New York Securities Fraud Lawyers Blog
Yesterday, Malecki Law filed its official response to FINRA’s proposed changes to FINRA Rule 3240, in which FINRA seeks to modify the five current exceptions to the general rule that prohibits any “registered person” with a brokerage firm, from borrowing or lending to their customers. The rule applies to registered persons, which is most typically the account’s stockbroker, but applies to any licensed person with the firm. While FINRA has proposed this rule to “narrow the scope” of certain exceptions to the rule, Malecki Law filed its comment because of concerns that some of the modifications do not go far enough and still leaves room for possible abuse of the customer.
The five existing exceptions that currently permit borrowing or lending arrangements with a customer under Rule 3240 are if the customer is (1) a member of the registered person’s immediate family; (2) if the customer is a financial institution; (3) if the customer is also a registered person with the same firm; (4) if the lending arrangement is based on a personal relationship with the customer such that the arrangement would not exist had the personal relationship not existed in the first place; and (5) if the lending arrangements is based on a business relationship external to the broker-customer relationship.
Malecki Law is in favor of Rule 3240’s general prohibition against borrowing or lending to customers, because, as noted in Malecki Law’s filed comment, “there are thousands of brokers and advisors in America,” and therefore plenty “available to take over the debtor or lender’s investment account until the loan is repaid.” So while we support any proposal that narrows the rule, we believe that the inherent conflicts of interest in allowing such arrangements, even with a narrowed set of exceptions, could be entirely avoided in the first place.
In its filed comment, Malecki Law expressed concern that FINRA’s “narrowing” of the first exception, for example, as to who is considered “immediate family,” remained too broad. In over thirty years of practice in the securities field, the firm’s proprietor, Jenice L. Malecki, expressed in the filed comment the reality that debt situations can easily cause serious friction within a family-owned business. If that business also has an account with the firm that employs a family member from that business, it is not unheard of for family members to disagree and raise questions amongst one another around any borrowing, lending, or brokered transactions within the account. The friction only increases when a broker becomes involved who is also managing the assets of the business. This is neither good for public investors or for the brokerage and advisor communities.
The filed comment also took exception to FINRA’s proposed omission, in the name of “efficiency,” of a requirement that the loan be supervised under Rule 3240 when supervision requirements already exist under Rule 3270, which is a separate rule that requires firms to monitor the outside business activities of its registered persons more generally. As Malecki Law has a long track record of fighting on behalf of vulnerable investors such as senior citizens and minors, we believe that more supervision is in order, not less.
So while, for example, we believe it should be permissible for a parent broker or advisor to manage the educational debt of their children’s accounts (which in large part is funded by the broker), FINRA should not ignore that there remain problematic regulatory scenarios, as FINRA itself has observed in the context of family member brokers and senior citizen investor family members:
“a number of recent studies indicate that the vast majority of elder financial exploitation is perpetrated by strangers, family members and caregivers, rather than by brokerdealers or other financial services organizations. See, e.g., Consumer Financial Protection Bureau’s Office of Financial Protection for Older Americans, Suspicious Activity Reports on Elder Financial Exploitation: Issues and Trends, at 18 (Feb. 2019); Statistics and Data on Elder Abuse, The National Center for Elder Abuse, Who are the Perpetrators?.”
FINRA Regulatory Notice 19-27, https://www.finra.org/rules-guidance/notices/19-27. (Emphasis added.)
Problems further arise when there are payment deficiencies, which is a common potential problem in any lending or borrowing arrangement, but especially when family members are involved. Such conflicts become harder to resolve when the broker, and necessarily the brokerage firm, must make decisions about what is best for the customer or best for repayment of the loan. As a result, we believe that there should be ongoing supervisory monitoring of any lending, with the exception of a child’s educational debt, to be closely supervised to ensure that the right decisions are being made, ultimately, for the protection of the customer.
Finally, Malecki Law’s filed comment expressed concern with Rule 3240’s last two exceptions, which are problematic and arguably give the most leeway for interpretation towards permitting borrowing and lending arrangements between customers and registered persons. Under exception nos. 4 and 5, it becomes a very slippery slope to permit such arrangements where all the broker has to do is say that a personal relationship with the customer exists outside of the broker-customer context. In theory and in practice, this exception circumvents the general prohibition because it could very easily apply to virtually anyone.
In deciding whether to approve the proposed rule change, FINRA will first review comments from Malecki Law, as well as other industry participants who naturally filed comment to loosen supervisory oversight. As a general matter, we believe that investors remain vulnerable and typically need more protection, not less. This is why we support more ongoing monitoring and supervision when it comes to lending and borrowing arrangements between brokers and customers.