updated: november 1, 2018 /litigation/regulatory actions · mlpf&s, without admitting or...

Merrill Lynch, Pierce, Fenner & Smith Incorporated

Bank of America Tower, NY1-100-04-00

One Bryant Park, New York, NY 10036

Updated: November 1, 2018 /Litigation/Regulatory Actions

Merrill Lynch, Pierce, Fenner & Smith Incorporated (the "Company” or “MLPF&S”), a Delaware

corporation, is registered with the U.S. Commodity Futures Trading Commission (“CFTC”) as a Futures

Commission Merchant (“FCM”). The Company is a clearing member of the Chicago Board of Trade, and

the Chicago Mercantile Exchange, and is either a clearing member or member of all other principal U.S.

futures and futures options exchanges. With regard to those domestic futures and futures options

exchanges of which it is not a clearing member, the Company has entered into third party brokerage

relationships with FCMs that are clearing members of those exchanges. The Company maintains its

principal place of business at One Bryant Park, New York, NY10036.

Bank of America Corporation (the "Corporation" or “Bank of America”), the Company’s ultimate parent

(the “Parent”) makes all required disclosures in its Annual Reports on Form 10-K and Quarterly Reports on

Form 10-Q, which may be updated by Current Reports on Form 8-K, all of which are filed with the

Securities and Exchange Commission ("SEC") ("Regulatory Filings"). The Company makes all required

disclosures in its Form BD and ADV filings (“Form BD and ADV Filings”) with the Financial Industry

Regulatory Authority ("FINRA"). Those Regulatory Filings and Form BD and ADV Filings include

disclosures of Regulatory Inquiries as required by federal law and applicable regulations. The Regulatory

Filings are publicly available on the SEC’s website at www.sec.gov. The Form BD Filings are publicly

available on the FINRA BrokerCheck system at http://brokercheck.finra.org/. The Form ADV filings are

publicly available on the SEC’s Investment Adviser Search website at:

http://www.adviserinfo.sec.gov/IAPD/default.aspx.

In the ordinary course of business, the Company is routinely a defendant in or party to many pending and

threatened legal, regulatory and governmental actions and proceedings. In view of the inherent difficulty of

predicting the outcome of such matters, particularly where the claimants seek very large or indeterminate

damages or where the matters present novel legal theories or involve a large number of parties, the

Company generally cannot predict what the eventual outcome of the pending matters will be, what the

timing of the ultimate resolution of these matters will be, or what the eventual loss, fines or penalties

related to each pending matter may be.

In accordance with applicable accounting guidance, the Company establishes an accrued liability when

those matters present loss contingencies that are both probable and estimable. In such cases, there may be

an exposure to loss in excess of any amounts accrued. As a matter develops, the Company, in conjunction

with any outside counsel handling the matter, evaluates on an ongoing basis whether such matter presents a

loss contingency that is probable and estimable. Once the loss contingency related to a matter is deemed to

be both probable and estimable, the Company will establish an accrued liability. The Company continues to

monitor the matter for further developments that could affect the amount of the accrued liability that has

been previously established.

In some of the matters described below, loss contingencies are not both probable and estimable in the view

of management, and accordingly, an accrued liability has not been established for those matters.

Information is provided below regarding the nature of all these contingencies and, where specified, the

amount of the claim associated with these loss contingencies. Based on current knowledge, management

does not believe that loss contingencies arising from pending matters, including the matters described

http://www.sec.gov/

http://brokercheck.finra.org/

http://www.adviserinfo.sec.gov/IAPD/default.aspx




herein, will have a material adverse effect on the Company’s consolidated financial position or liquidity.

However, in light of the inherent uncertainties involved in these matters, some of which are beyond the

Company’s control, and the very large or indeterminate damages sought in some of these matters, an

adverse outcome in one or more of these matters could be material to the Company’s results of operations

or cash flows for any particular reporting period.

The actions against the Company include, but are not limited to, the following:

LITIGATION

European Commission - Credit Default Swaps Antitrust Investigation

On July 1, 2013, the European Commission (“Commission”) announced that it had addressed a Statement

of Objections (“SO”) to BAS, Bank of America and a related entity (together, the “Bank of America

Entities”); a number of other financial institutions; Markit Group Limited; and the International Swaps and

Derivatives Association (together, the “Parties”). The SO sets forth the Commission’s preliminary

conclusion that the Parties infringed EU competition law by participating in alleged collusion to prevent

exchange trading of credit default swaps and futures. According to the SO, the conduct of the Bank of

America Entities took place between August 2007 and April 2009. As part of the Commission’s

procedures, the Parties have been given the opportunity to review the evidence in the investigative file,

respond to the Commission’s preliminary conclusions, and request a hearing before the Commission. If the

Commission is satisfied that its preliminary conclusions are proved, the Commission has stated that it

intends to impose a fine and require appropriate remedial measures. On December 4, 2015, the

Commission announced that it was closing its investigation against the Bank of America Entities and the

other financial institutions involved in the investigation.

