MLPFS Pays Over $8 Million to Settle SEC Conflict Based Fraud Charge

When firms make representations regarding the policies and procedures that govern their operations it is critically important that they be reviewed and updated as required. Perhaps more importantly, the firm should have internal compliance procedures which ensure that it is acting in accord with the representation it makes to shareholders and others. This is particularly true of regulated entities such as investment advisers and broker-dealers. Indeed, the Commission has brought a series of cases in which firms have violated their own policies and procedures as stated in public filings. In the Matter of Merrill Lynch, Pierce, Fenner & Smith Inc. Adm. Proc. File No. 3-18651 (August 20, 2018) is the latest such action.

In 2012 and 2013 Merrill, as a registered investment adviser, maintained what it called Platforms – a service in which third-party investment managers were available for selection by clients for performance, reporting, advice and guidance. Clients were only permitted to select from those identified on the Platforms.

The adviser’s brochures – Form ADV part 2 – detailed for clients the selection and evaluation process of Platform products. A series of factors were specified in the brochure, informing clients about the process to facilitate their selection. Marketing materials made available to clients highlighted the experience that guided its due diligence analysis and the process. The process was also touted in a Merrill publication titled the “Evaluation Brochure” which discussed the due diligence and overall process.

Generally, when there was a product change a due diligence process was undertaken; an analysis was performed. An internal governance committee made the final decision. In December 2012 the due diligence committee recommended terminating certain products on the Platform. At the time advisory clients had invested about $575 million in the products. The products were managed by a U.S. investment advisory subsidiary of a foreign multinational banking and financial services firm. The internal recommendation stemming from the due diligence group was presented to the internal governance committee in January 2013.

The U.S. investment advisory subsidiary learned about the recommendation to terminate the products prior to any decision by the governance committee inadvertently from a Merrill employee charged with managing the logistics of any termination. That touched off a concerned effort by the U.S. investment advisory subsidiary to reverse the decision and keep the products on the Merrill Platform. As part of that process the U.S. investment advisory pitched the merits of the products. In addition, the firm focused on its broader relation with Merrill and other business conducted with the overall firm. Eventually the decision was reversed – the products stayed on the platform.

While Merrill disclosed in its brochure and marketing materials factors that guided its due diligence regarding products on the Platform, the disclosure did not list Merrill’s other business interests with product sponsors. Thus while advisory clients could expect Merrill to evaluate the merits of a product, the disclosure did not specify that the adviser’s decision would be driven in part by Merrill’s other business interests that were unrelated to the merits of the product. The failure to disclose that the adviser’s self-interest would taint the process not only constituted a conflict of interest but a violation of Advisers Act Section 206(2) which prohibits any transaction, practice or course of business which operates “as a fraud or deceit up an client or prospective client.”

In resolving the proceedings the Commission considered the remedial acts and cooperation of the adviser. Merrill consented to the entry of a cease and desist order based on Advisers Act Section 206(2) and a censure. The firm will pay disgorgement of $4,032,871.89, prejudgment interest of $806,981.03 and a penalty equal to the amount of disgorgement.

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