Thursday, September 13, 2007

Merrill Lynch - Compliance Management

NASD Fines Merrill Lynch $5 Million for Call Center Supervisory Failures, Sales Contest Violations


Call Center Sales Contests Prohibited for Three Years, Firm Ordered To Impose Special Supervisory Measures Until Corrective Measures Completed

Washington, D.C. — NASD announced today that it has fined Merrill Lynch, Pierce, Fenner & Smith Inc. $5 million for supervisory failures, registration violations, impermissible sales contests and other violations in connection with the operation of its Financial Advisory Center (FAC) located in Hopewell, NJ and Jacksonville, FL. The firm was also prohibited from staging any sales contests for FAC personnel for three years.

In addition, Merrill Lynch was ordered to retain, at its own expense, an independent consultant to recommend corrective measures to firm policies and supervisory and compliance procedures and systems for the FAC. Until those corrective measures are implemented, Merrill Lynch must impose special supervisory procedures, including monitoring calls between FAC personnel and customers.

In connection with today's announcement, NASD is releasing a new Investor Alert, Customer Advisory Centers: Not Your Typical Securities Firm Call Center.

"Regardless of the size of their brokerage account, all investors are entitled to services from registered representatives acting in their clients' best interests who are reasonably supervised by properly registered professionals," said NASD Senior Vice President and Acting Head of Enforcement James Shorris. "In this case, Merrill Lynch failed to meet these basic standards by permitting its call center to function without proper supervisory controls, which gave rise to impermissible sales contests, unsuitable mutual fund switches, and other systemic failures."

NASD found that, from 2001 to 2004, Merrill Lynch did not have an adequate supervisory system and procedures that were reasonably designed to oversee the trading activities of its registered representatives at the FAC, referred to within the firm as Investment Service Advisors (ISAs). Certain of the ISAs engaged in a pattern of mutual fund switch recommendations that were accompanied by misrepresentations and omissions of facts to customers. Further, Merrill Lynch permitted individuals lacking the proper securities licenses and qualifications to be responsible for the supervision of the ISAs. Merrill Lynch also conducted several sales contests which improperly awarded non-cash compensation to ISAs in the form of rock concert tickets, sporting events and dinners based solely on the sale of the firm's proprietary mutual funds.

The FAC was originally designed as a centralized "call center," where customers could call with questions or requests about their accounts and which initially held only a small number of customer accounts. NASD found that the character of the FAC changed in 2001. As a result of an overall Merrill Lynch strategy to improve its retail business by "segmenting" customer accounts, the firm began relocating thousands of customer accounts from branch offices throughout the country to the FAC. Generally, smaller accounts with assets of $100,000 or less, or those with minimal transactional activity, were moved to the FAC, in part so that Merrill Lynch's full service Financial Advisors in branch offices could devote more attention to larger accounts.

NASD found that between March 2001 and August 2002, more than 1 million customers were transferred to the FAC. At its peak size in 2002, the FAC had approximately 1.3 million accounts holding approximately $20 billion in assets. That year, the FAC had gross revenues of approximately $210 million.

For new FAC accounts, Merrill Lynch promised around-the-clock customized financial advice from a "team of Merrill Lynch professionals." NASD found that Merrill Lynch failed to disclose that the ISAs often had five years or less brokerage experience, and that when making recommendations regarding securities, they were limited to mutual funds. ISAs were prohibited from soliciting orders in equities or bonds, unless requested to do so by a client.

ISAs solicited securities transactions from the newly transferred customers, generating millions of dollars in annual gross revenues for Merrill Lynch. There was significant mutual fund switching activity. For example, in one week in March 2002, there were approximately 1,324 mutual fund switches reported by the FAC. Moreover, NASD found that several ISAs recommended mutual fund switches that were not suitable for their customers. For example, ISA's had an obligation, before making a recommendation, to consider whether many of those switches were necessary given that reasonable, free-exchange alternatives were available for customers within their existing mutual fund families. NASD also found that, in connection with the unsuitable switches, certain of the ISAs made false representations to customers, and/or omitted material facts, concerning costs and other important information.

NASD found that, from 2001 through 2004, Merrill Lynch lacked an adequate supervisory system and procedures reasonably designed to supervise the ISAs, particularly given the growth of the FAC. Merrill Lynch, among other things, lacked adequate written supervisory procedures regarding mutual fund recommendations (including switch transactions); did not employ a sufficient number of properly trained and qualified supervisors to monitor activities within the FAC; and failed to conduct annual compliance audits for the FAC's two most active years. Thousands of mutual fund switches were not reviewed or were not adequately reviewed by Merrill Lynch principals.

