Merrill Lynch Gets Sued, Settles with the SEC

January 31, 2011

The SEC recently sued (and settled with) Merrill Lynch over two types manipulating its clients’ assets.  First, Merrill was executing trades for itself after its customer put in a larger order to buy or sell, something Merrill told customers it would not do.  Although this sounds a lot like insider trading, this doesn’t seem as nefarious as the second count of misconduct.  Second, the SEC sued Merrill for marking up securities that it sold to its clients. Specifically, Merrill would buy securities in the open market and them sell them to its own clients for a profit.  The SEC order found that:

In July 2003, Merrill received from an institutional customer an order to buy 300,000
shares of NetApp, Inc. over the course of the day.  The customer did not ask Merrill to place its
own capital at risk, and Merrill had agreed that its only compensation for executing the trade T
would be a commission equivalent.  Contrary to this agreement, Merrill also charged the
customer, in addition to a commission equivalent, an undisclosed mark-up, by filling the
customer’s order at a higher price than it paid to purchase the securities in the market.
In November 2003, Merrill received from an institutional customer a series of orders to
sell more than 5 million shares of Novell, Inc.  The customer did not ask Merrill to place its own
capital at risk, and Merrill had agreed that its only compensation for executing the trade would
be a commission equivalent.  Contrary to this agreement, Merrill also charged this customer, in
addition to a commission equivalent, an undisclosed mark-down, by filling the customer order at
prices below the prices at which Merrill sold the securities in the market.

What’s wrong with this?  Well, first, Merrill has a duty to its clients to get the best price for a security, and not simply mark up securities to clients for a gain.  And, it told the customers it was only marking up the securities equivalent to what a commission would be, which they did, then added a couple points.
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