WASHINGTON — In the first case of its kind, the Financial Industry Regulatory Authority fined Southwest Securities Inc. $500,000 for paying unaffiliated individuals to solicit municipal securities business for it, in violation of Municipal Securities Rulemaking Board Rule G-38.
Specifically, FINRA found that the Dallas-based firm, between October 2006 and April 2009, received more than $1.9 million in gross revenues from 24 muni offerings and two financial adviser stints for Texas municipalities that outside consultants obtained for the firm.
Southwest paid the consultants more than $200,000.
Since August 2005, Rule G-38 has prohibited broker-dealers from directly or indirectly providing payments to unaffiliated persons for soliciting municipal securities business on their behalf.
Brad Bennett, FINRA’s executive vice president and chief of enforcement, said this is the first time a firm has been fined for violating Rule G-38’s ban on the use of outside consultants.
“It’s an important case, [and] an important rule,” he said. “In the scheme of things, it’s a significant sanction.”
FINRA also found that the firm had violated: former Rule G-36 (which was rescinded as of June 1, 2009) by failing to file timely forms in connection with transactions; Rule G-14 by failing to report accurate transaction data to the MSRB’s Real-Time Transaction Reporting System; and Rule G-27 for supervisory failures.
As part of the settlement announced Monday, FINRA also censured Southwest and required an officer of the firm to certify in writing, within 60 days, that Southwest has reviewed its MSRB rule-compliance procedures and established systems reasonably designed to achieve compliance with those rules.
The fine comes as the firm’s parent company, SWS Group Inc., posted a $21.1 million net loss for the first half of its 2011 fiscal year, on net revenue of $188 million, according to financial results released last month.
But James Ross, the chief executive officer of SWS Group, said last month that the firm’s broker-dealer business has performed well in spite of the economic downturn. Southwest ranked 27th among senior managers for 2011 through Monday, underwriting 13 issues totaling $156.6 million. In 2010, it ranked 29th, underwriting 188 issues totaling $2 billion, and in 2009 it ranked 24th, underwriting 144 issues worth $2.11 billion.
“We believe this settlement is in the best interest of our firm, our shareholders and our clients,” Ross said in a release.
According to FINRA, between March 2007 and April 2009, Southwest used a former official of a Texas issuer to solicit business on its behalf from various municipal issuers. Under a consulting agreement with the firm, the unaffiliated individual received a monthly $2,000 consulting fee and finder’s fees of about 15% of Southwest’s net profits on any underwritings he helped obtain.
In return, he agreed to promote Southwest’s muni bond department as a potential underwriter and financial adviser for public entities throughout Texas. All told, he helped solicit 23 muni deals, on which Southwest grossed $1.7 million in revenue, and for which he snagged $51,000 in total monthly consulting fees and more than $122,000 in finder’s fees.
A second unaffiliated individual, also a former official of a Texas issuer, entered into a consulting agreement with Southwest in May 2008, entitling him to a 15% finder’s fee on any muni underwritings he helped secure.
Though he failed to land Southwest any such business, the firm reimbursed him for more than $5,100 in expenses stemming from his solicitations, including contacting and meeting with Texas municipal officials.
Aside from the consulting agreements, FINRA said Southwest also made one-time payments of over $26,000 to three other unaffiliated individuals for their roles in snaring muni-securities business for the firm, including two financial adviser positions with Texas municipalities. Southwest netted more than $250,000 in gross revenues from the business obtained by the individuals, including one who also was a former official of a Texas municipality.
Monday’s settlement follows a history of disciplinary run-ins by Southwest, including a $470,147 settlement with the Securities and Exchange Commission last year for violating MSRB Rule G-37’s pay-to-play provisions. That rule prohibits firms from engaging in negotiated muni securities business with an issuer for two years if they, their muni-finance professionals or political action committees make significant contributions to issuer officials who can influence the award of bond business.
In the SEC case, announced in March 2010, the commission said Southwest had run afoul of Rule G-37 by co-underwriting Massachusetts bond deals within two years after its former senior vice president made political contributions to state Treasurer Timothy Cahill.
Southwest paid more than $225,000 in fines and restitution to FINRA since September 2007 to settle four previous matters involving MSRB rule violations, including infringements of the provisions governing fair pricing and timely transaction reporting and violations of Rule G-41 for failing to develop an anti-money-laundering program.
