[Photo:  by Michael Gray / Flickr]

by Howard Haykin

Merrill Lynch, Pierce, Fenner & Smith agreed to a $1.4 million fine to settle FINRA charges that it failed to properly identify and account for extended settlement transactions over a 2-year period.

Extended Settlement Trades (“ES Trades”) are characterized by a longer time between trade and settlement than the standard settlement period of one to 3 business days. In this case, Merrill retail and institutional customers engaged in ES Trades across numerous Firm product lines, including mortgage-backed securities (MBS’s), government and agency debt, corporate debt, as well as municipal and equity securities.

BACKGROUND.    Merrill Lynch, headquartered in New York, NY, has been a FINRA member since 1937. The firm operates over 3,200 branch offices and employs around 33,000 registered reps. Merrill is a full-service brokerage firm, providing sales and trading, research, and underwriting services to institutional and retail clients. Since January 2009, the firm has been a broker-dealer subsidiary of Bank of America Corporation.

FINRA FINDINGS.    From at least April 2013 through June 2015 (the "Relevant Period"), Merrill's customers engaged in ES Trades with notional values of hundreds of millions of dollars. Yet, due to deficiencies in Merrill’s supervisory system - including its WSPs – the computation of margin requirements and net capital deductions for tens of thousands of these ES Trades was inaccurate.

As a result, the firm:

• failed to collect the requisite margin in violation of FINRA Rule 4210;
• failed to take the appropriate net capital deduction in violation of SEA Rule 15c3-1(c);
• improperly extended hundreds of millions of dollar of margin credit to cash-account customers in violation of Reg. T; (these transactions should only have been permitted in margin accounts, not in customer cash accounts.)
• maintained inaccurate schedules to the general ledger in violation of SEA Rule 17a-3 and FINRA Rule 4511; and,
• filed inaccurate FOCUS Reports in violation of SEA Rule 17a-5.

Though Merrill was aware of the deficiencies in its supervisory system by April 2013, the firm failed to implement any remedial measures until mid-2014. And it was not until mid-2015 that Merrill established a firm-wide supervisory system and WSPs to address extended settlement transactions.

[For details on this case, go to ... FINRA Disciplinary Actions Online, and refer to FINRA AWC #2014041808101.]