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June 23, 2016 at 10:31 AM
The Securities and Exchange Commission said early Thursday that Merrill Lynch has agreed to pay $415 million and to admit wrongdoing in the abuse of customer cash used to generate profits for the firm and for its failure to safeguard customer securities from creditors’ claims.
In addition, the regulator says it will conduct a sweep of broker-dealers regarding their compliance with the Customer Protection Rule broken by Merrill Lynch, Rule 15c3-3, and that BDs can self-report noncompliance by Nov. 1.
“Simultaneous with today’s action, SEC staff will begin a coordinated effort across divisions to find potential violations by other firms through a targeted sweep and by encouraging firms to self-report any potential violations of the Customer Protection Rule,” said Michael J. Osnato, chief of the SEC Enforcement Division’s Complex Financial Instruments Unit, in a statement.
SEC also announced Thursday that it had fined Merrill $10 million and the Financial Industry Regulatory Authority had fined it $5 million for misleading customers on sales of structured notes.
In the customer protection case, an SEC investigation found that Merrill Lynch, instead of putting customer cash into a reserve account, used it for “complex options trades that lacked economic substance and artificially reduced the required deposit of customer cash in the reserve account” while financing its own trading activities from 2009 to 2012. If Merrill Lynch gone under, the regulatory group says, clients would have been exposed to “a massive shortfall” in the reserve account.
Furthermore, Merrill violated the Customer Protection Rule by not holding client securities that had been fully paid for in lien-free accounts and not shielding the securities from claims by third parties during and after the financial crisis, the SEC says.
“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,” the SEC explained in the order.
“This is by far the largest customer protection settlement in SEC history, and the severity of the misconduct is much more significant than prior cases,” said Andrew Ceresney, director of the SEC’s Enforcement Division, during a press conference on Thursday.
For its part, Merrill Lynch said in a statement, “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. The issues related to our procedures and controls have been corrected. We have cooperated fully with the SEC staff throughout this investigation.”
The broker-dealer adds that it discussed the matter in two recent regulatory filings and that it “will have no impact on 2Q earnings.”
In a separate matter on Thursday, the SEC imposed a fine of $10 million on Merrill Lynch for misleading customers on sales of structured notes linked to a proprietary volatility index; the Financial Industry Regulatory Authority ordered the BD to pay $5 million to settle the issue. (The firm declined to comment on these $15 million fines.)
“The second settlement [of $10 million] … involves the firm’s sale of complex structured notes to retail investors. This is our second structured-note settlement, coming on the heels of our case against UBS last year,” Ceresney explained. (UBS agreed to pay $19.5 million in October to settle the charges.)
The $425 million in combined SEC fines represents the second-largest penalty imposed by the regulatory group against Merrill Lynch in its history, he says.
Also on Thursday, the SEC filed a cease-and-desist action against William Tirrell, head of regulatory reporting for Merrill Lynch from 2004 to April 2016, in connection with the use of client cash to conduct leveraged conversion trades — conversion trades that used listed options financed by customers through margin loans extended by Merrill Lynch.
The SEC’s Enforcement Division alleges that Tirrell “was ultimately responsible for determining how much money Merrill Lynch would reserve in its special account, and failed to adequately monitor the trades and provide specific information to the firm’s regulators about the substance and mechanics of the trades.”
To resolve the matter, Tirrell must appear before an administrative law judge.
“Mr. Tirrell is justifiably proud of his distinguished 35-year career and leadership positions in the securities industry. While we are disappointed that the SEC filed this action, Mr. Tirrell looks forward to the opportunity to vindicate himself at trial,” said Steven M. Witzel of the law firm Fried Frank, in a statement. Tirrrell is still employed by Merrill.
In addition, the SEC says Merrill violated an SEC rule by impeding employees from voluntarily providing information to the regulator in its severance contracts.
“Merrill Lynch also engaged in significant remediation in response to the [whistleblower rule] 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,” the SEC said in a statement.
The SEC declined to acknowledge the role of whistleblowers in the case.
