The Securities and Exchange Commission (SEC) has fined Merrill Lynch nearly $4 million for poor oversight of client investments. This action stems from issues with a strategy managed by Harvest Volatility Management LLC.
Between March 2016 and April 2018, Merrill Lynch failed to monitor client investment limits properly. The SEC’s decision highlights the importance of financial firms meeting their duties to clients.
Merrill Lynch and Harvest Volatility Management together paid $9.3 million in penalties and disgorgement. This case involved an options strategy linked to the S&P 500 index for wealthy investors.
By January 2017, over 100 accounts exceeded their set investment amounts. This number grew to 186 accounts by year-end, with some 50% above agreed levels. The SEC accused both firms of breaching their responsibilities to clients.
These breaches led to higher fees and losses for investors. Bank of America, Merrill’s parent company, has since stopped new sign-ups with Harvest. The SEC’s action shows its commitment to protecting investors.
What other steps might regulators take to prevent such oversights?
Key Takeaways
Table of Contents
- The SEC fined Merrill Lynch $3.8 million for failing to monitor client investment limits in Harvest Volatility Management’s options trading strategy from 2016 to 2018.
- Merrill Lynch allowed 186 client accounts to exceed pre-set exposure levels by 30% or more, with 74 accounts surpassing 50% of their designated amounts.
- Harvest Volatility Management paid $5.5 million in penalties, bringing the total settlement to $9.3 million for oversight issues and breach of fiduciary duty.
- Merrill Lynch earned about $1 million in extra commissions and $2 million from excess management fees due to the oversight failure.
- The case highlights the importance of financial firms maintaining proper oversight, transparency, and communication with clients about their investments and risk levels.
SEC Fines Merrill Lynch Over Harvest Volatility Management
The SEC fined Merrill Lynch for issues with Harvest Volatility Management. Merrill Lynch failed to oversee Harvest’s options trading strategy, leading to client losses.
Allegations and Settlement
The Securities and Exchange Commission (SEC) charged Merrill Lynch and Harvest Volatility Management for exceeding client investment limits. This breach occurred over a two-year period, violating agreed-upon exposure levels.
Merrill Lynch failed to monitor these limits properly, leading to excess fees and increased financial risks for clients.
Both firms settled the charges without admitting or denying the SEC’s claims. Merrill Lynch agreed to pay $3.8 million in total, including disgorgement, interest, and a civil penalty.
Harvest Volatility Management also faced penalties, agreeing to pay $5.5 million in disgorgement, interest, and fines. The combined settlement reached $9.3 million, addressing the oversight issues and breach of fiduciary duty.
Time Frame and Oversight Issues
Merrill Lynch faced serious oversight issues from March 2016 to April 2018. During this period, the firm failed to monitor and control Harvest Volatility Management’s activities properly.
By January 2017, Merrill knew that over 100 client accounts exceeded their set notional amounts. The problem grew worse. By late 2017, 186 accounts surpassed client-specified limits by 30% or more.
Even more alarming, 74 accounts went beyond 50% of their designated amounts.
Oversight failures can lead to significant breaches of client trust and financial exposure.
Merrill’s inaction worsened the situation. Despite knowing about these limit breaches, the firm allowed Harvest to continue managing accounts without intervention. This lack of oversight exposed clients to higher risks than they had agreed to.
Bank of America, Merrill’s parent company, finally stepped in. They stopped new enrollments with Harvest in 2019 and advised existing clients to unwind their positions. This delayed response highlighted the critical need for timely and effective oversight in investment management.
Breach of Fiduciary Duty
The SEC found Merrill Lynch guilty of breaching its fiduciary duty to clients. This breach involved Merrill’s failure to inform clients that their investments exceeded pre-set exposure levels.
As a result, clients faced higher fees and investment losses. The firm allowed accounts to surpass these levels by 50% or more, showing a lack of proper oversight.
Merrill’s actions led to serious financial consequences for both the firm and its clients. The company gained about $1 million in extra commissions and $2 million from excess management fees.
These charges came directly from customer accounts. The SEC’s ruling highlights the importance of investment advisers upholding their duty to act in their clients’ best interests.
Investments Related to Harvest’s Collateral Yield Enhancement Strategy
Harvest’s Collateral Yield Enhancement Strategy aimed to boost returns for clients. Merrill Lynch failed to follow client limits on this risky investment plan.
