WASHINGTON – Merrill Lynch, Pierce, Fenner & Smith Inc. has agreed to pay roughly $780,000 in restitution to 22 customers who had 75% or more of their assets invested in Puerto Rico bonds and funds and suffered huge losses trying to liquidate them to meet margin calls.
The Financial Industry Regulatory Authority found Merrill, a subsidy of Bank of America, N.A., did not have an adequate supervisory system to ensure the investments were suitable.
The firm agreed to pay the restitution without admitting or denying the findings. William Halldin, a spokesperson with Bank of America said that "following a comprehensive internal review of our loan management accounts (LMAs), we reported issues to FINRA, cooperated fully with their inquiry and have strengthened our controls and procedures." FINRA noted that it considered those actions when determining the sanctions against the firm.
LMAs are lines of credit that allowed Merrill's customers to borrow money from Bank of America using the securities held in their Merrill brokerage accounts as collateral.
FINRA found that Merrill's supervisory failures from January 2010 through July 2013 violated rules from FINRA's predecessor NASD as well as FINRA's rule on professional conduct.
During the period of time covered by the settlement, many of the firm's Puerto Rico customers were concentrated in Puerto Rico securities because the securities gave unique benefits to the residents like exemptions from U.S. estate and gift taxes as well as taxes at the municipal, state, and federal levels.
A number of those customers used leverage to buy additional Puerto Rico securities either through the LMAs or the use of margin in their securities accounts, FINRA found. The leveraged customers were required to maintain account equity in order to provide adequate collateral to support their leverage.
The customers who were both leveraged and highly concentrated in the commonwealth's securities ran a significant risk that a market event affecting the value of the securities could significantly decrease their total account value and their equity, FINRA said. The risk became a reality in 2012 and 2013 as the Puerto Rico debt market began to unravel.
As of July 2013, a few hundred accounts in the firm's Puerto Rico branch with modest net worth and conservative or moderate investment objectives had 75% or more of their account assets invested in Puerto Rico securities, FINRA said in the settlement document.
About 50 of the accounts were also leveraged through LMAs or margin. Twenty-five of those accounts received margin or maintenance calls that led them to liquidate their Puerto Rico securities for an aggregate loss of nearly $1.2 million, the self-regulator found. The three customers who were not part of this settlement, already settled with Merrill.
In addition to the Puerto Rico-related findings in the settlement, Merrill also agreed to a $6.25 million fine for supervisory failures related to the use of proceeds from loans under its LMAs. The firm opened 121,000 LMAs with more than $85 billion in aggregate credit extended by Bank of America as of Aug. 31, 2014, FINRA found.
The supervisory failures the self-regulator included in the settlement had to do with inadequate education of the firm's representatives about differences in LMAs, various prohibitions on the use of proceeds from certain types of LMAs, and the regulatory requirements applicable to LMAs used to buy margin stock. Merrill's representatives should have been required to explain certain information about LMAs to customers but were not, FINRA said.