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SEC investigating whether Bank of America violated rules protecting client funds

The bank may have used large, complex trades to save billions in funds that would have normally been kept in off-limit accounts designed to pay customers off in the event of financial failure, according to a report in the Wall Street Journal.

By Fred Lambert
SEC investigating whether Bank of America violated rules protecting client funds
A Bank of America sign is displayed in the Columbia Heights neighborhood of Washington DC on August 12, 2010. On Monday, April 28, 2015, the Wall Street Journal reported on an SEC investigation into whether the bank used complex trades and loans to save billions it otherwise would have had to set aside in an off-limit account used for customer protection. File photo by Alexis C. Glenn/UPI | License Photo

CHARLOTTE, N.C., April 28 (UPI) -- The Securities and Exchange Commission is investigating whether Bank of America violated customer protection rules through complex trades and loans that allowed it to save funds from being placed in an off-limit emergency account, and whether the bank misled regulators in the process, according to a report.

The Wall Street Journal reported the matter on Tuesday, citing unnamed sources who it says are familiar with the investigation.

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Dating from 2009 at Merrill Lynch, which Bank of America bought the same year, to 2012, the bank may have engaged in commercial activities with billions of dollars otherwise designed to pay back clients in the event of financial failure, the sources reportedly said.

"These transactions, which began at Merrill Lynch before the acquisition by Bank of America, received extensive review and approval," a spokeswoman for Bank of America told the WSJ. "The firm fully complied with the rules designed to safeguard client funds."

The SEC, which declined comment, is basing the inquiry around a 1972 law requiring banks and lending firms to set aside enough funds and securities to quickly pay off clients if an investment fails, the sources say.

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Rule 15c3-3, as it is referred to in the industry, was strengthened after Lehman Brothers collapsed in 2008 and MF Global Inc. followed suit in 2011, leaving some clients waiting for the return of billions of dollars.

The law requires financial institutions handling customer trades to do weekly calculations of how much clients owe the bank (in the form of loans, for example) in comparison to how much the bank owes clients (such as deposited money). The more the bank owes clients, the more money needs to be kept in a reserve account for emergency situations.

Bank of America would recruit clients to put up money -- sometimes a few million dollars -- for loans worth up to 100 times those amounts, the sources said. The clients would then take the opposite side of large trades set up by the bank in order to hedge its multibillion-dollar position. One result was a large increase in what customers owed the bank, thus reducing the net amount the bank owed clients and how much had to be set aside in the reserve account.

The practice allegedly saved Bank of America up to $20 million a year.

The SEC is also investigating whether the bank misled regulators about the practice and is looking into the accuracy of other prior statements issued to the agency, according to the sources.

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Bank of America has faced heavy scrutiny in the past, last year paying the Department of Justice nearly $17 billion in a settlement over selling toxic mortgage-backed securities before the 2008 financial crisis.

Last month the bank nearly failed a financial stress test administered by the U.S. Federal Reserve, reportedly demonstrating "deficiencies" in its ability to predict how it would perform in an economic downturn.

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