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For Immediate Release:  
For Further Information Contact:
March 8, 2005

Office of The Attorney General
- Peter C. Harvey, Attorney General
Bureau of Securities
- Franklin L. Widmann, Chief

 

Peter Asteltine (OAG)
609-292-4791

 

Attorney General Harvey Reaches Agreement with Merrill Lynch Covering Securities Practices

Firm Will Pay State $10 Million For Failing to Supervise Financial Advisers,
Will Institute Reforms to Ensure Oversight of Trades Made Through Annuities

>> View the Consent Order with Merrill Lynch (32K PDF) free plug-in

TRENTON – Attorney General Peter C. Harvey today announced that Merrill Lynch Pierce Fenner & Smith Inc. will pay New Jersey $10 million and implement significant reforms throughout the firm to resolve allegations that it failed to reasonably supervise certain financial advisers in New Jersey who market timed mutual funds in violation of the firm’s policies.

The agreement reached by the Attorney General settles allegations by the New Jersey Bureau of Securities concerning trading by a hedge fund, Millennium Partners, L.P. The allegations focus on market timing conduct by three financial advisers who joined Merrill Lynch’s Fort Lee branch office in January 2002. Millennium was a prior client of the three Merrill Lynch employees, and they continued market timing for Millennium at Merrill Lynch, seeking to profit from market fluctuations by trading in and out of mutual funds using accounts at Merrill Lynch as well as outside accounts. Over a third of the trades involved mutual funds held as sub-accounts of variable annuity contracts purchased for Millennium.

Despite warnings from supervisors that they were violating Merrill Lynch’s policies, the financial advisers continued to market time for Millennium until they were fired in October 2003, using multiple accounts, undisclosed agreements and other ploys to conduct and disguise their trading. They did not keep records of trades placed through non-Merrill Lynch variable annuity contracts or placed directly in mutual fund accounts held outside of Merrill Lynch.

“Merrill Lynch failed to reasonably supervise these financial advisers, whose market timing siphoned short-term profits out of mutual funds and harmed long-term investors,” said Attorney General Harvey. “To resolve these securities issues, Merrill Lynch has agreed to implement reforms to enhance supervision of its financial advisers, particularly in the area of annuities, where trading in annuity sub-accounts has been done under the radar, without records. This is an industry-wide issue, and the record-keeping and supervision requirements in this agreement should set a new standard.”

New Jersey worked cooperatively in this matter with the New York Stock Exchange, which is announcing a separate settlement with Merrill Lynch today.

The three financial advisors, and a fourth who was involved to a lesser degree, placed 12,457 trades for Millennium in at least 521 mutual funds and 63 mutual fund sub-accounts of at least 40 variable annuities. Millennium made profits in over half of the funds and fund sub-accounts. In those funds where Millennium made profits, its gains totaled about $60 million.

“This case illustrates the critical role the states play in regulating securities and the investment industry,” said Franklin L. Widmann, Chief of the Bureau of Securities. “Our investigation of these rogue financial advisers based in New Jersey led to an agreement with Merrill Lynch that will protect investors by enhancing supervision of financial advisers throughout the firm.”

Reforms That Set New Industry Standard for Compliance

Under the agreement reached cooperatively with Merrill Lynch, the firm will pay New Jersey a $10 million civil penalty. In addition, the firm and its affiliate Merrill Lynch Insurance Group Inc. will implement new procedures to maintain, as a required “book and record” under New Jersey and federal securities laws, records of all client reallocation requests made through a Merrill Lynch employee that involve mutual funds held as sub-accounts of variable annuity products of outside insurance carriers. Neither firm recorded those requests in the past. By properly treating such transactions as subject to the requirement that financial advisers record every request by a client for a trade of a security, Merrill Lynch will subject such transactions to oversight under its policies requiring supervisors to review such records to monitor trading.

