Merrill Lynch, a Bank of America Corp. (BAC) unit must pay a $12.5M fine to resolve Securities and Exchange Commission allegations accusing the brokerage firm of having weak controls that led to mini-flash crashes. This is the largest penalty ever imposed for alleged market access rule violations.
According to the SEC, at least 15 times from 2012 to 2014, the bank established internal trading limits that were too high and, as a result not effective. These caused disruptions in the market.
Even though there were red flags, said the regulator, Merrill Lynch purportedly did not adequately assess whether it had controls that were reasonably designed and the brokerage firm did not remedy the issues when they arose fast enough. In one example cited by the SEC, Merrill Lynch purportedly applied a 5-million shares/order limit for one stock that traded at only about 69,000 shares/day. Because of this erroneous orders compelled certain stock prices to drop and then recover abruptly within seconds. For example, nearly 3% of Google’s stock dropped in under a second.
Another example, said the Commission, were the trading strategies that established limits of up to 25 million shares that the firm lowered to 50,000 shares after the SEC began conducting its probe. Stock crashes also led to declines in certain stock, such as the 99% drop felt by Andarko Petroleum Corporation’s stock on 5/17/13 and a similar one for Qualys Inc. stock the following month.
Even though it is settling, Bank of America is not denying or admitting to the findings.
Other firms that have had to settle SEC enforcement cases over Market Access Rule in the past include Goldman Sachs (GS), for $7M, Knight Capital for $12M, Latour Trading for $5M, Morgan Stanley (MS), for $4M and Wedbush for $2.44M.
Meantime, Merrill Lynch must also pay $3M in fines to six exchanges over disciplinary actions brought on their behalf by the Financial Industry Regulatory Authority for the alleged violation of the SEC’s market access rule and the exchanges’ supervision rules.
The exchanges are:
- Bats BYX Exchange
- Bats BZX Exchange
- Bats EDGEX Exchange
- NYSE Arca Inc.
- New York Stock Exchange LLC
- Nasdaq Stock Market LLC
Under the Commission’s Rule 15c3-5, which is the market access rule, brokerage firms who grant market access to customers have to put into place risk management controls that are designed reasonably enough to stop the entry of accidental or mistaken orders that could otherwise put the firm’s financial state, as well as that of market participants, or the market’s integrity at risk. The exchanges said that on numerous occasion from 7/14/11 through 10/20/14, Merrill Lynch’s controls for stopping unintended or wrong orders were inadequate, the single order quantity limits and single order notional value limits set up by the firm’s trading desks were too high to prevent mistaken orders, certain Merrill Lynch trading desks did not put into place a control that could reject orders with prices that were not reasonably related to the price quoted for the security, controls for managing the risk of unintended orders caused by malfunction systems or software programs were not reasonably designed to do this job, and the firm did not review its “erroneous order controls” on a regular basis so as to make sure that they were working effectively.
According to the exchanges, between 7/11 and 10/14, the firm submitted over 200 petitions to get the trades labeled “clearly erroneous.” These orders caused “substantial market disruption.”
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Read the SEC Order (PDF)
SEC Market Access Rule (PDF)