RIA Compliance Blog
Last week, the Financial Industry Regulatory Authority (FINRA) issued a Letter of Acceptance Waiver and Consent (AWC) censuring Merrill Lynch and ordering $7.2 million in restitution to investor clients. Merrill had already reimbursed the clients as a result of an internal review and had self-reported the underlying violations to FINRA, a move that earned praise from FINRA in the AWC.
At issue was the failure to honor rights of reinstatement in connection with mutual fund purchases. Mutual fund companies usually offer various rights to their shareholders, as set forth in a fund’s prospectus or the fund’s statement of additional information. Some funds grant shareholders a right of reinstatement, which allows investors to buy fund shares without incurring a front-end charge if the investor previously sold shares of any fund within the same family. Usually, this involves A-shares, but it could apply to different classes of shares, depending on the fund company. Similarly, a right of reinstatement usually allows the investor to recoup any previously charged contingent deferred sales charge relating to the sale of a fund within the family. Rights of reinstatement typically specify that the new purchases must occur within 30 to 90 days of the prior sale, but the period could be as up to one year later, depending on the fund and the particular situation.
According to the AWC, Merrill Lynch had not put in place supervisory systems and procedures “reasonably designed” to ensure that affected customers received the benefits of the rights of reinstatement. 13,328 accounts were affected, resulting in over $6 million in excess charges or unapplied rebates. Between 2011 and 2017, Merrill Lynch had relied on its registered representatives to monitor and keep track of when their clients would be entitled to receive the waivers and rebates. According to FINRA, relying on the representatives was not reasonable since so many customers were affected, and the process for determining what waivers and rebates applied was complex. Additionally, although Merrill Lynch had a system in place to determine re-purchases of funds within the same family for up to one week after a sale, that system was not reasonably designed since waivers and rebates were available for much longer periods, including up to one year in some instances.
Merrill Lynch noticed the problem internally, and conducted an internal investigation, resulting in the hiring of an outside consultant to assure that all impacted customers were identified, along with the amounts of unreceived rebates or avoided fees. In 2017, Merrill enhanced its procedures designed to detect the situations and assure the credits were received. The firm reimbursed its customers in 2019.
The firm’s internal investigation followed a separate 2014 AWC, which imposed an $8 million fine and ordered $24.2 million in restitution for similar violations relating to mutual fund sales to retirement plans and charitable organizations. In that order, FINRA alleged that between 2006 and 2011, Merrill sold Class A shares with sales charges to more than 30,000 accounts that were eligible to purchase the shares without a sales charge.
In the recent action, FINRA declined to order any penalties, noting that it valued a firm’s cooperation when it refunds customers voluntarily. Ultimately, Merrill paid over $7.2 million, including interest.
Parker MacIntyre provides legal and compliance services to investment advisers, broker-dealers, registered representatives, hedge funds, and issuers of securities, among others. Our Broker-Dealer Group assists financial service providers with complex issues that arise in the course of their business, including complying with federal and state laws and rules. Please visit our Broker-Dealer Practice Group page for more information.