Merrill Lynch, Pierce, Fenner & Smith Inc. consented to a censure and a $175,000 fine to settle allegations by the Financial Industry Regulatory Authority that the firm committed municipal securities rule violations, including through its failure to disclose certain material market discounts.
New York-based Merrill Lynch accepted and consented to FINRA's findings, contained in a settlement document accepted by FINRA on June 18, without admitting or denying them.
FINRA found that between January 2021 and September 2023, the firm failed to provide material disclosures concerning municipal securities purchased with market discounts for more than 4,000 transactions involving 1,072 self-directed customer accounts.
Merrill Lynch during that time frame also lacked a supervisory system adequate to ensure compliance with the firm's obligation to supply self-directed customers with all material information regarding muni securities transactions subject to a market discount at or before the time of trade, FINRA found.
Consequently, Merrill Lynch violated Municipal Securities Rulemaking Board Rules G-47 and G-27.
MSRB Rule G-47 requires dealers to disclose to customers at or before the time of trade all material information known about the transaction as well as material information concerning the security that's reasonably accessible to the market. MSRB Rule G-47(b)(ii) says that information is material if there's "a substantial likelihood" that "a reasonable investor" would deem the information important when making an investment decision.
During times of rising interest rates, muni bonds may be traded at a "market discount," FINRA noted in its findings. A market discount occurs when a muni bond is bought for less than its par value or, if the bond was an original issue discount bond, its adjusted issue price.
"The fact that a municipal security bears a market discount may affect its tax treatment," FINRA said in its findings.
When a market discount tops an Internal Revenue Code-defined threshold, the discount may be deemed "non-de minimis" and generally will be taxed as ordinary income, FINRA said. Bonds bearing a "de minimis" amount of market discount are subject to capital gains tax treatment.
"MSRB guidance in effect during the relevant period stated that the fact that a municipal security bears a market discount is material information required to be disclosed to a customer under MSRB Rule G-47," FINRA said.
Between January 2021 and September 2023, Merrill Lynch failed to disclose to customers non-de minimis market discounts in 4,181 purchases of muni securities with a total principal value of about $87 million by 1,072 self-directed customer accounts.
"The firm subsequently provided market discount disclosures to the impacted self-directed customers, as well as an offer to compensate the customers who demonstrated that they incurred tax liability above the capital gains rate as a result of purchasing the municipal securities," FINRA said in its findings.
MSRB Rule G-27 requires dealers to set up and maintain a supervisory system – including written procedures – to ensure compliance with MSRB rules and applicable provisions of the Securities Exchange Act of 1934 and Exchange Act rules.
During the relevant time period, Merrill Lynch lacked a supervisory system sufficient to ensure compliance with the firm's obligation to disclose to self-directed customers all material information concerning muni securities that traded at a market discount, "including that all or a portion of the investor's investment return represented by accretion of the market discount might be taxable as ordinary income," FINRA said.
Merrill Lynch's written procedures didn't address its obligation to supply time of trade disclosures concerning market discounts to customers who used the firm's self-directed platform, according to FINRA.
"Moreover, the firm did not have any process to determine whether all material information regarding market discounts was provided to self-directed customers at or prior to the time of trade," FINRA said.
In September 2023, Merrill Lynch "updated its written procedures regarding the market discount disclosures for its self-directed platform, and added a market discount disclosure for applicable transactions on its self-directed platform," FINRA said.
"We have remediated the issue and are committed to the highest standards of transparency in serving our clients," Merrill Lynch, which is part of Bank of America Corporation, said in a statement Monday.
