SEC Charges Merrill Lynch for Failure to Supervise RMBS Traders

Firm ordered to pay nearly $16 million for ‘deceiving’ customers.

Merrill Lynch, Pierce, Fenner & Smith Inc. has agreed to pay $15.7 million to settle SEC charges that its employees misled customers into overpaying for residential mortgage-backed securities (RMBS).

The SEC said that Merrill Lynch traders and salespersons convinced its customers to overpay for RMBS by lying about the price Merrill Lynch paid to acquire the securities.  Merrill was a broker-dealer engaged in secondary market trading of non-agency RMBS, according to the SEC.

In trading non-agency RMBS, Merrill purchased the securities for its own account and then sold them from its own account to its customers. Merrill didn’t charge a commission on the trades, but instead profited from the difference between the price of the securities it sold, and the price at which it had purchased them.

“The false or misleading statements led customers to accept less, or pay more, for securities than they otherwise might have accepted or paid,” said the SEC in its charges. “Merrill personnel, directly and indirectly, made false or misleading statements to Merrill customers.”

The SEC also said Merrill Lynch’s RMBS traders and salespersons illegally profited from “excessive, undisclosed commissions,” which in some cases were more than twice the amount the customers should have paid.  The SEC’s order said Merrill Lynch failed to have compliance and surveillance procedures in place to prevent and detect the misconduct that increased the firm’s profits on RMBS transactions “to the detriment of its customers.”

In one instance, Merrill purchased more than $15.6 million original face amount of a bond at a price of $1.86. Later that day, one of its traders, through a salesperson, sold the bond to a Merrill customer at a price of $4.00, which represented an intra-day mark-up of 115.1%, and profits to Merrill of approximately $334,289, according to the SEC.

Merrill traders made false or misleading statements directly to customers in some cases, said the SEC, and in other instances, traders made false or misleading statements to Merrill salespersons, who then communicated the bad information to customers. It also said some Merrill salespersons made their own false or misleading statements to customers.

Although the firm neither admitted nor denied the SEC’s charges, Merrill Lynch agreed to be censured, pay disgorgement and interest of more than $10.5 million to its customers, and pay a penalty of approximately $5.2 million.

“In opaque RMBS markets, lying to customers about the acquisition price can deprive investors of important information,” Daniel Michael, chief of the SEC Enforcement Division’s Complex Financial Instruments Unit, said in a release.  “Merrill Lynch failed in its obligation to supervise traders who allegedly used their access to market information to take advantage of the bank’s own customers.”


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