Merrill Lynch has settled the third different FINRA case in the past eight years alleging that its clients paid unneccessarily high fees on their mutual funds.
The wirehouse agreed to pay $15.2 million in restitution and interest to thousands of clients affected by a glitch in its automated system that mistakenly left them invested in Class C shares when cheaper Class A products were available over a six-year span, according to FINRA’s June 1 letter of acceptance, waiver and consent. Despite the fact that the problem continued from January 2015 to January 2021 and overlapped with a separate case involving similar allegations against Merrill, FINRA refrained from adding a fine due to its cooperation with the investigation.
Merrill’s latest case comes the month after top SEC and FINRA enforcement officials speaking at FINRA’s annual conference warned wealth managers that firms may face tougher sanctions based on the previous misconduct of other companies. At the SEC, investigators strive for both a “deterrent effect and protection going forward,” which isn’t evident if another firm is committing an identical violation after a case has been made public, said SEC Associate Enforcement Director Melissa Hodgman.
“If there’s someone else who is doing the exact same thing, we have the sense that it’s become a cost of doing business analysis for people,” Hodgman said. “And that’s not the business we’re in. We’re in the business of protecting investors and market integrity. So if the penalty we saw last time didn’t work, the penalty is going to be higher, because that’s what the system needs in order for us to have a safe and effective market and for investors to feel as if market integrity is being protected.”
At FINRA, which is overseen by the SEC, officials similarly expect firms to “react and do something about it” when they notice disciplinary actions against rivals, Head of Enforcement Jessica Hopper said.
“Your compliance department probably has a group of people or a person or somebody who looks through the disciplinary action reports and says, ‘Oh my God, look what happened,’” she said. “This firm got hit with a fine. I don’t know if that becomes white noise at a certain point and people just don’t pay attention, but please don’t let it become white noise just because you are not the subject of that disciplinary action. It has an effect on what you should be doing.”
In Merrill’s case, the firm had set up a system to avoid the pricier share classes amid separate cases in 2014 and 2020, according to FINRA. The company prevented Class C share purchases that come with annualized expenses of up to 80 basis points higher in some cases when Class A shares were available at a discount or without any sales charge at their net asset value, investigators say. However, the firm’s system ran up $13.4 million in “excess” fees and costs because it erroneously applied the purchase limits for some Class C shares, FINRA says.
To the firm’s credit, it detected the problem, carried out a review of the firm’s sales of Class C shares, hired a third-party consultant “at considerable expense” to identify the harmed accounts, created a plan to provide restitution, and converted C-shares to A-shares, according to the regulator. It also gave “substantial assistance to FINRA in its investigation,” the settlement states. Merrill didn’t admit or deny the allegations as part of the settlement.
“We proactively detected this issue, reported it to FINRA and developed a client reimbursement plan,” spokeswoman Naomi Patton said in a statement. “We implemented enhancements to address the issue and appreciate FINRA’s acknowledgement of our extraordinary cooperation.”
The restitution plus interest in the most recent settlement, plus those ordered in Merrill’s two previous FINRA cases, adds up to $46.8 million in client mutual fund fees during the past eight years — or $119.6 million when including a fine in the first matter and $64.8 million that FINRA said the firm had already paid back to “disadvantaged investors” in 2014.
The case from that year revolved around sales charge waivers for charities and retirement accounts, while the one from 2020 stemmed from other waivers and fee rebates for more than 13,000 accounts, according to the regulator.