During the period January through April of 2002, the brokers executed over 3,700 short-term mutual fund transactions in multiple accounts held for a single hedge fund client at Merrill Lynch. When some of the mutual funds began to complain about market timing, the Firm instructed the brokers to refrain from engaging in market timing transactions in the client’s Merrill Lynch accounts. As a result, in or about August 2002, with the consultation of Merrill Lynch managers, the brokers facilitated the opening of accounts for the hedge fund client at various mutual funds and then moved mutual fund positions held at Merrill Lynch to the accounts held outside the Firm. The brokers placed themselves as “Broker of Record” on the outside accounts and continued to execute frequent trades on the hedge fund’s behalf in the accounts held at those funds. The brokers later moved the positions back to fee-based accounts at Merrill Lynch.
Notwithstanding these trading patterns and the receipt of commissions paid by the mutual funds in connection with the brokers’ trading, Merrill Lynch failed to recognize that its brokers were continuing to engage in frequent mutual fund trading in outside accounts. The Merrill Lynch managers eventually did become aware of the brokers’ trading in the outside accounts in November 2002 based on market timing complaints from several mutual funds. The brokers were then instructed to take no role in effecting trades at the various mutual funds. However, the Firm took no additional steps to ensure that the brokers complied with that instruction. In fact, the brokers did not comply and continued to execute trades on behalf of the hedge fund in outside accounts until at least April of 2003.
In addition, the same group of brokers executed a purchase of a multi-million dollar variable annuity and other insurance policies on behalf of the same hedge fund client. The hedge fund client instructed the brokers to facilitate transactions in the sub-accounts underlying the variable products offered within the annuity policies -- accounts that were held outside the Firm. The brokers facilitated frequent transactions on the client’s behalf. Nevertheless, the Firm failed to make or maintain any record of those transactions, including over 3,000 confirmations received from the annuity companies.
An NYSE hearing panel found that, between January 2002 and October 2003 the firm failed to adequately supervise certain business activities involving the trading of mutual funds, failed to review and maintain certain incoming and outgoing communications with the public and failed to make and/or preserve accurate books and records relating to variable annuity product sub-accounts transactions executed by firm employees in accounts outside the firm. The firm consented without admitting or denying guilt.
“When a firm discovers that brokers have engaged in misconduct, the Exchange expects and demands that the firm will heighten supervision and take all necessary action to ensure that the conduct has ceased,” said Susan L. Merrill, chief of enforcement, NYSE Regulation.
The NYSE imposed a penalty of a censure, $13.5 million fine, and a requirement that the firm review its procedures regarding the creation and retention of documents relating to orders placed on behalf of Firm clients in accounts outside of Merrill Lynch for compliance with Exchange rules and the federal securities laws and other procedures applicable to mutual fund trading. Merrill Lynch consented to the penalty. The fine imposed by the Exchange will be satisfied by the payment of a $10,000,000 fine to the State of New Jersey, also being announced today in a related proceeding, and a total of $3.5 million in furtherance of a pending settlement with the State of Connecticut.
The Exchange worked cooperatively in this matter with the New Jersey Office of Attorney General and Bureau of Securities, which is announcing a separate settlement with Merrill Lynch today. The Exchange also acknowledges the substantial support and assistance rendered in this investigation by the Northeast Regional Office of the Securities and Exchange Commission.
About NYSE Regulation
On December 17, 2003, the SEC approved a new governance structure for the NYSE. Under the new design, the NYSE Board of Directors is comprised solely of independent directors, except for the chief executive officer, who have no affiliation with any regulated member firm. A new position of chief regulatory officer was created and reports directly to the board of directors through a new Regulatory Oversight Committee. As a result, NYSE Regulation is insulated from potential influence from NYSE members and member firms, operates separately from the business side and is independent in its decision-making.
NYSE Regulation plays a critical role in monitoring and regulating the activities of its members, member firms and listed companies, as well as enforcing compliance with NYSE rules and federal securities laws. Nearly 400 of the largest securities firms in America are members of the New York Stock Exchange. These firms service 92 million customer accounts, or 90 percent of the total public customer accounts handled by broker-dealers, with total assets of over $3 trillion. They operate from 19,000 branch offices around the world and employ 146,000 registered personnel. Nearly 700 employees, or more than 40 percent of the Exchange’s staff, work for NYSE Regulation, which consists of four divisions: Market Surveillance, Member Firm Regulation and Enforcement and Listed Company Compliance.
