FINRA fined Merrill Lynch, Pierce, Fenner & Smith Incorporated ("Merrill Lynch") $1.4 million for violations relating to extended settlement transactions.

According to FINRA, Merrill Lynch failed to identify and evaluate extended settlement transactions between 2013 and 2015. As a result, for many of these transactions, FINRA found that Merrill Lynch failed to collect requisite margin and committed a variety of ancillary violations.

In connection with the extended settlement trade violations, FINRA also found that Merrill Lynch did not implement adequate supervisory policies and procedures that were tailored to the nature of extended settlement transactions.

To settle the charges, Merrill Lynch agreed to a censure in addition to the $1.4 million fine.

Commentary /Nihal Patel



The violations all boil down to the single question of whether margin should have been collected on transactions where settlement was extended beyond the standard settlement cycle.

On this key question, FINRA did not provide any legal analysis, which is problematic given that the issue is quite complicated.

  • FINRA states that "pursuant to Rule 4210(a)(13)(B)(ii)(e)" certain customer accounts are exempt from margin collection and instead subject to capital charges. The cited provision is a portion of a definition. Read literally, this might suggest that only those particular types of exempt accounts are actually exempt accounts for purposes of extended settlement transactions and determining whether margin or capital is required. This simply cannot be the case.
  • FINRA never provides a citation for the conclusion that margin collection on extended settlement transactions is not required for exempt accounts but is required for non-exempt accounts. It's possible that FINRA is basing its conclusion on Rule 4210(f)(3), but that provision is not mentioned anywhere in the enforcement action and sets forth particular terms for when-issued transactions. While this is one of the most common reasons why settlement might be extended, it does not cover all grounds, and in fact contains a full exception for distributions to the general public.
  • FINRA states that Section 220.8 of Regulation T requires, for cash account transactions, payment or liquidation within five business days after trade date. While this is generally true (although now four business days, given the shorter settlement cycle), Reg. T also contains important exceptions to that general requirement, including for: (1) refunding transactions; (2) foreign securities with longer settlement cycles; (3) delivery-versus-payment transactions where settlement is delayed due to "the mechanics of the transaction." But none of these exceptions are mentioned in the enforcement action.
  • FINRA Rule 4210(f)(6) provides that margin requirements must be satisfied "as promptly as possible and in any event within 15 business days from the date such deficiency occurred." This provision is not mentioned anywhere in the enforcement action - i.e., it is not clear whether all of the relevant transactions that resulted in violations of Rule 4210 were for trades that where settlement was extended more than 15 business days.
  • Every rule violation in the enforcement action is also deemed a violation of FINRA Rule 2010. Rule 2010 is notoriously broad, but in light of this enforcement action, it's worth asking whether there is any violation of a FINRA rule that is not also a violation of Rule 2010?

It is simply not possible for a market participant to read this enforcement action and determine which aspects of the conduct were improper, or how FINRA interprets the rules it is charged with enforcing. This makes it very difficult for market participants to determine how to conduct their business and vitiates any value that an enforcement action might have in guiding market conduct.

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