A class action lawsuit against Merrill Lynch filed on August 27, 2019 alleges that sweep program disclosures provided to customers by Merrill Lynch were not valid and demands a “reasonable market rate” of interest as compensation and a declaration that the disclosures violate a 2005 New York Stock Exchange Information Memo and SEC Rule 15c3-3. The complaint does not address why the claims should not be subject to mandatory binding arbitration as provided in the Merrill Lynch customer agreements.

A similar class action brought in 2007 against a number of large broker-dealers, including Merrill Lynch was ultimately dismissed for various pleading deficiencies, which this new complaint attempts to avoid.¹

1. Plaintiff Classes

A representative plaintiff filed a complaint in the Southern District of New York on behalf of three putative classes who were enrolled in programs that either swept free credit balances to, or directly deposited customer funds into, a low-yield deposit account at Bank of America:

• Customers with online Merrill Edge self-directed accounts (“Merrill Edge Plaintiffs”);
• Customers with self-directed retirement accounts (“Retirement Plaintiffs”); and
• Customers who were advised by Merrill Lynch to deposit funds directly (rather than the funds being swept) into a deposit account at Bank of America (“BofA Plaintiffs”).

2. Causes of Actions

The complaint asserted the following causes of action against Merrill Lynch:

• For the Merrill Edge Plaintiffs, the complaint alleges that there was no valid, bilateral contractual provision between Merrill Lynch and its customers with respect to the payment of interest on the swept funds because of the “click-through” process for entering into an agreement, and that in the absence of such a provision, Merrill Lynch is liable for paying a reasonable market rate of interest under a quasi-contract theory.
• For the Retirement Plaintiffs, the complaint alleges that Merrill Lynch breached its contract with its customers promising to pay a “reasonable rate” of interest.
• For the BofA Plaintiffs, the complaint alleges that Merrill Lynch was negligent by violating FINRA’s suitability rules, which establish the standard of care Merrill Lynch owed its customers.
• The complaint further alleges that Merrill Lynch violated Massachusetts’ unfair trade practices statute with respect to Massachusetts residents.

3. Allegations Against Merrill Lynch

a. Claims by Merrill Edge Plaintiffs

The claims asserted by the Merrill Edge Plaintiffs relate to online contract formation. The complaint does not allege that the sweep program disclosures provided to the Merrill Edge Plaintiffs were themselves materially deficient. Rather, the complaint alleges that the manner in which the disclosures were provided did not result in the Merrill Edge Plaintiffs giving their “prior written affirmative and informed consent” to the sweep program, and thus the disclosures were ineffective and non-binding.

According to the complaint, new Merrill Edge customers opening an account online are informed that opening an account “should take less than 10 minutes,” allegedly demonstrating Merrill Lynch’s intention that the sweep disclosures not be read before customers agree to be bound by their terms. The complaint alleges that new Merrill Edge customers are then provided a list of many separate “agreements,” “terms of service,” and “disclosures” to which they are agreeing to be bound, one of which is the “Merrill Edge Self-Directed Cash Management Account Disclosures and Agreement,” which contains the “scattered and buried” sweep disclosures.

The complaint alleges that new Merrill Edge customers are not forced to open or scroll through the documents, including the relevant sweep disclosures. Courts have termed these type of electronic agreements “browsewrap” agreements, as contrasted with “clickwrap” agreements which force parties to scroll through contract terms before signing. Moreover, the complaint alleges that new Merrill Edge customers are not required to acknowledge that they have reviewed the agreement containing the relevant sweep disclosures prior to account opening.

The complaint asserts that these account opening procedures violate SEC Rule 15c3-3 and NYSE Information Memorandum 05-11 (notwithstanding the fact that such Information Memoranda do not carry the force of law, contrary to the complaint’s assertion to the contrary) by insufficiently providing the sweep disclosures to the Merrill Edge Plaintiffs.