Client Indications and Fees
Clients set their market exposure through a “notional amount” in dollars. This amount guided the number of index options bought in Harvest’s Collateral Yield Enhancement Strategy. Ultra-high-net-worth investors used cash or assets as collateral for this plan.
Harvest charged a yearly fee of 50 basis points for managing this strategy. Merrill Lynch also made money from trading commissions within the program. The SEC found issues with how Merrill handled client instructions and fee structures.
Awareness of Exceeding Notional Amounts
Merrill Lynch became aware of serious issues with client accounts in January 2017. Over 100 accounts had gone far beyond their set notional amounts. By the end of that year, the problem had grown.
A total of 186 accounts were 30% or more above their specified limits. Even worse, 74 accounts had ballooned to 50% above their set amounts. Harvest Volatility Management had tried to alert Merrill’s financial advisors about this problem.
In late 2016 and early 2017, they told Merrill that some accounts were 20% or more above client-set levels.
The S&P 500 index played a big role in this issue. It rose more than 25% during this time. This increase caused clients’ notional amounts to grow along with it. Despite knowing about these problems, Merrill Lynch failed to take action.
They didn’t adjust the accounts or inform clients about the increased risk. This lack of action would later lead to trouble with the SEC and hefty fines for the company.
Actions and Adjustments
Merrill Lynch failed to act on the high exposure levels in Harvest’s strategy. This inaction led to regulatory penalties and changes in Harvest’s approach.
Failure to Act by Merrill
Merrill Lynch failed to act on clear signs of trouble in the Collateral Yield Enhancement Strategy (CYES). The firm allowed 186 client accounts to exceed pre-set exposure levels by 50% or more.
This lack of oversight led to increased risk for clients without their knowledge. Despite these issues, Merrill continued to let Harvest Volatility Management handle these accounts.
The Securities and Exchange Commission (SEC) found that Merrill earned about $1 million in extra fees from this oversight failure. The firm did not step in to protect clients or inform them of the heightened risk.
Merrill only stopped new sign-ups for the CYES program in 2019 after spotting the problem. This delay in action showed a breach of fiduciary duty to clients.
Adjustments by Harvest
Harvest Volatility Management LLC made changes to its trading process in the second quarter of 2018. These changes aimed to better match the number of options contracts with client-directed notional amounts.
The firm took this step after exceeding clients’ investment limits by 50% or more since 2016. Harvest managed the Collateral Yield Enhancement Strategy, which involved trading options in a volatility index.
Harvest’s adjustments came after profiting from higher management fees while increasing investors’ risks. The firm typically created a structure of options contracts for CYES every six to eight weeks.
This iron condor strategy involved trading in the commodities markets and dealing with market data. The changes were meant to address issues with exposure levels and align with policies set by registered investment advisers.
Regulatory Penalties and Consequences
The SEC imposed hefty fines on Merrill Lynch and Harvest Volatility Management. Merrill Lynch agreed to pay $3.8 million, which included $2 million in disgorgement, $800,000 in prejudgment interest, and a $1 million civil penalty.
Harvest faced even steeper consequences, agreeing to pay $5.5 million. This sum consisted of $3.5 million in disgorgement and prejudgment interest, plus a $2 million civil penalty.
The total combined payment reached $9.3 million in penalties and disgorgement.
FINRA also took action against Merrill Lynch. The regulatory body issued a separate $275,000 fine for untimely Form U4 updates. Merrill Lynch responded to these violations by stopping new enrollments with Harvest in 2019.
They also advised clients to unwind their positions related to the problematic investments. These actions aimed to address the oversight issues and breaches of fiduciary duty identified by regulators.
The next section will explore the specific investments tied to Harvest’s Collateral Yield Enhancement Strategy.
Conclusion
Merrill Lynch’s oversight failure led to significant penalties and exposed client investments to undue risk. This case highlights the critical need for robust monitoring systems in financial institutions.
Clients must stay vigilant about their investment limits and strategies. Financial advisors should prioritize transparency and regular communication with clients. Regulatory bodies play a vital role in maintaining market integrity and investor protection.
Investors can learn from this incident and ask probing questions about their portfolio management.
