FINRA has fined Merrill Lynch $1.5 million over its alleged breach of supervisory and disclosure-related rules involving short positions in municipal securities. The firm was censured, fined, and required to certify that its supervisory systems and written procedures are reasonably designed to achieve compliance with Municipal Securities Rulemaking Board (MSRB) Rules G-17 and G-27 and Rule 15C3-3(D)(4) of the Securities Exchange Act of 1934 (Exchange Act). The firm was also required to certify that its revised written supervisory procedures have been distributed to all firm personnel with responsibilities for compliance with MSRB Rules G-17 and G-27 and Exchange Act Rule 15C3-3(D)(4).
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FINRA Letter of Acceptance, Waiver, and Consent No. 2016050801701
Merrill Lynch and FINRA entered into a Letter of Acceptance, Waiver, and Consent (“AWC”) on October 4, 2021, after FINRA alleged that from February 2015 through June 2021, Merrill Lynch violated MSRB Rule G-27 by failing to establish and maintain a supervisory system, including written procedures, reasonably designed to address short positions in municipal securities and their effects on customers who hold them, namely, the payment of substitute interest and the taxable status of the substitute interest they received.
By failing to take prompt steps to bring short positions in municipal securities within its control within 30 days, Merrill Lynch also violated Exchange Act Rule 15c3-3(d)(4) and FINRA Rule 2010.
Exchange Act Rule 15c3-3(d)(4) requires that no later than one business day after 30 calendar days, broker-dealers must take prompt steps to obtain physical possession or control of securities that are included on the broker-dealer’s books or records that allocate to a short position of the broker or dealer or a short position for another person. A violation of Exchange Act Rule 15c3-3(d)(4) also constitutes a violation of FINRA Rule 2010, which requires members to observe high standards of commercial honor and just and equitable principles of trade.
Additionally, by failing to provide its customers with a notice clearly identifying their receipt of substitute interest payments and the potential tax liability resulting from these payments, Merrill Lynch violated MSRB Rule G-17 during the same time period.
MSRB Rule G-17 provides that, in the conduct of its municipal securities activities, each broker, dealer, and municipal securities dealer shall deal fairly with all persons and shall not engage in any deceptive, dishonest, or unfair practice.
Background on Municipal Securities
The interest earned on municipal securities is exempt from federal (and, at times, state and local) taxes when received from the municipal issuer. However, FINRA member firms may be short municipal securities that are held in customer accounts due to duplicative or erroneous orders, a partial redemption or call, or delayed delivery of the security by the counterparty, among other reasons. When this occurs, the firm is the source of the interest payments to the customers. This “substitute” interest is not tax-exempt. As a result, customers are deprived of the favorable tax status associated with their municipal security investments and exposed to potential tax liability.
Merrill Lynch (CRD#: 7691)
Merrill Lynch is headquartered in New York, New York, and operates over 4,000 branch offices employing approximately 31,000 registered representatives. Merrill Lynch is a full-service brokerage firm providing sales and trading, research, and underwriting services to institutional and retail customers. The firm has been a FINRA member since 1937.
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If you have suffered investment losses with Merrill Lynch, contact New York securities arbitration lawyers of Iorio Altamirano LLP toll-free at (855) 430-4010 for a free and confidential evaluation of your account.
Iorio Altamirano LLP is a securities arbitration law firm based in New York, NY. We pursue FINRA arbitration claims nationwide on behalf of investors to recover financial losses arising out of wrongful conduct by financial advisors and brokerage firms.