Tutor Perini Corp. v. Banc of America Securities LLC and Bank of America, N.A.

Tutor Perini Corporation filed an action on May 18, 2011 in the U.S. District Court for the District of Massachusetts entitled Tutor Perini Corporation v. Banc of America Securities LLC, now known as Merrill Lynch, Pierce, Fenner & Smith Incorporated, successor by merger, and Bank of America, N.A. The complaint alleges that Defendants failed to disclose material facts about the market for auction-rate securities (“ARS”) that Tutor Perini purchased from BAS in late 2007 and early 2008. The complaint alleges that auctions for those ARS failed beginning in February 2008, allegedly preventing Tutor Perini from liquidating its ARS at par value in the auctions, and that Tutor Perini subsequently sold its ARS on the secondary market at a loss. The complaint asserts federal securities-fraud, Massachusetts Uniform Securities Act (“MUSA”), Massachusetts Unfair and Deceptive Trade Practices Act (“UDTPA”), common-law fraud, unsuitability, and intentional- and negligent-misrepresentation claims. Plaintiff seeks damages in excess of $100M.

On August 12, 2015, the District Court granted defendants summary judgment dismissing all claims. On November 21, 2016, the U.S. Court of Appeals for the First Circuit affirmed the District Court’s decision with respect to all claims against BANA and as to Perini’s unsuitability, common-law fraud, and intentional misrepresentation claims against BAS, but vacated and remanded for further proceedings on the federal securities-fraud, MUSA, UDTPA, and negligent-misrepresentation claims against BAS. The parties




resolved the matter for $37 million and the case was dismissed with prejudice on June 6, 2017. REGULATORY ACTIONS

FINRA AWC 12/16/2015

FINRA alleged that from January 2009 through October 28, 2013, MLPF&S did not conduct adequate

background checks on approximately 4,500 non-registered associated persons, after its acquisition by Bank

of America Corporation and the resulting organizational changes. Of that total, approximately 3,145 were

fingerprinted, but were screened under the standards applicable to banks and not to broker-dealers;

approximately 1,115 were not fingerprinted; and approximately 240 were not fingerprinted until after they

joined MLPF&S. As a result, FINRA alleged individuals were not properly screened for statutory

disqualifications under the Securities Exchange Act of 1934 (“Exchange Act”) (and one person subject to

an Exchange Act statutory disqualification actually associated with MLPF&S); MLPF&S did not have

adequate records and MLPF&S did not adequately supervise the fingerprinting process. FINRA alleged

violations of Section 17(f) of the Exchange Act and Rule 17f-2 thereunder; Section 17(a) of the Exchange

Act and Rules 17a-3(a)(12)(i)(G) and 17a-3(a)(13) thereunder; Article III, Section 3(b) of the FINRA By-

Laws; NASD Rule 3010 and FINRA Rules 4511 and 2010. MLPF&S accepted and consented to the entry

of an AWC, without admitting or denying the findings. Without admitting or denying the findings,

MLPF&S consented to the imposition of the following sanctions: (1) a censure, (2) a fine in the amount of

$1,250,000, and (3) a certain undertaking. MLPF&S agreed to an undertaking to review its systems and

procedures regarding the identification, fingerprinting, and screening of non-registered associated persons

to ensure that current systems and procedures are reasonably designed to achieve compliance with all

securities laws and regulations, including Section 17(a) of the Exchange Act and Rule 17a-3 thereunder,

Section 17(f) of the Exchange Act and Rule 17f-2 thereunder, FINRA By-Laws Article III, Section 3(b),

and FINRA Rule 4511.

SEC Customer Protection Rule Order 6/23/2016

On June 23, 2016, the SEC issued an administrative order in which it found MLPF&S and Merrill Lynch

Professional Clearing Corp. (“MLPro”) (collectively, “ML”) had willfully violated Section 15(c)(3) of the

Exchange Act and Rule 15c3-3 thereunder and Section 17(a)(1) of the Exchange Act and Rules 17a-

3(a)(10) and 17a-5(a) thereunder, and that MLPF&S willfully violated Section 17(a)(1) of the Exchange

Act and Rules 17a-5(d)(3) (as it existed prior to amendments to Rule 17a-5 in 2014), 17a-5(d)(2)(ii), 17a-

5(d)(3) and 17a-11(e) thereunder, and Exchange Act Rule 21F-17. Specifically, the order found that (i) ML

engaged in a series of complex trades that allowed it to use customer cash to finance firm inventory and (ii)

MLPF&S allowed certain of its clearing banks to hold liens on customer securities. In determining to

accept ML’s offer, the SEC considered remedial acts promptly undertaken by ML and substantial

cooperation afforded the SEC staff during the course of its investigation. In the order, (i) MLPF&S and

MLPro were censured, (ii) MLPF&S was ordered to cease and desist from committing or causing any

violations and any future violations of Sections 15(c)(3) and 17(a)(1) of the Exchange Act and Rules 15c3-

3, 17a-3(a)(10), 17a-5(a), 17a-5(d)(2)(ii), 17a-5(d)(3), 17a-11(e) and 21F-17 thereunder, (iii) MLPro was

ordered to cease and desist from committing or causing any violations and any future violations of Sections




15(c)(3) and 17(a)(1) of the Exchange Act and Rules 15c3-3, 17a-3(a)(10) and 17a-5(a) thereunder, (iv)

MLPF&S and MLPro were ordered to pay disgorgement of $50,000,000 and prejudgment interest in the

amount of $7,000,000, and (v) Merrill Lynch was ordered to pay a civil monetary penalty of $358,000,000.

