FINRA Hits Merrill Lynch With Historic $1 Million Fine For Circumventing Mandatory Arbitration During Collection of Employee Promissory Notes

January 26, 2012

For the purpose of proposing a settlement of rule violations alleged by the Financial Industry Regulatory Authority ("FINRA") and without admitting or denying the findings, prior to a regulatory hearing and without an adjudication of any issue, Respondent Merrill Lynch, Pierce, Fenner & Smith Incorporated (‘Merrill Lynch") submitted a Letter of Acceptance, Waiver and Consent ("AWC"), which FINRA accepted. In the Matter of Merrill Lynch, Pierce, Fenner & Smith Incorporated, Respondent (AWC 2009020188101/January 25, 2012).

Few Wall Street firms are more iconic than Merrill Lynch, a FINRA member firm since 1937 with over 31,000 registered individuals and more than 1,200 branch offices. 

Notwithstanding its legendary status, Merrill Lynch's recent history - particularly since the onset of the Great Recession - has not been particularly sterling and the Wall Street giant stumbled and fell from its once lofty heights.  In January 2009, Merrill Lynch was acquired by Bank of America Corporation.

The ATP 

In an effort to retain high-producing brokers during the tumultuous days of the Great Recession and on the heels of its merger into Bank of America, Merrill Lynch implemented its Advisor Transition Program ("ATP") through which it paid  about $2.8 Billion in lump sum retention payments to some 5,000 brokers. By no means was Merrill Lynch alone in seeking ways to attract and retain its top producers - similar efforts occurred at Wells Fargo, JP Morgan, Morgan Stanley Smith Barney, UBS and other big boys.

Although many brokers refer to these payments as retention "bonuses," in fact, the payments are actually structured as "Promissory note" promissory note.  Bonuses tend to be fully earned when paid. Loans come with strings - not the least of which is an obligation to repay.

SIDE BAR: In accordance with terms set forth in an Agreement between the retained brokers and Merrill Lynch, following each month of employment, the firm made a payment minus taxes on a pro rata portion of the loan, over a period that typically lasted for a seven-year term.  An acceleration of the loan balance's interest and principal repayment by the broker was typically triggered by the individual's bankruptcy, insolvency, failure to make a payment, or the termination of employment by Merrill Lynch for any reason.

Impermissible Circumvention

The ATP promissory notes securing the loans were made by Merrill Lynch International Finance, Inc. (MLIFI), a non-registered Merrill Lynch affiliate with which the brokers had no relationship. The loans were funded by Merill Lynch's parent via a payment to an account at the FINRA member firm in the name of MLIFI.  The executed promissory notes obligated the brokers to make repayment to MLIFI when employment at Merrill Lynch was terminated and contained a clause stating:

[t]he undersigned agrees that any actions regarding the [n]ote, including actions to recover amounts due under this [n]ote, shall be brought solely in the Supreme Court of the State of New York in New York County.

On the surface, a seemingly hyper-technical legal maneuver.  A well known FINRA rule is that all intra-industry disputes - between member firms and other member firms, between member firms and their associated persons -  must be arbitrated before a FINRA arbitration panel.  This is such an ironclad policy that it's know as "mandatory" industry arbitration. Mandatory as in no ifs, ands, or buts. How then did Merrill Lynch's ATP court-based collection pass FINRA muster?

SIDE BAR: The New York State court jurisdictional language provided Merrill Lynch with the ability to pursue collections of amounts due under the promissory notes in expedited New York court proceedings, as provided under New York State Civil Practice Law and Rule ("CPLR") 3213.  An advantages of invoking CPLR 3213 is that New York State's expedited collection procedure restricts the debtor's ability to assert counterclaims against the creditor.

CPLR § 3213: When an action is based upon an instrument for the payment of money only or upon any judgment, the plaintiff may serve with the summons a notice of motion for summary judgment and the supporting papers in lieu of a complaint. The summons served with such motion papers shall require the defendant to submit answering papers on the motion within the time provided in the notice of motion. The minimum time such motion shall be noticed to be heard shall be as provided by subdivision (a) of rule 320 for making an appearance, depending upon the method of service. If the plaintiff sets the hearing date of the motion later than the minimum time therefor, he may require the defendant to serve a copy of his answering papers upon him within such extended period of time, not exceeding ten days, prior to such hearing date. No default judgment may be entered pursuant to subdivision (a) of section 3215 prior to the hearing date of the motion. If the motion is denied, the moving and answering papers shall be deemed the complaint and answer, respectively, unless the court orders otherwise.

