Securities Regulation Daily Merrill Lynch to pay nearly $8.9M over undisclosed conflict involving retail products
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Tuesday, August 21, 2018

Merrill Lynch to pay nearly $8.9M over undisclosed conflict involving retail products

By Mark S. Nelson, J.D.

Bank of America’s investment adviser and broker-dealer subsidiary Merrill Lynch, Pierce, Fenner & Smith Incorporated will pay $8.873 million to settle charges that a Merrill Lynch senior executive and an officer of a foreign bank’s U.S. subsidiary that managed certain Merrill Lynch products had a conflict of interest regarding whether those products would be terminated or retained. The platform involved consisted of funds in which retail customers had invested $575 million. Merrill Lynch was censured and agreed to pay disgorgement and a civil money penalty for its role in the conflicted product review process, although the firm neither admitted nor denied the SEC’s findings. The penalty amounts reflect the SEC’s consideration of Merrill Lynch’s remedial actions and cooperation (In the Matter of Merrill Lynch, Pierce, Fenner & Smith IncorporatedRelease No. 34-83886, August 20, 2018).

According to the SEC’s order, the foreign bank’s U.S. subsidiary notified the due diligence unit within Merrill Lynch’s unit that oversees product platforms that the long-time adviser for certain products would be departing and would be replaced by a team based in another location. Initially, the due diligence unit put a hold on new investments in the affected products before recommending to the internal governance committee that the products should be replaced in light of the experienced portfolio manager’s departure and the new teams’ comparative lack of experience in concentrated bond portfolios.

Although Merrill’s internal governance committee was set to meet to decide whether to terminate the affected products, an unnamed Merrill Lynch employee contacted the foreign bank U.S. subsidiary portfolio manager ostensibly to begin resolving logistical issues that would arise if the products were terminated. This disclosure prompted an officer of the foreign bank’s U.S. subsidiary to ask a senior executive within Merrill Lynch’s business unit that holds the due diligence unit to retain the products that the internal governance committee was to mull terminating. As a result, six days before the internal governance committee meeting, the Merrill Lynch executive told the officer at the foreign bank’s U.S. subsidiary the products would not be terminated and the portfolio manager could have more time to approach the due diligence unit. The internal governance committee then deferred its determination, although neither the full committee nor Merrill Lynch’s retail customers were aware of the secret deal to retain the affected products.

Meanwhile, the foreign bank U.S. Subsidiary engaged in a full court press to persuade Merrill Lynch to retain the products, including by pushing Merrill Lynch to reflect on the two firms’ "broader business relationship." Over time, the new team that would manage the affected products going forward had a chance to demonstrate its abilities. Merrill Lynch found the team sometimes outperformed the proposed replacement products and, ultimately, the existing slate of products was retained, and the internal governance committee removed its hold on new investments. During the relevant period, Merrill Lynch earned fees approaching $4.03 million, a sum that closely matches both the disgorgement and civil money penalty imposed on Merrill Lynch.

The SEC had charged that the undisclosed conflict of interest that arose during the termination process resulted in Merrill Lynch’s violation of Adviser Action Sections 206(2) and 206(4) (antifraud provisions), along with Rule 206(4)-7 (firms must have written policies and procedures reasonably designed to prevent violations of the Advisers Act and its rules). The SEC’s order noted departures from Merrill Lynch’s brochures and Form ADV. "Clients relied on Merrill to use these disclosed investment quality factors in determining which investments are available on the platforms and did not expect that Merrill would evaluate investments based on other business interests," said the order. The SEC also cited other deviations from Merrill Lynch’s establish practices, such as curbing the time a due diligence analyst was given to make a presentation to the internal governance committee and the committee’s decision not to vote on the matter.

Marc Berger, Director of the SEC’s New York Regional Office, summarized the basis for the SEC's action: "By failing to disclose its own business interests in deciding whether certain products should remain available to investment advisory clients, Merrill Lynch deprived its clients of unbiased financial advice. Retail clients must feel confident that their advisors are eliminating or disclosing such conflicts and fulfilling their fiduciary duties."

The release is No. 34-83886.

Companies: Merrill Lynch, Pierce, Fenner & Smith Incorporated

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