Compliance July 28, 2009

FINRA Fines Merrill, UBS Related to Closed-End Funds Sales

The Financial Industry Regulatory Authority (FINRA) said it has fined Merrill Lynch, Pierce, Fenner & Smith, Inc. and UBS, as well as some Merrill brokers, for supervisory failures related to the sale of closed-end funds (CEFs).

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Merrill Lynch, Pierce, Fenner & Smith, Inc. (acquired by Bank of America) was fined $150,000 and UBS was fined $100,000 for the failures that FINRA said led to unsuitable short-term sales of CEFs purchased at the funds’ initial public offerings (IPOs), according to a news release.

Additionally, FINRA suspended five Merrill Lynch brokers each for 15 days and fined them $10,000 for making unsuitable CEF recommendations to customers. FINRA continues to investigate the activities of former UBS brokers involved in the short-term sales of CEFs.

FINRA said 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 failed to provide guidance to both supervisors and registered persons. 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, according to FINRA.

“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.”

The five Merrill Lynch brokers sanctioned by FINRA for recommending the unsuitable short-term sales of CEFs are:

  • Kenneth C. Iwelumo of the Newark, New Jersey, branch, whose customers suffered losses totaling approximately $563,000.
  • Ronald Kemp of the Denver branch, whose customers suffered losses totaling approximately $411,000.
  • Joseph Miller of the Springfield, Massachusetts, branch, whose customers suffered losses totaling approximately $130,000.
  • John Ong of the New York City branch, whose customers’ suffered losses totaling approximately $350,000.
  • Michael Kizman of the Schaumburg, Illinois, branch, whose customers suffered losses totaling approximately $221,000.

Merrill Lynch, UBS, and the Merrill brokers neither admitted nor denied the charges, but consented to the entry of FINRA’s findings.

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Compliance July 28, 2009

SEC Makes ‘Naked’ Short-Selling Rule Permanent

The Securities and Exchange Commission (SEC) yesterday made permanent its temporary rule aimed to curb abuses of short-selling.

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The SEC made permanent an interim final temporary rule, established last September in order to boost investor confidence in the face of a market crisis by reducing the number of “naked” short sales in the market (see “SEC Bans Shorts of 799 Financial Stocks ”). Rule 204  requires broker/dealers to promptly purchase or borrow securities to deliver on a short sale.

The SEC said that short-selling can play an important role in the market; however, in some circumstances, it can be used as a tool to manipulate the market. In a “naked” short sale, the investor sells shares “short” without first having borrowed them. Such a transaction is permitted because there is no legal requirement that a short-seller actually borrow the shares before effecting a short sale, according to an SEC news release.

The SEC reported that since the inception of its temporary rule, the agency met its goal to reduce fails to deliver and addressing potentially abusive “naked” short-selling. Therefore, it made permanent the rule with “only limited modifications to address commenters’ operational concerns.”

Also last fall, the Commission adopted a short sale reporting interim rule, Rule 10a-3T, which requires certain market participants to provide short sale and short position information to the SEC. Instead of renewing the rule, the SEC said it is working with self-regulatory organizations (SRO) to substantially increase the public availability of short sale-related information.

“Today’s actions demonstrate the Commission’s determination to address short-selling abuses while at the same time increasing public disclosure of short-selling activities that affect our markets,” said SEC Chairman Mary Schapiro, in the news release.

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