Merrill Lynch has lots of relationships and is trying to manage an advisory business, a brokerage business and an investment banking business. It got into trouble for letting the last two interfere with the normal operations of its advisory business.
In general during the time of the SEC action, a material change in any product on Merrill’s advisory platforms, such as replacing the product’s portfolio manager, results in Merrill’s Due Diligence team conducting an in-depth review of the product. If they give it a thumbs down, the analysts put together a termination recommendation. It eventually ends up with Merrill’s Governance Committee for the ultimate decision. The Governance Committee had apparently always approved termination recommendations.
In 2012 one of the products in platform managed by a U.S. subsidiary of a foreign multinational bank announced a change in portfolio manager. It was a big change. The product was run by a single portfolio manager with accounts having a minimum of $100,000 invested in portfolios of 20-25 bonds specifically selected by the portfolio manager. The new manager was a team that had been responsible for institutional accounts with a minimum of $100 million invested in diversified portfolios of approximately 150 bonds.
That was a big change and had no track record for the new investing style. It seems like an easy termination and due diligence recommended the termination.
The problem is that a Merrill employee contacted the platform before the Governance Committee vote. The employee was trying to get in front of the operational issues from inevitable termination.
But that proactive communication gave the platform time to lobby Merrill management for a reconsideration. Apparently, that also included discussion of a possible active bookrunner role in a registered offering associated with the platform. Senior management apparently intervened in the termination process.
The most unusual part was the person who ran the agenda for Merrill’s Governance Committee got an email from a platform employee telling the Merrill person that the item was going to removed from the agenda.
The Due Diligence Employee received this email on the morning of January 16 and forwarded the email to another Merrill executive, stating, “Here is a first. An external manager telling an internal product staffer what can go on an internal governance agenda” to which the recipient responded, “[A]stonishing.”
The Governance Committee did not vote on the termination and instead diligence went back for more review.
Merrill ended up with non-active bookrunner rule in the offering, getting a smaller allocation.
Ultimately, the product stayed on hold for a year. The performance was satisfactory. It performed as well and in some instances better than the products that would have replaced it.
Investors were not harmed, but Merrill had a breakdown in procedure. It’s decision-making was clearly in conflict. The SEC came down hard, forcing Merrill to disgorge the fees it earned on the platform over the year and pay an equivalent fine.
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