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BofA Nears Accord with SEC Over Client Accounts Case

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Per a Wall Street Journal report, Bank of America Corporation (BAC - Free Report) is in talks with the Securities and Exchange Commission (“SEC”) to bring an end to the probe related to breach of rules designed to protect client accounts. The bank may shell out $400 to $450 million to settle these allegations, according to people familiar with the matter.

The settlement would be one of the highest ever for the SEC after a $616 million fine paid by the affiliates of SAC Capital Advisors LP in 2013.

Matter In Brief

The SEC investigation was first revealed by a Wall Street Journal report in April last year. The SEC began a probe to verify whether BofA violated rules set for safeguarding of customer accounts and putting retail-brokerage funds at risk for more profits.

The bank was accused of adopting unusual strategy and improper controls for certain client accounts and retail brokerage funds. The use of such strategy, which occurred in BofA’s Merrill Lynch unit, was ceased by BofA in mid-2012 due to internal debate regarding its possible regulatory and other related risks.

Also, it was a matter of question whether BofA used complex trades and loans to save millions of dollars in funding costs along with easing billions of dollars in cash and securities for its own uses, instead of keeping it inaccessible in order to meet regulatory requirements.

Rule 15c3-3

SEC designed rule 15c3-3 under the Securities Exchange Act of 1934 to address issues related to customer margin for security futures products. The purpose is to ensure that investment banks and trading firms retain sufficient cash and easy-to-sell securities to be able to repay customers in case of failure.

A bank is supposed to reserve more in segregated reserve funds, known as “lockup” accounts, the more it owes customers. However, sitting idle on billions of dollars in lockup accounts prove costly to banks, which cannot put this money to any other use given the customer protection rule. Nonetheless, the banks want to free up such money for carrying out trading activities.

BofA’s Merrill Lynch came into regulatory radar for this reason. The unit is said to have carried out complex trades and loans since 2009 to minimize the amount of money in lockup accounts. Also, the regulator is looking into the accuracy of the bank’s statements to the SEC about its lockup practices.

Another Merrill Lynch Case

The SEC is setting up a civil enforcement case against BofA’s Merrill Lynch, which is alleged to have misrepresented risks involved in structured notes that later slumped as much as 95% in value. The news was reported by the Wall Street Journal.

Merrill Lynch sold Strategic Return Notes in 2010 and raised nearly $150 million. However, the value of the five-year notes plunged swiftly after issuance due to fall in market volatility and increase in cost of the underlying options, leading to client complains.

This resulted in a dispute between Merrill Lynch and two of its brokers that sold structured notes to their clients. The brokers are said to have secretly taped calls with executives at Merrill Lynch and then quit the bank to join UBS Group AG (UBS - Free Report) only to later file a whistleblower complaint with the SEC.

Our Take

Wall Street biggies such as BofA, The Goldman Sachs Group, Inc. (GS - Free Report)   and Wells Fargo & Company (WFC - Free Report) continue to be in focus for never-ending investigations pertaining to their past business malpractices.

For BofA, these lawsuits and subsequent settlements add to its numerous litigation headwinds. The company has been striving hard to get past its legal matters and focus on its core operations.

Currently, BofA holds a Zacks Rank #4 (Sell).

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