Thursday, June 04, 2015

Merrill Lynch Receives Rule 506 Disqualification Waiver in Connection with Short Sale Violations

By Jacquelyn Lumb

The SEC’s Division of Corporation Finance has determined that Merrill Lynch, Pierce, Fenner & Smith Incorporated and Merrill Lynch Professional Clearing Corporation have made a showing of good cause for why it is not necessary to deny their reliance on Rule 506 of Regulation D based on their violation of Regulation SHO. In an order dated June 1, Merrill Lynch admitted the SEC’s findings that it violated Reg. SHO in connection with its practices relating to the execution of short sales. The firm agreed to cease and desist from committing or causing any future violations of Rule 203(b) of Reg. SHO, to be censured, and to pay disgorgement of over $1.5 million plus prejudgment interest. The firm also agreed to pay a civil monetary penalty of $9 million and to retain an independent consultant to review its policies and procedures related to its executions of short sales.

Reg. SHO violations. The SEC found that Merrill Lynch accepted new short sale orders in reliance on an easy to borrow list even after learning that reliance on the list was no longer reasonable. In some instances, the firm used data that was more than 24 hours old to construct the easy to borrow list, which resulted in some securities being included on the list when they should not have been.

Waiver request. Merrill Lynch sought a waiver of any disqualifications from relying on exemptions from Rule 506 that would apply as a result of the SEC’s administrative order. The firm explained that the alleged misconduct was not widespread and related to a discrete area of the business. Some of the conduct was the result of a programming flaw in the firm’s systems, according to Merrill Lynch. The problem has since been resolved and its practices have undergone significant change.

Merrill Lynch also wrote about the impact that a denial of its waiver request would have on its customers and affiliates. The firm acknowledged that it was already subject to a prior waiver from the Rule 506 disqualifications in connection with an order issued in 2014 (Rel. No. 9682, November 25, 2014). However, Merrill Lynch noted that it was enjoined in the 2014 order not because it engaged in the alleged activities, but because after the activities occurred, Merrill Lynch was acquired by Bank of America Corp. and the BAC subsidiary that engaged in the activities was merged into Merrill Lynch.

Waiver conditions. The staff said the waiver is granted on the condition that the firm fully complies with the terms of the order. The prior order remains in effect. Merrill Lynch must retain a qualified independent consultant to review its short sale policies and practices and cooperate fully with the consultant. The consultant must complete its review and submit a written preliminary report within 90 days of the issuance of the order, after which Merrill Lynch must adopt and implement its recommendations.

Merrill Lynch was also ordered to hire a consultant in connection with its prior Rule 506 waiver. The consultant is currently engaged in conducting the required review.

The release is No. 34-75083.

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