No customers were harmed, and the issues related to ML’s procedures and controls have been corrected.

SEC Strategic Return Notes Order 6/23/2016

On June 23, 2016, the SEC issued an administrative order (“Administrative Order”) in which it found that

MLPF&S, without admitting or denying any SEC findings, violated Section 17(a)(2) of the Securities Act

of 1933 (“Securities Act”), which prohibits obtaining money or property by means of omissions of material

facts in the offer or sale of securities. In the Administrative Order, the SEC found that MLPF&S failed to

adequately disclose certain fixed costs in a proprietary volatility index lined to structure notes known as

Strategic Return Notes (“SRNs”) of Bank of America Corporation, which resulted in materially misleading

disclosures in the offering materials of the fixed costs associated with the SRNs. MLPF&S was ordered to

(1) cease and desist from committing or causing any violations and any future violations of Section

17(a)(2) of the 1933 Act; and (2) pay a civil monetary penalty of $10 million.

FINRA Strategic Return Notes AWC 6/23/2016

Without admitting or denying the findings, MLPF&S consented to the sanctions and to the entry of findings

that it sold approximately $168 million of structured notes known as "strategic return notes" (“SRNs”)

linked to a proprietary volatility index, without adequately disclosing certain fixed costs. The findings

stated that MLPF&S emphasized in offering materials that investors would be subject to a 2% sales

commission and a 0.75% annual fee in connection with the SRNs. MLPF&S also disclosed a third fixed,

regularly occurring cost included in its proprietary volatility index known as the "execution factor" (distinct

from "holding" or "decay" costs associated with daily calculation of the underlying index which are

variable and depend on market conditions), but did not do so in the same manner as the sales commission

and annual fee. As a result, MLPF&S’s disclosures in the offering materials of the fixed costs associated

with the SRNs were materially misleading, were not fair and balanced and failed to provide a sound basis

for evaluation of the SRNs by not adequately disclosing the execution factor. The findings also stated

MLPF&S failed to maintain supervisory procedures reasonably designed to ensure compliance with

applicable disclosure standards in connection with the sale of the SRNs. MLPF&S was censured and fined

$5,000,000.

SEC Market Access Rules Order 9/26/2016

On September 26, 2016, MLPF&S entered into a settlement with the SEC resulting in the SEC issuing an

order. MLPF&S consented to the entry of the order (the “Order”) that finds that it violated Section 15(c)(3)

of the Exchange Act and Rule 15c3-5 thereunder (the “Market Access Rule”). The Order finds that

MLPF&S violated the Market Access Rule by failing to establish, document, and maintain a system of risk

management controls and supervisory procedures reasonably designed to manage the financial, regulatory,

and other risks of its market access activity. In particular, MLPF&S failed to establish pre-trade risk

management controls reasonably designed to prevent the entry of erroneous orders, to establish pre-trade

risk management controls reasonably designed to prevent the entry of orders that would exceed pre-set




credit or capital limits for several of its trading desks, to establish required controls and procedures for

fixed income securities, to review adequately the effectiveness of its risk management controls and

supervisory procedures required by the Market Access Rule, particularly for preventing the entry of

erroneous orders, and to comply with the Rule’s CEO certification requirements. The Order censures

MLPF&S and directs it to cease-and-desist from committing or causing any violations and any future

violations of Exchange Act Section 15(c)(3) and Rule 15c3-5 thereunder. Additionally, the Order requires

MLPF&S to pay a $12,500,000 civil money penalty, which was paid on October 3, 2016.

NASDAQ Stock Market AWC 9/26/2016

On September 26, 2016, MLPF&S entered into a letter of acceptance, waiver and consent (the “Consent”)

with the Nasdaq Stock Market LLC (“Nasdaq”). The Consent finds that MLPF&S violated Rule 15c3-5

under the Exchange Act and Nasdaq Rules 3010, 2010a (for conduct on or after Nov. 21, 2012) and 2110

(for conduct prior to Nov. 21, 2012), and 4611(d) by failing to establish, document, and maintain a system

of risk management controls and supervisory procedures reasonably designed to manage the financial,

regulatory, and other risks of market access. The Consent censures MLPF&S and requires MLPF&S to

pay a fine of $1,350,000.