NASD also found that Merrill Lynch's form "switch letters" sent to customers were often inaccurate. Specifically, the letters represented that that the administrative manager signing the letter had discussed the mutual fund switch with the ISA to confirm that proper disclosure of costs had been made to the customer. In fact, the administrative managers rarely discussed this issue with the ISA before sending the switch letters.

Merrill Lynch allowed its FAC sales managers to exercise direct supervisory responsibility over the ISAs. The majority of those sales managers, however, were not properly registered as securities principals. They were therefore not qualified to supervise ISAs. NASD also found that, even with approximately 300 ISAs generating thousands of trades per day, Merrill Lynch employed only three to six registered principals to review all of the transactions.

NASD's investigation showed that, in 2002, the FAC conducted three sales contests that violated the non-cash compensation rule because they favored the sale of Merrill Lynch's proprietary mutual funds. NASD rules prohibit non-cash compensation arrangements between firms and their brokers for sales of mutual funds and variable contracts that are not based on concepts of "total production" and "equal weighting" - that is, the contests must be based on total sales of all products within a single category, such as mutual funds.

NASD found that the firm offered and awarded various forms of non-cash compensation to the contest winners. For example, one contest rewarded the six ISAs who sold the most proprietary mutual fund products with tickets to a rock concert. Another offered a total of $10,000 in expense credits to the top four teams of ISAs in total of proprietary product sales. These contests, along with several other contests based on overall production, contributed to a dramatic increase in the volume of proprietary mutual fund sales by the FAC. For example, in the first half of 2002, gross sales of proprietary products increased from $36.4 million in the first quarter to $138.7 million in the second quarter - an increase of nearly 300 percent.

In settling this matter, the firm neither admitted nor denied the charges, but consented to the entry of NASD's findings.

Investors can obtain more information about, and the disciplinary record of, any NASD-registered broker or brokerage firm by using NASD's BrokerCheck. NASD makes BrokerCheck available at no charge to the public. In 2005, members of the public used this service to conduct more than 4.3 million searches for existing brokers or firms and requested more than 194,000 reports in cases where disclosable information existed on a broker or firm. Investors can link directly to BrokerCheck at Investors can also access this service by calling (800) 289-9999.

NASD is the leading private-sector provider of financial regulatory services, dedicated to investor protection and market integrity through effective and efficient regulation and complementary compliance and technology-based services. NASD touches virtually every aspect of the securities business - from registering and educating all industry participants, to examining securities firms, enforcing both NASD rules and the federal securities laws, and administering the largest dispute resolution forum for investors and registered firms. For more information, please visit our Web site at

Merrill Lynch agrees to e-mail monitoring and pays $100 million
OUT-LAW News, 22/05/2002

Investment bank Merrill Lynch has agreed to pay $100 million and to settle charges filed by New York State Attorney General Eliot Spitzer over conflicts between investment advice and analyst comments which were revealed by internal e-mails.

The firm, one of Wall Street’s oldest and largest securities firms which controls total client assets of approximately $1.5 trillion, was charged with misleading investors by promoting certain stocks to please its investment banking clients.

Leaked internal e-mails revealed that analysts were publicly rating some stocks as recommended buys while internally rating the same stocks as “crap”. One senior analyst wrote in an e-mail obtained by Eliot Spitzer: "the whole idea that we are independent of [the] banking [division] is a big lie."

The settlement avoids a criminal trial and represents neither evidence nor admission of wrongdoing or liability. However, in addition to the monetary payment, the firm has undertaken to implement:

A complete separation of the evaluation and determination of research analyst compensation from the investment banking business, to be achieved through a number of new policies. Research analysts will be compensated for only those activities and services intended to benefit Merrill Lynch's investor clients.
Creation of a new Research Recommendations Committee to review all initiations of and changes to stock ratings for objectivity, integrity and a rigorous analytical framework.
Appointment of a compliance monitor who, for a period of one year, will ensure compliance with the agreement.
A new system to monitor electronic communications between investment bankers and equity research analysts.
The settlement has not prevented civil lawsuits against the firm. The revelations contained in the e-mails released by Spitzer prompted the raising of a class action against Merrill Lynch and its internet analyst Henry Blodget by investors in search engine company

In a case launched yesterday, investors allege that on the day of giving the company a positive rating, Henry Blodget admitted in an e-mail that there was “nothing interesting about GoTo except banking fees.” The lawsuit also claims that the firm deliberately downgraded a GoTo competitor. When GoTo took its underwriting business to another bank, the lawsuit claims that Merrill Lynch downgraded GoTo in retribution.

