Finra fines Jefferies for conflicts in sale of auction-rate securities

By Susanna Moon

Chicago, April 14 - The Financial Industry Regulatory Authority said it reached a settlement with Jefferies & Co., Inc. for conflicts and for failure to disclose additional compensation associated with the sale of auction-rate securities.

Finra said it fined the firm $1.5 million and ordered the repayment of $425,000 in fees and commissions.

The non-governmental securities regulator also sanctioned two Jefferies brokers and filed a complaint against a third, Richard Morrison, for their role in failing to disclose the extra compensation and conflicts. Anthony Russo received a $20,000 fine and five-day suspension, and Robert D'Addario received a $25,000 fine and 10-day suspension.

Russo, D'Addario and Morrison comprised the firm's corporate cash management group that provided investment advice and services, including purchasing and selling the auction-rate securities, to 40 Jefferies institutional clients.

From Aug. 1, 2007 to March 31, 2008, the three brokers for Jefferies failed to disclose material facts to a group of eight corporate customers for whom they exercised discretion to purchase and sell the auction-rate securities, which Finra found in the settlement and alleged in the Morrison complaint, according to a press release from the regulator.

The brokers used their discretion to purchase for these customers new issue auction-rate securities that paid them and the firm additional compensation. By exercising discretion, Jefferies and the brokers were obligated to disclose that they received this additional compensation and that they could have purchased other comparable or similar auction-rate securities with higher yields, Finra said.

In 32 other transactions, they used their discretion to purchase auction-rate securities for the customers from other corporate cash management group customers but failed to disclose the conflict created because they acted as agent for both the buying and selling customer. They also failed to disclose the existence of comparable or similar auction-rate securities with higher yields, the release noted.

Finra also found that Jefferies committed several other violations in connection with its auction-rate securities business:

• Exercising discretion without written authority;

• Failing to deliver official statements in connection with purchases of municipal new issue auction-rate securities;

• Using misleading auction-rate securities advertising and marketing materials;

• Selling restricted (Rule 144A) auction-rate securities to a customer that was not qualified to buy them;

• Failing to implement an information barrier with a customer;

• Deficiently completing order tickets for auction-rate securities trades; and

• Failing to establish and maintain an adequate supervisory system, including written supervisory procedures, relating to the operation of the corporate cash management group and its preparation and use of advertising and sales material for auction-rate securities.

Settlement with Jefferies

In reaching the settlement, Finra said it took into account that in December 2008, Jefferies spent about $68 million in a partial voluntary buyback of auction-rate securities held in retail accounts.

As part of the settlement announced Thursday, which included findings relating to Jefferies' auction-rate securities advertising and inadequate supervisory review of auction-rate securities advertising, Jefferies agreed to purchase auction-rate securities from additional retail accounts.

Also, in July 2008, Jefferies began remitting all trailing commissions received for frozen auction-rate securities held in customer accounts directly to its customers on a go-forward basis, and as of October 2010, it had remitted more than $868,000, the securities regulator said.

As part of the settlement, Jefferies also agreed to participate in a special Finra-administered arbitration program to resolve eligible investor claims for consequential damages, the release noted.

In concluding this settlement, Jefferies, Russo and D'Addario neither admitted nor denied the charges but consented to the entry of Finra's findings. The Morrison complaint is not yet adjudicated.

Under Finra rules, a firm or individual named in a complaint can file a response and request a hearing before a Finra disciplinary panel. Possible remedies include a fine, censure, suspension or bar from the securities industry; giving up gains associated with the violations; and payment of restitution.

The issuance of a disciplinary complaint represents the initiation of a formal proceeding by Finra in which findings as to the allegations in the complaint have not been made, and it does not represent a decision as to any of the allegations contained in the complaint.

"In exercising discretion over customers' accounts, Jefferies was obligated to ensure that its customers were aware of material facts about the transactions. Instead, Jefferies and its brokers failed to disclose the additional compensation they earned in selling new issue [auction-rate securities] to their customers, their role in effecting trades between client accounts, and the existence of comparable or similar [auction-rate securities] with higher yields," Brad Bennett, Finra executive vice president and chief of enforcement, said in the press release.

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