Regulator did not cite any individuals as being responsible for the alleged violations.

[ by Howard Haykin ]

Merrill Lynch agreed to settle FINRA charges related to the firm's alleged failures to provide best execution in certain customer transactions involving non-convertible preferred securities transactions.  All trades in question were executed on ML BondMarket, one of the firm's proprietary order management systems.  The firm was further cited for an inadequate supervisory system and WSPs.  

In addition to monetary sanctions, Merrill must revise its written supervisory procedures regarding ML BondMarket best execution obligations within 30 business days. 

Tom Gira,  FINRA EVP and Head of Mkt Regulation, said this about his department's investigation of Merrill Lynch:  "It is paramount that a broker-dealer's systems are adequately designed to ensure that customers receive fair prices in securities transactions. Merrill Lynch lacked the necessary systems and supervision to ensure that it provided customers with the best execution of their non-convertible preferred securities transactions which resulted in many customers receiving inferior prices for more than four years."

FINRA Findings and Allegations.   The Customer Issues staff of FINRA's Market Regulation Division investigated retail transactions in exchange listed non-convertible preferred securities ("NCP securities") that were executed off exchange on the firm’s proprietary ML BondMarket ("MLBM") order execution system from 4/1/06 through 12/31/10 - the “review period”.

MLBM was one of the options available to the firm for executing these customer transactions - having been programmed to automatically execute transactions in NCP securities of 5,000 or fewer shares, based upon published quotations. 

However, during the review period, MLBM apparently had a major flaw in its pricing logic.  The Program only incorporated the quotations from the 2 primary exchanges where the NCP securities were listed, but disregarded bestter quotations offered on markets other than the primary listing exchange.  And so, the MLBM systematically executed transactions in NCP securities at prices that were inferior to the NBBO.  During the review period, this occurred in 12,259 transactions for or with a customer. 

Probable Violations.  Having faulty executions transacted over a prolonged period, would indicate that the firm may have failed to use reasonable diligence to ascertain the best inter-dealer market and thus failed to provide best execution - each such occurrence might constitute separate and distinct violations of NASD Rules 2320 and 2110 or FINRA Rule 2010.

Red Flags on FINRA Best Execution Report Cards.   Some 2,200 transactions were listed on FINRA’s best execution report cards from February 2008 through June 2011.  Yet, personnel at Merrill Lynch either failed to review these statistics or they disregarded the statistics. 

If Merrill personnel had been doing a meaningful supervisory review for best ex of NCP transactions executed on MLBM, they might have noted the statistical “red flags” and performed meaningful follow-up supervisory reviews.  That would have indicated the cause of the program.  Either ML personnel were supposed to review the report cards and follow up with exceptions, but chose hot to do so, or the supervisory system and WSPs were set up inadequately without regard to such reviews.  In either case, it would not have taken a major effort to determine responsibility in this matter.

FINRA Sanctions.   Merrill Lynch agreed to accept the following sanctions in order to settle the FINRA charges:   (i) Pay $1.1mn fine;  (ii) pay $324K plus interest in restitution to customers;  and, (iii) revise the WSPs for noted deficiences within 30 days.

For further details, go to:   [ FINRA News Release, 4/16/13 ]    [ FINRA AWC #20080145847—01 ].