SEC Enforcement Actions: Merrill Lynch and Harvest Volatility—Transparency and Compliance Are Key

The SEC's recent enforcement actions against Merrill Lynch and Harvest Volatility Management emphasize once again that compliance, transparency, and adherence to fiduciary duties are crucial for investment advisers. These cases, involving excessive fees and improper exposure levels, highlight recurring themes we've explored in previous articles: business practices must match what is disclosed to clients, and failure to comply with fiduciary obligations can lead to costly penalties.

The Case Against Merrill Lynch and Harvest Volatility

Merrill Lynch and Harvest were sanctioned for violations of the Collateral Yield Enhancement Strategy (CYES) , an options trading strategy involving high-net-worth clients. According to the SEC, Merrill Lynch and Harvest failed to manage the investment exposure levels clients had agreed upon in their contracts properly. Specifically, Harvest allowed client portfolios to significantly exceed agreed-upon risk levels, resulting in higher fees and greater exposure to market volatility, leading to client losses during specific periods.

During the relevant period, Merrill Lynch also failed to notify clients about the excessive exposure to the CYES strategy, breaching its fiduciary duties. This lack of disclosure violated the Investment Advisers Act and led to substantial client losses and millions in excess fees and commissions for Merrill and Harvest.

Business Practices Must Match Disclosures

One of the central issues in these enforcement actions was the mismatch between what clients were told and what happened. This mirrors previous cases where companies made claims about processes, risk levels, or investment strategies that didn't reflect reality.

For example, our earlier discussion of Rari Capital and TrueCoin explored how misleading disclosures about a platform's decentralization or token backing can lead to significant regulatory scrutiny. Whether a company claims to be fully decentralized or promises to follow a specific investment process, regulators expect that firms will adhere to the standards they advertise. As in Merrill and Harvest's case, failing to do so can result in severe penalties.

The lesson for investment advisers and digital asset companies is clear: you cannot present an idealized version of your processes while implementing something different. Any discrepancy between disclosed practices and actual operations will almost certainly trigger enforcement actions from regulators.

Fiduciary Duties and the SEC's Ongoing Focus

The SEC's findings in these cases center on fiduciary duty violations, which involve the fundamental obligation of advisers to act in their clients' best interests. In this instance, Merrill Lynch was found to have failed in its duty by not notifying clients of the higher-than-agreed risk exposure in their portfolios. Harvest, as the strategy's direct manager, similarly failed to adjust exposure levels and maintain the contracts as specified by clients.

This echoes a broader trend where the SEC aggressively targets companies that breach fiduciary responsibilities, whether in traditional finance or decentralized finance (DeFi). As we've seen in other cases, such as the enforcement actions against Mango Markets , the SEC is uncompromising when enforcing fiduciary duties, particularly when clients are exposed to hidden risks.

Aligning with Fiduciary Obligations in the Digital Asset Space

The takeaway is critical for DeFi founders and digital asset projects: decentralization or innovative technology does not excuse failing to meet fiduciary standards. Whether managing a stablecoin's backing or overseeing a lending platform's risk profile, founders must ensure that all promises to investors and users are faithfully kept.

Moreover, just as Merrill Lynch and Harvest failed to adjust their investment practices to match market changes, digital asset projects must continually align their business models with current market conditions and client expectations. Misleading users about risks, even unintentionally, is a sure way to attract the SEC's attention.

Compliance Is Non-Negotiable

As we've repeatedly emphasized, ignoring regulatory obligations—whether under the Howey Test for digital assets or the fiduciary standards for investment advisers—is a costly mistake. Merrill and Harvest's combined penalties, which include disgorgement, civil fines, and sanctions, run into the millions. For firms in traditional finance or the crypto space, these penalties should be a stark warning that compliance is non-negotiable.

Conclusion: Protecting Your Firm

The SEC's enforcement actions against Merrill Lynch and Harvest Volatility underscore that failing to align business practices with disclosures and fiduciary obligations will lead to significant penalties. Whether managing traditional assets or launching a decentralized finance platform, ensuring that your processes match your promises is essential to avoid regulatory action.

If your firm navigates complex compliance issues or needs help aligning disclosures with operations, seeking legal guidance is a crucial first step. In an era of heightened regulatory scrutiny, staying compliant from the outset is far better than facing enforcement actions later.