Merrill Lynch, Pierce, Fenner & Smith Incorporated has agreed to pay a $1.5 million fine to settle it charges it failed to adopt supervisory measures to address short positions in municipal securities, Finra announced.
The firm also failed to accurately notify customers of their receipt of substitute interest payments, and the potential tax liability from these payments, Finra said.
Finra said from February 2015 through June 2021, Merrill violated rules related to municipal securities by failing to establish and maintain a supervisory system related to the securities, including written procedures addressing short positions. Merrill also failed to promptly bring short positions in municipal securities within its control within 30 days, the regulator said.
Finra said that in February 2015, Merrill was advised to cover its short positions in municipal securities by the end of the month. But in the following month, Merrill reported having 255 short positions older than 30 days and not within the firm’s possession or control, including 83 short positions in municipal securities, Finra said.
Also, Finra said, those short positions increased from 83 to 231 between March and December 2015.
This resulted in Finra advising Merrill to implement supervisory measures to resolve its short positions in municipal securities, but the firm's efforts were unsuccessful, leading to multiple instances of the firm holding too many short positions between 2016 and 2021, Finra said. By June 2021, Merrill had 69 municipal securities short positions with an associated par value of $2,182,854, Finra said.
“Merrill’s supervisory systems were designed only to prevent short positions originating from retail transactions in certain fixed rate bonds and did not consider or address short positions created by other causes,” Finra said.
“Merrill’s failure to implement supervisory systems and procedures designed to detect and resolve short positions in municipal securities, and to prevent their consequences, and to take prompt steps to bring short positions in municipal securities within its control, was not reasonable considering the municipal securities business the firm conducted," Finra added.
Additionally, Finra said Merrill failed to provide prompt disclosures to its customers holding municipal securities of their receipt of substitute interest. From January 2015 through December 2018, Merrill had to pay at least $796,000 in substitute interest to more than 1,500 customers, relating to aged short positions in municipal securities, Finra said.
Asked for a response, Bill Halldin, spokesman for Merrill parent company Bank of America, said, "We have implemented enhancements to our supervisory system and procedures."