Merrill Lynch, Pierce, Fenner & Smith Incorporated,
In addition to violating Rule G-27 on supervision, Merrill Lynch-was charged with failing to take steps to bring short positions in municipal securities within its control within 30 days in violation of Exchange Act Rule 15c3-3(d)(4) and FINRA Rule 2010.
FINRA also found that from 2015 to 2018, the firm did not comply with MSRB Rule G-17’s fair dealing requirement with regard to $796,000 in substitute interest for more than 1500 customers, which stemmed from the aged short positions.
Without admitting or denying FINRA’s findings, Merrill Lynch consented to sanctions including censure, and a requirement that the firm submit written certification of its supervisory systems in compliance with the relevant MSRB and Exchange Act Rules.
In 2015, FINRA advised Merrill Lynch to take prompt action to cover the firm’s existing short positions. At that time, the firm had 255 short positions aged more than 30 days, which it said were not in its control. That included 83 short positions in municipal securities.
Later that year, FINRA issued Regulatory Notice 15-27, reminding firms that their written supervisory procedures checklists (WSPs) had to, among other things, include processes for detecting, resolving, and preventing consequences of municipal short positions. The Exchange Act requires that firms take prompt steps to obtain physical control of municipal securities that are short more than 30 days.
For most of 2015, FINRA found that the number of short positions on Merrill Lynch’s books that were aged more than 30 days--or in some instances, a year or more-- had increased from 83 to 231. The associated par value was near $29.6 million.
In 2015 and 2016, FINRA again advised the firm that it needed to implement supervisory systems. Merrill Lynch did so in late 2016, but FINRA found the systems and WSPs failed to comply with MSRB and Exchange Act requirements.
“For example, Merrill’s supervisory systems were designed only to prevent short positions originating from retail transactions in certain fixed rate bonds and did not consider or address short positions created by other causes,” FINRA
With regard to customer disclosures, FINRA found that from February 2015 through June 2021, Merrill Lynch violated MSRB Rule G-17’s fair dealing requirements.
Customer account statements provided by Merrill Lynch to customers during that time period described substitute interest and so-called “gross-up payments,” as miscellaneous income.
The firm updated the language in its statements in June of 2017 to reflect the taxable nature of substitute interest. However, FINRA found that Merrill Lynch’s failure to provide express notice that the substitute interest was taxable, took away customers' ability to make informed decisions regarding their securities.
“By failing to provide its customers with notice clearly identifying their receipt of substitute interest payments, and the potential tax liability wrestling from these payments, Merrill violated MSRB Rule G-17 during the same time period,” FINRA stated.
In the fall of 2020, the firm enhanced its supervisory systems, WSPs and customer disclosures. But this summer, FINRA determined that Merrill Lynch had 69 municipal securities short positions with an associated par value of nearly $2.2 million.
As a result, FINRA found that Merrill Lynch violated MSRB Rules G-27 and G-17, Exchange Act Rule 15c3-3(d)(4), and FINRA Rule 2010 and imposed the $1,500,000 fine and related sanctions.
“We have implemented enhancements to our supervisory system and procedures,” William Halldin of Bank of America media relations said in a statement.