that it submitted to the FINRA/Nasdaq trade reporting facility (“TRF”) millions of inaccurate trades in

which purchases were reported as principal sales and agency crosses. MLPF&S also submitted millions of

trades it was not required to submit. The findings stated that MLPF&S also submitted millions of

inaccurate or incomplete reportable order events (“ROES”) to the order audit trail system (“OATS”)

including the submission of new orders with inaccurately placed cancel stamps, new order reports for

modifications of existing orders, broker-dealer orders reported as customer orders, inaccurate good till time

(“GTT”) time in force designations, and intermarket sweeps orders (“ISOs”) without the required ISO

special handling code. MLPF&S also failed to report millions of execution reports to OATS. The findings

also included that MLPF&S failed to capture the minimum quantity (“MQT”) special handling instructions

on millions of order tickets which are used for transactions that should be canceled if a specified minimum

quantity cannot be executed. MLPF&S also recorded incorrect receipt and route timestamps on millions of

order tickets. In addition, FINRA found that MLPF&S included incorrect information as to cancelled

shares in its Rule 605 report. FINRA found that MLPF&S's written supervisory procedures (“WSPs”) were

not reasonably designed to ensure compliance with FINRA's trade and OATS reporting rules, customer

confirmation rules, and the books and records requirements in SEC Rule 17a-3. MLPF&S's WSPs required

supervision of a number of modifiers but failed to call for a supervisory review of the .rx modifier which

concern transactions reported for regulatory transaction fees. MLPF&S's OATS reporting WSPs required

the review of a small number of OATS reports on a monthly basis to ensure the accuracy of such reports.

Given the volume of MLPF&S's OATS reporting obligations, the scope of MLPF&S's WSPs was not

reasonably designed to capture and identify any reporting problems. MLPF&S's books and records,

customer confirmations and OATS WSPs required the review of a small number of books and records and

customer confirmations on a monthly basis to ensure the accuracy of such records. Given the volume of

MLPF&S's books and records, customer confirmations and OATS reporting obligations, the scope of




MLPF&S’s WSPs was not reasonably designed to capture and identify the accuracy of such records.

MLPF&S was censured, fined $2,800,000, and undertakes to revise its written supervisory procedures.



that it did not establish and maintain adequate supervisory systems, and did not establish, maintain, and

enforce adequate written procedures, reasonably designed to achieve compliance with applicable securities

laws and regulations governing the use of proceeds from loans originated under a securities-based lending

program called loan management accounts (“LMAs”). The findings stated that MLPF&S did not

adequately educate its representatives about LMAs or train them on the differences between purpose and

non-purpose LMAs, the contractual and firm prohibition against using proceeds from non-purpose LMAs

to buy margin stock, or the regulatory requirements applicable to LMAs used to buy margin stock.

MLPF&S also did not reasonably supervise the LMA account-opening process. The findings also stated

MLPF&S did not establish and maintain reasonable supervisory systems, or establish, maintain, and

enforce adequate written procedures, designed to prevent, deter, and detect the use of proceeds from non-

purpose LMAs to purchase margin stock. Except in limited situations where a customer had an open

margin debit balance or a pending trade, there was no effective control in place to prevent customers from

transferring proceeds from a non-purpose LMA to their firm brokerage account and immediately

purchasing margin stock, nor any effective post-transaction review to detect such prohibited use of the

LMA proceeds. This failure to supervise extended to MLPF&S's policies and procedures, which prohibited

the use of proceeds from non-purpose LMAs to purchase securities generally, and to the LMA agreements,

which prohibited the use of proceeds from non-purpose LMAs to purchase margin stock. Likewise, because

MLPF&S did not have adequate systems to monitor whether proceeds from non-purpose LMAs were used

to purchase margin stock, MLPF&S failed to adequately monitor to ensure the collateral requirement was

met in those instances when LMA proceeds were, in fact, used to purchase margin stock. As a result of

these failures, during the LMA review period, MLPF&S customers drew down on non-purpose LMAs,

transferred the funds to their firm brokerage accounts, and within a short timeframe (often the same day) on

thousands of occasions purchased margin stock. The findings also included that MLPF&S failed to

establish and maintain a supervisory system, and failed to establish, maintain, and enforce written

procedures, reasonably designed to ensure the suitability of transactions in Puerto Rico municipal bonds

and Puerto Rico closed-end funds (“PR Securities”) in certain circumstances. Many Puerto Rico customers

were concentrated in PR Securities, and many used leverage to buy additional PR Securities either through

LMAs or through the use of margin in their securities accounts. Leveraged customers were required to

maintain account equity in order to provide adequate collateral to support their leverage. Despite the risk of

customers who were both leveraged and highly concentrated in PR Securities, MLPF&S did not establish

and maintain adequate supervisory systems and procedures to ensure that, where customers were both

highly concentrated in PR Securities and using leverage, transactions were suitable in light of the

customers' risk objectives and profiles. FINRA found that several hundred customer accounts in MPF&S's

