Finra Looks to Tighten Rules for Broker-Client Lending, Borrowing
On the face of it, brokers borrowing money from clients whose investments they direct seems like an obvious conflict of interest, and in most cases it isn’t permitted. But not all.
Brokerage industry self-regulator Finra is looking to further narrow the already-stringent rules governing borrowing and lending between financial professionals and their clients.
The organization has submitted a proposal to the Securities and Exchange Commission, which oversees Finra and signs off on its rule changes, to “strengthen the general prohibition against borrowing and lending arrangements,” the regulator says in its filing.
To reinforce the standard that borrowing and lending arrangements with clients aren’t typically allowed, Finra is proposing to rename the operative regulation, Rule 3240, “Prohibition on Borrowing From or Lending to Customers.” The rule, which was last amended in 2010, is currently titled, “Borrowing From or Lending to Customers.”
The revised rule would clarify that the general prohibition applies to borrowing/lending situations that predate a broker-client relationship, proposing to “prohibit registered persons from initiating a broker-customer relationship with a person with whom the registered person has an existing borrowing or lending arrangement.”
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It would also clarify that the prohibition continues after the broker-client relationship ends: The revised rule would generally bar brokers from borrowing or lending with anyone who had been a client in the past six months, a “cooling off period” that some commentators wanted to see extended to 12 months.
Clear conflicts. Finra initiated a review of Rule 3240 in 2019 as part of a broader assessment of its regulatory framework, and invited interested parties to weigh in. Some commenters pointed out the obvious potential for conflicts and even exploitation when brokers co-mingle their personal finances with their clients’.
“Member firms have long recognized that registered persons accepting loans from customers is problematic,” faculty members with the University of Pittsburgh’s Securities Arbitration Clinic wrote in a 2022 letter, citing the potential for financial exploitation of elderly clients, among other concerns.
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Some commenters, including the North American Securities Administrators Association, a consortium of state regulators, argued for a total ban on any client borrowing and lending.
“Nasaa maintains that there should be an outright prohibition on borrowing from or lending to customers, including family members,” the group wrote in its comment letter. “The conflicts of interest for a registered person inherent in a lender-debtor relationship and the potential harm to investors outweigh any benefit to be gained under this rule.”
However, rather than banning the practice, Finra’s current proposal is mainly focused on limiting the exceptions under which client-lending arrangements are permitted. A major exception is when immediate family members are involved.
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The proposed rule would update the definition of an immediate family member, and also stipulate that it would generally be prohibited for the broker to engage in borrowing or lending with a relative of the client’s, and similarly prohibit brokers from arranging for their clients to enter into a borrowing/lending arrangement with one of their own relatives. The proposal also clarifies that owner-financing arrangements—such as the sale of a piece of property to a broker with repayments to be made over time—would be generally prohibited.
In cases where the client is a direct relation to the broker under the immediate-family exception, Finra is proposing to replace “husband and wife” with “spouse or domestic partner,” and add “step and adoptive relationships.”
The current rule lists several direct relationships that qualify as immediate family, ending the list with: “any other person whom the registered person supports, directly or indirectly, to a material extent.”
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Finra is seeking to add a cohabitation requirement, proposing to limit the “any other person” clause to only include “any other person who resides in the same household as the registered person and the registered person financially supports, directly or indirectly, to a material extent.”
Finra is also proposing to narrow the exceptions that would permit broker-client lending in situations where the two individuals had an outside personal or business relationship. In both cases, Finra proposes the exception be limited to “bona fide” relationships and stipulates that the personal-relationship exception should apply only to close relationships formed prior to the individual becoming a client.
The SEC will now determine whether to accept, reject, or ask for revisions to Finra’s proposal.
