A pair of U.S. investment firms — Merrill Lynch, Pierce, Fenner & Smith Inc. and Harvest Volatility Management LLC — are being sanctioned for failing to adhere to investment limits in a complex options trading strategy that they sold to investors.
The U.S. Securities and Exchange Commission (SEC) alleged that the firms violated the rules governing advisers in connection with their deployment of a strategy known as the Collateral Yield Enhancement Strategy (CYES).
Harvest was the primary investment adviser and portfolio manager for the product, while Merrill approved its sale to ultra-high net worth clients, and received a 30% share of the management fees charged to Merrill investors.
The regulator alleged that Harvest allowed many investors’ accounts to exceed the investment limits that were agreed upon when the investors signed up for the strategy. The SEC alleged that, as a result, the firms generated excess management fees, while exposing investors to higher risks, and ultimately greater losses.
“By failing adequately to notify certain clients of their over-exposure to an options overlay strategy relative to what those clients had contractually agreed to with Harvest, Merrill breached its fiduciary duties to those clients,” the SEC order said.
To settle the allegations, without admitting or denying the SEC’s findings, the firms agreed to pay a combined US$9.3 million in penalties and disgorgement.
Specifically, Harvest agreed to pay a US$2 million penalty and US$3.5 million in disgorgement, while Merrill was fined US$1 million, and ordered to pay US$2.8 million in disgorgement and prejudgment interest.
“In this case, two investment advisers allegedly sold a complex options-trading strategy to their clients, but failed to abide by basic client instructions or implement and adhere to appropriate policies and procedures,” said Mark Cave, associate director of the SEC’s enforcement division, in a release.
“Today’s action holds Merrill and Harvest accountable for dropping the ball in executing these basic duties to their clients, even as their clients’ financial exposure grew well beyond predetermined limits,” Cave said.