Following the resignation or termination in 2009 of a number of its brokers, Merrill Lynch pursued collection of the principal and interest balances due on those loans that were not repaid in accordance with the ATP program's terms. Between January 2009 and November 2009, Merrill Lynch filed over 90 summary collection proceedings in New York state court in the name of MLIFI.

FINRA Steps In  

FINRA's Code of Arbitration Procedure for Industry Disputes Rule 13200(a) requires the mandatory arbitration of  intra-industry disputes between member firms and associated persons, and the failure to abide by that obligation has frequently been interpreted by FINRA as "conduct inconsistent with just and equitable principles of trade" in violation of FINRA Rule 2010.

FINRA Code of Arbitration Rule 13200: Required Arbitration
(a) Generally
Except as otherwise provided in the Code, a dispute must be arbitrated under the Code if the dispute arises out of the business activities of a member or an associated person and is between or among:
  • Members;
  • Members and Associated Persons; 
  • or Associated Persons. . . 

FINRA alleged that Merrill Lynch's conduct constituted an impermissible violation of its obligation to engage in intra-industry arbitration of business-related disputes with its associated persons, in violation of FINRA Rule 2010.  In accordance with the AWC, Merrill Lynch was Censured and fined $1,000,000.

In addition to entering into the AWC, Merrill Lynch submitted a Corrective Action Statement to FINRA which represented:


As a corrective action, Merrill Lynch and MLIFI stopped pursuing ATP collection actions in New York state court in January 2010, and will not do so in the future.

This Corrective Action Statement does not constitute factual or legal findings by FINRA, nor does it reflect the views of FINRA or its staff. 

Bill Singer's Comment  

Those familiar with my decades of published commentary about Wall Street know that I have frequently chided the industry regulators for a double standard that too often comes down like a ton of bricks on the smaller firms and individual brokers while showing too much leniency for the powerful and connected.  As I noted in Padded Expense Accounts Ends Hartford Broker's Career ( Blog, September 7, 2011):

[W]hat bothers me is the double standard that permeates all of Wall Street regulation.  In this FINRA case, an individual stockbroker is rightfully barred from the industry for defrauding his employer through the submission of bogus business expenses, some of which are double-billed.  A just comeuppance and good riddance!

However, this high dudgeon, this moral outrage by FINRA just doesn't seem to apply to the big boys - be they senior management at major brokerage firms or the too-big-to-fail firms themselves.  For example, remember this incident from about the same 2008 - 2009 time period involved in Lee's case?

The Perfect Office

No longer content with the corner office or the penthouse in hues of teakwood, former Merrill Lynch CEO John Thain, whose tenure drove Merrill Lynch to lose $15 billion in the fourth quarter of 2009, spent $1,405 on a trash can. As his company was eliminating jobs, a newly acquired $87,000 rug graced the floor of his office.

Most executives hire interior designers, and Thain was no exception hiring Michael Smith, of celebrity design fame. The tab for his designer office - $1.2 million.

"5 Outrageous CEO Spending Abuses and Perks" (Forbes  "Personal Spending" by Investopedia, August 3, 2011).

Thain's questionable office expenses in 2008 were well documented and have become the stuff of legend - and, yes, in the face of public outrage, he purportedly repaid the full cost of the renovation.  On the other hand, did FINRA or any regulator bring charges against him for submitting those charges? . . .

I applaud FINRA for taking this overdue action against its larger member firms.  For too long, FINRA has fostered a counterproductive image that it was little more than a lapdog serving the interests of its more influential members. If, indeed, this first step towards re-balancing the self-regulator's agenda is sincere, then there may yet be hope for over 600,000 registered persons and nearly 4,000 small member firms. Although I am not yet convinced, I welcome this historic action and will continue to monitor this regulator.