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FinOp/Acting CFO Settles with SEC Over Role in Merrill’s Customer Protection Rule Violations
by Howard Haykin
William Tirrell, former FinOp and Head of Regulatory Reporting for Merrill Lynch, Pierce, Fenner & Smith ("MLPF&S") and its wholly-owned subsidiary, Merrill Lynch Professional Clearing Corp. ("MLPro"), agreed to settle SEC charges that he aided and abetted and negligently caused violations of the Customer Protection Rule and the Net Capital Rule by both Merrill entities ("Merrill Lynch"). The SEC did not report on Mr. Tirrell’s imposed sanctions.
BACKGROUND. Tirrell, 64, is a resident of Lawrenceville, NJ, and an associated person of broker-dealer and investment adviser MLPF&S. From 2004 until April 2016 he was a FinOp and Head of the Regulatory Reporting Department for MLPF&S. Tirrell oversaw regulatory reporting for MLPF&S and MLPro. Concurrent with that role, Tirrell was the interim CFO of MLPF&S from 8/9/11 to 9/5/12. He holds a Series 27 license. According to FINRA BrokerCheck, Tirrell is still employed by Merrill Lynch, though the firm(s) no longer sponsor his registrations.
SEC FINDINGS PERTAINING TO THE MERRILL LYNCH SETTLEMENT [SEC PR #16-128, 6/23/16]. In 2016, Merrill Lynch admitted wrongdoing and agreed to pay $415 million in fines, interest and disgorgement to settle SEC charges that, among other things, it committed two violations of the Customer Protection Rule - which requires broker-dealers to safeguard the cash of their customers so that customer assets can be quickly returned if the firm fails.
Violation #1. From 2009 to 2012, SEC investigators found that Merrill Lynch misused customer cash that rightfully should have been deposited in a reserve account. Merrill Lynch engaged in complex options trades, known internally as the “Leveraged Conversion Trades,” that lacked economic substance and artificially reduced the required deposit of customer cash in the reserve account.
► ML made billions of dollars in margin loans to finance riskless trades that lacked defined terms and economic substance which ML structured and then executed with newly-created counterparty entities. Through these trades, ML improperly reduced by billions of dollars the amount it was required to deposit in its customer reserve account. These Trades evolved over time and, in their final iteration, became instantaneous roundtrips structured to provide financing for ML’s activities rather than in response to customer trading objectives.
► ML used these Trades to remove up to $5 billion of customer cash week over week from its customer reserve account. ML then used these funds to finance its business activities.
► Had ML failed when the Trades were in use, its customers would have been exposed to a shortfall of customer cash in the customer reserve account.
- Violation #2. The second set of violations involved the custody of customer securities from 2009 to 2015. Rule 15c3-3(c) requires broker-dealers like MLPF&S to hold customer securities that are not collateralizing margin loans in a segregated account free of liens. The purpose of this requirement is to protect customer securities from claims by a failed broker-dealer’s creditors.
► Merrill Lynch, however, held up to $58 billion per day of customer securities in a clearing account that was subject to a general lien by its clearing bank and held additional customer securities in accounts worldwide that similarly were subject to liens. Had Merrill Lynch collapsed at any point, customers would have been exposed to significant risk and uncertainty of getting back their own securities.
SEC FINDINGS PERTAINING TO WILLIAM TIRRELL SETTLEMENT. According to the SEC Administrative Proceeding - which was toned down somewhat from the SEC 6/23/16 Complaint that ordered a public hearing to consider the charges against Mr. Tirrell - the Commission concluded the following:
- As Head of Regulatory Reporting, Tirrell’s department was responsible for, among other things, ensuring ML protects its customers by complying with the Customer Protection Rule.
- As designated FinOp, Tirrell had specific and primary responsibilities for the firm’s compliance with that Rule.
- In these capacities, Tirrell and his subordinates calculated the customer reserve requirement each week.
- Tirrell caused Merrill Lynch to reduce the amount reserved by billions as a result of the Trades.
- Tirrell took these actions while failing to respond to questions from regulators about changes being made to the Trades, of which he and others at Merrill Lynch had given approval.
- Tirrell should have known that the purpose of the Trades was to finance firm inventory and should have conveyed that purpose to regulators.
- In so doing, Tirrell was negligent.
POSTSCRIPT. According to FINRA BrokerCheck, a putative class action complaint was filed on 5/19/17 in California federal court against Merrill Lynch and William Tirrell, alleging fraud and negligence (among other counts) against the named Defendants.