The complaint attempts to contrast Merrill Lynch’s disclosure procedures and interest rates with the allegedly more transparent procedures and higher rates associated with cash investments offered by Fidelity, Vanguard, E*TRADE, and Charles Schwab.

i. Contract Claim

The Merrill Edge Plaintiffs’ contract claim does not rely on the alleged violation of SEC and NYSE rules, but rather rests on common law contract principles. The cause of action asserts that the Merrill Edge Plaintiffs had insufficient notice of the sweep disclosures and therefore are not bound by them. As a result, the Merrill Edge Plaintiffs had a quasi-contract with Merrill Lynch with respect to the “omitted essential term” of the interest rate and the court should fill in the blank term with a “reasonable market rate” to be determined by the trier of fact.

ii. Negligence/Suitability Claim

The Merrill Edge Plaintiffs also claim that Merrill Lynch had a duty “to place customers into investments that are suitable and in their best interest” pursuant to FINRA Rule 2111 and negligently violated that duty by defaulting them into the sweep program rather than a higher yielding investment.

This claim appears to be most relevant to the lead class plaintiff whom Merrill Lynch representatives knew maintained “cash balances in excess of $1,000,000 in accounts yielding 0.14% and 0.06%, at a time when other Merrill-sponsored accounts yielded as high as 2.07%.”

The complaint further asks the court to apply an “enhanced standard of suitability in this case” because Merrill Lynch’s sweep programs have violated the new Regulation Best Interest. It is unclear how the court could retroactively apply a regulation that is not yet in effect.

b. Claim by Retirement Plaintiffs

The complaint alleges that with respect to “retirement account assets,” multiple agreements between the Retirement Plaintiffs and Merrill Lynch state that the “interest rate . . . will be at no less than a reasonable rate.” The complaint asserts that Merrill Lynch has breached their contracts by failing to provide the Retirement Plaintiffs with a “reasonable rate on cash assets.”

c. Claim by BofA Plaintiffs

The BofA Plaintiffs also assert a negligence claim based on the FINRA suitability rule, NYSE Information Memorandum 05-11, and SEC Rule 15c3-3,² which allegedly establish the requisite standard of care.

d. Massachusetts Claims

Finally, as to all class members, the complaint alleges that a laundry list of Merrill Lynch actions related to the sweep disclosures and yields earned by class members violates the Massachusetts Consumer Protection Law.3

4. Conclusions

The complaint does not explain why these claims would not be subject to the mandatory binding arbitration clauses that are industry standard for these types of agreements.

Because the complaint only alleges that the disclosure process used by Merrill Lynch was deficient – and does not allege that the disclosures concerning the sweep program itself were deficient – we do not believe that broker-dealers need to change their agreements or disclosures. Nonetheless, it is prudent to take steps during the account opening process, and before any subsequent material changes to a sweep program, to ensure that customers receive actual notice of relevant disclosures to ensure that they will be bound in the event of any future controversy.

Seward & Kissel LLP will continue to provide insight on any developments regarding this case. If you have any questions, please contact Paul Clark, or Casey Jennings in the Washington, DC Office at 202-737-8833.

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¹ See DeBlasio v. Merrill Lynch, 2009 U.S. Dist. LEXIS 64848 (S.D.N.Y. July 27, 2009). The court dismissed DeBlasio on the following grounds:

First, Plaintiffs have failed to offer allegations capable of supporting a plausible inference that they had anything more than a nondiscretionary broker-client relationship with any Defendant. Second, although the Brokerage Defendants owed Plaintiffs a transaction-specific duty of care, Plaintiffs have not alleged that this duty was breached through Defendants’ implementation of the Cash Sweep Programs. Third, Plaintiffs have not identified any materially misleading statements, or omissions by Defendants in contravention of an existing disclosure obligation.

The complaint in this new action attempts to avoid these deficiencies by alleging that the lead plaintiff relied on the advice of Merrill Lynch representatives, alleging transaction-specific duties owed by Merrill Lynch to plaintiffs, and by pleading that Merrill Lynch’s disclosures contravene NYSE and SEC disclosure obligations.

² The complaint alleges that NYSE Information Memorandum 05-11 and Rule 15c3-3(j)(2) should apply to the BofA Plaintiffs’ claim notwithstanding the fact that the BofA Plaintiffs’ claim is not related to a sweep program per se.

³ Mass. Gen. Laws ch. 93A, et seq.