July 28 (Bloomberg) -- New Jersey sued Merrill Lynch & Co., claiming the securities firm sold $300 million in preferred stock to the state’s investment division based on misleading information.

Merrill breached contract terms on convertible shares that paid a 9 percent dividend in a January 2008 offering, according to a complaint filed today in state court in Jersey City, New Jersey. The state Division of Investment agreed to exchange those shares in July 2008 for 11 million shares of Merrill common stock, according to the complaint.

The complaint alleges that Merrill’s true financial condition emerged only after its Jan. 1 purchase by Bank of America Corp., the biggest U.S. bank by assets. On Jan. 16, Bank of America reported a $15.3 billion fourth-quarter loss at Merrill, the New York-based securities firm, which was later revised to $15.8 billion. Those losses prompted Bank of America to consider scuttling the deal.

“Merrill Lynch repeatedly misrepresented its financial position to the NJ DOI and investors generally,” according to the complaint by Attorney General Anne Milgram. “If NJ DOI had known Merrill’s true financial condition, it would not have participated in the January 2008 offering and would not have agreed to a conversion in July 2008.”

Breach of Contract

The complaint, which seeks compensatory damages, alleges breach of contract, negligent misrepresentation and breach of good faith and fair dealing.

William Halldin, a Merrill spokesman, declined to comment on the complaint.

Bank of America, based in Charlotte, North Carolina, also is named as a defendant in the complaint, which seeks compensatory damages. Bank spokeswoman Shirley Norton declined to comment.

The Division of Investment, which manages $63.2 billion for 780,000 current and future retirees, was contacted by Merrill on July 21, 2008, about modifying the subscription agreement to its earlier purchase of convertible shares, according to the complaint.

Merrill told New Jersey that it needed to sell common shares to shore up its capital because of subprime mortgage- related losses, according to the complaint.

Merrill “falsely represented” that the other six holders of preferred shares, including TPG-Axon Capital Management LP, would not get better terms for converting their shares, according to the complaint. In fact, Merrill agreed to allow TPG to exchange its shares on more favorable terms, according to the complaint.

Merrill Sale

On Sept. 15, Bank of America announced that it agreed to acquire Merrill for about $50 billion in stock. At that point, Merrill had been battered by $52.2 billion in losses and writedowns under Chief Executive Officer John Thain. Bank of America CEO Kenneth Lewis earlier had bought Countrywide Financial Corp. to become the nation’s biggest home lender.

In the sale, Merrill shareholders received 0.8595 share of Bank of America stock for each Merrill share. When the deal was completed, the New Jersey DOI’s stake was worth $135.5 million.

The complaint cites a CNBC interview in January 2009 with Thain, who discussed the deteriorating value of Merrill’s mortgage-related assets even before he took over the firm in December 2007. That meant Thain knew that Merrill held “troubled assets” before New Jersey exchanged its shares in July 2008, according to the complaint.

“Merrill misrepresented to NJ DOI that Merrill was well- capitalized and omitted to inform NJ DOI that it retained great exposure to these already-materialized or, at least, highly probable losses,” according to the complaint.

Bank of America shares today rose 25 cents to $13.34 in New York Stock Exchange composite trading. They’ve fallen 52 percent in the past year.

The case is State of New Jersey v. Merrill Lynch & Co., Superior Court of New Jersey, Hudson County (Jersey City).

To contact the reporter on this story: David Voreacos in Newark, New Jersey at dvoreacos@bloomberg.net; Terrence Dopp in Trenton, New Jersey, at tdopp@bloomberg.net.

Last Updated: July 28, 2009 19:29 EDT