The Law Offices of Robert Wayne Pearce, P.A. filed a claim against Merrill Lynch Pierce Fenner & Smith Incorporated (Merrill Lynch) for an investor residing in Puerto Rico (the “Claimant”) arising out of Merrill Lynch’s Puerto Rico office. A summary of Claimant’s allegations against Merrill Lynch are set forth below. If you or any family member received similar misrepresentations and/or misleading statements from Merrill Lynch and its Puerto Rico stockbrokers or found yourself with an account overconcentrated in Puerto Rico municipal bonds and/or closed-end bond funds, or if you borrowed monies from Merrill Lynch and used your investments as collateral for those loans, we may be able to help you recover your losses. Contact our office for a free consultation about your case.
SUMMARY OF ALLEGATIONS MADE AGAINST MERRILL LYNCH
I. SUMMARY
This arbitration arises out of a series of unsuitable recommendations by a Merrill Lynch financial advisor that Claimant purchase and hold an excessive concentration of Puerto Rico bonds on margin in a Merrill Lynch account. As a result, the Claimant’s investment portfolio was not diversified from not only an asset allocation standpoint but overly concentrated in securities issued in a single geographic area, i.e., Puerto Rico. The leveraged and excessively concentrated Puerto Rico bond account was unsuitable. Merrill Lynch through its representatives also disseminated false and misleading information to Claimant about both the nature, mechanics and risks of owning the bonds and the leveraged investment strategy. Merrill Lynch and its representatives not only violated the FINRA Code of Conduct but they also committed fraud, breached their fiduciary duties to Claimant and were negligent in advising her on how to safeguard her investment capital. Merrill Lynch also negligently failed to supervise its employees in connection with the management of Claimant’s account. As a result of Merrill Lynch and its representatives’ misconduct, the Claimant suffered substantial damages in an amount to be determined at the final arbitration hearing.
II. BACKGROUND
The Claimant is a 40 year old single mother raising two children in Florida, Puerto Rico. She worked as a sales person earning less than $40,000 per year to support her children. In 2012, the Claimant received $250,000 from a third party. The Claimant was never educated or licensed in any profession relating to the securities or commodities industry. She had absolutely no prior investment experience in the securities or commodities markets. The Claimant’s co-workers urged her to contact professionals for financial advice on how to safeguard her gift.
The Claimant was introduced to a Merrill Lynch stockbroker. She met with the Merrill Lynch advisor at his offices and listened carefully to his speech about the importance of making investments for her that would provide financial security and income. In the end, her only instruction to the broker was she only wanted “safe investments” in her Merrill Lynch account. The Claimant told him that she wanted investments that would be “garantizadas,” i,e., “guaranteed” (i.e., preserve her principal). The Merrill Lynch broker stated that he would manage her investments and protect her from loss. Claimant relied exclusively upon her stockbroker for investment advice and management of the investments in her Merrill Lynch account.
The Merrill Lynch broker acknowledged Claimant’s goals and needs and recommended what he described as “seguro, de bajo riesgo y conservadores bonos,” i.e., “safe, low risk, and conservative bonds.” He told her that the bonds were “estan garantizados por la constitución de Puerto Rico,” i.e., “they are guaranteed by the Puerto Rico constitution.” There was no detailed discussion about the nature, mechanics or risks of the proposed investments in the Puerto Rico bonds that he recommended. Neither Merrill Lynch nor its employee ever provided Claimant with a prospectus, offering memorandum or any other document relating to the bonds or the investment strategy. Contrary to the Merrill Lynch broker’s representations, these were very speculative investments due to the excessive concentration in Puerto Rico bonds and leverage he employed in the account to purchase the Puerto Rico bonds.
The Claimant followed the Merrill Lynch broker’s advice and allowed him to select and manage over $1 million of Puerto Rico bonds. She did not understand that he was going to purchase all of those bonds on margin; that is, with money borrowed from Merrill Lynch. By August, 2012, the broker had caused a margin loan balance of almost $800,000 to be incurred. He excessively leveraged Claimant’s account four-to-one (4:1). There was no discussion with Claimant about the risk to those bonds as collateral for the loan. He never even mentioned the phrases “margin calls” or “margin account” to her. Thereafter, Claimant and the broker rarely met and discussed her investments in her Merrill Lynch account. The Merrill Lynch advisor was the de facto manager of Claimant’s Merrill Lynch account.
