May 23 (Bloomberg) -- Merrill Lynch & Co., the third- largest U.S. securities firm, is probing one of its trading desks in London and has suspended a trader after discovering he may have overstated the value of some of the bank's equity derivatives.

``The firm routinely reviews the marks our traders set,'' Merrill spokesman Jezz Farr said today in an e-mailed statement. ``Our preliminary review determined that one desk used marks that appear to be outside of our accepted policy. We have suspended a trader and we continue to review this matter.''

The trader, whom Merrill declined to identify, was a member of a team that traded derivatives based on individual stocks for the firm's own account, according to a person with direct knowledge of the matter. Merrill, based in New York, has determined that he may have overstated the value of some holdings by less than 10 million pounds ($19.8 million) during April, when his marks were detected, the person said.

Declines on European and U.S. markets this year have exposed a growing list of errant traders, tarnishing firms including Credit Suisse Group and Societe Generale SA. The discovery of potential trading lapses at Merrill may spur regulatory scrutiny as Chief Executive Officer John Thain works to reassure shareholders that the firm has improved risk management after his predecessor's bad bets on mortgages contributed to a record loss of $7.8 billion in 2007.

`System Works'

``This case shows our oversight system works,'' Farr said in the statement, referring to the firm's detection of the suspended trader's conduct. Merrill dropped $1.14, or 2.6 percent, to $43.36 at 4:15 p.m. in New York Stock Exchange composite trading.

The firm has notified the Financial Services Authority, the U.K. market regulator, about its internal probe of the single- stock derivatives group, the person familiar with the case said.

Equity derivatives can be linked to a stock, exchange- traded fund or equity index, and are used to bet on underlying share prices or hedge against losses. Single-stock-flow traders focus on specific companies.

The collapse of the subprime mortgage market and the ensuing writedowns and credit losses at the biggest banks and brokerages spurred regulators including the U.S. Securities and Exchange Commission to scrutinize the way Wall Street firms report the values of assets that aren't easily priced, such as mortgage-backed securities. Authorities are concerned that firms and their employees may be tempted to manipulate or put off changes in valuations to hide losses from investors.

Toronto-Dominion

The FSA fined Toronto-Dominion Bank 490,000 pounds last year, settling claims that internal-control lapses let a senior fixed-income trader in London assign false values to positions from 2005 to 2007. He also created fictitious trades, the FSA said.

The Toronto-based company said at the time it took the matter ``very seriously'' and shored up procedures to prevent similar misconduct in the future.

Credit Suisse, Switzerland's second-biggest bank, announced in March that it would write down the value of debt securities by $2.65 billion after discovering employees had deliberately mispriced the instruments. The incident contributed to the Zurich-based bank's first quarterly loss in almost five years.

Societe Generale, France's second-largest bank, said in January that it lost 4.9 billion euros ($7.73 billion) after 31- year-old trader Jerome Kerviel took unauthorized positions on European stock index futures. ``Fragmented'' internal controls allowed the alleged misconduct, a report commissioned by the bank said today.

In February, MF Global Inc., the largest broker of exchange-traded futures and options, said trader Evan Dooley lost $141.5 million with bets on the wheat market.

``Fraud is the CEO's ultimate nightmare,'' Thain, 52, said in January, when asked about the Kerviel case. ``You can have all the systems in the world, but you can't prevent fraud.''

To contact the reporters on this story: Jacqueline Simmons in Paris at jackiem@bloomberg.net; David Scheer in Washington at dscheer@bloomberg.net.

Last Updated: May 23, 2008 16:23 EDT