual amount of cash flows from non-cash
exchanges related to the retained interests for reporting on your Statements
of Cash Flows.
Response 3:
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Retained interests in securitized loans are classified as either trading
assets or securities available-for-sale. Retained interests classified as
trading assets are included in cash flows from operating activities within the
"Trading assets" line item in the Consolidated Statements of Cash Flows.
Retained interests classified as securities available-for-sale are included in
cash flows from investing activities within the line items "Maturities of
available-for-sale securities", "Sales of available-for-sale securities" and
"Purchases of available-for-sale securities" in the Consolidated Statements of
Cash Flows.
The basis for this treatment is Statement of Financial Accounting Standards
No. 95 - Statement of Cash Flows ("SFAS 95") and Statement of Financial
Accounting Standards No. 102 - Statement of Cash Flows - Exemption of Certain
Enterprises and Classification of Cash Flows from Certain Securities Acquired
for Resale ("SFAS 102"). Specifically, paragraph 15 of SFAS 95 and paragraph 8
of SFAS 102 state that cash flows from operating activities include certain
loans or other debt or equity securities that are originated or acquired
specifically for resale and are carried at market value or lower of cost or
market value through the income statement. Further, paragraph 21 of SFAS 95
states that operating activities include all transactions and other events
that are not defined as investing or financing activities as outlined in
paragraphs 15-20 of SFAS 95. Merrill Lynch's retained interests in securitized
loans classified as trading assets are held specifically for the purpose of
resale; they do not result from the activities specified in paragraphs 15-20
of SFAS 95 and therefore, they are included in cash flows from operating
activities in the Consolidated Statements of Cash Flows. Retained interests
Laurence A. Tosi
Merrill Lynch & Co., Inc.
September 19, 2006
Page 9 of 9
classified as available-for-sale securities are classified as investing
activities as prescribed by paragraph 8 of SFAS 102.
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