Puerto Rico branch with modest net worth and conservative or moderate investment objectives had 75

percent or more of their account assets invested in PR Securities. Of those accounts, approximately 50 also

were leveraged through LMSs or margin. Approximately half of those accounts eventually received

margin or maintenance calls upon which they liquidated PR Securities at a loss. These customers - 25 in

total - suffered aggregate losses of nearly $1.2 million as a result of liquidating PR Securities to meet the




calls. MLPF&S was censured, fined $6,250,000, and required to pay $779,999, including prejudgment

interest, in restitution to 22 customers. The amount of restitution ordered takes into account that MLPF&S

has already reimbursed certain affected customers pursuant to private settlement agreements. In

determining the appropriate sanction, FINRA considered the following factors: prior to detection by a

regulator, MLPF&S conducted a comprehensive internal review of the use of non-purpose LMA proceeds

to purchase margin stock and took remedial measures to strengthen its related controls and procedures;

MLPF&S reported to FINRA certain of the violations addressed in the AWC; and MLPF&S provided

substantial assistance during FINRA's investigation by sharing the results of its internal investigation with

FINRA.

CFTC Order 9/22/2017

On September 22, 2017, the Commodity Futures Trading Commission announced that MLPF&S agreed to

the entry of an order that alleged that the CFTC had reason to believe that MLPF&S (a) violated Regulation

166.3, 17 C.F.R. § 166.3 (2016), under the Commodity Exchange Act (“CEA”) in connection with its

alleged failure to supervise diligently MLPF&S’s response to the investigation by the CME Group Inc.’s

Market Regulation Department regarding recordkeeping and execution practices with respect to block

trades; (b) violated Regulation 166.3, 17 C.F.R. § 166.3 (2016), under the CEA in connection with its

alleged inadequate procedures for preparing and maintaining records for block trades executed by the

Swaps Desk, including procedures for recording accurate block trade execution times and not being diligent

in ensuring that its existing procedures for preparing and maintaining records for block trades were being

implemented; and (c) violated Section 4g of the CEA, 7 U.S.C. § 6g (2012) and Regulations 1.31 and 1.35

under the CEA, 17 C.F.R. §§ 1.31 and 1.35 (2016) in connection with the alleged failure to maintain certain

books and records regarding the execution of block trades. Without admitting or denying any of the

findings or conclusions in the order, MLPF&S consented to the imposition of the following sanctions: (1)

to cease and desist from violating Section 4g of the CEA and Regulations 1.31, 1.35 and 166.3 thereunder,

(2) to pay a civil monetary penalty in the amount of $2,500,000, and (3) to comply with certain

undertakings.


On December 19, 2017, without admitting or denying the findings, MLPF&S consented to the entry of the

following findings by FINRA: MLPF&S failed to identify and evaluate certain trades with extended

settlement dates (“ES Trades”) across its product lines and business units for margin and net capital

purposes. As a result, MLPF&S for these trades failed to collect the requisite margin in violation of

FINRA Rules 4210 and 2010; take the appropriate net capital deduction in violation of Section 15(c) of the

Exchange Act and Rule 15c3-1(c) thereunder and FINRA Rule 2010; prevent extension of credit in cash

accounts in violation of FINRA Rule 2010 by violating Regulation T of the Board of Governors of the

Federal Reserve System (“REG T”); maintain accurate schedules to the general ledger in violation of

Section 17(a) of the Exchange Act and Rule 17a-3 thereunder and FINRA Rules 4511 and 2010; and file

accurate FOCUS reports in violation of Exchange Act Rule 17a-5 and FINRA Rule 2010. MLPF&S also

failed to establish, maintain and enforce a reasonable supervisory system, including written supervisory

procedures (“WSPs”), designed to achieve compliance with applicable federal securities laws and

regulations with respect to margin, net capital, books and records, and financial and operational combined




uniform single (“FOCUS”) reports in violation of FINRA Rule 3110, and its predecessor rule, NASD Rule

3010. MLPF&S's supervisory system and written procedures failed to identify and consider ES Trades

across its product lines and business units. Although MLPF&S was made aware of these supervisory

deficiencies in April 2013 through findings made during a FINRA Department of Member Regulation

member regulation examination, MLPF&S failed to implement any remedial measures until mid-2014, and

failed to implement a reasonable firm-wide supervisory system to identify and consider ES Trades until

mid-2015. MLPF&S was censured and fined $1,400,000.

