FINRA fines Merrill Lynch $1.5M for rule violations related to short positions
The United States Financial Industry Regulatory Authority (FINRA) has imposed a fine of $1.5 million on Merrill Lynch, Pierce, Fenner & Smith Incorporated as a part of a settlement offered by the respondent.
From February 2015 through June 2021, Merrill violated Municipal Securities Rulemaking Board (MSRB) Rule G-27 by failing to establish and maintain a supervisory system, including written procedures, reasonably designed to address short positions in municipal securities and their effects on customers who hold them. By failing to take prompt steps to bring short positions in municipal securities within its control within 30 days, Merrill also violated Exchange Act Rule 15c3-3(d)(4) and FINRA Rule 2010.
In September 2015, and again in May 2016, FINRA advised Merrill that it needed to implement supervisory systems and WSPs reasonably designed to promptly detect and resolve short positions in municipal securities, and prevent their consequences, such as the payment of substitute interest. FINRA also informed Merrill it needed to provide notice to customers of the taxable status of the substitute interest they received.
However, from approximately February 2015 until October 2016, Merrill did not establish or maintain supervisory systems or WSPs specifically designed to detect and resolve short positions in municipal securities on the firm’s books and records, or to prevent their effects on customers who hold these securities.
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. Because the WSPs only required the firm to assess the need for substitute interest shortly before the scheduled interest payment (i.e., coupon payment date), in practice, the calculation of substitute interest was the firm’s primary means for identifying short positions in municipal securities.
As of September 2016, Merrill had 164 short positions in municipal securities with an associated par value of $27,726,712 that were aged over 30 days. Through June 6, 2017, the associated par value of Merrill’s short positions exceeded $28 million. From July 2017 through December 2018, Merrill’s aged short positions ranged from 130 to 190 with an associated par value ranging from $3.1 million to $7.2 million.
As of May 2019, seven of the 83 municipal securities short positions the Firm first identified in March 2015 in response to FINRA’s inquiry remained outside of the firm’s possession or control. By June 2021, Merrill had 69 municipal securities short positions with an associated par value of $2,182,854.00.
Merrill’s failure to implement supervisory systems and procedures designed to detect and resolve short positions in municipal securities, and to prevent their consequences, and to take prompt steps to bring short positions in municipal securities within its control, was not reasonable considering the municipal securities business the firm conducted.
In September 2020, Merrill began enhancements to its supervisory systems, WSPs, and customer disclosures. As of June 2021, Merrill amended its processes to address short positions when created and communicated its revised processes and WSPs to its registered representatives.
Therefore, Merrill violated MSRB Rule G-27, Exchange Act Rule 15c3-3(d)(4) and FINRA Rule 2010.
From January 2015 through December 2018, the aged short positions in municipal securities described above required Merrill to pay at least $796,000 in substitute interest to more than 1,500 customers.
In February 2015 and September 2015, FINRA informed Merrill it needed to provide prompt disclosures to its customers holding municipal securities of their receipt of substitute interest. Regulatory Notice 15-27 also reminded member firms of their obligation to ensure communications with customers regarding municipal securities transactions are not false or misleading and to correct any inaccurate or misleading communications regarding the tax status of interest payments.
By virtue of the foregoing, Merrill violated MSRB Rule G-17.
On top of the fine, the respondent has agreed to a censure.
Merrill’s settlement offer was accepted by FINRA on October 4, 2021.