Since the Commission revamped its enforcement approach there has been no real discussion about requiring admissions to settle an action. To date there has been one settled enforcement action under Chairman Clayton involving admissions. That action involved a recidivist brokerage firm. Now there are two. Again a brokerage firm is involved. In this instance the focus is a years long, intentional scheme to deceive investors. In the Matter of Merrill Lynch, Pierce, Fenner & Smith, Inc., Adm. Proc. File No. 3-18549 (June 19, 2018).
Over a five year period which ended in 2013 Merrill Lynch engaged in a practice known interally at the firm as “masking.” The practice involved deceiving customers – primarily financial institutions such as asset managers, mutual fund investment advisers and pension funds – about the manner in which their trades were executed. Specifically, the brokerage firm often routed customer orders to other broker-dealers, proprietary traders and market makers for execution. The practice was called Electronic Liquidity Partners or ELP. Not only did Merrill Lynch fail to tell customers about the practice, the firm deceived the traders about the manner in which their transactions were executed to the point of altering customer documents. The practice was used even where the broker received express instructions not to execute the transactions using an ELP.
Masking at Merrill Lynch traces to 2008. One of the key functions of a broker-dealer is the routing of customer orders for execution to one of a number of possible trading venues. Following execution the customer is given information about the transaction which may identify where it took place.
In 2007 Merrill Lynch began developing a program to route certain customer orders on an immediate or cancel basis to one or more of its ELPs or “trading partners” after first attempting execution in its dark pool or at other ATSs. One of the goals was to increase trading with the firm’s partners. At the same time the practice gave the ELPs access to customer orders. It also permitted Merrill Lynch to avoid paying the access fees typically charged by exchanges while receiving commissions from the customer. At the same time, it created the misleading impression that Merrill Lynch was a more active trading center.
To “mask” the venue where the transaction took place Merrill Lynch reconfigured certain codes that showed where the execution occurred. The firm also reprogramed its systems to conceal where the execution took place on customer documents. The billing invoices received by the clients were altered to conceal the execution venue.
The masking practice was extended to the trading centers. While clients were provided on request with what the firm called “liquidity maps” supposedly showing where the executions took place with the proviso that the firm thought the information was important for customers, in fact traders were furnished with incorrect facts. This was true even when traders specifically asked Merrill Lynch about the identity of the trade venue.
Masking took place even when the broker was given specific instructions on the manner in which the trade should be executed. Indeed, in some instances traders told the firm not to route orders to ELPs. The instructions were ignored.
Despite the fact that the information about the venue and execution was important to the traders, the firm deceived them and continued the practice. During the five year period of the scheme over 5.4 billion shares were traded in this manner with a notional value of $141 billion.
While customers were deceived, Merrill Lynch knew internally where the transactions were executed. Those records were maintained internally and available for regulators. In 2013 the firm elected to halt the practice but did not inform its customers. The Order alleges violations of Securities Act Sections 17(a)(2) and (3).
To resolve the proceeding Merrill Lynch admitted to the facts alleged in the Order and that its conduct violated the federal securities laws. The firm consented to the entry of a cease and desist order and a censure. It also agreed to pay a penalty of $42 million.