SMH Capital Fined $450,000 for Procedural Failures Regarding Soft Dollar Payments,...

SMH Capital Fined $450,000 for Procedural Failures Regarding Soft Dollar Payments, Distributing Improper Hedge Fund Sales Materials

Two SMH Brokers Fined $200,000 for Improper Commission Sharing,
One Broker Sanctioned for Registration Violation
WASHINGTON--(Business Wire)--The Financial Industry Regulatory Authority (FINRA) today
announced that it has fined SMH Capital Inc. (f/k/a Sanders Morris
Harris, Inc.) of Houston, TX, $450,000 for failing to adopt adequate
supervisory procedures and systems designed to address its prime
brokerage and soft dollar services to hedge funds. As a result, SMH
made improper payments of $325,000 in soft dollars to a hedge fund
manager.

The firm's failures also included drafting and distributing hedge
fund sales materials that did not adequately disclose material
investment risks to potential hedge fund investors. In addition, SMH
entered into an improper compensation arrangement with two SMH brokers
who also managed hedge funds, allowing them to share in commissions
earned from fund trading contrary to representations made in the
offering documents and a separate agreement.

In addition to the fine, SMH was ordered to retain an Independent
Consultant to conduct a comprehensive review of the adequacy of the
firm's policies, systems, procedures and training with regard to its
hedge fund operation.

FINRA imposed $100,000 fines and 20-day suspensions on Michael S.
Rosen and Jack D. Seibald, the two brokers who helped manage SMH's
prime brokerage services business while at the same time serving as
the managers of a hedge fund that executed trades at SMH. Rosen and
Seibald improperly received compensation from a profit pool derived,
in part, from commissions on trading by their fund. This was contrary
to the fund's private placement memorandum (PPM) and a separate
contractual agreement. FINRA also imposed a 10-day suspension and
$15,000 fine on Anthony M. Gallo, an unregistered employee who engaged
in activities that required securities industry registration.

"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," said Susan L. Merrill, FINRA Executive
Vice President and Chief of Enforcement. "SMH's inadequate procedures
resulted in the firm making soft dollar payments without a reasonable
inquiry into red flags indicating the payments were improper."

FINRA found that SMH commenced its hedge fund services business in
July 2000 and eventually established relationships with more than 15
different hedge funds, making the hedge fund business an important
part of the firm's overall operations. SMH provided a platform of
services to hedge fund managers including office space (complete with
desks, computers, telephones and internet access), marketing
assistance and capital introduction, with the fund managers paying for
such services through commissions earned on trades directed to SMH.

The firm also operated soft dollar accounts for hedge funds that
opted not to join SMH's prime brokerage services platform. These
accounts collected a portion of the commissions earned when SMH
executed trades for each fund. Fund managers could then submit, or
cause to be submitted from third party service providers, invoices for
products and services. SMH then paid the providers from the balances
accumulated in the soft dollar accounts.

FINRA found that, by failing to have policies and procedures to
police its soft dollar payments, SMH sent two improper soft dollar
payments totaling $325,000 to a hedge fund manager. The manager had
submitted an invoice to SMH requesting that SMH issue one check for
$75,000 to an individual for "consulting services" and a second check
for just under $250,000 to the manager for "research expense
reimbursement." The invoice raised several red flags. It requested
that SMH pay the hedge fund manager directly for expenses that had
purportedly been provided by a third party; it did not describe what
research had been provided to the manager or who had provided the
research; and it failed to describe the "consulting services" the
individual provided. The hedge fund manager did not provide SMH with
any invoice or backup documentation from the individual consultant or
from any research provider to support the invoice. The invoice was
suspect on its face.

Despite the red flags, SMH took no steps to determine whether the
manager was relying on the soft dollar safe harbor under Section 28(e)
of the Securities Exchange Act and, if not, whether the manager had
disclosed to its clients that it was operating outside the safe
harbor. Had SMH taken such steps, it would have revealed the invoice
should not have been paid.

FINRA also found that Rosen and Seibald were employed as SMH
brokers while managing a hedge fund that operated on SMH's prime
brokerage services platform. To eliminate the conflict that arose from
their dual roles, the fund's PPM as well as an October 2001 agreement
between SMH, Rosen, Seibald and an outside firm that marketed the
brokers' hedge fund prohibited Rosen and Seibald from sharing, in
whole or in part, in any commissions SMH earned from trading for the
hedge fund. In April 2002, contrary to the PPM and the agreement, SMH,
Rosen and Seibald negotiated a new arrangement that allowed the two
brokers to receive bonuses from a "profit pool" derived in part from
the hedge fund's trading commissions. Nevertheless, Rosen and Seibald
continued to disseminate the fund's PPM that incorrectly stated the
brokers would not share in whole or in part in the fund's trading
commissions.

FINRA also found that, as part of SMH's marketing assistance for
its hedge fund clients, the firm's employees prepared and disseminated
hedge fund sales materials to potential investors that failed to
adequately disclose the risks inherent in hedge fund investing.
Furthermore, these sales materials were not approved by a registered
principal or signed, dated, and maintained in SMH's files for three
years, as required by FINRA rules.

FINRA further determined that SMH failed to retain and preserve
certain e-mails and instant messages of firm employees between January
2003 and December 2004, as required by federal securities laws and
FINRA Rules. SMH's failure to retain these communications hampered
FINRA's ability to investigate the firm's activities.

In settling this matter, SMH, Rosen, Seibald and Gallo neither
admitted nor denied the charges, but consented to the entry of FINRA's
findings.

Investors can obtain more information about, and the disciplinary
record of, any FINRA-registered broker or brokerage firm by using
FINRA's BrokerCheck. FINRA makes BrokerCheck available at no charge.
In 2006, members of the public used this service to conduct more than
4.7 million searches for existing brokers or firms and requested more
than 207,000 reports in cases where disclosable information existed on
a broker or firm. Investors can link directly to BrokerCheck at
www.finra.org/brokercheck. Investors can also access this service by
calling (800) 289-9999.

FINRA, the Financial Industry Regulatory Authority, is the largest
non-governmental regulator for all securities firms doing business in
the United States. Created in 2007 through the consolidation of NASD
and NYSE Member Regulation, FINRA is dedicated to investor protection
and market integrity through effective and efficient regulation and
complementary compliance and technology-based services. FINRA touches
virtually every aspect of the securities business - from registering
and educating industry participants to examining securities firms;
writing rules; enforcing those rules and the federal securities laws;
informing and educating the investing public; providing trade
reporting and other industry utilities; and administering the largest
dispute resolution forum for investors and registered firms.

For more information, please visit our Web site at www.finra.org.

Financial Industry Regulatory Authority (FINRA)
Nancy Condon, 202-728-8279
Herb Perone, 202-728-8464

Copyright Business Wire 2008