From the SEC: Merrill Lynch to Pay $415 Million for Misusing Customer Cash and Putting Customer Securities at Risk
“The Securities and Exchange Commission today announced that Merrill Lynch has agreed to pay $415 million and admit wrongdoing to settle charges that it misused customer cash to generate profits for the firm and failed to safeguard customer securities from the claims of its creditors.
An SEC investigation found that Merrill Lynch violated the SEC’s Customer Protection Rule by misusing customer cash that rightfully should have been deposited in a reserve account. Merrill Lynch engaged in complex options trades that lacked economic substance and artificially reduced the required deposit of customer cash in the reserve account. The maneuver freed up billions of dollars per week from 2009 to 2012 that Merrill Lynch used to finance its own trading activities. Had Merrill Lynch failed in the midst of these trades, the firm’s customers would have been exposed to a massive shortfall in the reserve account.
According to the SEC’s order instituting a settled administrative proceeding, Merrill Lynch further violated the Customer Protection Rule by failing to adhere to requirements that fully-paid for customer securities be held in lien-free accounts and shielded from claims by third parties should a firm collapse. 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 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, Director of the SEC’s Division of Enforcement. “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.”
In conjunction with this case, the SEC announced a two-part initiative designed to uncover additional abuses of the Customer Protection Rule. The first encourages broker-dealers to proactively report potential violations of the rule to the SEC and provides for cooperation credit and favorable settlement terms in any enforcement recommendations arising from self-reporting. Second, the Enforcement Division, in coordination with the Division of Trading and Markets and the Office of Compliance Inspections and Examinations, will conduct risk-based examinations of certain broker-dealers to assess their compliance with the Customer Protection Rule.
“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 addition to the Customer Protection Rule violations, Merrill Lynch violated Exchange Act Rule 21F-17 by using language in severance agreements that operated to impede employees from voluntarily providing information to the SEC. Merrill Lynch also engaged in significant remediation in response to the Rule 21F-17 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. Merrill Lynch and Bank of America also agreed to provide employees, on an annual basis, with a summary of their rights and protections under the SEC’s Whistleblower Program.
The SEC separately announced a litigated administrative proceeding against William Tirrell, who served as Merrill Lynch’s Head of Regulatory Reporting when the firm was misusing customer cash in violation of the Customer Protection Rule. 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. 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.
The SEC’s order finds that Merrill Lynch violated Securities Exchange Act Sections 15(c)(3) and 17(a)(1) and Rules 15c3-3, 17a-3(a)(10), 17a-5(a), 17a-5(d)(2)(ii), 17a-5(d)(3), 17a-11(e), and 21F-17. Its subsidiary Merrill Lynch Professional Clearing Corporation is charged with violating Sections 15(c)(3) and 17(a)(1) and Rules 15c3-3, 17a-3(a)(10) and 17a-5(a). 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 with the Customer Protection Rule. Merrill Lynch agreed to pay $57 million in disgorgement and interest plus a $358 million penalty, and publicly acknowledged violations of the federal securities laws”.