In a comment letter on FINRA’s proposal to amend the current prohibition on borrowing from or lending to customers, NASAA reiterated its position that such borrowing or lending should be prohibited outright. If FINRA does allow these arrangements, however, the accounts should be subject to heightened supervision at a minimum, NASAA wrote. The group also urged that the cooling-off period for arrangements with former customers be extended to at least 12 months.
NASAA explains that the proposed amendments would allow broker-dealers to maintain preexisting loan agreements, or enter into new ones, with customers as long as the arrangements meet certain criteria. These criteria include the parties being immediate family members; the customer being a lending institution; the parties both being registered persons of the same FINRA-member firm; the lending arrangement being based on a personal relationship with the customer; and the arrangement being based on a business relationship outside the broker-customer relationship.
NASAA believes that a registered person should be prohibited entirely from entering into these loan arrangements with customers. Its own model rule on Dishonest or Unethical Business Practices of Broker-Dealers and Agents, enacted in whole or in part in 44 jurisdictions, prohibits agents from lending or borrowing money or securities from a customer, and NASAA included similar provisions in a model rule for investment advisers. “NASAA maintains that the conflicts of interest that exist when a registered person enters into a lending or borrowing arrangement cannot simply be mitigated by additional policies and procedures imposed by the registered person’s firm.”
The group said its position aligns with the SEC’s approach in Regulation Best Interest, which eliminates sales contests, quotas and certain compensation arrangements. Loans implicate direct personal incentives that are of equal or greater concern, NASAA writes. NASAA also said that while it supports the proposal’s modernization of the definition of “immediate family,” family members are not immune from fraud and bad actors, and may in fact be susceptible to them. Any intrafamily loans should be subject to firm scrutiny and approval, particularly where the customer is a senior or vulnerable adult.
Similarly, NASAA enumerated several other ways in which FINRA should strengthen the guidelines, disclosure requirements, and lockout periods in the proposal. At a minimum, registered persons entering into loans with customers should disclose the proposal’s recommended disclosures, and the firm should document the steps it took to assess risk prior to lending; the steps it will take to minimize conflicts; how the member firm communicated risks to the customer; and what supervisory measures the firm will take. NASAA also suggests that the customer be interviewed, preferably by a compliance officer, outside the presence of the registered person.
NASAA also cautions that relationships that may start with good intentions can develop into exploitation, or a registered person may even groom a customer with the goal of exploitation. Where the proposal asks for comment on whether a six-month look-back period suffices to determine if an individual was a customer prior to the loan, NASAA argues for at least a 12-month period. Given that firms are required to retain books and records for three to six years, NASAA does not think the 12-month period is overly burdensome.
Finally, while NASAA appreciates that applying the new rule retroactively could be a significant undertaking, applying the rule to current customers could identify ongoing abuse, high risk arrangements, and areas of concern for regulators.