DOB: Merrill Lynch - 2006 Consent Order

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IN THE MATTER OF:

MERRILL LYNCH, PIERCE,
FENNER & SMITH INCORPORATED
CRD NO. 7691

    ("Merrill Lynch")

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CONSENT ORDER

DOCKET NO. CO-2006-7013-S


PRELIMINARY STATEMENT

WHEREAS, the Banking Commissioner (“Commissioner”) is charged with the administration of Chapter 672a of the Connecticut General Statutes, the Connecticut Uniform Securities Act (“Act”), and Sections 36b-31-2 et seq. of the Regulations of Connecticut State Agencies promulgated under the Act (“Regulations”);

WHEREAS, Merrill Lynch is a broker-dealer registered in the state of Connecticut;

WHEREAS, the Commissioner, through the Securities and Business Investments Division (“Division”) of the Department of Banking, conducted an investigation pursuant to Section 36b-26(a) of the Act effective prior to October 1, 2005, into the activities of Merrill Lynch to determine whether Merrill Lynch had violated, was violating or was about to violate any provisions of the Act or Regulations (“Investigation”);

WHEREAS, as a result of the Investigation, the Division alleges the following:

1.
From January 2002 to October 2003, Merrill Lynch employed Christopher D. Chung, CRD # 2132475 (“Chung”), Kevin P. Brunnock, CRD # 2836503 (“Brunnock”), and William B. Savino, CRD # 721027 (“Savino”), as agents in its Fort Lee, New Jersey, branch office (“Fort Lee Branch”);
2.
From January 2002 to September 2003, Chung, Brunnock and Savino engaged in the practice of market timing mutual funds and underlying “subaccounts” in variable annuity products, many of which were offered by Connecticut financial institutions, on behalf of a hedge fund client through accounts maintained at Merrill Lynch and mutual fund companies.  Market timing is the practice of trading in and out of mutual funds in order to exploit inefficiencies in mutual fund pricing and to capture a profit at the expense of long-term investors and the mutual funds;
3.
Since June 1999, Merrill Lynch’s Branch Office Policy Manual (“Policy Manual”) expressly prohibited market timing.  In pertinent part, it provided that:
Merrill Lynch prohibits “market-timing” trading in mutual funds. . . .
 
The Firm will not execute mutual fund trades placed for the purpose of market timing and will decline to open accounts established for the purpose of market-timing mutual funds.
4.
Merrill Lynch represents that on various occasions during 2002, it had instructed Chung, Brunnock and Savino that their hedge fund client’s short-term trading of mutual funds violated Merrill Lynch’s internal policy which prohibited market timing transactions in mutual funds;
5.
In the summer of 2002, the Complex Managing Director for the Fort Lee Branch advised Chung, Brunnock and Savino that the hedge fund client could purchase mutual fund positions at Merrill Lynch, but instructed that any short-term trading of mutual fund positions must be done directly by the client at the mutual fund companies outside of Merrill Lynch;
6.
Thereafter, Chung, Brunnock and Savino assisted the hedge fund client in executing market timing transactions in accounts maintained by the client outside of Merrill Lynch at mutual fund companies;
7.
Merrill Lynch failed to maintain memoranda of orders concerning trades executed at the mutual fund companies and reallocations of underlying “subaccounts” in variable annuity products;
8. The Resident Manager of the Fort Lee Branch did not enforce or implement adequate procedures to maintain and review incoming and outgoing correspondence and facsimile transmissions concerning such activities; and
9. Merrill Lynch, through its Resident Manager, Complex Managing Director, Regional Managing Director and Regional Administrative Manager, failed to implement adequate procedures to enforce its Policy Manual in the Fort Lee Branch in order to prevent Chung, Brunnock and Savino from engaging in market timing;

WHEREAS, the Commissioner believes that Merrill Lynch’s failure to maintain certain books and records in connection with the execution of trades in accounts maintained at mutual fund companies is a violation of Section 36b-31-14a of the Regulations, which may constitute a basis for the issuance of an order suspending or revoking Merrill Lynch’s registration as a broker-dealer in Connecticut pursuant to Section 36b-15(a)(2)(B) of the 2006 Supplement to the General Statutes and the imposition of a fine upon Merrill Lynch not to exceed Ten Thousand Dollars ($10,000) per violation pursuant to Section 36b-27(d) of the Act effective prior to October 1, 2003;

