The settlement, announced on Thursday along with an unrelated $10 million disclosure violation, is the second-largest against a Wall Street company after Goldman Sachs paid $550 million in 2010 over the sale of mortgage-backed securities before the financial crisis. Unlike Goldman Sachs, however, Merrill Lynch admitted to the violations announced on Thursday.
The S.E.C. said Merrill Lynch misused as much as $5 billion in customer cash weekly from 2009 to 2012, making complex options trades that generated $50 million in profits for the company over that period. In the process, the bank failed to safeguard customer assets that could have been jeopardized in the event the company failed.
That is not a minor concern. The activity in question, which began before Bank of America bought Merrill Lynch in January 2009, coincides with the height of the financial crisis. Merrill Lynch’s merger with Bank of America came as the bank faced steep losses; Bank of America would eventually receive $45 billion in government bailout money.
The settlement is the largest against a company over the customer protection rule.
The S.E.C. also said Thursday that Merrill Lynch improperly put as much as $58 billion of customer cash daily into accounts that were subject to liens from clearing banks. That money was also at risk had Merrill Lynch failed. The activity ran from 2009 until last year, when the S.E.C. said it notified the bank about the issue.
“The rules concerning the safety of customer cash and securities are fundamental protections for investors and impose lines that simply can never be crossed,” said Andrew J. Ceresney, the S.E.C.’s director of enforcement.
Though customers did not lose money, the enormous exposure to risk brought on such steep penalties, Mr. Ceresney said.
“Merrill Lynch violated these rules, including during the heart of the financial crisis, and the significant relief imposed today reflects the severity of its failures,” he said.
Under the customer protection rule, brokerage firms are supposed to hold customer cash in a reserve account, separate from other firm assets. This is an expensive rule for banks because they cannot use that idle money for other activities, but it is in place to protect customer assets and make them accessible to customers in a crisis. Lehman Brothers’ collapse in 2008 left brokerage customers unable to recover billions of dollars of assets for months if not years.
“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,” Merrill Lynch said in a statement. “The issues related to our procedures and controls have been corrected. We have cooperated fully with the S.E.C. staff throughout this investigation.”
The S.E.C. says Merrill Lynch created complex options trades that lacked economic substance but had the effect of reducing the amount of money it needed to set aside in the customer reserve account. That freed money for the bank in what amounted to interest-free loans from customer funds.
A newly hired executive raised questions about the trades in April 2012, and Merrill Lynch discontinued them after a review, Mr. Ceresney said during a call with reporters on Thursday. But Merrill Lynch did not tell regulators about its decision to stop the trades, a failure of transparency that made its penalties in the case more severe, he said.
The agency will begin a review of other brokerage firms to unearth potential misuses of customer funds, though the S.E.C. says it is encouraging firms to come forward with information by offering leniency.
Merrill Lynch is paying $50 million in disgorgement of the profits from the trades, another $7 million in interest and a $358 million penalty.
The S.E.C. also announced a case against William Tirrell, who was Merrill Lynch’s chief of regulatory reporting when the violations occurred. He faces an administrative hearing over accusations that he failed to adequately monitor the trades and provide information about them to regulators.
His lawyer, Steven M. Witzel of Fried Frank Harris Shriver & Jacobson, said in an emailed statement: “While we are disappointed that the S.E.C. filed this action, Mr. Tirrell looks forward to the opportunity to vindicate himself at trial.”
Separately, Merrill Lynch will pay $10 million to settle S.E.C. claims that it sold complex securities to 4,000 investors in 2010 and 2011 with inadequate disclosures. The bank sold $150 million of the securities, called structured notes. It did not admit to wrongdoing in this case. It paid $5 million to the Financial Industry Regulatory Authority, which helped investigate the case.
In October, the S.E.C. announced its first structured note settlement with UBS, which agreed to pay $19.5 million to settle charges that it made false or misleading statements and omissions in its sale of the products to investors.
By: Liz Moyer (New York Times).
Photo: WSJ.
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