SEC said to be probing complex Bank of America trades

The Securities and Exchange Commission is investigating whether Charlotte-based Bank of America broke rules designed to protect client accounts in order to generate more profits, The Wall Street Journal reported Tuesday.

Investigators are probing a variety of large, complex trades and loans that were used in a strategy that ran over a three-year period ending in 2012, the Journal reported, citing unidentified people familiar with the inquiry.

The strategy, devised by New York-based executives in the bank’s Merrill Lynch brokerage arm, was intended to save on funding costs and free up billions of dollars in cash and securities for trading, the Journal reported.

The SEC is also investigating whether Bank of America misled regulators about the strategy. The bank bought Merrill Lynch in 2009.

“These transactions began at Merrill Lynch prior to the merger with Bank of America and received extensive review and approval,” Merrill Lynch spokesman Bill Halldin told the Observer. “The firm fully complied with the rules designed to safeguard client funds.”

The SEC declined to comment.

According to the Journal, the probe is focused on Bank of America’s compliance with a 1972 federal rule.

The rule requires investment banks and trading firms to set aside enough cash and easy-to-sell securities that they can use to repay whatever they owe customers in the event of a failure.

According to the Journal, having billions of dollars set aside in “lockup” accounts to pay customers in an emergency is expensive for banks. That’s partly because the money generally can’t be used for trading and other profitable but potentially risky uses, the Journal reported.

In one variety of the strategy to reduce the amount of money stuck in lockup, a small team from Bank of America’s equities desk recruited a handful of clients to put up small amounts of their own money in exchange for loans of nearly 100 times the amounts, the Journal reported, citing people familiar with the trades.

Bank of America would then arrange large trades, with those clients taking the opposite side, to satisfy other financing needs at the bank.

Such trades dramatically increased the amounts of money customers owed to Bank of America, lowering the net amount the bank owed clients, the Journal reported. That then reduced how much Bank of America had to keep in lockup.

The strategy also benefited the bank by enabling it to reduce its use of more expensive funding from alternate sources, the Journal reported.

Recently, the bank has settled other unrelated matters with the SEC.

▪ In September, the bank agreed to pay a $7.65 million civil penalty to settle charges resulting from the bank’s multi-billion dollar miscalculation of its capital ratios. The settlement with the SEC stemmed from the bank’s finding that it had been incorrectly accounting for a type of debt it inherited in the Merrill Lynch acquisition.

▪ As part of a $16.65 billion settlement it reached in August with the U.S. government over toxic mortgages, the bank agreed to a $245 million settlement with the SEC to resolve claims in two cases resulting from the financial crisis. The bank admitted wrongdoing in reaching the SEC settlement.

This story was originally published April 28, 2015 at 8:51 AM with the headline "SEC said to be probing complex Bank of America trades."