Hong Kong's Securities and Futures Commission (SFC) has fined Merrill Lynch (Asia Pacific) Limited and Merrill Lynch Futures (Hong Kong) Limited HK$3.5 million ($450,000) for systems and controls failings associated with mis-marking activities in a trading book.
A spokesman at Bank of America Merrill Lynch declined to comment.
The problems occurred from December 2007 to October 2008, shortly before Merrill was acquired in a shotgun wedding by Bank of America. An unidentified managing director at Merrill had mis-marked a trading book in exotic options by manipulating the volatility marks in the valuation model, and accessed the computer system without authority to alter pricing parameters on various occasions.
The mis-marking activities, which did not apply to any other books, resulted in the value of the book being inflated by around $25 million and caused the actual loss in the book to be wrongly reported internally.
The SFC found that Merrill Lynch did not have adequate internal control procedures in place to manage the risks associated with mis-marking. It says there was uncertainty as to supervisory responsibilities over the trader and the book; that the price-verification mechanism applied to other trading books was not applied to this book; that there were inadequate checks and balances over the book to mitigate operation risks, including risks associated with fraud and dishonest activities.
The SFC also found there were insufficient safeguards over information security and integrity as regards the book; that trading and valuation policies were not sufficiently implemented; and that senior management failed to adequately manage associated risks.
"For books that deal in illiquid assets which have low price transparency, more robust measures must be in place," says Mark Steward, executive director of enforcement at the SFC. "The proper implementation of an effective risk-management framework could have enabled Merrill Lynch to detect the mis-marking earlier."
Merrill Lynch has accepted that its systems and controls fell short of those expected in respect of the book, while the SFC accepts that Merrill's misconduct was not intentional, that the firm cooperated in the case and that the firm has since addressed its compliance weaknesses.
