CFTC Orders FCM to Pay Fine for Supervision Failures
Commentary by Bob Zwirb
The CFTC issued an order filing and settling charges against Merrill Lynch for failing to diligently supervise its officers', employees' and agents' processing of futures exchange and clearing fees charged to its customers in the period from January 2010 through April 2013.
According to the CFTC order, Merrill Lynch's fee reconciliation process for identifying and correcting discrepancies between the invoices from the exchange clearinghouses and the amounts charged to its customers had been "faulty for more than two years." As a result, Merrill over-accrued fees from some clients and under-accrued them from others.
The order found that Merrill Lynch did not hire qualified personnel to conduct and oversee its fee reconciliations, or provide manuals or sufficient training regarding fee reconciliations to its staff.
See: CFTC Order; CFTC Press Release.
Commentary
Although the conduct found wanting here involved Merrill's process for identifying and correcting discrepancies, the CFTC went after it for something else: for failing to adequately supervise the personnel in charge of this task. Moreover, although the amount wrongly allocated was $451,318, or 0.14% of the fees charged to 196 customers, the civil penalty assessed by the CFTC amounts to nearly triple that amount, or $1.2 million. Merrill was severely penalized notwithstanding the fact that its response when this discrepancy was brought to its attention was to initiate an internal review, fire the fee group's manager and his successor, and retain two outside consulting firms to review its fee reconciliation process.
This matter illustrates the importance of having adequate supervisory procedures in place (including good compliance manuals) and diligently carrying out such procedures (including providing good training and systems to compliance staff). Here, the CFTC found both components of Rule 166.3 to have been breached; i.e., that the firm "both employed an inadequate supervisory system and failed to perform its supervisory duties diligently." Market participants also should be aware that under CFTC case law, a violation for failure to supervise under Rule 166.3 is an independent violation for which no underlying rule violation is necessary. GNP Commodities Inc., CCH ¶ 25,360; Monieson v. CFTC, 996 F.2d 852; Paragon Futures Ass'n, CFTC No. 88-18, CCH ¶ 25,266. Where underlying violations do exist and should have been detected by a diligent system of supervision, the existence of the underlying violations may constitute independent proof of a failure to supervise.