The National Association of Securities Dealers has fined Merrill Lynch, Pierce, Fenner & Smith Inc. US$5 million for supervisory failures, registration violations, impermissible sales contests and other violations in connection with the operation of a couple of its call centres.

The NASD found that, from 2001 to 2004, Merrill Lynch did not have an adequate supervisory system and procedures that were reasonably designed to oversee the trading activities of its registered representatives in two of its call centres, known as Financial Advisory Centres. Certain reps engaged in a pattern of mutual fund switch recommendations that were accompanied by misrepresentations and omissions of facts to customers. It also permitted individuals lacking the proper securities licenses and qualifications to be responsible for the supervision of the reps. Merrill Lynch also conducted several sales contests which improperly awarded non-cash compensation to reps in the form of rock concert tickets, sporting events and dinners based solely on the sale of the firm’s proprietary mutual funds.

In settling this matter, the firm neither admitted nor denied the charges, but consented to the entry of NASD’s findings.

Along with the fine, the firm was also prohibited from staging any sales contests for FAC personnel for three years. And, Merrill Lynch was ordered to retain an independent consultant to recommend corrective measures to firm policies and supervisory and compliance procedures and systems for the FAC. Until those corrective measures are implemented, Merrill Lynch must impose special supervisory procedures, including monitoring calls between FAC personnel and customers.

The NASD notes that the FAC was originally designed as a centralized call centre where customers could call with questions or requests about their accounts, but regulators found that the character of the FAC changed in 2001. As a result of an overall Merrill Lynch strategy to improve its retail business by “segmenting” customer accounts, the firm began relocating thousands of customer accounts from branch offices throughout the country to the FAC.

Generally, smaller accounts with assets of US$100,000 or less, or those with minimal transactional activity, were moved to the FAC, in part so that Merrill Lynch’s full service advisors in branch offices could devote more attention to larger accounts. Between March 2001 and August 2002, more than 1 million customers were transferred to the FAC. At its peak size in 2002, the FAC had approximately 1.3 million accounts holding approximately $20 billion in assets. That year, the FAC had gross revenues of approximately US$210 million.

The NASD found that Merrill Lynch failed to disclose that the reps in the call centres often had five years or less brokerage experience, and that when making recommendations regarding securities, they were limited to mutual funds. It also found that several reps recommended mutual fund switches that were not suitable for their customers, and that certain reps made false representations to customers, and/or omitted material facts, concerning costs and other important information.

The regulator found that, from 2001 through 2004, Merrill Lynch lacked an adequate supervisory system and procedures reasonably designed to supervise the call centre reps, particularly given the growth of the FAC. It lacked adequate written supervisory procedures regarding mutual fund recommendations (including switch transactions); did not employ a sufficient number of properly trained and qualified supervisors to monitor activities within the FAC; and failed to conduct annual compliance audits for the FAC’s two most active years. Thousands of mutual fund switches were not reviewed or were not adequately reviewed by Merrill Lynch principals.

In connection with today’s announcement, the NASD released a new investor alert about call centres too. “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,” said NASD senior vice president and acting head of enforcement James Shorris. “In this case, Merrill Lynch failed to meet these basic standards by permitting its call centre to function without proper supervisory controls, which gave rise to impermissible sales contests, unsuitable mutual fund switches, and other systemic failures.”