Merrill Lynch, Pierce, Fenner & Smith Inc. has agreed to pay more than $15 million in disgorgement and penalties to settle charges that its employees misled customers into overpaying for residential mortgage backed securities (RMBS). The broker-dealer agreed to return $10.5 million to customers and pay $5.2 million in civil penalties after the SEC found that Merrill Lynch deceived investors about the price it paid to acquire the securities (In the Matter of Merrill Lynch, Pierce, Fenner & Smith, Inc., Release No. 34-83408, June 12, 2018).
"In opaque RMBS markets, lying to customers about the acquisition price can deprive investors of important information," said Daniel Michael, Chief of the SEC Enforcement Division’s Complex Financial Instruments Unit in a news release. "The Commission found that Merrill Lynch failed in its obligation to supervise traders who allegedly used their access to market information to take advantage of the bank’s own customers."
Failure to supervise. Specifically, the SEC's order found that from June 2009 through December 2012, Merrill Lynch failed to supervise personnel regarding the firm’s secondary market purchases and sales of non-agency RMBS. Although Merrill Lynch had policies that prohibited false or misleading statements and had the means to monitor communications for these statements, the firm failed to design and implement reasonable monitoring procedures. In addition, while Merrill Lynch had policies that prohibited excessive mark-ups, the policies and procedures to prevent this conduct were also not reasonably designed and implemented.
Misleading statements. In one instance, Merrill Lynch made profits of approximately $386,042 on one intra-day transaction after purchasing $29,966,000 of a bond at 70-00 and selling $15,966,000 of the bond at 74-00. Among other things, one of Merrill Lynch’s traders misrepresented to a seller that the firm had received a bid at a price of 68-00 rather than the 74-00 price bid by the buyer. The trader also misrepresented that he had pushed the buyer "pretty hard" to get the buyer to a bid in the high 60s when the salesperson had sought a price of 75-00 and had received a bid of 74-00. Finally, the trader misrepresented that he had received a 69-00 bid from the buyer, when, in fact, the buyer had bid 74-00 for the bond.
Excessive mark-ups. The SEC also found that Merrill Lynch’s traders charged customers markups that bore no reasonable relationship to the prevailing market prices. For example, in one instance Merrill Lynch purchased $15,621,000 original face amount of a bond at a price of 1.86. Later that day, a trader, through a salesperson, sold the bond to a Merrill customer at a price of 4.00. The 4.00 price represented an intra-day mark-up of 115 percent and profits to Merrill of approximately $334,289.
Censure and penalties. Without admitting or denying the findings, Merrill Lynch consented to be censured for failing reasonably to supervise its personnel within the meaning of Exchange Act Section 15(b)(4)(E). Merrill Lynch also agreed to pay a penalty of approximately $5.2 million, and pay disgorgement and interest of more than $10.5 million to customers that were parties to the transactions that were the subject of the order.
In determining to accept the offer, the Commission considered the remedial steps undertaken by Merrill Lynch, including, among other things, creating an electronic communications monitoring tool to compile communications related to a trade in which the mark-up exceeds a certain percentage. The firm also enhanced its surveillance procedures for preventing excessive mark-ups by requiring surveillance employees to document and record the specific bases for the resolution of mark-up alerts and by establishing an independent review of all RMBS trades with mark-ups above 1.5 percent.
The release is No. 34-83408.
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