Merrill Lynch Settles SEC Market Access Charges

The Commission has brought a series of cases under Exchange Act Section 15(c)(3) and Rule 15c3-5, its market access rule. That rule requires that broker-dealers with market access establish risk management controls to prevent the entry of erroneous orders and those that would exceed appropriate credit or capital thresholds. Settled actions imposing fines for violations of the rule have been filed in which Goldman Sachs, Knight Capital, Latour Trading, Morgan Stanley and Wedbush as Respondents. Merrill Lynch has now joined that list. In the Matter of Merrill Lynch, Pierce, Fenner & Smith Inc., Adm. Proc. File No. 3-17573 (Sept. 26, 2016).

Merrill Lynch orders from its cash equities and derivative businesses and others used by electronic trading clients were routed to the market through an internal trading platform called Electronic Trading Technology Stack or ETTS. It had an order management system, an algorithmic engine and a smart order router that sent orders to market.

To comply with the market access rule the firm determined that its orders would flow though four order controls: 1) single order quantity limits; 2) single order notional value limits; 3) controls based on the limit price assigned to the order; and 4) duplicate order check. Those controls were what is called a hard block – orders of a certain size were blocked from market access. Before the market access rule the Merrill Lynch had other types of risk management controls. Those were not implemented across all equity order flow.

Many of the thresholds selected by senior managers of the business units were set at such high levels that the controls became ineffective. For example, as of July 2011 most orders originating in the institutional cash equities business unit were subject to a single order quantity hard block of $250,000,000 and a single order quantity hard block that ranged from 5 million shares to 25 million shares. Other units had similar controls.

Since the controls at Merrill Lynch were ineffective, numerous orders which should not have reached the market did. Those orders at times caused the prices of the stock involved to fluctuate dramatically. For example, in September 2012, the share price of Tyco International Ltd. rose 4% in less than 2 seconds after a Merrill Lynch trader inadvertently sent an institutional customer order of 200,000 shares to the market for immediate execution rather than over the course of the day as the customer instructed. In April 2013 the price of Qualys, Inc. fell over 99% in less than 2 seconds after the firm erroneously entered an institutional customer order to sell 381,020 shares using the wrong algorithm. These, and other similar orders. harmed the markets.

Merrill Lynch conducted periodic reviews of its risk management controls under its procedures. The firm verified the controls and procedures that were in place, concluding that they were functioning as expected. The reviews failed to consider if the high thresholds were effective. No adjustments were made. The Order alleges violations of Exchange Act Section 15(c)(3) and rule 15c3-5.

To resolve the action the firm undertook remedial steps. Merrill Lynch also consented to the entry of a cease and desist order based on the Section and rule cited in the Order and a censure. The firm agreed to pay a penalty of $12.5 million.

Program: The Dorsey Private Funds Symposium, Sept. 28 2016, New York City. For further information click here.

Tagged with: ,