US regulator the Securities and Exchange Commission (SEC) has fined Bank of America Merrill Lynch US$10 million for misusing customer order information for its own proprietary trading operations and charging clients undisclosed trading fees.
The proprietary trading charges relate to Merrill Lynch's Equity Strategy Desk (ESD), which operated from 2003 to 2005 and managed over US$1 billion of the firm's capital. The ESD operated on the same equity trading floor in New York as market making desk that received and executed client orders.
The SEC found that the proprietary traders on the ESD could see customer order information on market makers' computer screens and hear market makers discussing customer orders.
The SEC order claimed that Merrill Lynch encouraged its market makers to “generate ideas and share ”trading ideas' with ESD traders, promising higher bonuses to market makers whose ideas were profitable”. It also quoted an instant message from an ESD trader to a market maker, which read, “[I] always like to do what the smart guys are doing.”
One example of information leakage detailed by the SEC concerns a sell order of 40,000 shares of Teva Pharmaceutical Industries placed by an institutional customer on 3 September 2003. Three minutes after the client's order was placed, a Merrill Lynch market maker sent an instant message to a proprietary trader notifying him about the trade, resulting in the ESD placing its own sell order of 10,000 in the same stock just two minutes later.
“Investors have the right to expect that their brokers won’t misuse their order information,” said Scott W. Friestad, associate director in the SEC’s division of enforcement. “The conduct here was clearly inappropriate. Merrill’s proprietary traders had improper access to information about the firm’s customer orders, and misused it to place trades on the firm’s behalf.”
The Dodd-Frank financial reform bill, which was signed into law last summer, introduced the Volcker Rule to ban proprietary activity by deposit-taking institutions. Merrill Lynch was acquired by Bank of America in January 2009.
The Financial Stability Oversight Council, a body established by the Dodd-Frank Act to provide comprehensive monitoring of the US financial system, released guidelines on the implementation of the Volcker Rule on 18 January 2011. Bank of America Merrill Lynch is one of a number of firms that are reported to have take steps to wind down or adapt their proprietary desks ahead of the Volcker Rule along with Goldman Sachs, J.P. Morgan and Morgan Stanley.
The SEC charge also relates to undisclosed commission payments charged by Merrill Lynch between 2002 and 2007 to institutional and high-net worth individuals. While the bank claimed it would only charge a commission for execution, the SEC found that the bank levied undisclosed fees at higher or lower than the price at which a trade was actually executed.
“Charging these undisclosed mark-ups and mark-downs was improper and contrary to Merrill’s agreements with its customers,” said Robert B. Kaplan, co-chief of the SEC’s asset management unit. “Brokers must act honestly and transparently when charging fees to their customers. There is no place in our markets for charging investors undisclosed trading fees.”
Merrill Lynch did not admit or deny the SEC's findings, but the regulator did take into account remedial actions taken by the firm after it was acquired by Bank of America.