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Merrill Lynch to Pay $425M to the SEC and $5M to FINRA for Misusing Customer Funds and Misleading Investors About Structured Notes

Merrill Lynch will pay $415M to resolve civil charges accusing the firm of misusing customer funds and not safeguarding customer securities from creditor claims. According to the Securities and Exchange Commission, the firm violated the regulator’s Customer Protection Rule by using customer funds inappropriately instead of depositing them in a reserve account.

Instead, said the SEC, Merrill Lynch took part in complex options trades that artificially lowered how much in customer funds needed to be in the reserve account. This liberated billions of dollars a week from ’09 to ’12. The firm used the funds for its own trades. If Merrill had failed with these trades there would have been a substantial shortfall in the reserve account.

Merrill Lynch, which is owned by Bank of America (BAC), has admitted wrongdoing as part of the settlement.

The SEC said that the firm violated the Customer Protection Rule when it didn’t abide by the requirement that customer securities that had been fully paid for be kept in lien-free accounts and protected from third parties claims in the event that Merrill Lynch were to collapse. Such a failure would have exposed customers to great risk and there would have been uncertainty as to whether they’d be able to get their securities back.
Also, contends the Commission, from ’09 to ’15, Merrill held up to $58B of customer securities a day in a clearing account that was subject to a general lien to be handled by its clearing bank.

The SEC also announced that it is litigating an administrative proceeding against former Merrill Lynch regulatory reporting head William Tirrell. During the time that Merrill was misusing the customer funds, Tirrell’s job was to figure out how much the firm needed to reserve in a special account. The SEC contends that he didn’t properly monitor trades or give specific information about the trades to regulators.

In another SEC case, Merrill Lynch has consented to pay $10M to settle charges that it issued misleading statements in offering documents for structured notes with ties to a proprietary volatility index. The offering materials were given to retail investors.

It was parent company Bank of America that issued the notes. However, it was Merrill Lynch’s job to draft and check retail-pricing supplements.

The SEC said that the offering materials placed emphasis on notes subject to a .75% yearly fee and a 2% sales commission. Because of these costs during the notes’ five-year term, the volatility index would need to go up by 5.93% from its starting value for investors to be able to make back their original investment on the date of maturity. However, the offering documents did not adequately disclose the “execution factor,” which was another cost that was part of the volatility index. The “execution factor” imposed 1% of the index value every quarter.

The SEC said that Merrill Lynch lacked effective procedures and policies to make sure that its staff drafted and approved disclosures that adequately revealed the execution factor’s effect.

FINRA is also fining Merrill over structured notes. The self-regulatory organization said that the firm, which will pay $5M, did not properly disclose specific costs related to five-year senior debt notes that it sold to retail clients. The notes were strategic return notes and Merrill Lynch sold $168M of them.

FINRA said that Merrill Lynch:

· Made it appear as if the fixed costs were lower than their actual cost.

· Failed to properly disclose the execution factor in the offering documents, and this omission made them materially misleading.

By settling, Merrill Lynch is not admitting or denying FINRA’s charges.

Shepherd Smith Edwards and Kantas, LTD LLP helps the victims of securities fraud recoup their losses. Contact our structured products fraud law firm today.

Read the SEC Order (PDF)

SEC’s Customer Protection Rule Initiative

FINRA Fines Merrill Lynch $5 Million for Failing to Disclose Material Facts in Sales of Volatility-Linked Structured Notes to Retail Customers, FINRA, June 23, 2016

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