FINRA Fines Merrill Lynch, UBS for Supervisory Failures in Sales of Closed-End Funds; Customers Get More Than $5 Million in Remediation
Five Merrill Brokers Suspended, Fined; Investigation of Former UBS Brokers Continues
Washington, D.C. — The Financial Industry Regulatory Authority (FINRA) announced today that it has fined Merrill Lynch, Pierce, Fenner & Smith, Inc. $150,000 and UBS Financial Services, Inc. $100,000 for supervisory failures that led to unsuitable short-term sales of closed-end funds (CEF) purchased at the funds' initial public offerings.
FINRA also suspended five Merrill Lynch brokers each for 15 days and fined them $10,000 for making unsuitable CEF recommendations to customers. FINRA's investigation into the activities of former UBS brokers involved in the short-term sales of CEFs continues.
"Closed-end funds possess complex features that can give rise to unsuitability for short-term investors, particularly when purchased at the initial public offering," said Susan Merrill, FINRA Executive Vice President and Chief of Enforcement. "Neither Merrill nor UBS had adequate supervisory systems and procedures to prevent brokers from engaging in unsuitable short-term sales of newly issued CEFs."
CEFs are investment companies that sell a fixed number of shares in an initial public offering (IPO), subject to built-in sales charges. After the offering, the shares trade in the secondary market, typically at a discount from the initial offering price. The CEFs at issue had sales charges of 4.5 percent, as well as a "penalty bid period" of generally 30 to 90 days immediately following the IPO.
During this period, brokers would lose their sales commission if their clients sold the CEFs purchased at the offering. One regulatory concern related to CEFs is the potential for brokers to earn high fees at their customers' expense by soliciting their customers to purchase CEFs at the IPO and then later, after the expiration of the penalty bid period, recommend that customers sell the CEFs, often at a loss, using the proceeds to purchase yet another CEF at an initial offering.
FINRA found that despite being aware that CEFs purchased at the IPO are more suitable for long-term investments - and that the sales charges applied to purchases at the IPO make short-term trading of these CEFs generally unsuitable - Merrill Lynch and UBS did not have adequate supervisory systems and procedures designed to detect and prevent unsuitable short-term trading of CEFs.
The firms also failed to provide supervisors with any guidance or warning about the potential abuses and disadvantages relating to short-term trading of CEFs purchased at the IPO. Without adequate guidance, branch managers were not on notice that there were potential problems with short-term sales of CEFs bought at the IPO.
FINRA also found that the firms failed to provide guidance or training to its registered persons regarding the impact of the sales charges on the short-term sales of CEFs purchased at the IPO. As a result, certain UBS and Merrill brokers recommended CEF purchases at the IPO and subsequent short-term sales without having a sufficient understanding of the effects that the sales charges and other pricing considerations had on the clients' investments.
The five Merrill Lynch brokers sanctioned by FINRA for recommending the unsuitable short-term sales of CEFs are:
- Kenneth C. Iwelumo of the Newark, NJ, branch, who has been registered with Merrill Lynch since 1986. Iwelumo's customers suffered losses totaling approximately $563,000.
- Ronald Kemp of the Denver, CO, branch, who has been registered with Merrill Lynch since 1997. Kemp's customers suffered losses totaling approximately $411,000.
- Joseph Miller of the Springfield, MA, branch, who has been registered with Merrill Lynch since 1995. Miller's customers suffered losses totaling approximately $130,000.
- John Ong of the New York City branch, who has been registered with Merrill Lynch since 1994. Ong's customers' suffered losses totaling approximately $350,000.
- Michael Kizman of the Schaumburg, IL, branch, who has been registered with Merrill Lynch since 1992. Kizman's customers suffered losses totaling approximately $221,000.
In determining the appropriate sanctions against the firms, FINRA considered the firms' remediation efforts, which included payments to customers in excess of $3 million by Merrill Lynch and more than $2 million by UBS. Also, FINRA considered the firms' self-reviews and prompt remedial measures to correct systems and procedures to prevent future violations.
FINRA found in this matter that, after receiving an anonymous tip and before FINRA's investigation into unsuitable short-term trading of CEFs, Merrill Lynch retained outside counsel to perform an internal investigation. Following the internal investigation, Merrill Lynch sanctioned 13 brokers and implemented remedial measures designed to prevent future violations involving CEFs.
In the case of UBS, FINRA found that after receiving the results of a Securities and Exchange Commission examination of a branch office and before FINRA's investigation, UBS retained outside counsel to conduct an internal investigation into its CEF practices. As a result of the investigation, the firm sanctioned 17 brokers found to have made unsuitable CEF recommendations and implemented remedial measures designed to prevent future violations involving CEFs.
In settling these matters, Merrill Lynch, UBS and the Merrill brokers neither admitted nor denied the charges, but consented to the entry of FINRA's findings.
Investors can obtain more information about, and the disciplinary record of, any FINRA-registered broker or brokerage firm by using FINRA's BrokerCheck. FINRA makes BrokerCheck available at no charge. In 2008, members of the public used this service to conduct 11.6 million reviews of broker or firm records. Investors can access BrokerCheck at www.finra.org/brokercheck or by calling (800) 289-9999.
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