AdvisorHub (January 3, 2024)  By Miriam Rozen

The Financial Industry Regulatory Authority proposed a rule change to tighten its requirements governing brokers’ borrowing from and lending to clients, according to a Tuesday filing with the Securities and Exchange Commission. 

The changes would “narrow” a list of exceptions to Finra’s general prohibition against engaging in borrowing and lending activities with customers, according to the filing. The SEC must approve the changes before they can take effect.   

Finra flagged the significance of its proposal by also suggesting to modify the title of Rule 3240 to “Prohibition on Borrowing From or Lending to Customers” from “Borrowing From or Lending to Customers.”

“The proposed rule change would reduce risks to investors through incremental adjustments that strengthen the general prohibition against borrowing and lending arrangements,” Finra wrote, acknowledging there is “some ambiguity” in the scope of the current rule. 

For example, brokers currently can obtain firm approval for loans with customers with whom they have a “personal relationship.” But the proposal would put in place more strict definitions, including measuring those in terms of their duration, such as “a childhood or long-term friend, a godparent, and other similarly close relationships,” Finra said. 

Under the proposed change, an exception for “business relationships” would also be narrowed to cases, for example, when a broker who had co-owned a small business for years was providing a loan to that business for additional operating capital. 

The Finra proposal also bolsters requirements for when and how the brokers must notify or seek approval from their firms for loans that do qualify for an exemption. It would also require firms to “perform a reasonable assessment of the risks created by the arrangement” before granting approvals. 

Finra is also proposing to prohibit brokers from starting a customer relationship with an individual if a lending arrangement is in place provided it does not qualify for an exemption. It would also limit any broker from taking a loan or providing a loan to a customer within six months of the customer relationship ending. 

The proposal does grant some additional leeway in seeking to “modernize” its definition of immediate family members, who are and will be allowed to lend money under the rule. Finra’s proposal will include domestic partners and stepchildren as immediate family. 

Finra last amended Rule 3240 in 2010, but in August 2019 launched a review of the requirements as part of its larger attempt to address concerns about senior exploitation. It then issued a regulatory notice in December 2021 and sought public comments, which led to its current proposal, Finra said.

The North American Securities Administrators Association (NASAA), which represents state securities regulators, previously objected to the changes in response to the notice and called for Finra to bar brokers from all borrowing or lending activities with clients. 

“NASAA will evaluate the proposal and comment accordingly,” a NASAA spokesperson said after Finra issued its proposal on Tuesday.

Michael Edmiston, a plaintiff lawyer in Studio City, California, and former president of the Public Investors Advocate Bar Association, welcomed the proposal. He said he appreciated the requirement for brokerages to “get involved and provide a reasonable assessment” of brokers’ lending or borrowing relationships with customers.

Finra has raised concerns about brokers’ borrowing from clients in multiple disciplinary actions. 

Between 2018 and 2021, there were an average of 15 enforcement cases per year tied to customer loan violations, Finra said. The broker was the borrower in all but one case, and the amounts ranged from $1,800 to $1.35 million.