FINRA Fines Broker-Dealer For Improper Soft Dollar Payments

Developments Of Note

FINRA Fines Broker-Dealer For Improper Soft Dollar Payments OFAC Finalizes Enforcement Guidelines Director Of SEC Division Of Investment Management Speaks At Independent Directors Council Conference Treasury And FRB Extend Effective Date To June 1, 2010 For Implementation Of Compliance Requirements Of Final Rule Restricting Internet Gambling SEC Inspector General Issues Report Recommending Changes To Processes For Selecting Investment Advisers And Investment Companies For Examination DEVELOPMENTS OF NOTE FINRA Fines Broker-Dealer For Improper Soft Dollar Payments FINRA fined a broker-dealer $400,000 after finding that the broker-dealer made more than $1,000,000 in improper soft dollar payments to or on behalf of five hedge fund managers. FINRA also sanctioned the broker-dealer's soft dollar administrator, the supervisor of the broker-dealer's soft dollar operation and the broker-dealer's chief compliance officer. The parties neither admitted nor denied the charges, but consented to the entry of FINRA's findings, which are summarized in this article based on FINRA's announcement describing the sanctions.

Starting in 2004 the broker dealer set up soft dollar accounts for eight hedge funds. The broker-dealer collected a portion of the commissions generated by fund trades and used those amounts to pay invoices from fund managers or third parties for various services. The broker-dealer's policies required it to obtain and review a copy of the offering documents for its hedge fund clients, which described policies allowing commissions on fund trades to be used to pay research or brokerage-related expenses and, in certain cases, other expenses as permitted under a fund's organizing documents.

FINRA found that certain soft dollar payments made by the broker-dealer out of five of the hedge funds' commissions were improper because they were not allowed by fund documents, e.g., payments for estate planning fees, administrative staff and accounting expenses, while other payments made directly to fund managers were improper because the broker-dealer did not receive written authorization from a third party evidencing that the payments were appropriate, as required under applicable fund documents. Among the payments deemed improper because the broker-dealer did not receive adequate documentation or conduct an adequate review to determine that the payments were authorized under fund documents were the following:

Payments for "consulting fees related to research" where the invoices requesting the payments did not sufficiently identify who provided the research or what research was being provided. Payments to managers based solely on the manager's representation that soft dollars would be used to "fund expenses in conjunction with our documents" without any clear or understanding of what expenses were being paid. OFAC Finalizes Enforcement Guidelines The U.S. Treasury Department's Office of Foreign Assets Control ("OFAC") published the final version of its "Economic Sanctions Enforcement Guidelines" (the "Final Guidelines"). The Final Guidelines amend and finalize OFAC's interim final Enforcement Guidelines (the "Interim Final Guidelines"), which have been in effect since they were published in September 2008. The Interim Final Guidelines were described in the September 16, 2008 Alert.

Under the Final Guidelines, OFAC will continue to apply the framework established by the Interim Final Guidelines when determining OFAC's enforcement response to apparent violations of OFAC sanctions programs. Like the Interim Final Guidelines, the Final Guidelines provide that:

OFAC may take one of seven types of enforcement actions depending on the facts and circumstances of each case. In response to an apparent violation, OFAC may issue (1) a no-action letter, (2) a request for additional information, (3) a cautionary letter, (4) a finding of a violation, (5) a civil monetary penalty, (6) a criminal referral to appropriate law enforcement agencies, or (7) other administrative actions (including license denial, suspension, or cease and desist order). OFAC will consider certain "General Factors" in determining the appropriate enforcement response to an apparent violation and, if a civil monetary penalty is warranted, in establishing the amount of that penalty. Included among the General Factors are (1) whether the conduct at issue involved a willful or reckless violation of the law; (2) awareness of the conduct at issue; (3) harm to sanctions program objectives; (4) the individual characteristics of the violating party, including (a) its level of commercial sophistication, (b) the size of its operations, (c) the total volume of its transactions compared to the apparent violations, (d) whether there is any history of violations, (e) the presence of a compliance program at the time of the violation, and (f) remedial steps taken in response to the violation; and (5) the violating party's cooperation with OFAC, including in cases where the violation was not voluntarily disclosed. In determining the amount of any civil money penalty, OFAC will distinguish between "egregious" and "non-egregious" cases. Egregious cases are those representing the most serious sanctions violations, based on an analysis of all applicable General Factors, with substantial weight given to considerations of whether the violation involved willfulness or recklessness, awareness of the conduct giving rise to an apparent violation, harm to sanctions program objectives, and the individual characteristics of the subject person. OFAC will impose significantly higher penalties for egregious cases. Where OFAC determines that a civil penalty is appropriate, OFAC will determine a "base penalty amount," based on two primary considerations...

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