Merrill Lynch's $5M Call Center Fine

Yesterday, March 15, 2006, the National Association of Securities Dealers (NASD) announced that it has fined Merrill Lynch (ML) $5 million in connection with the brokerage firm's Financial Advisory Center (FAC), a call center operation housed in Hopewell, N.J., and Jacksonville, Fla.

The fine centered around practices within the call center operation in 2001-2004 that gave incentives for representatives to convince customers to switch mutual funds and invest in ML's proprietary products, even if those switches were to the customer's detriment. ML was charged with "supervisory failures" that allowed sales contests with non-cash awards such as tickets to rock concerts and sports events.

The FAC was originally set up as a channel to provide investment services for customers with lower assets (accounts of $100,000 or less) or with lower transaction volumes, so advisors in ML's full-service branch offices could focus on more lucrative clients. ML transferred over a million clients to FAC between March 2001 and August 2002. NASD says FAC was managing $20 billion in 1.3 million accounts at its peak in 2002.

NASD has released an Investor Alert, "Customer Advisory Centers: Not Your Typical Securities Firm Call Center," containing warnings and tips for dealing with sales-oriented investment call centers.

The $5 million fine appears to be a harsh penalty, but to put it in perspective, the FAC's gross revenue was about $210 million just for 2002. The greater damage here might be to Merrill Lynch's reputation and its credibility as a provider of investment services.

And I would even go a step further and say that the damage might easily be extended to the financial services industry in general. Consumers and small investors aren't stupid, at least fewer of them are these days, and they are sick of seeing hard-earned savings go down the drain when a big company goes belly-up because of executive dishonesty or when the bottom drops out of the stock market. And they're not likely to be happy to find that their money ended up in a costly or low-performing fund when something better was easily available.

These days consumers are much more likely to be on guard when communicating with anyone calling himself an investment or financial advisor, consultant or counselor, because often such representatives have a hidden sales agenda and an incentive to push the customer toward certain products. Savvy investors are able to pick up on the nuances. And the less savvy become more savvy after getting burned the first time. All this contributes to an atmosphere of suspicion and cynicism.

A scandal like this over abusive sales practices adds to the atmosphere of distrust in the consumer market for financial services and can contribute to pressures on government for stronger regulation. NASD, which describes itself as a "private-sector provider of financial regulatory services," is an example of the value of industry self-regulation. This kind of self-regulation is essential and probably needs to be even stronger to forestall greater consumer backlash and more restrictive legislation and government enforcement.

AB -- 3/16/06