WHEREAS, the Commissioner believes that Merrill Lynch’s failure to reasonably supervise Chung, Brunnock and Savino is a violation of Section 36b-31-6f of the Regulations, which may constitute a basis for the issuance of an order suspending or revoking Merrill Lynch’s registration as a broker-dealer in Connecticut pursuant to Sections 36b-15(a)(2)(B) and 36b-15(a)(2)(K)(i) of the 2006 Supplement to the General Statutes and the imposition of a fine upon Merrill Lynch not to exceed Ten Thousand Dollars ($10,000) per violation pursuant to Section 36b-27(d) of the Act effective prior to October 1, 2003;

WHEREAS, the Commissioner believes that the practice of market timing has a detrimental effect on Connecticut investors and mutual fund companies;

WHEREAS, Merrill Lynch terminated Chung, Brunnock and Savino in October 2003 for failing to follow its policy prohibiting certain short-term trading activities in mutual funds and for engaging in other related violations of Merrill Lynch policies.  In addition, Chung and Savino were terminated for failing to follow specific Merrill Lynch directives;

WHEREAS, Merrill Lynch fined its Complex Managing Director, Regional Managing Director and Regional Administrative Manager for failing to adequately supervise its agents in connection with the conduct described above;

WHEREAS, Merrill Lynch has cooperated in the Investigation by responding to inquiries, providing documentary evidence and other materials, and providing access to facts relating to the Investigation;

WHEREAS, Merrill Lynch, through its affiliate, Financial Data Services, Inc., implemented a change in its procedures such that Merrill Lynch now provides client tax identification numbers (“TIN”) to the National Securities Clearing Corporation (“NSCC”) when transmitting orders to mutual fund companies.  Merrill Lynch has also developed the capability to provide a TIN to NSCC when transmitting orders to sell mutual fund positions, provided the mutual fund companies elect to receive the TIN (“TIN Transmittal Procedure”);

WHEREAS, Merrill Lynch has begun implementing procedures to maintain, as a required record under the Act and the Regulations, client reallocation requests made to Merrill Lynch employees concerning underlying “subaccounts” in non-proprietary variable annuity products (“Reallocation Request Procedures”);

WHEREAS, Merrill Lynch issued a Global Compliance Alert communication detailing its policies and procedures with respect to the review and retention of incoming and outgoing correspondence and facsimile transmissions and advising agents and compliance personnel that correspondence and facsimile transmissions concerning a client’s reallocation of “subaccounts” underlying variable annuity products shall be maintained in accordance with such policies and procedures (“Global Compliance Alert”);

WHEREAS, Merrill Lynch implemented a policy and procedure addressing how agents should deal with instructions from Merrill Lynch clients to trade mutual fund positions in accounts held outside of Merrill Lynch (“Outside Position Policies & Procedures”);

WHEREAS, an administrative proceeding initiated under Section 36b-15 or 36b-27 of the Act would constitute a “contested case” within the meaning of Section 4-166(2) of the Connecticut General Statutes;

WHEREAS, Section 4-177(c) of the Connecticut General Statutes provides, in relevant part, that “[u]nless precluded by law, a contested case may be resolved by . . . consent order”;

WHEREAS, Section 36b-31(a) of the 2006 Supplement to the General Statutes provides, in relevant part, that “[t]he commissioner may from time to time make . . . such . . . orders as are necessary to carry out the provisions of sections 36b-2 to 36b-33, inclusive”;

WHEREAS, Merrill Lynch and the Commissioner now desire to resolve the foregoing matter without the need for administrative proceedings, and agree to the language in this Consent Order.


CONSENT TO WAIVER OF PROCEDURAL RIGHTS

WHEREAS, Merrill Lynch, through its execution of this Consent Order, voluntarily waives the following rights:

1.
To be afforded an opportunity for a hearing within the meaning of Sections 36b-15(f) and 36b-27(d)(2) of the 2006 Supplement to the General Statutes, and Section 4-177(a) of the Connecticut General Statutes;
2.
To present evidence and argument and to otherwise avail itself of Sections 36b-15(f) and 36b-27(d)(2) of the 2006 Supplement to the General Statutes, and Section 4-177c(a) of the Connecticut General Statutes;
3. To present its position in a hearing in which it is represented by counsel;
4. To have a written record of the hearing made and a written decision issued by a hearing officer; and
5. To seek judicial review of, or otherwise challenge or contest the matters described herein, including the validity of this Consent Order.

