Texas Prime Broker Slapped For ‘Inadequacy’

Jan 10 2008 | 8:34am ET

A Houston prime brokerage and three employees have been disciplined for a variety of failures in dealings with its hedge fund clients.

According to the Financial Industry Regulatory Authority, SMH Capital made $325,000 in improper soft-dollar payments to a hedge fund client in spite of “several red flags” raised by the manager's requests, including the fact that the hedge fund asked to be paid directly for third-party services, identified neither the research provider nor the provider, or provide any invoice or backup documentation. FINRA said that SMH “took no steps” to determine whether the soft-dollar payment was proper.

What’s more, SMH allowed two of its brokers to collect commissions on trades made for a hedge fund the two managed while employed at SMH.  Michael Rosen and Jack Seibald received bonuses from a “profit pool” filled in part with commissions from their own hedge funds.

SMH was fined $450,000 for failure to adopt adequate supervisory procedures and systems. The firm was also ordered to retain an independent consultant to review its policies and systems. Rosen and Seibald were each hit with $100,000 fines and 20-day suspensions.

“As broker-dealers increasingly provide services to hedge funds, they need to carefully tailor their supervisory systems and procedures to ensure they guard against conflicts of interest that result in securities law violations,” FINRA enforcement chief Susan Merrill said. “SMH’s inadequate procedures resulted in the firm making soft-dollar payments without a reasonable inquiry into red flags indicating the payments were improper.”

The regulator found other lapses at SMH. Employee Anthony Gallo was found to have engaged in activities requiring securities industry registration without it, an offense for which he was hit with a $15,000 fine and 10-day suspension. FINRA also found that SMH prepared and disseminated marketing materials for its clients that failed to adequately disclose the investment risk and were not approved by a registered principal, and that the firm did not retain e-mails and instant messages as required by law.

SMH, Gallo, Rosen and Seibald did not admit or deny the charges, but consented to the entry of FINRA’s findings.


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