The decision follows one of the many investigations started in Italy after local governments suffered hefty losses on derivatives deals.

The case relates to bonds issued by the Apulia region in 2003-2004 in a restructuring of its health sector debt through Merrill Lynch.

Merrill Lynch said in a statement it would continue to defend itself vigorously, denying it or any of its employees had committed any wrongdoing.

Italian authorities disclosed the probe in 2010, saying Merrill Lynch, a unit of Bank of America Corp (>> Bank of America Corp), and Dexia Crediop, a unit of Belgium's Dexia SA (>> DEXIA), were being investigated for failing to prevent misconduct by employees.

The magistrates in the southern town of Bari dropped the case against Dexia Crediop and the former head of its Italian arm, Claudio Zecchi, the sources said.

When the investigation was unveiled more than four years ago, Dexia Crediop said it had not underwritten any derivative operations with the Apulia region and that it had adopted required organisational measures since 2003.

The trial against Merrill Lynch and two former Merrill Lynch executives, Daniele Borrega and Maurizio Pavesi, will start on Feb. 12.

The debt restructuring included an interest rate swap that switched bond issues from a variable rate to a fixed rate. It also changed capital payback from a single "bullet" repayment at maturity to an amortising scheme, Italian authorities have said.

(Reporting by Vincenzo Damiani and Giulio Piovaccari; Editing by Mark Potter)

Stocks treated in this article : DEXIA, Bank of America Corp