By Kat Greene
Law360, Los Angeles (February 28, 2017, 6:36 PM EST) — Bank of America Corp.’s wealth management unit was hit Tuesday with a proposed class action over complex trades that allowed the firm to use customer money for its own trading, months after it paid $500 million and admitted to wrongdoing over the activities. Back in June, Merrill Lynch Pierce Fenner & Smith Inc. agreed to pay $57 million in disgorgement and interest and a $500 million civil penalty while admitting to wrongdoing, after the U.S. Securities and Exchange Commission alleged the wealth manager violated the agency’s Customer Protection Rule by engaging in complex options trades that artificially reduced the amount Merrill Lynch needed to keep in a reserve account, freeing up cash the unit used for its own trading activities.
Customer James Jiao filed a civil suit Tuesday over the money handling, saying Merrill Lynch had deprived him and other customers of the legal interest they would have been entitled to had Merrill Lynch obtained the investment funds through authorized loans. The wealth manager also leached profits made from the unauthorized use of the funds, namely the disgorgement Merrill Lynch had to pay into the U.S. Department of the Treasury after the firm’s conflict with the SEC, according to Jiao.
“Merrill Lynch’s conduct caused plaintiff to lose out on either lost income due to loaning his assets to Merrill Lynch or lost income or gains he would have made had [he] subjected his investments to these same risks independently, without Merrill Lynch,” the suit says.
Jiao seeks to represent a class of customers whose securities or cash were invested by Merrill Lynch and were used to trade for Merrill Lynch’s own accounts from Jan. 1, 2009, to Dec. 31, 2012, and a subclass of similar consumers specifically in California, according to the complaint.
A spokesman for Merrill Lynch said the lawsuit was baseless.
“As the SEC noted at the time this was resolved, there were no customers harmed in this matter, and as a result, there is no basis for this lawsuit,” the spokesman said.
The SEC’s Customer Protection Rule requires broker-dealers to safeguard the cash and securities of their customers by maintaining a reserve. The value of the reserve is calculated by subtracting debits that customers owe the broker-dealer, like margin loans, from credits the firm owes the customers, like cash in the customer securities accounts.
According to the SEC’s order instituting administrative proceedings, Merrill Lynch had gamed the reserve calculation from 2009 to 2012 by creating complicated options trades with limited liability companies that Merrill Lynch itself had set up, artificially creating customer debits that reduced the minimum account the firm needed to keep in its reserve account by up to $5 billion per week.
The wealth manager further violated the rule, the SEC alleged, from 2009 to 2015 by holding up to $58 billion in customer securities in a clearing account that was subject to a general lien from Merrill Lynch’s clearing bank, exposing customers to significant risks had Merrill Lynch collapsed.
Regulators said at the time of Merrill Lynch’s deal last summer that the SEC went after more in civil penalties because the wealth manager was not transparent with the SEC during its investigation.
Meanwhile, in December, Morgan Stanley agreed to pay $7.5 million to settle allegations it violated the Consumer Protection Rule, without admitting or denying the SEC’s accusations that the financial services firm violated the rules about funds in the customer reserve account.
Jiao is represented by Abbas Kazerounian of Kazerouni Law Group APC. Counsel information for Merrill Lynch could not be immediately determined.