SEC AML Program Settlement 12/21/2017

On December 21, 2017, the SEC deemed it appropriate and in the public interest that public administrative

and cease-and-desist proceedings be, and hereby are, instituted pursuant to Sections 15(b), and 21c of the

Exchange Act and Section 203(e) of the Investment Advisers Act of 1940 (“Advisers Act”) against

MLPF&S. MLPF&S, in addition to offering its customers the ability to buy and sell securities, offered its

customers other services in brokerage accounts, such as ATM cash deposits, wires, journal-entry transfers,

check writing, ATM withdrawals, cash advances, and ach transfers. By offering these additional services,

MLPF&S was susceptible to risks of money laundering and other illicit financial activity associated with

these services. During the relevant period, MLPF&S primarily used a system called "Mantas" for the

automated monitoring of retail brokerage accounts to detect potential money laundering activity related to

money movements. Mantas alerted on transactions that fit within the parameters of specific scenarios

selected by MLPF&S. MLPF&S had other methods of detecting suspicious movements of funds in

accounts, but those methods were primarily manual, or only alerted on certain types of activity. MLPF&S

also used a separate automated surveillance system to conduct trade surveillance and referred to the alerts

produced by its anti-money laundering (“AML”) detection channels as "events." MLPF&S also used a

system called "Event Processor," or "EP," which grouped Mantas events and events produced by other

MLPF&S detection channels and assigned points to the event groups. From 2006 through May 2015,

MLPF&S did not apply its Mantas automated monitoring to certain accounts. From about September 2011

through January 2012, MLPF&S did not investigate mantas events that were not grouped with an event

from one of the other detection channels, such as an employee referral, a government subpoena, or an event

related to a wire transfer or ATM transaction that had been routed through a consumer bank before being

debited or credited to an MLPF&S customer's retail brokerage account. EP used a number of systems and

techniques to group events arising from related retail brokerage accounts. However, EP inadvertently did

not link related accounts that involved customers who had both U.S. dollar-denominated and foreign

currency-denominated accounts. Accordingly, certain event groups did not meet the risk-based threshold

and become an investigation for further review as rapidly as they otherwise would have, if at all. MLPF&S

did not have adequate policies and procedures for filing what were commonly known as "continuing

activity" or "ongoing activity" suspicious activity reports (“SARS”). MLPF&S had AML policies and

procedures that were not reasonably designed to account for the additional risk associated with the

additional services offered by certain of its retail brokerage accounts. Once an AML case was opened, the

platform used by MLPF&S's AML investigators during part of the relevant period did not provide

sufficient visibility into transactions occurring in an account, causing the investigators sometimes unduly to

limit their review to the specific events that triggered the event and not to review the account more broadly

to determine whether the risk associated with that event warranted additional investigation or reporting.

Because of the deficiencies in its AML policies and procedures, MLPF&S failed to adequately monitor for,




detect, and report certain suspicious activity related to transactions or patterns of transactions in its

customers' accounts. By failing to file SARS with Financial Crimes Enforcement Network (“FINCEN”) as

required by the BSA with respect to certain of its customers' activity as described above, MLPF&S

willfully violated Section 17(a) of the Exchange Act and Rule 17a-8 thereunder. MLPF&S was ordered to

cease and desist from committing or causing any violations and any future violations of Exchange Act

Section 17(a) or Rule 17a-8 promulgated thereunder, censured, and fined $13,000,000.

FINRA AML Program Settlement 12/21/2017

On December 21, 2017, without admitting or denying the findings, MLPF&S consented to the sanctions

and to the entry of findings that at various relevant times, MLPF&S's implementation of certain systems

and procedures that comprise its AML program related to retail brokerage accounts suffered from

numerous deficiencies. The findings stated that MLPF&S used an automated monitoring system called

Mantas as a central part of its AML program to monitor for potentially suspicious activity in MLPF&S

brokerage accounts. In approximately October 2010, MLPF&S connected Mantas to a company's, that

MLPF&S was a subsidiary of, enterprise-wide, proprietary system called "Event Processor." Thereafter,

Mantas generated events related to potentially suspicious activities and fed these events into Event

Processor, and Event Processor grouped Mantas events with other events generated by other monitoring

systems into "event groups." Each event group was scored based on the AML risk posed by the events or

customer types identified; if the total score for an event group reached a certain risk-based threshold,

MLPF&S opened an investigation of the activity. For a four-month period, MLPF&S did not investigate

suspicious activity detected only by Mantas. By 2011, MLPF&S believed that system was producing too

many "false positives" and determined to change how the system generated and scored Mantas events and

investigated potentially suspicious activity. From September 2011 until February 2012, MLPF&S decided

to not investigate event groups generated only from Mantas events while it implemented the changes.

MLPF&SS also decided not to review hundreds of mantas alerts that had been generated by the automated

surveillance system. As a result of these decisions, MLPF&S failed to investigate 1,015 instances of

potentially suspicious activity at that time and then only after the investigation that led to this settlement

had begun. The findings also stated that how MLPF&S scored certain events in its automated surveillance

system minimized potentially suspicious activity or prevented such activity from being reviewed. For

example, MLPF&S determined to score multiple occurrences of potentially suspicious money movements

involving high risk counterparties and entities once. Until 2015, it did not link related accounts for some of

MLPF&S's highest risk customers and did not consistently identify or monitor customers in certain high

risk jurisdictions or senior foreign political figures who were opening or conducting transactions through