Claimant did not question any of the activity in her account until the summer of 2013. During an August telephone call, she questioned the broker about her investments and the decline in the value of her account. Claimant quizzed the advisor on whether her investments were still “safe” investments to own. He told her, among other things: “tiene inversiones solidas,” i.e., “you have solid investments;” “no se preocupe,” i.e., “not to worry;” and “las inversiones estan garantizadas por la constitución de Puerto Rico,” i.e., “they are guaranteed by the Puerto Rico constitution.” The Claimant asked the broker whether she should sell the Puerto Rico bonds. The Merrill Lynch advisor said, “no!” “mantenga sus inversiones,” i.e., “hold your investments;” “no venda, ” i.e., “don’t sell;” “no puede reemplazar el ingreso,” i.e., “you cannot replace this income;” and “sus inversiones estan seguras porque estan garantizadas,” i.e., “your investments are safe because they are guaranteed.” The Merrill Lynch broker minimalized the importance of the declines in the value of her account. He never expressed any concern about her account in light of the fact that it was an excessively leveraged account in a precarious bond market, especially the Puerto Rico bond market. He said nothing about the near junk bond ratings of the Puerto Rico bond market by the major credit rating agencies, Moody’s, Standard and Poors, and Fitch ratings. The Merrill Lynch broker said nothing about the speculative nature of the investment strategy he employed. He was silent about the risk of holding an excessive and leveraged concentration of Puerto Rico securities in the account. Unfortunately, Claimant relied upon the Merrill Lynch broker’s advice, held her investments, and paid the price.
In September 2013, Claimant discovered that a check she had written had bounced. Upon contacting the Merrill Lynch broker, she learned that the value of her account had declined sharply and that she would be unable to withdraw any more money from her account to pay her family’s expenses. The broker attempted to arrange for a loan to Claimant but failed. He recommended that she sell $25,000 of bonds in order to receive the $15,000 she needed for expenses. Claimant agreed, but only received $8,000 and learned that the Merrill Lynch broker had misled her about the safety of her investments and hid the excessive risks taken by him. Eventually, Claimant was forced to liquidate the entire account and realize substantial losses in order to obtain the funds necessary to support her family.
III. THE WRONGFUL CONDUCT
The wrongful conduct of Merrill Lynch and its financial advisor included but is not limited to, the overconcentration of Claimant’s account with just a limited number of Puerto Rico bonds. The risk of the excessive concentration was compounded by the aggressive use of margin. The Merrill Lynch broker’s strategy was highly speculative and unsuitable for Claimant. And then, when market conditions dictated otherwise, the advisor made an unsuitable “hold” recommendation to Claimant in the summer of 2013. Subsequently, the value of Claimant’s account collapsed and she was forced to liquidate into a fragile Puerto Rico bond market in the Fall of 2013. Merrill Lynch, as a result of its employee’s acts and omissions, violated industry rules and standards of professional care. Merrill Lynch failed to supervise its stockbroker and protect Claimant from his sales abuse. Accordingly, Merrill Lynch is liable for its employees and its own misconduct as more fully set forth below.
A. MERRILL LYNCH OVER-CONCENTRATED CLAIMANT’S ACCOUNT WITH PUERTO RICO BONDS
Merrill Lynch’s employee knew or should have known that an investment in Puerto Rico bonds was only suitable as a small part of Claimant’s portfolio and that his recommendations that she purchase and then “hold” a concentrated position in Puerto Rico bonds on margin were “unsuitable” recommendations. It is widely understood in the securities industry that the key to sound investing is diversification. Investors need proper asset allocation (diversification among various asset classes, i.e., cash, bonds, and equities). They also need further diversification by geography, sector, issuers, styles, credit availability, etc. The Merrill Lynch broker knew or should have known that you “do not put all of your eggs in one basket.” Brokerage firms like Merrill Lynch and its financial advisors understand the importance of asset allocation and diversification. However, Merrill Lynch permitted its employee to ignore the principles of asset allocation and diversification as Claimant’s financial advisor. At the end of July 2013, 100% of Claimant’s account was concentrated in the “fixed income” asset class and 100% of those so-called fixed income securities were concentrated in one geographic area – Puerto Rico!
