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SEC Hits Merrill for $11 Million Over Faulty Short-Sale Orders

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Two Bank of America Merrill Lynch entities agreed Monday to pay nearly $11 million to the Securities and Exchange Commission and admit wrongdoing for using old, inaccurate, data when executing short-sale orders for customers.

The SEC found that Merrill Lynch, a dually registered broker-dealer and RIA, and Merrill Lynch Professional Clearing Corp. (MLPro) — both based in New York — violated Regulation SHO of the Exchange Act. The violations arose from two separate issues concerning Merrill’s use of its “easy to borrow” (ETB) lists, which involved flaws in Merrill’s execution platforms.

According to the SEC’s order instituting a settled administrative proceeding, “Merrill Lynch and other broker-dealers are routinely asked by customers to ‘locate’ stock for short selling, and firms prepare ETB lists comprised of stocks they have deemed readily accessible for the purpose of granting locates.”

At times during the course of a trading day, the SEC states, “some securities that Merrill Lynch placed on its ETB list that morning became no longer easily available to borrow as determined by lending desk professionals tracking market events and other daily developments.”

The SEC’s order finds that while Merrill Lynch personnel appropriately ceased using the ETB list to source locates when availability of certain shares became restricted, the firm’s execution platforms were programmed to continue processing short-sale orders based on the ETB list. 

For example, “while personnel received responses from lenders that a supply of a particular security was no longer available, Merrill Lynch’s systems continued to rely on the ETB list and execute short sales totaling thousands of shares of that security,” the SEC states. “It wasn’t until the platforms received the next day’s ETB list that they returned to utilizing accurate and present data. After the SEC started investigating, Merrill Lynch began implementing systems enhancements to correct the problem.”

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The SEC’s order further finds that for a period until 2012, “a flaw in Merrill Lynch’s systems occasionally triggered the inadvertent use of day-old data when constructing ETB lists. The stale data caused some securities to be included on an ETB list when they should not have been.”

Merrill Lynch agreed to pay a $9 million penalty, $1,566,245.67 in disgorgement, and $334,564.65 in prejudgment interest and retain an independent compliance consultant in order to settle the charges.

“We have taken steps to improve our internal controls related to execution of short sales,” a Merrill spokesperson said.

The independent compliance consultant must conduct a comprehensive review of the firm’s policies, procedures, and practices for accepting short sale orders for execution, effecting short sales in reliance on the ETB list, and monitoring compliance.

“Firms must comply with their short-selling obligations by making sure they do not rely on inaccurate ETB lists,” said Andrew Calamari, director of the SEC’s New York Regional Office, in a statement announcing the settlement. “When firm personnel determine that a security should no longer be considered easy to borrow, the firm’s systems need to incorporate that knowledge immediately.”

— Check out Merrill, Securities America & Commonwealth Add Reps From Rivals on ThinkAdvisor.