The Financial Industry Regulatory Authority (FINRA) fined Merrill Lynch, Pierce, Fenner & Smith, Inc. $5 million for alleged negligent disclosure failures in connection with the sale of five-year senior debt notes to retail customers. In particular, Merrill Lynch allegedly failed to adequately disclose certain costs, making it appear that the fixed costs were lower than they actually were.
FINRA charges that the notes, known as strategic return notes or “SRNs”, were linked to a Merrill Lynch proprietary volatility index. During 2010 and 2011, the firm allegedly sold approximately $168 million worth of the SRN notes to its retail customers, promoting them as a hedge against potential downturns in the equities markets.
FINRA charges that included in the costs associated with the notes was the “execution factor,” a feature of the Index intended to replicate transaction costs incurred in the simulated buying and selling of S&P 500 Index options. According to FINRA, these transaction costs allegedly accrued on a daily basis and totaled 1.5 percent per quarter, but were not disclosed in the offering materials for the SRNs. FINRA charges that in buying the notes, a reasonable retail customer would have considered it important that the execution factor imposed these costs.
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