The SEC announced charges against Harvest Volatility Management and Merrill Lynch, Pierce, Fenner & Smith for exceeding the investment limits designated by clients over a two-year period starting in March 2016, resulting in clients paying higher fees, being exposed to greater market risk, and incurring investment losses.
As part of separate settlements, Harvest and Merrill have agreed to pay a combined total of $9.3 million in fines and restitution to resolve the SEC’s claims, according to the regulator’s statement.
According to the SEC’s orders, Harvest was the primary investment advisor and portfolio manager of the Collateral Yield Enhancement Strategy (CYES), which traded options on a volatility index with the goal of generating incremental returns.
The SEC determined that, starting in 2016, Harvest allowed dozens of accounts to exceed the exposure levels designated by investors when they subscribed to the CYES strategy, including many accounts that exceeded the limit by 50% or more, as detailed in the statement.
Merrill and Harvest earned higher management fees when investors’ exposure levels rose above the pre-established thresholds, thereby subjecting investors to increased financial risks.
The SEC’s order regarding Merrill concludes that Merrill introduced its clients to Harvest and received a portion of Harvest’s management and incentive fees, as well as trading commissions. It also found that Merrill was aware that CYES investors were exceeding the pre-established exposure levels but did not adequately inform the affected CYES investors, most of whom had advisory relationships with Merrill, the statement added.
The SEC also found that Harvest and Merrill “failed to adopt or implement policies and procedures reasonably designed to ensure that they communicated all material facts to their clients and alerted them to excessive exposure.”
“In this case, two investment advisors allegedly sold their clients a complex options trading strategy but failed to follow basic client instructions or apply and adhere to proper policies and procedures,” said Mark Cave, Associate Director of the SEC’s Enforcement Division.
The SEC’s orders conclude 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, receive cease-and-desist orders, and pay 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.