MLPF&S accounts. The findings also included that MLPF&S excluded millions of accounts from its

automated monitoring system and therefore failed adequately to monitor the accounts for potentially

suspicious activity. These accounts included retirement accounts, certain securities-based loan accounts

and the accounts pledged to them, and certain managed accounts whose investments were not controlled by

the beneficial owner. As a result of these deficiencies, MLPF&S failed to have systems and procedures

reasonably designed to monitor for, detect, and report suspicious activity. FINRA found that MLPF&S

failed to implement adequate systems and procedures as part of its AML program and as a result it failed to

detect and investigate potentially suspicious activity. Due in large part to the deficiencies in the operation

of the AML monitoring systems for retail brokerage accounts, MLPF&S failed to detect or investigate

certain potentially suspicious activity in retail brokerage accounts maintained for non-resident aliens at




"international" and non-resident client branches, among others, for non-U.S. citizens domiciled outside the

U.S. and activity involving customers who were taking out loans from MLPF&S affiliates. MLPF&S was

censured and fined $13,000,000.

SEC Longtop Settlement 3/08/2018

On March 8, 2018, the SEC issued an administrative order against MLPF&S finding that MLPF&S, from

January 24, 2011 to August 18, 2011, violated the registration provisions of the Federal securities laws by

effecting unregistered sales of almost three million shares of Longtop Financial Technologies Limited’s

securities for a customer that maintained an account at a MLPF&S branch office in Singapore. In 2013,

MLPF&S sold its Singapore branch office and the branch employees handling the account ceased their

association with MLPF&S. MLPF&S consented to the issuance of the administrative order without

admitting or denying the SEC’s findings. The SEC found that, although in advance of the sales MLPF&S

reviewed Longtop’s public filings, gathered information from the Singapore branch concerning Longtop

and the account, had discussions with Longtop’s U.S.-based outside counsel who was not on a list of

known securities law offenders, and consulted with in-house counsel, MLPF&S did not perform a

reasonable inquiry into the facts surrounding the proposed sales to determine if there was an available

exemption from registration under the Securities Act, and as a result MLPF&S was not entitled to rely on

the brokers’ transaction exemption in Section 4(a)(4) of the Securities Act. The SEC found that the sales

through the account, generated approximately $38 million in proceeds for the benefit of Longtop and its

affiliates. MLPF&S wired the proceeds from the nominee account to a Hong Kong bank account in the

name of a different entity that was controlled by Longtop management. Unknown to MLPF&S, the

majority of the proceeds were then transferred from the Hong Kong bank account to one or more affiliates

of Longtop. MLPF&S received over $127,000 in commissions and fees during the relevant period. As a

result, the SEC found that MLPF&S willfully violated Sections 5(a) and 5(c) of the Securities Act.

MLPF&S is censured and ordered to cease and desist from committing or causing any violations and any

future violations of Sections 5(a) and 5(c) of the Securities Act. MLPF&S is also ordered to pay

disgorgement of $127,545 along with prejudgment interest of $27,340, and pay a civil money penalty in the

amount of $1.25 million.

Attorney General of the State of New York Investor Protection Bureau 3/22/2018

On March 22, 2018, the Attorney General of the State of New York (“NYAG”) Investor Protection Bureau

alleged that Bank of America Corporation (“BAC”) and MLPF&S (1) concealed from its institutional

clients that orders were routed to and executed by “electronic liquidity providers,” (2) misstated the

composition of orders and trades in its dark pool, and (3) did not accurately describe its use of a proprietary

“venue ranking” analysis, in violation of the Martin Act and Executive Law § 63(12). In connection with

the agreement, BAC and MLPF&S agreed (1) not to engage, or attempt to engage, in conduct in violation

of any applicable laws, including but not limited to the Martin Act and Executive Law § 63(12); (2) to pay

a penalty in the amount of $42,000,000; and (3) provide the NYAG a summary of the review of its

electronic trading policies and procedures.




State of Maine Office of Securities 5/25/2018

On May 25, 2018, the State of Maine Office of Securities (“Maine Securities”) issued a Consent Order

(“Order”) in connection with Merrill Lynch’s activities as distribution agent of Maine’s NextGen 529

College Investment Plan-Client Select Series (“NextGen”) and the fees associated with the different classes

of units available to NextGen investors (Class A units and Class C units). The Order cited Merrill Lynch

for (i) having violated 32 M.R.S. 16412(4)(M) and Maine Office of Securities Rule Chapter 504 Section

8(3) when its representatives recommended Class C units of NextGen to investors for whom Class A units

likely would have been less expensive over the investors’ investment horizon given the age of the

investors’ beneficiaries, and (ii) having violated 32 M.R.S. 16412(4)(I) and Maine Office of Securities

Rule Chapter 504 Section 7(1) by failing to (a) reasonably supervise its agents, and (b) establish and

maintain policies and procedures, and effective monitoring or other controls reasonably designed to ensure

that its agents properly considered the beneficiaries’ age, investment time horizon, and relative expense of

Class A and Class C units when representatives recommended NextGen. The Order stated that Merrill

Lynch has undertaken to make financial remediation payments to all Maine and non-Maine residents who

purchased NextGen Class C units during a specified period (“Eligible Investors”) through Merrill Lynch as

distribution agent pursuant to a voluntary written plan submitted to the Maine Securities Administrator.