See also:

(202) 514-2008
TDD (202) 514-1888


Merrill Lynch Agrees To Cooperate With Enron Investigation, Implement Reforms, With Oversight By Monitor

WASHINGTON, D.C. - Assistant Attorney General Christopher Wray of the Criminal Division, Enron Task Force Director Leslie R. Caldwell, and Assistant Director Grant Ashley of the FBI?s Criminal Investigative Division announced today that three leading former employees of Merrill Lynch & Co., Inc., have been indicted by a federal grand jury on charges of conspiracy to commit wire fraud and falsify books and records. One of the defendants was also charged with perjury and obstructing a federal investigation into the Enron Corporation?s multibillion dollar collapse.

The three-count indictment, returned by a federal grand jury in Houston, Texas, yesterday and unsealed this morning, charges: Daniel Bayly, 56, of Darien, Connecticut, the former head of the Global Investment Banking division at Merrill Lynch; James A. Brown, 51, of Darien, Connecticut, the head of Merrill Lynch?s Strategic Asset Lease and Finance group; and Robert S. Furst, 42, of Dallas, Texas, the Enron relationship manager for Merrill Lynch in the investment banking division.

In a separate agreement reached with the Department of Justice, announced today, Merrill Lynch accepted responsibility for the conduct of its employees. Merrill Lynch also agreed to cooperate fully with the continuing Enron investigation and to implement a series of sweeping reforms addressing the integrity of client and third-party transactions. An independent monitor, along with an outside auditing firm, will monitor Merrill Lynch?s compliance with these new reforms.


The indictment alleges that Enron and Merrill Lynch engaged in a year-end 1999 deal involving the ?parking? of Enron assets with Merrill Lynch. That arrangement allowed Enron to enhance fraudulently the year-end 1999 financial position that it presented to the public and used to pay its executives unwarranted bonuses. The indictment alleges that Bayly, Brown and Furst knowingly participated in this illegal scheme, along with co-conspirators Andrew S. Fastow, Enron?s then-chief financial officer, and Daniel Boyle, then-vice president of Global Finance at Enron. Fastow and Boyle were both charged in a May 2003 indictment, and Fastow?s case is scheduled for trial in April 2004.

According to the indictment, Enron attempted unsuccessfully in 1999 to sell an interest in electricity-generating power barges moored off the coast of Nigeria. Enron, through Fastow, Boyle and others, then arranged for Merrill Lynch to serve as a temporary buyer so that Enron could record earnings and cash flow in 1999, making Enron appear more profitable than it was. Merrill Lynch?s purchase of the Nigerian barges allowed Enron to improperly record $12 million in earnings and $28 million in funds flow in the fourth quarter of 1999. The indictment alleges that Enron promised Merrill Lynch that it would receive a return of its investment plus an agreed-upon profit within six months - an oral agreement that was not disclosed in the written contact used by Enron?s internal and external accountants to determine the accounting treatment of the deal. Specifically, Enron promised in an oral ?handshake? side deal that Merrill Lynch would receive a rate of return of approximately 22 percent, and that Enron would sell the barges to a third party or repurchase the barges within six months. That agreement meant that Merrill Lynch?s supposed equity investment in the barges was not truly ?at risk? and did not qualify as a sale from which earnings and cash flow could be recorded.

On June 29, 2000, having found no true third-party purchaser to buy Merrill Lynch?s interest in the barges, Enron arranged for a special purpose entity known as LJM2, which was owned and operated by Andrew Fastow, to purchase Merrill Lynch?s interest for $7,525,000 - fulfilling the side agreement.

All three defendants were charged with conspiracy to commit wire fraud and falsify books and records, and Brown was also charged with perjury before the Enron Grand Jury and obstruction of the Enron Grand Jury investigation. Specifically, the indictment alleges that while testifying under oath before the grand jury in September 2002, Brown falsely stated he was ?not aware of the promise? by Enron to Merrill Lynch regarding the Nigerian barge investment. The indictment further charges that Brown sought to obstruct and impede the grand jury by making false statements. The indictment also alleges that the defendants made false statements regarding the barge deal when questioned under oath before Congress, the Securities and Exchange Commission, and a court-appointed bankruptcy examiner.

