Jeffries & Company Inc., and two of its brokers agreed to settle FINRA charges related to the sale of auction rate securities ("ARSs").  FINRA filed a complaint against a third broker, Richard Morrison.  In total, Jefferies will pay $1.5mn in fines and restitution.  Broker Anthony Russo will pay a $20K fine and serve a 5-day suspension, while broker Robert D'Addario received a $25K fine and 10-day suspension. 

The sanctions focused on the fact that Jefferies, acting through the 3 brokers, allegedly failed to disclose to  corporate customers that they received additional compensation and had conflicts in connection with the sale of ARS's.  As part of the sanction, Jefferies will pay the customers $425K in fees and commissions that was earned on sales to the affected customers. 

        FINRA Allegations.   Russo, D'Addario and Morrison comprised the firm's Corporate Cash Management (CCM) group that provided investment advice and services, including purchasing and selling ARS, to 40 Jefferies institutional clients.   From 8/1/07 to 3/31/08, acting through Russo, D'Addario and Morrison, Jefferies failed to disclose material facts to a group of eight corporate customers for whom they exercised discretion to purchase and sell ARS.  The brokers used their discretion to purchase for these customers new-issue ARS that paid them and the firm additional compensation. 

By exercising discretion ... Jefferies and the brokers had an obligation to disclose that they received additional compensation from these ARS sales, and that the customers could have purchased other comparable or similar ARS's with higher yields. 

In 32 other transactions, they used their discretion to purchase ARS for the customers from other CCM 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 ARS with higher yields.

        Discretionary Authority Begets Obligations.   Brad Bennett, FINRA EVP and Chief of Enforcement, said:  "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 ARS to their customers, their role in effecting trades between client accounts, and the existence of comparable or similar ARS with higher yields."

        FINRA's Other Alleged Findings.   Jefferies allegedly committed several other violations in connection with its ARS business, including the following:

• exercising discretion without written authority;
• failing to deliver official statements in connection with purchases of municipal new issue ARS;
• using misleading ARS advertising and marketing materials;
• selling restricted (Rule 144A) ARS to a customer that was not qualified to buy them;
• failing to implement an information barrier with a customer;
• deficiently completing order tickets for ARS trades; and,
• failing to establish and maintain an adequate supervisory system, including WSP's, relating to the operation of the CCM group and its preparation and use of advertising and sales material for ARS.

        Factors Weighed in Determining Sanctions.   FINRA took into account that, in December 2008, Jefferies spent approximately $68mn in a partial voluntary buyback of ARS held in retail accounts.  Jefferies also agreed to purchase ARS's from additional retail accounts. 

Also, in July 2008, Jefferies began remitting all trailing commissions received for frozen ARS held in customer accounts directly to its customers on a go-forward basis;  as of October 2010, had remitted in excess of $868K. 

Jefferies also agreed to participate in a special FINRA-administered arbitration program to resolve eligible investor claims for consequential damages.

        FINRA Staff Credits.   Investigation was conducted by Paul Schindler, Gary Carleton, Perry Hubbard, and supervised by Jim Day, Chief Counsel, AVP.

For further details, go to:   [FINRA News Release, 4/14/11;  and   FINRA AWC, 4/11/11]