(Dow Jones) Corporate compliance officers have been rolling their eyes at the unfolding story of Terra Nova Financial LLC, the Chicago broker-dealer fined $400,000 for making improper soft dollar payments on behalf of five hedge fund managers. The case, announced by the Financial Industry Regulatory Authority (Finra) on Monday, has drawn attention for the blatant impropriety of the payments.

According to Finra, Terra Nova arranged over $1 million in improper soft-dollar payments, mostly for undocumented expenses and research. Among the bills that Terra Nova covered was $65,000 worth of credit card expenses that included meals, clothing, car repairs, limousines, hotel stays and even parking tickets.

The biggest eyebrow-raiser was a $13,700 tab at a "gentlemen's club" over a two-week period.

Finra also sanctioned three former employees of the firm, including Chief Compliance Officer David Persenaire, who it said made payments that in some cases were obviously improper and in other cases were not authorized by fund disclosure documents. The company and the individuals have neither admitted nor denied any wrongdoing, but have consented to the findings.

It would be an understatement to say the news has turned heads. "When a company is fined $400,000 on a compliance matter, we tend to pay attention," says David Sobel, chief compliance officer at Abel/Noser, an independent broker-dealer. But he added that the case was so outrageous as to be an anomaly. "There's a lot more subtlety going on in the soft-dollar world than this," he said. "Even Madoff was a little more subtle than this."

Finra spokesman Herb Perone says the Terra Nova case arose out of a general crackdown on improper soft-dollar payments three years ago. It took so long to conclude, he says, because the company obstructed the investigation. "The thing to remember is there are not a lot of broker-dealer firms engaged in soft-dollar payments," he says. "It's maybe the top 200 or 250." He added, however, that Finra is involved in internal litigation on another soft-dollar investigation.

The Terra Nova case highlights the different rules that govern soft-dollar payments made by ERISA-covered institutional investors (like big mutual funds and pension plans) and those made by non-ERISA (Employee Retirement Income Security Act) investors like hedge funds. In both cases, soft-dollar payments to broker-dealers offset hard-dollar commissions, thus allowing the funds to advertise lower fees to investors. In the long run, of course, over-reliance on soft-dollar payments will drag down investment performance (the money comes from investors' gains), and so fund managers must weigh their use carefully.

Soft-dollar payments made by ERISA-covered investors are bound by Securities and Exchange Commission rule 28(e), which establishes a "safe harbor" for certain types of carefully documented soft-dollar expenses, such as legitimate stock research and clerical expenses. "To me, 28(e) is very clear cut," says Sobel. "If you're using soft dollars to pay for a computer system that will be used for trading 73 percent of the time, that's legitimate, but you have to deduct 27 percent of the cost."

By contrast, hedge funds and other non-ERISA investors work in a soft-dollar gray area. While soft-dollar payments from such funds are required to be used for the benefit of the fund's investors, it's largely up to the fund itself to define what that means. The key is disclosure.

"If the fund says in its prospectus that soft dollars will be used to entertain clients, then the broker-dealer can pay for that," says Sobel. "It's okay because you disclosed it."