[18641]
March 11, 2005
TO: BROKER/DEALER ADVISORY COMMITTEE No. 7-05
BROKER/DEALER ASSOCIATE MEMBERS No. 3-05
CHIEF COMPLIANCE OFFICER COMMITTEE No. 24-05
COMPLIANCE ADVISORY COMMITTEE No. 22-05
SEC RULES MEMBERS No. 37-05
SMALL FUNDS MEMBERS No. 24-05
RE: NYSE AND NEW JERSEY SETTLE WITH BROKER-DEALER RELATING TO MARKET
TIMING
The New York Stock Exchange and the Attorney General of New Jersey announced the
settlement of related disciplinary actions to resolve allegations that a broker-dealer failed to
reasonably supervise certain of its registered representatives in connection with market-timing
activities.* In both actions, the broker-dealer consented to the findings without admitting or
denying guilt. The settlements are summarized below.
New York Stock Exchange Action
Findings
According to the NYSE Decision, from January 2002 to October 2003, the broker-dealer
employed a team of brokers who engaged in deceptive practices to effect short-term trading of
mutual funds for a hedge fund client, which was in violation of the broker-dealer’s policies and
potentially detrimental to other mutual fund shareholders. Specifically, the NYSE Decision
finds that, during the period January through April 2002, the brokers executed over 3,700 short-
term mutual fund transactions in multiple accounts held for a single hedge fund client. When
some of the mutual funds began to complain about the market timing, the broker-dealer
instructed the brokers to refrain from engaging in market timing transactions in the client’s
accounts. In response, and after consulting their managers, the brokers facilitated the opening
of accounts for the hedge fund client at various mutual funds with themselves as the broker of
record. They then moved the mutual fund positions held at the broker-dealer to these new
* See Merrill Lynch, Pierce, Fenner & Smith Incorporated, NYSE, Exchange Hearing Panel Decision 05-27 (March 7,
2005) (“NYSE Decision”), which is available at http://www.nyse.com/pdfs/05-027.pdf and In the Matter of Merrill
Lynch, Pierce, Fenner & Smith Incorporated, State of New Jersey, Office of the Attorney General, Consent Order
(March 7, 2005) (“NJ Order”), which is available at
http://www.state.nj.us/lps/newsreleases05/merrilllynchconsentorder3-05.pdf.
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accounts held outside of the broker-dealer and continued to execute frequent trades on the
hedge fund’s behalf in them. According to the NYSE Decision, the brokers later moved the
positions back to fee-based accounts at the broker-dealer.
The NYSE Decision finds that, notwithstanding these trading patterns and the receipt of
commissions paid by the mutual funds in connection with the brokers’ trading prior to
November 2002, the broker-dealer failed to recognize that its brokers were engaging in short-
term trading of mutual funds in outside accounts. The NYSE Decision further finds that the
broker-dealer eventually did become aware of the brokers’ trading in the outside accounts in
November 2002 based on market timing complaints from several mutual funds. The brokers
were then instructed to stop effecting trades at the various mutual funds. According the NYSE
Decision, however, the broker-dealer took no additional steps to ensure that the brokers
complied with that instruction. The brokers continued to execute trades on behalf of the hedge
fund in outside accounts until at least April 2003.
The NYSE Decision also finds that the same group of brokers purchased a multi-million
dollar variable annuity and other insurance policies on behalf of the same hedge fund client.
Based on the client’s instructions, the brokers facilitated frequent transactions in the sub-
accounts underlying these products. According to the NYSE Decision, the broker-dealer failed
to make or maintain any record of those transactions, including confirmations received from the
annuity companies.
The NYSE Decision states that, in October 2003, the broker-dealer terminated three of
the brokers and fined their managers for failing to adequately supervise certain activities in
connection with the conduct described above. As a result of the conduct generally described
above, the NYSE Decision finds that the broker-dealer violated:
• NYSE Rule 342 by failing to reasonably supervise certain business activities, establish
and maintain appropriate procedures for supervision and control with respect to certain
business activities involving the trading of mutual funds, and failing to review and
maintain certain incoming and outgoing communications with the public; and
• NYSE Rule 440 and Section 17(a) of the Securities Exchange Act of 1934 and Rules 17a-3
and 17a-4 under that Act for failing to maintain books and records relating to trading in
variable annuity product sub-accounts.
Undertakings
According to the NYSE Decision, the broker-dealer agreed to the following
undertakings:
• Global Compliance Alert: The broker-dealer agreed to issue a Global Compliance Alert
communication detailing the broker-dealer’s policies and procedures with respect to the
review and retention of incoming and outgoing correspondence and fax transmissions.
The Global Compliance Alert will also advise financial advisors that correspondence
and fax transmissions with respect to a client’s reallocation of the sub-accounts of
variable products will be maintained in accordance with the broker-dealer’s policies and
procedures.
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• Outside Accounts: The broker-dealer agreed to implement a policy and procedure
addressing how financial advisors should deal with instructions from clients to trade
mutual fund positions in accounts held outside of the broker-dealer.
• Client Reallocation Requests: The broker-dealer agreed to develop technology to allow the
recording of client reallocation requests regarding the underlying sub-accounts of non-
proprietary variable annuity products.
• Tax Identification Numbers: The broker-dealer agreed to implement a procedure that will
provide tax identification numbers to the National Securities Clearing Corporation when
transmitting orders to mutual fund companies on behalf of its clients.
Sanctions
• The broker-dealer was censured.
• The broker-dealer was fined $13,500,000, which was waived in consideration of a
$10,000,000 fine paid to the State of New Jersey and a payment totaling $3,500,000 in
furtherance of a settlement with the State of Connecticut.
New Jersey Action
The New Jersey Order, which contains factual allegations that generally mirror those in
the NYSE Decision, finds that the broker-dealer’s conduct violated the recordkeeping and
supervision requirements of the New Jersey securities laws. The New Jersey Order requires the
undertakings similar to those described in the NYSE Decision.
According to the New Jersey Order, the broker dealer will pay a $10,000,000 civil
monetary penalty.
Jane G. Heinrichs
Assistant Counsel