The Financial Industry Regulatory Authority has fined Terra Nova Financial $400,000 for making more than $1 million in improper soft dollar payments to hedge fund clients for accounting expenses, estate planning fees and more questionable expenses.
The improper soft dollar payments went to or were made on behalf of five hedge fund managers. The Chicago-based financial company did not follow its own policies to ensure the payments were proper, according to FINRA.
FINRA found that starting in 2004, Terra Nova set up soft dollar accounts for eight hedge funds to encourage the funds to execute trades with the firm. Terra Nova collected a portion of the commissions generated by the funds' trading in separate soft dollar accounts and from those accounts paid invoices from the fund managers or third parties for various services.
Federal securities laws allow advisors to use soft dollars to pay for research or brokerage-related expenses. But advisors may only use soft dollars to pay for personal expenses or other non-research or non-brokerage related expenses if those types of payments were previously disclosed to investors and if they are made in accordance with the terms of the fund's organizing documents.
FINRA found that in 2004 and 2005, Terra Nova made numerous improper soft dollar payments to or on behalf of five hedge fund advisors totaling more than $1 million. Some payments (for estate planning fees, administrative staff and accounting expenses) were not allowed by the fund documents. Other payments made directly to the funds' managers were improper because Terra Nova did not receive written authorization from a third party evidencing that the payments were appropriate, as required by fund documents that the firm had or should have obtained under its own policies.
Terra Nova paid at least $1 million in expenses without receiving adequate documentation or conducting an adequate review to determine that the payments were for expenses authorized by fund documents. Those payments included:
$13,700 for seven trips by a hedge fund manager to a "gentlemen's club" in a two-week period.
$65,000 for credit card bills that contained charges for meals, clothing, auto repairs and parking tickets. Terra Nova made other payments for limousines, airline tickets and hotel stays.
$145,000 for salaries and benefits of non-clerical employees when the fund documents only permitted payments for "clerical staff salaries and benefits."
$389,000 in payments for "consulting fees related to research" when the invoices requesting the payments did not sufficiently identify who provided the research or what research was being provided.
More than $470,000 to one manager based solely on the manager's representation that soft dollars would be used to "fund expenses in conjunction with our documents" without any clear understanding of what expenses were being paid.
Terra Nova was also charged with failing to properly supervise its soft dollar program, failing to implement adequate supervisory procedures and failing to retain its business-related electronic instant messages. Terra Nova also reportedly failed to timely respond to FINRA's requests for productions of various documents, including emails and instant messages, thus delaying FINRA's investigation.
FINRA sanctioned three individuals: Cleovan Jordan, the soft dollar administrator who managed Terra Nova's relationship with its hedge fund clients; Joshua Teuber, who supervised the soft dollar operation; and David Persenaire, the firm's chief compliance officer until September 2009.
As part of the settlement, Terra Nova is required to retain an independent consultant to review and enhance its policies, systems and procedures relating to its soft dollar operations.
