Finra is telling brokers more forcefully than it has before not to become a customer’s creditor or debtor.
The Financial Industry Regulatory Authority Inc. filed a rule proposal with the SEC this week that would tighten existing rules limiting the ability of brokers to lend money to or take loans from clients. Such arrangements can create conflicts of interest and lead to enforcement actions and customer complaints.
One of the provisions of the proposal demonstrates Finra’s position on the practice. It would change the name of the rule from “Borrowing From or Lending to Customers” to “Prohibition on Borrowing From or Lending to Customers.”
“Ninety-nine percent of the time, lending to customers or borrowing from them is a bad idea,” said Patrick Mahoney, owner of an eponymous securities law firm in Los Angeles. “This is Finra rightly trying to tighten the screws further on what is already a general prohibition on the practice.”
The proposal strengthens the general prohibition by preventing a registered representative from initiating a customer relationship with someone with whom the rep already has a borrowing or lending arrangement. It would prohibit borrowing or lending within six months of the termination of a broker-customer relationship and ban borrowing or lending arrangements with someone related to the rep or the customer. It also would curtail owner-financing arrangements.
The proposed rule would tighten “tailored exceptions” to the borrowing and lending ban by narrowing the definitions of an immediate family member and personal and business relationships. It also strengthens requirements that reps to notify their firms about borrowing and lending arrangements.
But the thrust of the rule is to get rid of the practice. That’s a good idea because brokers might be more aggressive in managing customer accounts when they owe customers money, said Tim Nagy, a partner at Mayer Brown.
“There is a potential for conflicts of interest in these types of arrangements,” Nagy said. “Finra is trying to bring clarity and reaffirm that there is a general prohibition on such arrangements in the first place absent those specific situations where there is a legitimate preexisting relationship.”
The rule change emanates from a review of existing rules that Finra launched in 2019. The broker-dealer self-regulator issued the proposal in December 2021 and then took public comments until February 2022.
The Securities and Exchange Commission, which must approve Finra rule changes, will now review the proposal. The SEC could open another comment period on the rule change. It’s not clear when the agency will act.
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