B. MERRILL LYNCH’S LEVERAGE STRATEGY WAS UNSUITABLE
The Merrill Lynch broker never told Claimant that the investments in her account were purchased on margin and they would be collateral for loans from Merrill Lynch. This was a very speculative and unsuitable investment strategy. There is no discussion about the risk of using those investments as collateral for any loan. There was no mention of “margin calls.” He said nothing about the risk of leveraging investments in Puerto Rico bonds. Initially, the Merrill Lynch broker borrowed almost $800,000 to purchase bonds in Claimant’s account, and her portfolio was at extreme risk of total loss upon any market decline.
C. MERRILL LYNCH’S UNSUITABLE “HOLD” RECOMMENDATION
In August 2013, the Merrill Lynch broker spoke with Claimant over the telephone about the decline in the value of her account. Claimant quizzed the broker on whether her investments were still “safe” investments to own. He told her, among other things: “tiene inversiones solidas,” i.e., “you have solid investments;” “no se preocupe,” i.e., “not to worry;” and “los inversiones estan garantizadas por la constitución de Puerto Rico,” i.e., “they are guaranteed by the Puerto Rico constitution.” Claimant asked her Merrill Lynch advisor whether she should sell the Puerto Rico bonds. The broker said, “no!” “mantenga sus inversiones,” i.e., “hold your investments;” “no venda, ” i.e., “don’t sell;” “no puede reemplazar el ingreso,” i.e., “you cannot replace this income;” and “sus inversiones estan seguras porque estan garantizadas,” i.e., “your investments are safe because they are guaranteed.” The Merrill Lynch broker minimalized the importance of the declines in the value of her account. He never expressed any concern about her account in light of the fact that it was an excessively leveraged account in a precarious bond market, especially the Puerto Rico bond market. He said nothing about the near junk bond ratings of the Puerto Rico bond market by the major credit rating agencies, Moody’s, Standard and Poors, and Fitch ratings. The broker said nothing about the speculative nature of the investment strategy he employed. He was silent about the risk of holding an excessive and leveraged concentration of Puerto Rico securities in the account. Unfortunately, Claimant relied upon her broker’s advice, held her investments and paid the price. The Merrill Lynch employee’s recommendation that Claimant not liquidate but continue to “hold” all of her investments in Puerto Rico bonds was an unsuitable recommendation.
D. THE MARKET COLLAPSE AND MARGIN CALLS
Puerto Rico bonds were promoted aggressively and over-concentrated in Puerto Rico Merrill Lynch client accounts, including, Claimant’s account. The Puerto Rico bonds in her account were leveraged and collateral for margin loans. By the summer of 2013, the Puerto Rico bonds in Claimant’s account were rated one notch above “junk” status and extremely sensitive to long term bond interest rate movements along with Puerto Rico political and economic news. As the summer drew to a close, there were few buyers for Puerto Rico bonds. As the Puerto Rico bond prices declined Merrill Lynch began issuing margin calls on its loans which triggered liquidations, including liquidations in Claimant’s account.
E. MERRILL LYNCH VIOLATED INDUSTRY RULES AND STANDARDS OF PROFESSIONAL CARE
The Merrill Lynch broker not only told Claimant “to purchase” only Puerto Rico bonds in her account but he took out margin loans to purchase them and then he told her “to hold” the bonds when the Puerto Rico bond market was clearly stressed. Claimant’s portfolio was 100% invested in Puerto Rico debt and fully leveraged. The Merrill Lynch employee’s recommendations were in violation of FINRA Rules of Conduct 2110, 2111 (f/k/a 2310) and 2120, which state:
2110. STANDARDS OF COMMERCIAL HONOR AND PRINCIPLES OF TRADE
A member, in the conduct of its business, shall observe high standards of commercial honor and just and equitable principles of trade.
2111. SUITABILITY
(a) A member or an associated person must have a reasonable basis to believe that a recommended transaction or investment strategy involving a security or securities is suitable for the customer, based on the information obtained through the reasonable diligence of the member or associated person to ascertain the customer’s investment profile. A customer’s investment profile includes, but is not limited to, the customer’s age, other investments, financial situation and needs, tax status, investment objectives, investment experience, investment time horizon, liquidity needs, risk tolerance, and any other information the customer may disclose to the member or associated person in connection with such recommendation.