ACKNOWLEDGEMENT OF THE COMMISSIONER’S ALLEGATIONS

WHEREAS, Merrill Lynch, through its execution of this Consent Order, acknowledges the following allegations of the Commissioner, without admitting or denying them:

1.
The entry of this Consent Order is necessary or appropriate in the public interest or for the protection of investors and consistent with the purposes fairly intended by the policy and provisions of the Act;
2.
Merrill Lynch failed to maintain adequate books and records in violation of Section 36b-31-14a of the Regulations, which may constitute a basis for an order suspending or revoking its registration as a broker-dealer in Connecticut pursuant to Section 36b-15(a)(2)(B) of the 2006 Supplement to the General Statutes and an order imposing fine pursuant to Section 36b-   27(d) of the Act effective prior to October 1, 2003; and
3.
Merrill Lynch failed to reasonably supervise its agents in violation of Section 36b-31-6f of the Regulations, which may constitute a basis for an order suspending or revoking its registration as a broker-dealer in Connecticut pursuant to Sections 36b-15(a)(2)(B) and 36b-15(a)(2)(K)(i) of the 2006 Supplement to the General Statutes and an order imposing fine pursuant to Section 36b-27(d) of the Act effective prior to October 1, 2003.

WHEREAS, if proven, the Commissioner would have the authority to enter findings after granting Merrill Lynch an opportunity for a hearing;
 
WHEREAS, this Consent Order concludes the Investigation by the Commissioner concerning the matters alleged herein and any related civil or administrative action that could be commenced under the Act or Regulations on behalf of the Commissioner relating to Merrill Lynch, its current affiliates and its current employees;

WHEREAS, Merrill Lynch acknowledges the possible consequences of an administrative hearing and voluntarily agrees to consent to the entry of the sanctions described below.


CONSENT TO ENTRY OF SANCTIONS

WHEREAS, Merrill Lynch, through its execution of this Consent Order, consents to the Commissioner’s entry of a Consent Order imposing on it the following sanctions:

1.
No later than the date this Consent Order is issued by the Commissioner, Merrill Lynch shall remit to the Department of Banking, by electronic funds transfer, the sum of One Million Dollars ($1,000,000) as an administrative fine;
2.
In addition to the amount that Merrill Lynch is scheduled to contribute to Merrill Lynch & Co. Foundation Inc. (“Foundation”) on behalf of its Investing Pays Off® program prior to the issuance of this Consent Order, Merrill Lynch shall contribute an additional $1.5 Million ($1,500,000) to the Foundation over three years, which shall be made available to public schools and non-profit organizations in all member jurisdictions of the North American Securities Administrators Association (“Member Jurisdictions”), in accordance with Foundation policies and procedures, for the purpose of promoting financial literacy in public schools through the Investing Pays Off® program.  Merrill Lynch shall comply with the following provisions concerning the $1.5 Million ($1,500,000) contribution:
a.
The payments to the Foundation shall be made in four equal installments of Three Hundred Seventy-five Thousand Dollars ($375,000) as follows:  Merrill Lynch shall pay the first installment of Three Hundred Seventy-five Thousand Dollars ($375,000) to the Foundation no later than January 31, 2007; the second installment no later than July 1, 2007; the third installment no later than January 31, 2008; and the fourth installment no later than January 31, 2009;
b. No later than 30 days after each payment of Three Hundred Seventy-five Thousand Dollars ($375,000) to the Foundation, Merrill Lynch shall submit to the Division Director written evidence or acknowledgment of such payment;
c. No later than 30 days after each January payment of Three Hundred Seventy-five Thousand Dollars ($375,000) to the Foundation, until evidence has been submitted to the Division Director that the $1.5 Million ($1,500,000) contribution has been completely expended or committed for expenditure, Merrill Lynch or the Foundation shall give notice to Member Jurisdictions of the availability of grants for the purpose of promoting financial literacy in public schools.  No later than ten (10) days after distribution of any such notice, Merrill Lynch shall mail a copy of the notice to the Division Director;
d. No later than January 31, 2008, January 31, 2009 and January 31, 2010, Merrill Lynch shall send to the Division Director a written report that accounts for the expenditure and commitment for expenditure by the Foundation of the $1.5 Million ($1,500,000) contribution through the previous calendar year-end;
e. No later than the date this Consent Order is issued by the Commissioner, both an authorized representative of Merrill Lynch and an authorized representative of the Foundation shall attest in writing to the Division Director that, pursuant to this Consent Order:  (1) Merrill Lynch will pay $1.5 Million ($1,500,000) to the Foundation and (2) that such $1.5 Million ($1,500,000) is in addition to Merrill Lynch’s scheduled contribution amounts to the Foundation;
3.
Merrill Lynch shall pay a total of Five Hundred Thousand Dollars ($500,000) over three years to the State of Connecticut Department of Education (“Department of Education”) in order to promote financial literacy initiatives in Connecticut public schools as determined by the Commissioner of Education, and shall comply with the following provisions:
a.
The payments shall be made to the Department of Education in four equal installments of One Hundred Twenty-five Thousand Dollars ($125,000) as follows:  Merrill Lynch shall pay the first installment of One Hundred Twenty-five Thousand Dollars ($125,000) no later than 30 days after notice by the Department that such first installment shall be paid; the second installment shall be paid no later than July 1, 2007; the third installment no later than July 1, 2008; and the fourth installment no later than July 1, 2009.
b. No later than 30 days after each payment of One Hundred Twenty-five Thousand Dollars ($125,000) to the Department of Education, Merrill Lynch shall submit to the Division Director written evidence or acknowledgement of such payment;
4.
Merrill Lynch shall pay a total of Five Hundred Thousand Dollars ($500,000) over three years to the National White Collar Crime Center (“NW3C”) for the purpose of training Connecticut regulatory and law enforcement personnel in the investigation and prosecution of administrative, civil and criminal violations of law governing financial, banking, corporate and securities matters, such as identity theft and Internet fraud, and shall comply with the following provisions:
a.
The payments shall be made to NW3C in four equal installments of One Hundred Twenty-five Thousand Dollars ($125,000) as follows:  Merrill Lynch shall pay the first installment of One Hundred Twenty-five Thousand Dollars ($125,000) no later than 30 days after notice by the Department that such first installment shall be paid; the second installment shall be paid no later than July 1, 2007; the third installment no later than July 1, 2008; and the fourth installment no later than July 1, 2009.
b. No later than 30 days after each payment of One Hundred Twenty-five Thousand Dollars ($125,000) to NW3C, Merrill Lynch shall submit to the Division Director written evidence or acknowledgement of such payment;
5. No later than 30 days from the date this Consent Order is issued by the Commissioner, Merrill Lynch shall send to the Division Director a written acknowledgment of its TIN Transmittal Procedure and copies of its Reallocation Request Procedures, Global Compliance Alert and Outside Position Policies & Procedures;
6. Merrill Lynch agrees not to take any action or to make or permit to be made any public statement denying, directly or indirectly, any finding in this Consent Order or creating the impression that this Consent Order is without factual basis.  Nothing in this paragraph affects Merrill Lynch’s (i) testimonial obligations, or (ii) right to take legal or factual positions in defense of litigation or in defense of other legal proceedings in which the State of Connecticut, Department of Banking is not a party;

