Thursday, December 23, 2010


According to the Third Circuit Court of Appeals, the SEC Department of Enforcement's imposition of a permanent bar upon a Merrill Lynch “Investment Service Advisor” for recommending unsuitable mutual fund switches was not a disproportionate sanction.

Former Merrill Lynch Investment Service Advisor Scott Epstein appealed the SEC's affirmation of the Enforcement Division’s imposition of the permanent bar, claiming that the sanction was grossly disproportionate and that the FINRA hearing process was flawed. In rejecting these claims, the U.S. Court of Appeals noted that Merrill Lynch provided a financial incentive for its advisors to switch its customer's funds between both classes of mutual fund shares and families of mutual funds. Epstein was accused of recommending unsuitable switches to 12 customers between the ages of 71 and 93 without providing a proper explanation of, or rationale for, the expenses associated with the switches.

One of the customers sent a letter of complaint, in response to which Merrill Lynch's Legal Department sent the standard “We regret...but too bad” letter. In an interesting twist, Epstein subsequently complained to FINRA about Merrill Lynch's application of pressure to make the switches after FINRA served him with a Wells Notice.

Almost four months after his lawyer walked out in the middle of Epstein's disciplinary hearing, the SEC issued a permanent bar for violating FINRA Conduct Rules 2310 and 2110, even though the FINRA sanctions guidelines called for a maximum penalty of $75,000 and a maximum suspension of one year. The National Adjudicatory Council (NAC) and SEC denied Epstein's appeals. In doing so, “the commission concluded that Epstein's case was egregious because he violated the suitability rule with numerous elderly, unsophisticated and retired customers, and because his involvement was 'more than a mere mistake'.”

The Third Circuit Court of Appeals agreed with this somewhat stunning conclusion in Epstein v. SEC, No. 09-1550 2010 W.L. 4739749 (Nov. 23, 2010). It did so despite noting that – where it comes to permanent bars - “the Commission has a greater burden of justification [and] has an obligation to explain why a less dramatic remedy would not suffice.” Investment advisors employed by insurance companies that recommend switches in pre-existing brokerage accounts or unlicensed recommendations to liquidate securities in order to fund annuities should pay heed to this remarkable case.

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