The Securities and Exchange Commission today charged Merrill Lynch, Pierce, Fenner & Smith with securities laws violations for having inadequate policies and procedures for controlling access to institutional customer order flow.
Merrill Lynch agreed to settle the SEC's charges and pay a $7 million penalty, among other remedies.
According to the SEC's order instituting proceedings, Merrill Lynch utilizes institutional equities "squawk boxes," which are internal intercom systems used by broker-dealers to broadcast institutional customer order information to traders and sales traders at the broker-dealer. From 2002 to 2004, several Merrill Lynch retail brokers at three branch offices permitted day traders at other firms to listen to confidential information on large unexecuted block orders of Merrill Lynch's institutional customers. The Merrill Lynch brokers put their telephones next to the squawk boxes and let the day traders listen to the squawk box, often for the entire trading day. The day traders used the broadcasts to trade ahead of the orders placed by Merrill Lynch's customers.
"It is critically important that registered broker-dealers and investment advisers protect institutional order information and control its flow," said Scott W. Friestad, Deputy Director of the Division of Enforcement. "Otherwise, unscrupulous people may misuse the information to the detriment of investors."
Kay Lackey, Associate Regional Director of the SEC's New York Regional Office, added, "Merrill Lynch gave sensitive order flow information to retail brokers who had no bona fide need for it. The firm lacked written policies or procedures to limit which employees within the firm had access to the equity squawk box, to track which employees had access, or to monitor employees for possible misuse of the order information. This created conditions that rogue brokers could exploit, as happened here."
In a series of related "squawk box" cases, the SEC previously sued brokers from Merrill Lynch and other broker-dealers and employees at the day-trading firms who used the information to illegally trade ahead.
Without admitting or denying the SEC's allegations, Merrill Lynch has agreed to a censure, to cease and desist from committing or causing violations of Section 15(f) of the Securities Exchange Act of 1934 and Section 204A of the Investment Advisers Act, and to pay a $7 million penalty. Merrill Lynch also agreed to various undertakings aimed at protecting customer order information transmitted on the squawk boxes and related technologies.