WHEREAS, the Commissioner believes that the sanctions contained herein are necessary to further the purposes and policies of the Act;

AND WHEREAS, Merrill Lynch specifically assures the Commissioner that none of the violations alleged herein shall occur in the future.


CONSENT ORDER

 NOW THEREFORE, the Commissioner enters the following:

1.
The Sanctions set forth above be and are hereby entered;
2.
Entry of this Consent Order by the Commissioner is without prejudice to the right of the Commissioner to take enforcement action against Merrill Lynch based upon a violation of this Consent Order or the matters underlying its entry, if the Commissioner determines that compliance with the terms herein is not being observed or if any representations made by Merrill Lynch and reflected herein are subsequently discovered to be untrue; and
3.
This Consent Order shall become final when issued.

Issued at Hartford, Connecticut
this 22nd day of November 2006.            ________/s/_________
                                                        Howard F. Pitkin
                                                        Banking Commissioner



CONSENT TO ENTRY OF ORDER

I, Andrew Kandel, state on behalf of Merrill Lynch, Pierce, Fenner & Smith, Incorporated, that I have read the foregoing Consent Order; that I know and fully understand its contents; that I am authorized to execute this Consent Order on behalf of Merrill Lynch, Pierce, Fenner & Smith, Incorporated; that Merrill Lynch, Pierce, Fenner & Smith, Incorporated agrees freely and without threat or coercion of any kind to comply with the terms and conditions stated herein; and that Merrill Lynch, Pierce, Fenner & Smith, Incorporated voluntarily consents to the issuance of this Consent Order, expressly waiving any right to a hearing on the matters described herein.

                                                   
 By:  ________/s/_________
       Name:  Andrew Kandel
       Title:  First Vice President
       Merrill Lynch, Pierce, Fenner & Smith, Incorporated

 

State of:  New York

County of:  Kings

On this the 16th day of November 2006, before me, ____________________, the undersigned officer, personally appeared Andrew Kandel, who acknowledged himself to be the FVP of Merrill Lynch, Pierce, Fenner & Smith, Incorporated, a corporation, and that he, as such FVP, being authorized to do so, executed the foregoing instrument for the purposes therein contained, by signing the name of the corporation by himself as FVP.

In witness whereof I hereunto set my hand.


                                                    ________/s/_________
                                                    Notary Public
                                                    Date Commission Expires:  4/12/07


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