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Merrill Lynch, Pierce, Fenner & Smith agreed to pay over $7 million in fines and restitution to settle FINRA charges the firm inadequately supervised its customers’ use of leverage in their Merrill brokerage accounts. Merrill “loan management accounts” (LMAs) are lines of credit that allow the firm’s customers to borrow money from an affiliated bank using the securities held in their brokerage accounts as collateral.

From January 2010 through November 2014, Merrill allegedly lacked adequate supervisory systems and procedures regarding its customers’ use of proceeds from these LMAs. More specifically, FINRA found that although both Merrill policy and the terms of the non-purpose LMA agreements prohibited customers from using LMA proceeds to buy many types of securities:

• the firm’s supervisory systems and procedures were not reasonably designed to detect or prevent such use.
• on thousands of occasions, Merrill brokerage accounts collectively bought hundreds of millions of dollars of securities within 14 days after receiving incoming transfers of LMA proceeds.

FINRA further found that:

• Merrill lacked adequate supervisory systems and procedures to ensure the suitability of transactions in certain Puerto Rican securities, including municipal bonds and closed-end funds, where customers’ holdings were highly concentrated in such securities and highly leveraged through either LMAs or margin.
• 25 leveraged customers with modest net worths and conservative or moderate investment objectives, and with 75% or more of their account assets invested in Puerto Rican securities, suffered aggregate losses of nearly $1.2 million as a result of liquidating those securities to meet margin calls.

Merrill has already reimbursed some customers and, as part of the settlement, will pay approximately $780,000 in restitution to the remaining 22 customers affected.