* * *2120. USE OF MANIPULATIVE, DECEPTIVE OR OTHER FRAUDULENT DEVICES
No member shall effect any transaction in, or induce the purchase or sale of, any security by means of any manipulative, deceptive or other fraudulent device or contrivance.
The most egregious suitability violations occurred at inception of the account when the Merrill Lynch broker concentrated Claimant’s holdings in Puerto Rico bonds and leveraged her account 4:1 and again in August 2013 when he told her to “hold” a leveraged portfolio bonds concentrated in a single geographic area – Puerto Rico when the market became stressed. This was a clear breach of FINRA’s suitability rule, which has long been applied to recommended “investments” and “investment strategies” including “hold” recommendations.
Merrill Lynch and its employee also misrepresented the Puerto Rico bonds as “safe,” “conservative,” “guaranteed” and “low risk” investments. The concentration, illiquidity, and leverage risks of the account were high and never disclosed. Thus, Merrill Lynch and its employee’s actions not only violated the FINRA standards of commercial honor and principles of trade but also included the use of manipulative, deceptive and fraudulent devices.
F. MERRILL LYNCH FAILED TO PROTECT ITS CLIENTS FROM SALES ABUSE
Pursuant to FINRA Rule 3010, Merrill Lynch was obligated to design and implement a reasonable system of supervision to assure compliance with Federal and Puerto Rico law as well as FINRA conduct rules and its own policies and procedures. Merrill Lynch knew that the Puerto Rico bonds were only suitable “as parts of a diversified portfolio.” Yet at no time did any supervisory or compliance personnel ever question the over-concentration of Puerto Rico bonds on margin in Claimant’s account. Merrill Lynch had computer exception reports designed to detect and prevent the over-concentration of Puerto Rico securities investments that occurred in Claimant’s account. But no supervisor ever looked at them or took any action to protect Claimant. Nor did Merrill Lynch ever take any action to properly disclose and stem the flow of misinformation to clients about the Puerto Rico bonds.
G. MERRILL LYNCH IS LIABLE FOR ITS EMPLOYEES AND ITS OWN MISCONDUCT
Merrill Lynch is responsible for its own wrongs and vicariously liable for the acts and omissions of its employee and its other employees, agents, registered representatives or associated persons who engaged in the misconduct described herein under the doctrine of respondeat superior and/or principles of actual, apparent and implied agency. Merrill Lynch is vicariously liable for its broker’s continuous dissemination of false and misleading information about the Puerto Rico bonds and mismanaging the Claimant’s account by recommending that Claimant purchase and then hold an overly concentrated, fully leveraged and unsuitable portfolio of Puerto Rico securities. Merrill Lynch is also directly liable for failing to supervise its stockbroker and its other agents who managed Claimant’s account and for fraudulently concealing the illiquidity and the other misconduct described above. Had Merrill Lynch and its employees recommended and adhered to a diversified investment strategy, Claimant would not have been damaged. Accordingly, Merrill Lynch violated and/or is vicariously liable for violations of the FINRA Code of Conduct and Uniform Securities Act of Puerto Rico and for common law fraud, constructive fraud, negligent misrepresentation, breach of fiduciary duty, breach of contract, negligent management, negligent supervision of its employees, and fraudulent concealment of its misconduct.
CONTACT US FOR A FREE CONSULTATION ABOUT YOUR CLAIM.
The Law Offices of Robert Wayne Pearce, P.A. understands what is at stake in Puerto Rico municipal bond and closed-end bond fund disputes and works hard to secure the best possible result for your case. Mr. Pearce provides a complete review of your case and fully explains your legal options. The entire firm works to ensure that you have all of the information necessary to make a sound decision before any action is taken in your case.
For dedicated representation by a law firm with substantial experience in all kinds of securities, commodities and investment disputes, contact the firm by telephone at 561-338-0037 or toll free at 800-732-2889 or via e-mail. We may also be able to arrange a meeting with you at offices located in San Juan, Puerto Rico and Boca Raton, Florida and elsewhere if we believe you have a viable case.
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