Bank of America’s broker-dealer arm, Merrill Lynch, has agreed to pay $425 million to resolve several accusations from the Securities and Exchange Commission (SEC), according to two separate announcements from the agency.
The SEC said its investigation found multiple types of violation involving customer protection rules and misleading investors on structured notes.
The US watchdog accused Merrill Lynch of two sets of violations. First, instead of keeping customers’ investments in a safe reserve account, from 2009 through 2012 it engaged in “complex options trades that lacked economic substance, allowing freed up billions of dollars per week that Merrill Lynch used to finance its own trading activities,” the statement read.
In a second case, SEC announced that Merrill Lynch will pay a $10 million penalty to settle the regulator’s claims that it violated federal securities laws through misleading statements in offering materials provided to retail investors for structured notes linked to a proprietary volatility index.
In conjunction with this case, the regulator also announced Thursday an initiative to uncover additional abuses by encouraging broker-dealers to proactively report potential violations. In return, the commission will provide credit and favorable settlement terms in any enforcement recommendations arising from self-reporting.
Misusing customer cash
In announcing the first settlement, the US watchdog said Merrill admitted to violating federal securities laws requiring broker-dealers to protect the cash and securities of their clients, which began during the financial crisis and in some cases continued as recently as this year. Bank of America’s brokerage arm has agreed to pay $415 million to resolve the regulator’s claims. The amount is divided into $57 million in disgorgement and interest plus a $358 million penalty.
Secondly, from 2009 to 2015, Merrill further violated the Customer Protection Rule by failing to adhere to regulations that require holding the customers’ fully-paid securities in lien-free accounts shielded from claims by third parties should a firm collapse.
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 failed at any point, customers would have been exposed to significant risk and uncertainty of getting back their own securities,” the regulator noted.
The SEC also sued the Merrill Lynch’s head of regulatory reporting, William Tirrell, in connection with the case.
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Tirrell was ultimately responsible for determining how much money the firm would reserve in its special account, and failed to adequately monitor the trades and provide specific information to the regulators about the substance and mechanics of the trades.
The litigated administrative proceeding against Tirrell will be scheduled for a public hearing before an administrative law judge who will issue an initial decision stating what, if any, remedial actions are appropriate.
In an unrelated settlement, Merrill Lynch agreed to pay $10 million to the SEC over allegations that brokers marketed complex offerings to customers without disclosing hefty fees hidden within.
According to the SEC’s order instituting, the brokerage offered “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.”
However, 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.
FINRA is also here
The Financial Industry Regulatory Authority (FINRA) separately fined Merrill Lynch $5 million for negligent disclosures related to the sale of five-year senior debt notes to retail investors, the regulator said on Thursday.
Merrill Lynch cooperated fully with the SEC’s investigation and has engaged in extensive remediation, including by retaining an independent compliance consultant to review its compliance.
In a statement, Merrill spokesman noted that no customers were harmed or losses incurred in connection with the activities.
“Our responsibility is to protect customer assets and we have dedicated significant resources to reviewing and enhancing our processes. The issues related to our procedures and controls have been corrected,” he added.