Merrill to Pay $415 Million to Settle SEC Charges of Putting Customer Cash at Risk
In a move that could rattle retail customers already on edge about the trustworthiness of brokerage firms, Merrill Lynch, Pierce, Fenner and Smith on Thursday agreed to pay a $415 million fine for financing its proprietary trading with customer cash that should have been segregated in a reserve account.
The Bank of America-owned brokerage firm put at risk as much as $58 billion of retail client money a day over three years by making complex options trades that lacked economic substance in order to reduce its customer reserve requirements, the SEC said. It it the second-highest penalty by the SEC against a Wall Street firm after a $550 million action against Goldman Sachs in 2010, according to an SEC spokeswoman.
If Merrill Lynch had failed during the trading that occurred from 2009 to 2012, customers would have been exposed to “a massive shortfall” in the firm’s reserve account, the SEC said.
Merrill’s strategy was so risky that the regulator’s enforcement division is launching risk-based examinations of selected other broker-dealers to assess their compliance with its Customer Protection Rule. The SEC also said it is suing William Tirrell, Merrill’s former head of regulatory reporting, over his role in the customer-cash trading strategy.
“The rules concerning the safety of customer cash and securities are fundamental protections for investors and impose lines that simply can never be crossed,” said Andrew J. Ceresney, director of the SEC’s enforcement division. “Merrill Lynch violated these rules, including during the heart of the financial crisis, and the significant relief imposed today reflects the severity of its failures.”
The SEC further emphasized its concerns by announcing a new initiative that will provide “cooperation credit and favorable settlement terms” to firms that proactively report potential violations of its customer protection rule.
A Merrill spokesman said the issues related to procedures and controls that have been corrected.
“While no customers were harmed and no losses were incurred, our responsibility is to protect customer assets and we have dedicated significant resources to reviewing and enhancing our processes,” he wrote in an email. “We have cooperated fully with the SEC staff throughout this investigation.”
Separately, Merrill Lynch on Thursday agreed to pay $10 million to settle SEC charges that it made inadequate disclosures about pricing to some 4,000 retail customers who bought around $150 million worth of structured notes between 2010 and 2011. The Merrill spokesman declined to comment on that settlement.
Finra also fined Merrill Lynch $5 million over the same disclosure issues on the structured notes, according to an announcement Thursday morning.
In the larger SEC settlement, the regulator said that Merrill’s severance agreement policies acted as hush money that dissuaded employees from voluntarily providing information to the regulator in violation of Exchange Act Rule 21F-17. Merrill and Bank of America have revised its agreements, policies and procedures and implemented a mandatory annual whistleblower-training program, the SEC said.
In the SEC’s structured note settlement, the regulator said Merrill’s marketing of the funds as low-cost vehicles was “materially misleading.” The funds charged a 2% sales commission and a 0.75% annual fee.
Investors have also filed Finra claims against Merrill Lynch arguing that risks of the Structured Return Notes sold to clients in 2010 were not adequately disclosed by the firm, according to Andrew Stoltmann, a Chicago-based plaintiff’s lawyer who is representing some of the claimants.