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Merrill Lynch Fined $450,000 for Poor Supervisory System Related to Structured Products

The Financial Industry Regulatory Authority (FINRA) fined Merrill Lynch, Pierce, Fenner & Smith Incorporated $450,000 for failure to maintain a satisfactory supervisory system over the sale of structured products, a charge stemming back to misconduct that occurred beginning on January 1, 2006.

Specifically, FINRA alleged that between 2006 and 2009, Merrill Lynch sold customers a wide range of structured products: enhanced return, enhanced income, market downside protection and market access offerings.

Structured products, a creation of Wall Street's financial alchemists, are a combination of an option in a single stock or index linked with an unrelated and unsecured promissory note. The promissory note is often issued by a financial institution. Investors are meant to receive income based on the interest rate paid by the promissory note. However, if the linked stock's price falls by a certain amount, instead of repaying the note, the structured product uses the option and puts the depressed stock to the investor, and the issuer keeps the principal investment. If the stock soars, the issuer keeps the stock and repays the principal on the promissory note. This way, the issuer is able to completely pass any outsized market risk to the investor while retaining the potential gains if the stock price soars. Head's I win, tails you lose.

In selling these products, many firms and brokers sell these products as income generating alternatives to certificates of deposit, government bonds, or highly rated corporate bonds. Often, a broker will improperly point out the credit rating of the firm issuing the promissory note in an effort to convince an investor of the safety of the structured product, while touting the above average interest rate.

Brokers often gloss over or fail to be sure their clients understand the two most critical risks presented by structured products: 1) the stock being put to him/her at a far depressed price, or 2) the borrower failing to repay the promissory note. Most notably, structured products linked to Lehman Brothers' unsecured promissory notes devastatingly failed when the firm went out of business.

Because of the risk involved in structured products, FINRA (then known as National Association of Securities Dealers or "NASD" established policies and procedures to determine account eligibility and suitability for structured product purchases. FINRA also required and still requires firms monitor their client accounts so that no one customer account is concentrated in these potentially toxic products.

In its latest disciplinary action, No. 2010022011901 FINRA found that from Jan. 1, 2006 through March 1, 2009, Merrill Lynch had no system in place to monitor for unsuitable concentration levels of structured products in customer accounts, a clear violation of its Conduct Rules. While paying the fine and consenting to the entry of the finds, Merrill Lynch denied any culpability for its conduct.

This isn't the first time Merrill Lynch has been censured for noncompliance with FINRA Rules. In May 2009, FINRA fined Merrill Lynch $150,000 for inadequate procedures and systems to detect unsuitable short-term trading related to initial public offerings (IPOs). At the time, Merrill Lynch submitted a Letter of Acceptance, Waiver and Consent, acknowledging FINRA's allegations, but again denying any culpability.

On December 20, 2010, our firm won a securities arbitration case against Wells Fargo Investments, LLC for its sale of structured products to a senior citizen. In this case, the investor had the stock put to him in place of receiving the return of his principal, resulting in losses of more than 33% in each product. The Award is for case No. 09-00039 and may be found here. We have settled several more structured product cases, all subject to confidentiality agreements insisted on by the Wall Street firms. In addition, we have several more cases pending hearing.

If you held an account with Merrill Lynch or any other firm and purchased structured products that have resulted in losses, call The Law Offices of Jonathan W. Evans & Associates at 800-699-1881 for an investigation and consultation.

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