Merrill Lynch fined $5M for call center violations
March 15, 2006
By Jaime Levy Pessin and Lynn Cowan, DOW JONES NEWSWIRES

NEW YORK -- Merrill Lynch & Co. (MER) says its call centers were created with the best interests of its smallest investors in mind, but a National Association of Securities Dealers investigation indicates that hasn't always been the case.

The country's largest retail brokerage was fined $5 million by the NASD Wednesday for violations that included recommending mutual fund switches that needlessly cost customers money and running contests that encouraged brokers to sell the firm's own funds. The investigation was first reported by The Wall Street Journal in October.

The call centers, in Hopewell, N.J., and Jacksonville, Fla., handle smaller customers' accounts - generally, those with assets of $100,000 or less or with few transactions - freeing up stockbrokers to focus on more affluent customers.

Merrill's activities in the call centers constituted a "massive ethical lapse," said Dan Solin, an attorney and registered investment advisor who wrote the 2002 book "Does Your Broker Owe You Money?"

"When you're dealing with an unsophisticated investor, you have to be more scrupulous, careful, honest and forthright," Solin said. "If these brokers were incentivized to sell broad-based, low-cost index funds, you can be assured that's what they'd be selling. These practices are clearly not in the best interest of investors."

NASD Senior Vice President Emily Gordy said that "in the earlier period, the violations were more egregious and widespread." Merrill made some improvements after the initial problems, she said, but didn't entirely fix its system.

In a statement, Merrill Lynch acknowledged it had "growing pains" in its call centers when they were first expanding four and five years ago.

"We are confident we've worked them out, made significant changes to our operations and management, and offered a service that 90% of our
(call-center) clients tell us leaves them 'highly satisfied,' " the statement read.

Experience Gap

While Merrill has always claimed the call centers offer the same quality of service as individual brokers, the NASD found that from 2001 to 2004 the centers didn't have an adequate supervisory system in place.

In addition, while the firm promised newly transferred account holders that they would receive advice from a "team of Merrill Lynch professionals" at the center, the representatives often had five years or less of brokerage experience and were only allowed to make mutual fund recommendations.

NASD found that several Merrill representatives at the call centers recommended mutual fund switches that weren't suitable given that reasonable, free-exchange alternatives were available for customers within their existing mutual-fund families. NASD also found that some Merrill representatives made false representations to customers, omitting material facts concerning costs and other important information. As a result, some customers incurred unnecessary charges and expenses.

NASD's investigation showed that in 2002 the call centers conducted three sales contests that violated the regulatory organization's non-cash compensation rule because they favored the sale of Merrill Lynch's proprietary mutual funds.

NASD rules prohibit such fund-family contests unless they are based on total sales of all brands of products within a single category. One contest rewarded the six top sellers of Merrill Lynch mutual-fund products with tickets to a rock concert. Another offered a total of $10,000 in expense credits to the top four teams of representatives.

These contests, along with several others based on overall production, contributed to a nearly fourfold increase in the volume of proprietary mutual-fund sales by the call centers, according to the NASD.

Corrective Measures

Among the dissatisfied customers was James Carskadon, a former Merrill Lynch customer in Oregon whose account was transferred to a call center after it dropped below $100,000, said his lawyer, Bob Banks. Banks described the letter informing his client of the switch as "misleading."

" It didn't tell him there was no benefit for him," Banks said. An arbitration panel in 2005 awarded Carskadon compensatory damages of close to $65,000, plus interest and attorneys fees.

"I think Merrill got off pretty easy," Banks said of the $5 million penalty, noting the NASD's finding that the call center generated $210 million in gross revenue in 2002, at its peak size.

In addition to the fine, Merrill Lynch was ordered to pay an independent consultant to recommend corrective measures. Until they are implemented, the company must impose special supervisory procedures, including monitoring calls between its center representatives and customers.
Gordy, of the NASD, said the costs associated with those measures, combined with the $5 million fine, constituted "a very strong message."

The NASD on Wednesday also issued a new investor alert to the public about call centers like Merrill's. Although Merrill was the first major firm to shift its smaller clients into such centers, other firms have followed.

Broader Warning

The NASD alert warns investors that their accounts may be switched into such call centers without their consent and that the letters alerting them to the change may tell them they have been "enrolled" or transferred to the center. Once there, they may not have a dedicated broker assigned to their account, and the representatives they deal with may be paid incentives to sell certain products or bring new money in to the accounts. The alert also details some of the findings from the NASD's investigation into Merrill's call centers.

Even firms using call centers have taken different approaches to handling clients with fewer assets. Morgan Stanley's call centers, which opened in 2005, handle households with combined assets of less than $100,000. But some traditional financial advisors around the country also specialize in the "emerging affluent" category.

At Piper Jaffray, financial advisors decide when clients should be shifted to its "investment center," which opened in 2002. A spokesman said clients are transferred based not only on asset level, but the level of service a customer wants. A client can choose to work consistently with the same financial advisor at the center.

Gordy declined to comment on whether the NASD is investigating any other call centers.

Still, Gordy and other industry observers cautioned that well-run call centers are not inherently bad for small investors. Andy Tasnady, who runs brokerage consulting firm Tasnady Associates in Port Washington, N.Y., said call centers are a good concept and can provide efficient, standardized brokerage advice to a group of investors who have few other options.

"The model should be able to work," Tasnady said. "Otherwise people with $5,000 won't get any service from anybody."

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