The Financial Industry Regulatory Authority (FINRA) fined Jefferies & Co. $1.5 million for failing to disclose that it was earning additional compensation when selling new-issue auction-rate securities to clients.
The New York-based firm also did not disclose conflicts of interest that arose from trading ARS between clients and that similar higher-yielding ARS securities were available, FINRA said.
The self-regulator announced the fine Thursday. It also ordered Jefferies to repay clients $425,000 in fees and commissions it earned from ARS sales and directed it to engage in an ARS buyback program. In addition, FINRA sanctioned two Jefferies brokers and filed a complaint against a third for their roles in the disclosure failures.
Anthony Russo was fined $20,000 and given a five business-day suspension. Robert D’Addario was fined $25,000 and given a 10 business-day suspension. Richard Morrison was charged with violating NASD — now FINRA — rules as well as the Municipal Securities Rulemaking Board’s Rule G-17 on fair dealing.
In imposing the sanctions, FINRA said it took into account efforts by Jefferies to remit some commissions to customers and to engage in a partial buyback of ARS from retail customers in late 2008.
A Jefferies spokesman said, “We are pleased to have reached an agreement with FINRA and to have this matter behind us.”
FINRA said the three brokers purchased new-issue ARS for clients in 32 transactions, earning additional compensation without disclosing to them that it could have purchased ARS at higher yields for less compensation.
The self-regulator also found that in 32 other transactions, the firm and its brokers used their discretion to purchase ARS for certain clients from other clients and did not disclose it was acting as agent for both buying and selling customers.
“In exercising discretion over customers’ accounts, Jefferies was obligated to ensure that its customers were aware of material facts about the transactions,” said Brad Bennett, FINRA executive vice president and chief of enforcement. “Instead, Jefferies and its brokers failed to disclose the additional compensation they earned in selling new-issue ARS to their customers, their role in effecting trades between client accounts, and the existence of comparable or similar ARS with higher yields.”
ARS are long-term securities with interest rates or dividend yields that are periodically reset through an auction process. Historically, broker-dealers often supported auctions to prevent them from failing. But during the financial crisis in mid-2007, firms stopped providing that support and auctions of ARS began to fail on a widespread basis. By February 2008, the markets were virtually frozen.
Jefferies served as a “downstream” broker of ARS, selling more than $1 billion of student loan, municipal, and preferred ARS to its customers between August 2007 and the end of March 2008, according to FINRA.
As of Feb. 28, 2008, about $845 million of ARS were held in Jefferies accounts and $659 million of that amount was held by the firm’s corporate cash management group, FINRA said.
The CCM group provided short-term investment advice and services for about 40 of its corporate clients. Eight of them had instructed the CCM group to exercise its discretion when buying and selling ARS for their accounts.
FINRA claimed that from Aug. 1, 2007, to March 31, 2008, the three brokers used their discretion to buy new-issue ARS for the eight corporate customers without making the required disclosures. In 32 other transactions, they traded ARS between clients without making the required disclosures about conflicts and the availability of ARS with higher yields.
FINRA said Jefferies exercised discretion for ARS purchases without written authority, failed to deliver official statements to clients for some ARS purchases, and had deficient or missing order tickets for about 400 trades. The firm and brokers violated FINRA rules as well as MSRB rules on fair dealing, advertising, disclosures, supervision, and books and records, the self-regulator said.