Customer Betrayal: Lessons From The Merrill Lynch Fraud Case

On January 25th, Merrill Lynch settled the company’s fraud case with the SEC for $10 million. Not a big penalty when you consider what the company was accused of.

Posted by Joe Gerard in on February 15th, 2011

It’s that time again! Another company has settled with the SEC for fraud accusations. On January 25th, Merrill Lynch settled the company’s fraud case with the SEC for $10 million. Not a big penalty when you consider what the company was accused of. If the SEC wants to be taken seriously and truly enforce the rules, the consequences they hand out need to reflect the damage that was done. If companies see others, like Merrill Lynch, receiving the equivalent of a slap on the wrist for their actions, it becomes acceptable to pay a small fine for an illegal activity that provides greater gains for the company – and that would be a total disaster.

Fraudulent Activity

In a press release from the SEC, it states that some of the traders at Merrill Lynch acted inappropriately, making trades based on information gathered from trades made for their clients. The SEC also noted that trades made on the company’s behalf were done so at a better price than the one charged to clients. The In Audit article “Merrill Lynch Charged with Misusing Customers’ Order Data, Hiding Trading Fees,” states that:

“The SEC alleged that Merrill Lynch, which declared bankruptcy at the height of the global financial meltdown in 2008, had misused the order data of institutional customers from other traders obtained through its equity strategy desk to place trades on behalf of its own account. Under the new regulation implemented last summer, banks are prohibited from making excessive proprietary trading on its own behalf.”

The customer data was misused between 2002 and 2007. Many outlets are reporting that the company likely made a lot more than $10 million off of these trades, which is why I mentioned earlier that this fine isn’t overly significant considering the crime.

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Lessons Learned

1. Keep it Separate

The Law 360 article “Merrill Lynch Settles SEC Fraud Charges For $10M,” reported that Merrill Lynch:

“Failed to maintain proper firewalls between its trading desks — enabling the equity strategy desk traders to track customer transactions and encouraging its market making desk traders to share profitable “trading ideas” with the equity desk traders.”

This information isn’t supposed to be shared between these two groups, as it violates the Vlocker Rule.

2. Good Deeds Go Far

When deciding the fate of Merrill Lynch, the SEC took into consideration actions that had been taken by the company after it had been acquired by the Bank of America. After the acquisition, Merrill Lynch had taken remedial action to address these issues. In the Law 360 article mentioned above, Bill Halldin, spokesperson for Bank of America/Merrill Lynch stated:

“Merrill Lynch adopted a number of policy changes to ensure separation of proprietary and other trading and to address the SEC’s concerns. Merrill Lynch also voluntarily implemented enhanced training and supervision to improve the principal trading processes at the firm.”

This proves to companies that cooperation, compliance programs and other activities are worth it – especially if your company finds itself in an unethical situation. I’m not saying that the good should outweigh the bad when the SEC makes these types of decisions, but in some cases, the act of a single person can bring an entire organization to its knees.

3. Transparency and Information Privacy

Merrill Lynch took information from clients and used it in more ways than they were permitted to. Order information is intended for just that, placing the client’s order. The actions of the traders at Merrill Lynch violated the agreement between the company and its clients. The company went on to further violate this agreement, as the SEC explains:

“In some instances, Merrill also charged customers undisclosed mark-ups and mark-downs by filling customer orders at prices less favorable to the customer than the prices at which Merrill purchased or sold the securities in the market.”

Companies need to be transparent in order to gain the trust of clients and customers. You need to let them know exactly where their money is going or what is being done with their information. People trusted Merrill Lynch to take their information and make trades for them, not to have the information shared with anyone else in the company for their benefit. These actions fail to promote transparency with the client and violated the company’s responsibility to maintain privacy over client information.

Joe Gerard
Joe Gerard

CEO, i-Sight

Spend my days showing off the i-Sight investigative case management software and finding ways to help clients improve their investigations. Usually working with corporate security, HR & employee relations, compliance and legal teams.

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