FINRA (Financial Industry Regulatory Authority) announced on June 2, 2022 that it ordered Merrill Lynch, Pierce, Fenner & Smith, Inc., to pay 15.2 million in restitution and interest to thousands of customers who purchased Class C mutual fund shares when Class A shares were available at a substantially lower cost. FINRA news releases are useful tools to look for trends in violations and other sanctions. These trends can assist you in identifying weak areas in your Firm’s compliance programs or surveillance. Below is a summary of the Merrill order, as well as key takeaways. Click here for the corresponding news release.
Summary of Merrill Mutual Fund Enforcement
From January 2015 to January 2021, Merrill used an automated exception reporting system to identify and calculate customer purchases and fund holdings to prevent Class C share purchases when Class A shares were available at a lower cost. Due to a technical issue with the system, the system mistakenly applied a purchase limit on Class C shares that was (1) inconsistent with a fund’s Class C share purchase limit, or (2) inconsistent with a fund’s threshold for when Class A shares were available at NAV.
This resulted in thousands of Merrill customers not taking advantage of the lower cost alternative and paying approximately $13.4 million in excess sales charges and fees. This was in violation of both FINRA Rule 3110(a), which requires FINRA members to establish and maintain a system to supervise the activities of each associated person that is reasonably designed to achieve compliance with applicable securities laws and regulations, and with applicable FINRA rules, and FINRA Rule 2010, which requires that a member, in the conduct of its business, observe high standards of commercial honor and just and equitable principles of trade.
When the issue was discovered, the Firm took immediate corrective action by initiating an investigation of the issue, engaging an outside consultant to identify affected customers and in January 2021 corrected the issues, established a plan of remediation, agreed to pay restitution to affected customers and provided substantial assistance to FINRA in its investigation. Through the Firm’s proactive compliance, FINRA imposed a censure but no fine on the Firm.
Key Takeaways
Exception Reports:
Supervisors should review and understand back end of exception reports and other technology used to aid in identification and controls of key products such as mutual funds. Firm must ensure that the technology is functioning as correctly. This includes reviewing thresholds and testing the system to make sure that exceptions are accurately identified and that the controls in place are actually being carried out by the system.
Mutual Fund Share Classes:
Mutual Fund’s have been an examination priority for FINRA for years. FINRA has noted examples of exam deficiencies related to share class purchases and supervisory systems designed to achieve compliance with purchases and discounts to clients. Because this is a hot topic, Firm’s are encouraged to review their current systems of supervision as well as training for associated persons.
Proactive Remediation:
This case is an excellent example of proactive remediation. The Firm took immediate action, performing the steps to resolve and make the clients whole at the expense of the company. This, along with assisting FINRA during their investigation, led to the Firm not being fined. Firm’s who identify issues should not just brush them under the rug hoping that they will go away. Facing the challenge and providing prompt action goes a long way in presenting a case to the regulators that may support the Firm if enforcement does occur.
For more information, check out Merrill Lynch Order Summary (PDF).
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