Recent FINRA Sanctions Against Merrill Lynch May Be Just the Beginning

The Financial Industry Regulatory Authority (FINRA) recently announced a small fine against Merrill Lynch, Pierce, Fenner & Smith Inc. (Merrill Lynch) relating to the recommendation of leverage to clients. In reality, FINRA has only scratched the surface of a monumental problem in the retail securities industry that will likely lead to devastating results for clients of Wall Street firms when interest rates rise, and the markets turn bearish as part of a natural business cycle.

Wall Street’s Drive for Revenue Compounds Problem

The problem is a compound problem created by Wall Street’s systemic drive to generate revenues and favorable terms by both borrowing money from its client base and loaning money to its client base. The borrowing is typically in the form of what are known as structured products. The lending is typically in the form of loans secured by the client’s investment portfolio.

Using Merrill as an example, and only as an example, Merrill Lynch has been sanctioned by regulators for both its techniques in borrowing from clients and its techniques in loaning money to clients.

With respect to borrowing money from clients, Merrill Lynch pushes what are known as structured products. Although these synthetic products designed by Wall Street are very complicated, the underlying premise is for Merrill Lynch advisors to convince clients to loan Merrill Lynch money on an unsecured basis. By unsecured, I mean that there is no collateral which lenders (Clients) can go after if the brokerage firm fails to repay the money. These products allow firms such as Merrill Lynch to not only borrow money without having to deal with sophisticated and demanding institutional investors, but also allows Merrill Lynch to borrow money on terms far more favorable than the terms which would be demanded by institutional investors.

Highlighting the Issues

To highlight what Vernon Litigation Group finds so troubling about this practice if an individual broker recommended to a client that the client should loan the broker money on an unsecured basis, the broker would be immediately fired, and regulators would sanction that individual broker. Brokerage firms such as Merrill Lynch borrow money from clients – through structured notes – on a regular basis with the blessing of regulators such as FINRA. And, on top of this practice of borrowing money from its own clients without having to put up any collateral, firms such as Merrill Lynch have a track record of misleading clients regarding these products.

The above-described practice of firms such as Merrill Lynch using its own client base as a credit facility is especially abusive in light of Merrill Lynch’s simultaneous push over the last several years to motivate it’s financial advisors to recommend lines of credit or other lending arrangements by using the client’s securities portfolio as collateral. As with the practice of borrowing from clients, not only is it a troubling premise, but Merrill Lynch has been sanctioned by regulators for failing to properly supervise this push to convert its client base into borrowers.

Incentives for Sales Force May Be A Bad Thing

In sum, Merrill Lynch and other Wall Street firms incentivize their sales force (ie. their “financial advisors”) to convert their client base into a collective group that both loans money to Merrill Lynch on a basis that is very favorable to Merrill Lynch and also borrows money from Merrill Lynch on terms that are favorable to Merrill Lynch. The word arbitrage comes to mind when you view these practices together in the cold light of day.

We believe these practices should be stopped immediately by regulators, but do not anticipate that FINRA will take any action until it is far too late. By too late, we mean after there is a market cycle that creates a situation in which investors will be stuck with their unsecured loans to Wall Street in the form of illiquid structured notes, while Wall Street immediately collects on its loans to customers by liquidating marketable securities from the client’s accounts in the middle of a down market. If this scenario comes to pass, it will be retail investors who bear the brunt of the harm, rather than the big financial institutions. In other words, Wall Street has done a good job of pushing the risks of leverage off of its own books and into the laps of retail investors who trust these Wall Street firms and their financial advisors to look out for their interests.


Investors should ask their financial advisors what will happen to their portfolio if there is a significant market correction while their portfolio as collateral for a loan. Investors should ask whether they can call in their loan without penalty on a structured note before the note matures if interest rates rise dramatically. Investors who are both borrowing money from their financial institution and loaning money to their financial institution, should ask whether it makes sense to simultaneously loan money to and borrow money from the same contra party without negotiating the terms of each.

If you are an investor with Merrill Lynch, see if you have the following: A Loan Management Account (“LMA” account) or other arrangements in which you have borrowed money from Merrill Lynch or its owner, Bank of America; along with a structured product investment in which you have effectively loaned money to Merrill Lynch. If you have this combination, you should obtain a second opinion from a qualified investment professional as to whether it makes financial sense to borrow money from Merrill Lynch (under terms in which you are paying interest and providing your investment portfolio as collateral) while simultaneously loaning money to Merrill Lynch (in which Merrill Lynch substitutes a synthetic return for interest payments and in which Merrill Lynch provide no collateral).

Given the financial disaster caused by many financial institutions a decade ago, investors and regulators should meticulously scrutinize these ongoing practices of Wall Street firms as they pose a tremendous risk to the retail investing public. Truthfully, we find it incredible that regulators and lawmakers are allowing these borrowing and lending practices to occur, especially in light of the fact that this is a practice engaged in by virtually all Wall Street firms and is not limited to Merrill Lynch.


Vernon Litigation Group is a litigation firm. It represents clients in courtroom litigation, arbitration, mediation, and regulatory filings throughout the United States. Our lawyers have collectively represented thousands of investors in FINRA and other securities arbitration and litigation claims nationwide and recovered many millions of dollars from financial institutions, both large and small. Please contact us to discuss your rights if you believe a Wall Street firm or other investment firm has failed to act in your best interests or otherwise abused your trust. For more information, visit our website at or contact Vernon Litigation Group by phone at (239) 319-4434 or by e-mail at to speak with Vernon Litigation Group.

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