Merrill Lynch Fine Renews the Question: Can You Trust Your Broker?


by Pam Martens and Russ Martens, Wall St On Parade:

Yesterday the Securities and Exchange Commission (SEC) quietly dropped a bomb on the relationship that the behemoth Wall Street firm Merrill Lynch has with its institutional clients. For those willing to skip past the timid press release from the SEC and dig carefully through the Administrative Proceeding Order, there was this startling revelation: Merrill Lynch had charged obscene markups (profits for the house) on bond trades over a three and a half-year period that were in two cases cited 23 times and 3 times the industry prescribed legal limit of less than 5 percent.

Merrill Lynch agreed to settle the charges by paying $10.5 million in disgorgement to its ripped-off customers and to pay penalties of $5.2 million to the SEC.

Merrill Lynch is best known as a firm with 15,000 brokers (financial advisors) in branch offices across the United States that caters to the retail market. But the charges brought by the SEC involved Merrill’s traders who were interacting with institutional investors. This raises the question that if Merrill was able to rip off sophisticated investors, what was it doing to its mom and pop clients?

The charges relate to conduct that occurred between June 2009 through December 2012. Let those dates sink in for a moment. It’s nine years since the start of this ripoff and the SEC is just now fining Merrill Lynch, raising the question as to whether the SEC lacks the will, or the staff, or the resources to do its job in a timely manner. It also gives Merrill the ability to tell customers that this all happened under trading supervisors who are long gone.

The bond trading at issue was in the “opaque” RMBS (residential mortgage backed securities) market. That was the subprime mortgage dreck that Wall Street created for the very purpose of making an opaque market in order to charge obscene fees at every stage of the pipeline. This had the upside of minting millionaires on Wall Street and the downside of collapsing the U.S. housing market, exploding the national debt via fiscal stimulus needed to resuscitate the U.S. economy and leaving taxpayers on the hook for the bailout of Wall Street. In addition to the billions of dollars that Merrill received from the publicly disclosed Troubled Asset Relief Program (TARP), Merrill was one of the top-three largest recipients of the secret loan program from the Federal Reserve, receiving $1.8 trillion cumulatively in almost zero-interest rate loans. The Fed battled in court for years to keep those payments secret.

In the current matter, the SEC cited the following two examples of outrageously obscene markups on bonds by Merrill:

“In one instance, Merrill purchased $15,621,000 original face amount of a bond at a price of 1.86. Later that day, a trader, through a salesperson, sold the bond to a Merrill customer at a price of 4.00. The 4.00 price represented an intra-day mark-up of 115.1% and profits to Merrill of approximately $334,289.

“In another instance, Merrill purchased $8,278,000 original face amount of a bond at a price of 34.6125. Later that day, a different trader, through another salesperson, sold the bond to a Merrill customer at a price of 40.00. The 40.00 price represented an intra-day mark-up of approximately 15.6% and profits to Merrill of approximately $388,182.”

Under any historically accepted norms on Wall Street, these markups constitute fraud. But the SEC doesn’t say the markups are fraudulent. It says “failing to disclose the excessive mark-ups” was the conduct that “violated antifraud provisions of the federal securities laws.”

The SEC notes that Merrill had policies in place that recognized that the SEC and FINRA (Wall Street’s self-regulator) “take the position that mark-ups on debt securities generally should be less than 5% and should be lower than mark-ups on an equivalent dollar amount of equity securities. Depending upon the circumstances, mark-ups of less than 5% may be considered unfair and unreasonable.”

Markups in the transparent, competitive U.S. Treasury market, depending on the size of the transaction, are typically conducted at a fraction of one percent. In the far less transparent corporate and municipal bond markets, markups are all over the map depending on the greed of the broker and the willingness to look the other way by the firm. Virtually all brokers know better than to exceed the 5 percent rule.

The SEC order notes that Merrill’s policies referenced FINRA’s exemption on the 5 percent rule “for transactions in non-investment grade debt securities, such as non-agency RMBS, sold to qualified institutional buyers. The policies, however, further provided that, regardless of whether transactions were exempt from the FINRA’s mark-up rules, ‘consideration must be given to the SEC’s anti-fraud rules for mark-ups above 10%.’ ”

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