SEC Charges Merrill Lynch and Harvest Volatility Management for Ignoring Client Instructions

The Securities and Exchange Commission today announced charges against Harvest Volatility Management LLC and Merrill Lynch, Pierce, Fenner & Smith Inc. for exceeding clients' designated investment limits over a two-year period beginning in March 2016, which resulted in clients paying higher fees, being subjected to increased market exposure, and incurring investment losses. As part of the separate settlements, Harvest and Merrill have agreed to pay a combined $9.3 million in penalties and disgorgement to resolve the SEC's claims.

According to the SEC's orders, Harvest was the primary investment adviser and portfolio manager for the Collateral Yield Enhancement Strategy (CYES), which traded options in a volatility index with the aim of generating incremental returns. The SEC's orders find that, starting in 2016, Harvest allowed scores of accounts to exceed the exposure levels that investors designated when they signed up to the CYES strategy, including dozens of accounts that exceeded the limit by 50 percent or more. Merrill and Harvest received larger management fees when investors' exposure levels climbed above pre-set levels and exposed investors to greater financial risks. The SEC order as to Merrill finds that it introduced its clients to Harvest and received part of Harvest's management and incentive fees, as well as trading commissions. It also finds that Merrill was aware that investors' exposure to CYES was exceeding pre-set exposure levels and failed adequately to inform affected CYES investors, most of whom had existing advisory relationships with Merrill. The SEC's orders also find that Harvest and Merrill neglected to adopt and implement policies and procedures reasonably designed to ensure that they disclosed all material facts to their clients and alerted them to the excessive exposure.

"In this case, two investment advisers allegedly sold a complex options trading strategy to their clients, but failed to abide by basic client instructions or implement and adhere to appropriate policies and procedures," said Mark Cave, Associate Director of the SEC's Enforcement Division. "Today's action holds Merrill and Harvest accountable for dropping the ball in executing these basic duties to their clients, even as their clients' financial exposure grew well beyond predetermined limits."

The SEC's orders find that Harvest and Merrill violated Sections 206(2) and 206(4) of the Investment Advisers Act of 1940 and Rule 206(4)-7 thereunder. Without admitting or denying the findings, Harvest and Merrill agreed to be censured, to cease-and-desist orders, and to penalties of $2 million and $1 million, respectively. Harvest will also pay $3.5 million in disgorgement and prejudgment interest, while Merrill will pay $2.8 million in disgorgement and prejudgment interest.

The SEC's investigation was conducted by Bobby Gray, Matthew Finnegan, and Suzanne Romajas, under the supervision of Jeff Leasure and Mr. Cave.