In re Merrill Lynch, Pierce, Fenner & Smith, Inc.

Scientific Control Corporation (Scientific) was in business between May 1964 and its November 1969 bankruptcy, during which time it never made a profit. In 1968 and 1969, broker-dealer Merrill Lynch, Pierce, Fenner & Smith, Inc.’s (Merrill) (defendant) research analyst Pierce recommended clients buy or hold Scientific stock, which Merrill classified as a speculative and growth investment. These recommendations mainly were based on information Pierce received from Scientific’s Securities and Exchange Commission (SEC) filings or from direct communications with Scientific. Pierce did not scrutinize Scientific’s often unjustifiably optimistic or false information and ignored red flags indicating that the information Scientific provided was unreliable. In addition, some of the Scientific-provided information was material and nonpublic. Pierce’s recommendations were conveyed to clients by Merrill’s account executives (defendants). Some account executives also communicated unsupported positive statements about Scientific, including (1) specific, optimistic predictions about its future stock price; (2) favorable comparisons with well-established companies; (3) claims that its stock would be listed on a stock exchange; and (4) an inaccurate newspaper article about it. Some account executives also engaged in high-pressure sales tactics. The SEC instituted an administrative proceeding against Merrill, Pierce, and 47 account executives to determine (1) whether they willfully violated § 17(a) of the Securities Act of 1933, § 10(b) of the Securities Exchange Act of 1934, or SEC Rule 10b-5 (collectively, the antifraud provisions) and (2) whether Merrill and an employee failed reasonably to supervise Merrill’s compliance with the antifraud provisions. The account executives defended their stock-price predictions because they purportedly were phrased as contingencies and not as guarantees. Merrill offered to settle the proceeding by (1) accepting a censure, (2) paying $1.6 million in compensation, (3) adopting new guidelines for research and sales activities, and (4) strengthening its account-executive training program as necessary. In addition, seven Merrill employees offered to accept suspensions and censures, and 22 employees offered to accept censures.