The Securities and Exchange Commission (SEC) announced that Merrill Lynch has agreed to pay $415 million and admit wrongdoing.
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Merrill Lynch would that way settle charges that it misused customer cash to generate profits for the firm and failed to safeguard customer securities from the claims of its creditors.
An SEC investigation found that Merrill Lynch violated the SEC’s Customer Protection Rule by misusing customer cash that rightfully should have been deposited in a reserve account.
Merrill Lynch engaged in complex options trades that lacked economic substance and artificially reduced the required deposit of customer cash in the reserve account.
The maneuver freed up billions of dollars per week from 2009 to 2012 that Merrill Lynch used to finance its own trading activities. Had Merrill Lynch failed in the midst of these trades, the firm’s customers would have been exposed to a massive shortfall in the reserve account.
According to the SEC’s order instituting a settled administrative proceeding, Merrill Lynch further violated the Customer Protection Rule by failing to adhere to requirements that fully-paid for customer securities be held in lien-free accounts and shielded from claims by third parties should a firm collapse.
From 2009 to 2015, Merrill Lynch held up to $58 billion per day of customer securities in a clearing account that was subject to a general lien by its clearing bank and held additional customer securities in accounts worldwide that similarly were subject to liens.
Had Merrill Lynch collapsed at any point, customers would have been exposed to significant risk and uncertainty of getting back their own securities.
In conjunction with this case, the SEC announced a two-part initiative designed to uncover additional abuses of the Customer Protection Rule.
The first encourages broker-dealers to proactively report potential violations of the rule to the SEC and provides for cooperation credit and favorable settlement terms in any enforcement recommendations arising from self-reporting.
Second, the Enforcement Division, in coordination with the Division of Trading and Markets and the Office of Compliance Inspections and Examinations, will conduct risk-based examinations of certain broker-dealers to assess their compliance with the Customer Protection Rule.
In addition to the Customer Protection Rule violations, Merrill Lynch violated Exchange Act Rule 21F-17 by using language in severance agreements that operated to impede employees from voluntarily providing information to the SEC.
Merrill Lynch also engaged in significant remediation in response to the Rule 21F-17 violation, including the revision of its agreements, policies and procedures, and the implementation of a mandatory annual whistleblower-training program for all employees of Merrill Lynch and its parent corporation, Bank of America.
Merrill Lynch and Bank of America also agreed to provide employees, on an annual basis, with a summary of their rights and protections under the SEC’s Whistleblower Program.
SEC announced that Merrill Lynch has agreed to pay a $10 million penalty to settle charges that it was responsible for misleading statements in offering materials provided to retail investors for structured notes linked to a proprietary volatility index.
According to the SEC’s order instituting a settled administrative proceeding, the offering materials emphasized that the notes were subject to a 2 percent sales commission and 0.75 percent annual fee.
Due to the impact of these costs over the five-year term of the notes, the volatility index would need to increase by 5.93 percent from its starting value in order for investors to earn back their original investment on the maturity date.
But the offering materials failed to adequately disclose a third cost included in the volatility index known as the “execution factor” that imposed a cost of 1.5 percent of the index value each quarter.
The notes were issued by Merrill Lynch’s parent company Bank of America Corporation, and Merrill Lynch had principal responsibility for drafting and reviewing the retail pricing supplements.
The SEC’s order finds that Merrill Lynch did not have in place effective policies or procedures to ensure its personnel drafted and approved disclosures that adequately disclosed the impact of the execution factor.
This is the agency’s second case involving misleading statements by a seller of structured notes.
In October 2015, UBS AG agreed to pay $19.5 million to settle charges that it made false or misleading statements and omissions in offering materials provided to U.S. investors in structured notes linked to a proprietary foreign exchange trading strategy. ■