Down-market brokers said to have made iffy fund-switch recommendations. Financial-service regulator NASD has fined Merrill Lynch $5 million for registration violations and supervisory failures at the wirehouse’s Financial Advisory Center (FAC) call-center locations in Hopewell, N.J., and Jacksonville, Fla. The securities regulator has also called a three-year moratorium on sales contests for FAC staffers.

The action goes to the heart of Merrill’s market segmentation efforts, an initiative closely connected with the evolution of the big-brokerage call center from an information bureau for investors to sales-oriented clearing houses for low-end clients.

Thanks for the advice

NASD says that Merrill was in some cases using supervisors who lacked the proper licenses to oversee FAC-based brokers from 2001 to 2004. At that time NASD says that some of those brokers made fund-switch recommendations “that were accompanied by misrepresentations and omissions of facts to customers.”

NASD says that mutual-fund switches – selling shares in one mutual fund to buy shares in one or more other funds – may be appropriate under certain conditions. “But some transfers between funds may constitute unsuitable switching, particularly if your broker recommends switching funds only to earn a commission from the sale or purchase. This kind of switch, in fact, is a violation of securities laws.”

The wirehouse also conducted sales contests “which improperly awarded non-cash compensation to ISAs in the form of rock concert tickets, sporting events and dinners based solely on the sale of the firm's proprietary mutual funds,” according to NASD.

Merrill’s two-office FAC was conceived and launched as a centralized call center to help answer clients’ questions about their investments. Initially FAC held only a few accounts. In 2001, however, and “as a result of an overall Merrill Lynch strategy to improve its retail business by ‘segmenting’ customer accounts,” the securities firm began migrating client accounts from branch offices to the FAC.

Hello, hello?

Generally speaking Merrill moved accounts worth less that $100,000 and those with “minimal transactional activity” to FAC, “in part so that Merrill Lynch's full service Financial Advisors in branch offices could devote more attention to larger accounts,” according to NASD. More than a million such clients were transferred to FAC between March 2001 and August 2002, many without the client’s prior consent. At its peak size in 2002, FAC had about 1.3 million accounts with about $20 billion in assets – and gross revenues for the year of approximately $210 million.

“Regardless of the size of their brokerage account, all investors are entitled to services from registered representatives acting in their clients' best interests who are reasonably supervised by properly registered professionals,” says James Shorris, NASD’s acting head of enforcement. “In this case, Merrill Lynch failed to meet these basic standards by permitting its call center to function without proper supervisory controls, which gave rise to impermissible sales contests, unsuitable mutual fund switches, and other systemic failures.”

NASD’s investigation of Merrill’s FAC has prompted it to issue a new investor alert called Customer Advisory Centers: Not Your Typical Securities Firm Call Center. It’s worth reading.

In addition to the fine and the contest prohibition, NASD is forcing Merrill hire an independent consultancy “to recommend corrective measures to firm policies and supervisory and compliance procedures and systems for FAC.” Until that’s done and the recommendations are implemented, Merrill “must impose special supervisory procedures,” including monitoring calls between FAC personnel and customers.

NASD used to stand for “National Association of Securities Dealers.” But a few years back the private-sector regulator re-branded itself as NASD, period. –FWR

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