In an announcement on June 23, the Securities and Exchange Commission (SEC) has agreed to settle charges with Merrill Lynch. The SEC alleges that Merrill Lynch misused customer cash in order to generate profit and fault to protect the customers’ securities from creditors’ claims. As part of the settlement, Merrill Lynch will pay $415 million and admit to wrongdoing.
As part of the SEC’s investigation, Merrill Lynch was found to be violating the agency’s Customer Protection Rule, using customer cash that should have been placed in a reserve account. The firm allegedly engaged in transactions that did not have economic substance, in turn reducing the required deposit amount of customer funds in reserve accounts. This resulted in billions of dollars freed up each week from 2009 to 2012 which the firm allegedly used to finance its own transactions. If these transactions were to fail, it would have resulted in a massive shortfall for the customers’ reserve accounts.
The SEC Order alleged that Merrill Lynch also violated the Customer Protection Rule by failing to abide by industry regulations regarding fully paid for customer securities requirements to be protected from third-party claims in the event of a collapse of the firm. Each day from 2009 to 2015, Merrill Lynch allegedly had $58 billion in customer securities held up in a clearing account which was subject to a general lien. They also held additional securities in accounts across the world. These accounts were also subject to liens and a firm collapse would have put the customers at significant risk of losing their securities.
Andrew J. Ceresney, Director of the Division of Enforcement for the SEC, said,
The rules concerning the safety of customer cash and securities are fundamental protections for investors and impose lines that simply can never be crossed. 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 a separate action, the SEC issued litigated administrative proceedings against William Tirrell. Mr. Tirrell served as the Head of Regulatory Reporting at Merrill Lynch during the time when the alleged misuse of customer cash occurred. The SEC alleges that Tirrell was responsible for determining the amount of money the firm would need to reserve in the special account. He allegedly failed to monitor the transactions and provide information to regulators regarding the mechanics and substance of the trades.
The SEC, in conjunction with this case, has announced a two-part initiative that would allow them to uncover further Customer Protection Rule violations, first encouraging broker-dealers to report violations, and second, by performing risk-based examinations to analyze broker-dealer compliance with the Customer Protection Rule.