More generally, Merrill Lynch will implement and enforce a new policy and procedure addressing how financial advisers should deal with instructions from clients to trade mutual funds in accounts held outside of Merrill Lynch. All such transactions are subject to New Jersey and federal books and records requirements. Merrill Lynch also will issue a global compliance alert to all of its financial advisers, supervisors and compliance personnel reinforcing its policies and procedures mandating retention and review of correspondence with clients. The firm has agreed to fully cooperate with the State in any investigation or litigation related to this matter.

Deputy Attorney General Anna Lascurain, Chief of the Securities Fraud Prosecution Section of the Division of Law, handled the case for the Attorney General. It was investigated by Chief of Enforcement Richard Barry, Regulatory Attorney Ethan Silver and Investigators Julian Leone and James Monagle of the Bureau of Securities.

>> View the Consent Order with Merrill Lynch (32K PDF) free plug-in

Market Timing Activity

Although the three financial advisers involved in the allegations were told by supervisors in February 2002 that Millennium’s short-term trading of mutual funds violated Merrill Lynch’s internal policy prohibiting market timing, the financial advisers continued such trading for Millennium and inadequate action was taken by Merrill Lynch to enforce its policy.

The financial advisers were warned again in May 2002 and subsequently were told by supervisors that any short-term trading of mutual fund positions by Millennium could not be done through Merrill Lynch. The financial advisers were instructed that Millennium could only make such trades directly in accounts maintained by Millennium at the mutual fund companies.

Despite the warnings, the Merrill Lynch financial advisers continued to engage in market timing for Millennium in mutual fund accounts outside of Merrill Lynch. The financial advisors also placed short-term trades for Millennium in mutual funds held as sub-accounts of non-Merrill Lynch variable annuity and corporate-owned life insurance contracts purchased for Millennium in the names of employees. Under such contracts, the investor may choose various investment options. No records were kept of those transactions.

After Merrill Lynch fired the three financial advisers in October 2003, it fined three supervisors in connection with the Millennium market timing.

The Bureau of Securities alleged that Merrill Lynch failed to reasonably supervise its financial advisers in that it failed to:

  • adequately react to red flags and enforce its policy prohibiting market timing;
  • detect and stop activity of the financial advisers in connection with accounts maintained by the client directly at the mutual funds – and adequately establish and enforce policies and procedures regarding record keeping, trading and supervision of this activity;
  • adequately enforce policies regarding the review and retention of communications between clients and financial advisers relating to its business;
  • timely discipline the financial advisers at times when they were discovered to be in apparent breach of Merrill Lynch’s policies.

Continued Securities Fraud Enforcement

Attorney General Harvey has increased the staff and resources of the Bureau of Securities, which played a major role in the landmark settlement in April 2003 between regulators and ten top Wall Street firms regarding stock analyst practices. New Jersey was co-chair of the steering committee for the multi-state task force that investigated the firms. New Jersey also led the investigation of Bear, Stearns & Co. The case brought industry reforms to ensure that stock analysts are not pressured to report favorably on stocks and bonds of investment banking clients of their firm.

On June 1, 2004, Attorney General Harvey reached an $18 million settlement with Allianz Dresdner Asset Management and two affiliated companies regarding allegations that they permitted a large investor to market time more than $4 billion in transactions in their mutual funds in violation of fund policies and to the detriment of long-term investors. The settlement involved the largest penalty ever collected by New Jersey in a securities case and required defendants to implement reforms to ensure that portfolio managers function independently of business managers and funds comply with their internal policies barring market timing.

Between those milestones, New Jersey filed eight major securities fraud cases involving over 1,000 investors and more than $160 million in investments. On June 2, 2004, Attorney General Harvey accepted an invitation to testify before the U.S. Senate Committee on Banking, Housing and Urban Affairs on the vital role of the states in regulating securities and protecting investors.

>> View the Consent Order with Merrill Lynch (32K PDF) free plug-in

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