Merrill Lynch will pay $3 million to settle FINRA allegations that the firm’s compliance procedures failed to catch instances of manipulative trading, including wash trading.
Starting in Dec. 2015, Merrill (and later, Bank of America Securities) failed to have a “reasonably designed” system of supervisory procedures to catch potentially manipulative trading, according to the settlement letter filed Aug. 28.
In particular, Merrill relied on “third-party automated surveillances” to check for such activity, including wash trading (in which brokers buy and sell shares of the same company to create the illusion of market activity and interest) and prearranged trading (in which brokers carry out trades at pre-set prices to reduce risk).
However, according to FINRA, the third-party automated parameters were too narrow to catch wrongdoing. In particular, the surveillance was limited to checking potential wash trades occurring between the same account or executed simultaneously or for the same volume and price, and then versed back to the original account.
But manipulative wash trading isn’t limited to trades under these confines, according to FINRA. The third-party automated software had similar parameters limiting the surveillance scope of potentially manipulative prearranged trades. FINRA found Merril didn’t take “reasonable steps” to determine whether these narrowed parameters made sense for the needed surveillance.
“The firm could not explain why it initially selected the particular modules that it used or why it did not select other modules that were available from the vendor,” the settlement letter read. “Additionally, although the firm’s procedures included a review process for one of its surveillance systems, the procedures provided insufficient guidance regarding how parameter change decisions should be made or documented.”
Additionally, FINRA alleged Merrill didn’t run its surveillanxce systems on trading in over-the-counter (OTC) securities during a period in 2017 and 2018 (OTC securities are those shares not traded on a national exchange, often consisting of securities for smaller companies).
For several years, the firm also didn’t review alerts generated by several of its surveillance systems in equities and options, according to FINRA. Merrill didn’t know about the issue until Aug. 2020, when it looked into the matter after responding to regulators on a separate investigation, despite what FINRA said were “numerous red flags, such as internal testing results.”
In all, the firm didn’t review about 155 alerts with about 700 potewntially manipulative equity trades, as well as about 1,000 alerts including approximately 125,000 potnwetially manipulative options trades, according to FINRA.
A spokesperson for Merrill noted there was no client harm and said “we have been enhancing our survreillance program and will continue to implement improvements to ensure we meet regulatory requirements.”
Merrill did not admit or deny the findings in the settlement.
$669,000 of the $3 million fine will be paid to FINRA, with the remainer going to a variety of exhcanges, including Nasdaq and the New York Stock Exchange. Merrill also agreed to a censure, and to relay in writing within 180 days that the firm had “remidiated the issues” in the settlement.
