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Editor: Eric C. Chaffee
Univ. of Toledo College of Law

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Wednesday, January 9, 2008

FINRA Fines Brokerage Firm for Improper Soft Dollar Payments

FINRA has fined SMH Capital Inc. (f/k/a Sanders Morris Harris, Inc.) of Houston, TX, $450,000 for failing to adopt adequate supervisory procedures and systems designed to address its prime brokerage and soft dollar services to hedge funds. As a result, SMH made improper payments of $325,000 in soft dollars to a hedge fund manager.  The firm's failures also included drafting and distributing hedge fund sales materials that did not adequately disclose material investment risks to potential hedge fund investors. In addition, SMH entered into an improper compensation arrangement with two SMH brokers who also managed hedge funds, allowing them to share in commissions earned from fund trading contrary to representations made in the offering documents and a separate agreement.  In addition to the fine, SMH was ordered to retain an Independent Consultant to conduct a comprehensive review of the adequacy of the firm's policies, systems, procedures and training with regard to its hedge fund operation.

FINRA found that SMH commenced its hedge fund services business in July 2000 and eventually established relationships with more than 15 different hedge funds, making the hedge fund business an important part of the firm's overall operations. SMH provided a platform of services to hedge fund managers including office space (complete with desks, computers, telephones and internet access), marketing assistance and capital introduction, with the fund managers paying for such services through commissions earned on trades directed to SMH.

The firm also operated soft dollar accounts for hedge funds that opted not to join SMH's prime brokerage services platform. These accounts collected a portion of the commissions earned when SMH executed trades for each fund. Fund managers could then submit, or cause to be submitted from third party service providers, invoices for products and services. SMH then paid the providers from the balances accumulated in the soft dollar accounts.

FINRA found that, by failing to have policies and procedures to police its soft dollar payments, SMH sent two improper soft dollar payments totaling $325,000 to a hedge fund manager, despite red flags that the payments were improper. In settling this matter, SMH neither admitted nor denied the charges, but consented to the entry of FINRA's findings.

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