SEC Charges Merrill Lynch and Harvest Volatility Management for Violating Client Investment Limits
The U.S. Securities and Exchange Commission (SEC) recently charged Harvest Volatility Management and Merrill Lynch for exceeding clients’ predesignated investment limits over a two-year period. Merrill Lynch, a financial services company owned by Bank of America, and Harvest have agreed to pay a combined $9.3 million in penalties to settle the claims.
Harvest was the primary investment advisor and portfolio manager for the Collateral Yield Enhancement Strategy, which involved trading options in a volatility index to generate incremental returns. However, beginning in 2016, Harvest allowed numerous accounts to surpass the exposure levels that investors had originally set when they enrolled in the enhancement strategy. According to the SEC’s orders, dozens of accounts exceeded the limits by 50% or more.
Merrill Lynch facilitated its clients’ connection to Harvest even though it was aware that the accounts were exceeding the set exposure levels under Harvest’s management. Additionally, Merrill received a portion of Harvest’s trading commissions, as well as management and incentive fees. Both Merrill and Harvest earned higher management fees while investors faced increased financial risks, as stated by the SEC.
The SEC found that both companies neglected to implement policies and procedures that could have alerted investors when their exposure exceeded the designated limits. Mark Cave, associate director of the SEC’s enforcement division, commented on the situation, saying, “In this case, two investment advisers allegedly sold a complex options trading strategy to their clients but failed to abide by basic client instructions or implement and adhere to appropriate policies and procedures.”
Consequences of Violating Client Investment Limits
The consequences of exceeding client investment limits can be detrimental to both investors and the companies involved. When clients’ exposure levels surpass predetermined limits, they are exposed to higher financial risks that they may not have been prepared for. In this case, investors who had signed up for the Collateral Yield Enhancement Strategy were unknowingly subjected to greater risks due to the negligence of Harvest and Merrill Lynch.
Moreover, when investment firms like Harvest and Merrill fail to adhere to client instructions and implement proper policies, it erodes trust in the financial system. Investors rely on these firms to act in their best interests and protect their investments. Violating client investment limits not only puts investors at risk but also damages the reputation of the firms involved.
Lessons Learned and Moving Forward
The SEC’s actions against Harvest Volatility Management and Merrill Lynch serve as a reminder to investment firms about the importance of following client instructions and implementing robust policies and procedures. Firms must prioritize the protection of their clients’ interests and ensure that they are operating within the agreed-upon limits.
In response to the charges, Bank of America, the parent company of Merrill Lynch, announced that they had ceased all new enrollments with Harvest in 2019 and advised existing clients to unwind their positions. This proactive approach demonstrates a commitment to rectifying the situation and mitigating any further risks to investors.
Moving forward, it is crucial for investment firms to conduct regular reviews of their client accounts to ensure compliance with investment limits. Clear communication with clients about the risks involved in different investment strategies is also essential to prevent similar incidents from occurring in the future. By learning from past mistakes and implementing necessary safeguards, firms can rebuild trust with their clients and uphold the integrity of the financial services industry.