On March 19, 2018, the Securities and Exchange Commission (“SEC”) announced its highest-ever whistleblower award, with the three recipients of the award receiving a total of approximately $83 million. The award involved three whistleblowers, two of whom split $50 million, and one of whom provided greater assistance in the process, thereby receiving $33 million. The $83 million award represents 20% of the $415 million fine levied against Merrill Lynch (“Merrill”) by the SEC.
This fine was the result of Merrill gaming SEC Rule 15c3-3 – a regulation that mandates broker-dealers keep customer cash separate from firm cash, so that in the event of a bankruptcy, customer funds would not be jeopardized. Merrill circumvented this rule by writing derivative contracts that would allow customer cash to be held in Merrill accounts. Merrill customers suffered no actual loss from these derivative contract trades that they were entered into, as the sole purpose of the contracts was not market exposure, but a way to account customer assets as being on Merrill books, so that for example the firm could have more cash with which to leverage.
This bespoke derivative contract that Merrill designed, called a “leveraged conversion” had no real economic substance, however it impacted the way “customer cash” was calculated. These contracts made it appear customers owed Merrill money that they did not, because the debt was simply notional. Merrill actually sought SEC approval on these leveraged conversions, and was granted it. The SEC likely granted this approval because they thought the intent of the trades was to help Merrill clients finance inventory, or had some other tangible benefit – they would not have approved the leveraged conversions had they known Merrill designed these contracts purely to skirt SEC Rule 15c3-3.
Three whistleblowers alerted the SEC as to the intent behind these leveraged conversions. This led to regulatory action and the resulting settlement between Merrill and the SEC. The Settlement Order states that Merrill agreed “to pay $415 million and admit wrongdoing to settle charges that it misused customer cash to generate profits for the firm and failed to safeguard customer securities from the claims of its creditors.”
The attorneys at Lax & Neville LLP have extensive experience in successfully prosecuting claims on behalf of customers who have suffered losses as a result of investment and securities fraud. Additionally, attorneys at Lax & Neville are experienced with employment law in the financial services industry, and dealing with regulatory bodies such as the SEC. If you are a victim of fraud, or feel you have a whistleblower claim, please contact Lax & Neville LLP today at (212) 696-1999 to schedule a consultation.