In our modernized world of peer-to-peer lending, where pulling a template promissory note from the internet is possible, one area of scrutiny that FINRA member firms often overlook is borrowing from and lending to a customer. FINRA Rule 3240 addresses this topic and provides some limited conditions under which a registered representative may borrow money from (or lend money to) a customer.
Generally speaking, broker-dealers widely prohibit borrowing from and lending to a customer. However, Rule 3240 permits borrowing or lending under certain well-defined circumstances:
- The broker-dealer must have written procedures that permit (and specify the supervision of) the practice of borrowing and lending of money between registered representatives and customers of the firm;
- The borrowing or lending arrangement must meet one of the following exceptions:
- The customer is a member of the registered representative’s immediate family;
- The customer is a financial institution engaged in the business of lending and is acting in that capacity;
- The customer and the registered representative are both registered with the same broker-dealer;
- The lending arrangement is based upon a personal relationship with the customer such that the personal relationship is what caused the loan, not the broker-customer relationship; or,
- The lending arrangement is based upon a business relationship outside the broker-customer relationship.
- The registered representative must have notified and received approval from their broker-dealer, as required, depending upon the proposed lending arrangement.
Taking the above into account, how do you ensure that you are properly following your firm’s protocol and FINRA Rule 3240? This depends largely on your firm’s procedures and the type of lending arrangement.
First, you must ensure that your firm’s procedures allow for the potential of a lending/borrowing arrangement with customers. If this is flatly prohibited, you cannot engage in such an arrangement. Barring such a flat prohibition, the lending scenario itself will determine the proper course to follow:
Scenario 1: The lending arrangement is between registered representatives from the same firm or between a representative and a customer with a pre-existing personal relationship. In this case, the registered representative must notify their broker-dealer of the proposed lending arrangement, and the broker-dealer must pre-approve the arrangement in writing.
Scenario 2: The lending arrangement is between a registered representative and a member of their immediate family. In this case, the broker-dealer’s procedures may indicate that the registered representative does not have to notify the firm or receive its permission prior to or subsequent to entering into such an arrangement.
Scenario 3: The lending arrangement is between a registered representative and a financial institution that engages in the lending business. In this case, the same idea applies (procedures may indicate that the registered representative does not have to notify the firm, etc.), so long as the loan has been made on commercial terms that the customer generally makes available to members of the public in similar circumstances (i.e., no special deals).
So, how does FINRA define “immediate family” in such a scenario? Rule 3240 states that “immediate family” shall mean a registered representative’s parents, grandparents, mother or father-in-law, husband or wife, brother or sister, brother or sister-in-law, son or daughter-in-law, children, grandchildren, cousin, aunt or uncle, niece or nephew, and any person whom the registered representative supports, directly or indirectly, to a material extent.
It is imperative that broker-dealers have procedures relating to borrowing from and lending to a customer. While many firms flatly and outright prohibit borrowing from and lending to customers altogether, they must still institute reasonable policies and procedures to ensure compliance with Rule 3240 and supervise accordingly. To do so, firms may seek to implement an annual (or even quarterly) questionnaire or certification completed by the firm’s registered and associated persons.
With the state of our economy always in flux, FINRA has taken numerous enforcement actions against registered representatives for either not disclosing lending arrangements, not seeking proper approval, or outright providing false information in response to questionnaires or attestations. FINRA and other regulators will most likely make this an area of focus in the years to come. Accordingly, registered representatives should also seek guidance from their firms prior to engaging in any lending arrangement with a customer.
So, can your client fund your vacation? It depends: is your trip to Disneyland worth being fined, suspended, or barred?