B-Ds pay $5.25M to settle charges

Wells Fargo Advisors LLC has been ordered by the Financial Industry Regulatory Authority Inc. to pay $3.25 million and Bank of America to pay $2 million for selling unsuitable mutual funds of floating-rate bank loans during the credit crisis.

This year, bank loan mutual funds have seen a fresh burst of popularity with investors hungry for yield but skittish of bonds and scared of rising interest rates.

For the first quarter, Morningstar Inc. reported $15.1 billion in investor money going into such mutual funds.

Wells Fargo Advisors will pay a fine of $1.25 million and reimburse $2 million in losses to 239 clients. Merrill Lynch will pay a $900,000 fine and reimburse $1.1 million in losses to 214 clients.

PREDECESSOR FIRMS

According to Finra, broker-dealers that were predecessors of both Wells Fargo Advisors and Merrill Lynch in 2007 and 2008 also failed to adequately supervise the brokers who sold the floating-rate funds. Wells Fargo Advisors is the successor firm of Wells Fargo Investments LLC, while Merrill Lynch is the successor broker-dealer of Banc of America Investment Services Inc.

Wells Fargo and Merrill Lynch neither admitted nor denied the charges but consented to Finra’s letter of acceptance, waiver and consent against each firm.

“We are pleased that this settlement with Finra resolves an issue related to activities that took place between 2007 and 2008 at Wells Fargo Investments prior to its merger into Wells Fargo Advisors,” Wells Fargo spokesman Tony Mattera said.

“We are pleased to resolve this matter,” Merrill Lynch spokesman Bill Halldin said.

Floating-rate mutual funds, also known as bank loan funds, senior loan funds and leveraged-loan funds, typically invest in a portfolio of secured senior loans made to businesses with a “junk” credit rating.

The funds have significant credit risks and can lack liquidity, according to Finra, which raised concerns about sales of such funds in its annual exam and priorities letter to the brokerage industry at the start of the year.

The funds shouldn’t have been sold to the customers in question, Finra said.

“Finra found that Wells Fargo and Banc brokers recommended concentrated purchases of floating-rate-bank-loan funds to customers whose risk tolerance, investment objectives and financial conditions were inconsistent with the risks and feature of floating-rate-loan funds,” Finra said in a statement. “The customers were seeking to preserve principal or had conservative risk tolerances, and brokers made recommendations to purchase floating-rate-loan funds without having reasonable grounds to believe that the purchases were suitable for customers.”

WARNINGS RAISED

According to the Finra acceptance, waiver and consent letter concerning the Wells Fargo brokerage, staff at the firm raised warnings about the funds, but the firm didn’t act on those concerns.

“Even after Wells Fargo Investments’ mutual fund product team raised concerns about the sales of floating-rate-loan funds, the firm failed to take reasonable steps to ensure that its sales force was informed of those concerns and took them into account when recommending and selling floating-rate-loan funds to customers,” the letter stated.

In August 2007, the mutual fund product team reported its concerns to the firm’s senior management, highlighting the high volume of sales of floating-rate funds, according to the Finra letter.

The firm’s brokers were confusing the funds with less risky investments such as bank certificates of deposit, according to the Finra letter.

The team “was concerned that “financial advisers are positioning these funds as an alternative to bank CDs or money market funds instead of part of an overall diversification strategy,’” according to the Finra letter.

Related Topics: Financial Industry Regulatory Authority, Merrill Lynch, Wells Fargo & Co.