Merrill Lynch agreed to the entry of the Order without admitting or denying the findings of fact and

conclusions of law of Maine Securities.

SEC Non-Agency RMBS Settlement 6/12/2018

On June 12, 2018, the SEC issued an administrative proceeding against MLPF&S finding that MLPF&S

failed reasonably to supervise MLPF&S personnel so as to prevent and detect violations of antifraud

provisions of the Federal securities laws in connection with MLPF&S’s secondary market purchases and

sales of certain bonds known as non-agency residential mortgage-backed securities (“RMBS”). The trading

took place from June 2009 through December 2012 (“Period”) and involved intra-day purchases and sales

of RMBS from and to MLPF&S’s institutional customers. During the period, MLPF&S personnel who

purchased and sold RMBS made false or misleading statements, directly and indirectly, to MLPF&S’s

institutional customers and/or charged MLPF&S’s institutional customers undisclosed excessive mark-ups.

By engaging in this conduct, MLPF&S’s personnel acted knowingly or recklessly. MLPF&S had both

policies that prohibited false or misleading statements and the means to monitor communications for such

statements. MLPF&S, however, failed reasonably to implement procedures to monitor for the types of

false or misleading statements that were the subject of the order. MLPF&S also had policies that

prohibited excessive mark-ups and procedures to monitor for excessive mark-ups on transactions in RMBS,

but the policies and procedures were not reasonably designed and implemented. Due to these deficiencies,

MLPF&S failed reasonably to perform a meaningful review of potentially excessive mark-ups on certain

RMBS transactions, including those that were the subject of the order. Under the circumstances described

above, MLPF&S failed reasonably to supervise for violations of antifraud provisions of the Federal

securities laws within the meaning of Section 15(b)(4)(e) of the Exchange Act. MLPF&S agreed to a

censure, pay disgorgement and pre-judgment interest totaling $10,535,441, and pay a civil money penalty

in the amount of $5,267,720.




SEC ATS (Masking) Settlement 6/19/2018

On June 19, 2018, the SEC issued an administrative proceeding against MLPF&S concerning MLPF&S's

sustained efforts to hide its practice of routing certain institutional customer orders to other broker-dealers

(“ELPs”), including proprietary trading firms and wholesale market makers, for execution. MLPF&S

configured a number of internal/external trade reporting systems so that institutional customer orders that

were executed at ELPs instead appeared to institutional customers to have been executed at MLPF&S.

MLPF&S similarly misreported ELP executions in reports provided to institutional customers and in billing

invoices. When responding to institutional customer questionnaires and in other communications,

MLPF&S specifically omitted ELPs from lists of venues to which institutional customer orders were

routed. MLPF&S referred to this practice internally as masking. MLPF&S masked the ELP executions of

MLPF&S's DSA institutional customers, typically financial institutions such as asset managers, mutual

fund investment advisers, and public pension funds. As a result, these institutional customers' orders

received unwanted executions against entities with which they believed their orders would not interact.

Because of masking, these institutional customers did not know that MLPF&S violated their instructions.

MLPF&S's efforts to mask the correct trading venues, including by altering trade reporting programs,

operated as a fraud or deceit upon its institutional customers. As a result, MLPF&S willfully violated

Sections 17(a)(2) and 17(a)(3) of the Securities Act. MLPF&S was censured and ordered to (i) cease and

desist from committing or causing any violations and any future violations of Sections 17(a)(2) and

17(a)(3) of the Securities Act; and (ii) pay a civil money penalty in the amount of $42,000,000.

SEC IMG Settlement 8/20/2018

On August 20, 2018, MLPF&S entered into a settlement with the Securities and Exchange Commission

(“SEC”) under which MLPF&S consented to the entry of an order (the “Order”) that finds that MLPF&S

willfully violated Sections 206(2) and 206(4) under the Advisers Act and Rule 206(4)-7 thereunder. The

Order finds that MLPF&S failed to disclose that the portfolio manager evaluation process employed in

connection with a January 2013 termination recommendation for over fifteen hundred of its retail advisory

accounts was exposed to a conflict of interest involving other business interests. The Order finds that this

undisclosed conflict of interest in MLPF&S’s decision-making process violated Section 206(2) of the

Advisers Act. MLPF&S also violated 206(4) of the Advisers Act and Rule 206(4)-7 promulgated

thereunder. Solely for the purpose of settling these proceedings, MLPF&S admitted the SEC’s jurisdiction

and the subject matter of these proceedings and consented to the Order. The Order requires MLPF&S to

cease and desist from committing or causing any violations and any future violations of Advisers Act

Sections 206(2) and 206(4) and Rule 206(4)-7, be censured, and pay disgorgement of $4,032,871.89,

prejudgment interest of $806,981.03, and a civil money penalty in the amount of $4,032,871.89.

updated: november 1, 2018 /litigation/regulatory actions · mlpf&s, without admitting or...

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