Alert December 01, 2009

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.