It's standard industry practice to disclose all fees and conflicts of interest to clients, but the recent sanction of Merrill Wealth Management for failing to do just that with certain customers illustrates how challenging the basics can be for advisors.
Merrill agreed to pay over $9.5 million under an
The Securities and Exchange Commission action against the Wall Street wirehouse comes as regulators
The SEC alleged that between May 2016 and July 2020, Merrill advertised programs in which clients could pay a fee for "a range of investment advisory services, including foreign currency exchanges."
The firm mentioned that it would charge "a markup or markdown on foreign currency exchanges," the SEC acknowledged.
"But it did not disclose an additional fee it referred to as a production credit, which, in more than 80 percent of the transactions, was equal to or greater than the disclosed markup or markdown," the SEC said, adding that the production credits were considered commissions for advisors in internal documents. A portion of the production credits was allegedly paid to the advisors.
The SEC also faulted Merrill for allegedly not having better policies and systems in place to catch the mistake.
"Investment advisers must ensure that they do not selectively disclose some fees but not others relating to a particular service," Antonia M. Apps, the director of the SEC's New York Regional Office, said in a statement.
"While Merrill Lynch disclosed the markups or markdowns charged on foreign currency exchanges, thousands of clients were left in the dark as to an often larger fee charged on these transactions and were charged millions of dollars in undisclosed fees."
Louis Straney, a managing partner and industry regulation consultant at Arbitration Insight
"What I'm really surprised by is that this would happen at Merrill," Straney said in an interview.
It's "rare" for such big broker-dealers these days to experience these lapses since they can easily "cut and paste" boilerplate disclosure words to cover themselves, he added.
"Merrill is a large firm," Straney said. "They do hundreds and hundreds of transactions with a prospectus, with disclosure requirements and various risks based upon the various types of variables in the product. So this was an oversight that was certainly manageable."
Still, he said that even if Merrill had disclosed the hidden commissions, customers likely would not have noticed. "Most clients don't pay much attention to those things anyway," Straney said.
The incident underscores how advisors everywhere, even at a big firm that spends so much on compliance and regulation, need to fully understand the products they're selling clients and read the fine print to ensure they can communicate about those accurately, Straney said.
Even if no individual advisor in Merrill's case is on the hook here, the risk for each advisor involved is losing clients who have diminished trust as a result of such mistakes.
"For that, or any other reason," Straney said, clients could move on — given the wide array of options they have to choose from, among advisors and firms in an expanding marketplace.
"This has established a benchmark for Merrill and other firms to be very careful in your offerings. Make sure that all material disclosures are made, and have people review it, understand the product and the manner in which it would be marketed at your organization," Straney said.
"If you were at, let's say Morgan Stanley, and they had a management meeting, they may bring this up and say: Listen, this is what happened at Merrill, and we've got a similar product coming out. Make sure that we don't make the same mistake."
Brian Hamburger, the chief counsel of the Hamburger Law Firm and president and CEO of compliance consulting firm MarketCounsel, said that it's "quite common for an investment advisor to identify a conflict of interest but fail to articulate the full scope and impact of the conflict."
"The SEC deems these partial disclosures to be misleading to clients and has been aggressive in pursuing them," Hamburger added.
In total, Merrill agreed to a cease-and-desist order, a censure and to pay disgorgement of around $4.1 million, interest of $760,000 and a civil penalty of $4.8 million, the SEC noted in its release, adding that the firm neither admitted nor denied the findings.
Merrill agreed as part of the settlement to distribute funds to the affected clients, the SEC said.
"As the order notes, we have updated our disclosures," a Bank of America spokesperson said in an email Tuesday commenting on the settlement.
