According to The Wall Street Journal, Merrill Lynch (NYSE: MER) set up deals with several hedge funds to delay having to report losses in its debt portfolios. The paper writes that "in one deal, a hedge fund bought $1 billion in commercial paper issued by a Merrill-related entity containing mortgages, a person close to the situation said. In exchange, the hedge fund had the right to sell back the commercial paper to Merrill itself after one year for a guaranteed minimum return, this person said."

The move hardly seems fair, and is almost certainly not legal. And, the SEC is probably going to want to have a look.

Desperate times call for desperate measures, and it appears that Merrill took that philosophy to heart. The big brokerage appears to have been shopping these one-year deals around to a large number of hedge funds, probably in the hope that the mortgage-related securities would make a financial comeback while they were held by the funds, rather than on Merrill's balance sheet.

In its report, the Journal added, "Merrill has been scrambling to line up hedge funds to take as much as $5 billion in mortgage-related securities."

Aside from an SEC investigation and possible prosecution of some Merrill employees, the company now finds itself in a position where getting someone strong to take the CEO's position will be more difficult.

The mess at Merrill has gotten much worse.

Douglas A. McIntyre is an editor at 247wallst.com