?Investigations of this type are extremely difficult and complicated, and are made even more so when people deliberately seek to hide the truth from investigators,? said Assistant Attorney General Christopher Wray. ?The American public is entitled to a full accounting of the circumstances behind Enron?s collapse, and the Department is committed to prosecuting those who lie or mislead in order to obstruct our investigation.?

If convicted of the conspiracy charge, all three defendants face a maximum sentence of five years in prison. Brown also faces a maximum sentence of five years in prison on the perjury count, and 10 years maximum on the obstruction of justice charge.

An indictment contains allegations that a defendant has committed a crime. Every defendant is presumed innocent until and unless proven guilty.

Merrill Lynch & Co., Inc., Agreement

In its agreement with the Department of Justice, Merrill Lynch acknowledges that the Department has developed evidence during its investigation that one or more Merrill Lynch employees may have violated federal criminal law, and accepts responsibility for any such violations.

The reforms agreed to by Merrill Lynch include:

The creation of a new committee, the Special and Structured Products Committee (SSPC), to review all complex structured finance transactions effected by a third party with Merrill Lynch. The committee will be comprised of senior representatives within the company, including representatives from Market Risk, Law and Compliance, and Accounting, Finance, Tax and Credit. The unanimous approval of the SSPC will be required to authorize a transaction.
For a period of 18 months, Merrill Lynch will retain an independent auditing firm to undertake a review of the processes established by the committee. Merrill Lynch will also retain an attorney, selected by the Department of Justice, to review and oversee the work of the auditing firm and issue periodic reports as to Merrill Lynch?s compliance.
he creation of a written report that sets forth each transaction approved by the SSPC. The reports will be given to the third party?s independent auditor, thereby assuring that a third party?s outside auditor and Merrill Lynch are being provided the same information about the transactions. This will prevent a third party from misleading others.
The development of a comprehensive training program for all personnel that highlights factors in a transaction that would warrant additional scrutiny. Merrill Lynch employees will be instructed to refer to the SSPC all transactions that would fall under its purview.
Based on Merrill Lynch?s acceptance of responsibility, its full cooperation with the Enron investigation, its adoption of a series of significant reforms, and its acceptance of a monitor to oversee the implementation of those reforms, the Department of Justice has agreed not to prosecute Merrill Lynch.

?We are pleased that Merrill Lynch has accepted responsibility, is cooperating fully and has agreed to enact these important reforms,? said Assistant Attorney General Wray. ?This is the kind of corporate response that the Department of Justice encourages and, frankly, expects in the course of a criminal investigation.?

The investigation into Enron?s collapse is being conducted by the Enron Task Force, a team of federal prosecutors supervised by the Department?s Criminal Division and agents from the FBI and the IRS Criminal Investigations Division. The Task Force also has coordinated with and received considerable assistance from the Securities and Exchange Commission. The Enron Task Force is part of President Bush?s Corporate Fraud Task Force, created in July 2002 to investigate allegations of fraud and corruption at U.S. corporations.

Several individuals have been charged, in addition to Fastow and Boyle. Former Enron Treasurer Ben Glisan, charged in the indictment with Fastow and Boyle, pleaded guilty last week to conspiracy to commit wire and securities fraud and immediately was sent to prison to serve a five-year sentence. Fastow?s wife, former Enron Assistant Treasurer Lea Fastow, was charged in May 2003 with conspiracy to commit wire fraud, money laundering conspiracy and filing false tax returns, and trial is set for January 2004. Another indictment charged seven former Enron Broadband Services executives with participating in a long-running scheme to defraud the investing public and others through a series of false statements and press releases about EBS?s financial condition.

In August 2002, former Enron finance executive Michael J. Kopper pleaded guilty to conspiracy to commit wire fraud and money laundering, and is cooperating with the government?s investigation. Former Enron energy traders Timothy N. Belden and Jeffrey Richter pleaded guilty in October 2002 and February 2003, respectively, to conspiracy to commit fraud by manipulating energy prices in the California market. In September 2002, a federal grand jury in Houston returned an indictment charging three former British bankers with wire fraud in a scheme involving the Southampton special purpose entity. In November 2002, former Enron finance executive Larry Lawyer pleaded guilty to making and subscribing a false tax return. And Enron?s former top outside auditor, Arthur Andersen partner David Duncan, pleaded guilty in 2002 to obstructing an SEC investigation into Enron. Andersen itself was convicted of obstruction of justice in June 2002.

The Task Force investigation is continuing.


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