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Loans Between Investment Advisors and Clients

Instructor: Glenn Fydenkevez

Glenn is an experienced financial services professional with particular expertise in the financial markets, securities law, and real estate.

Loans between investment advisors and clients are strictly regulated. In this lesson you will learn about the specific regulations regarding borrowing and lending among Financial Industry Regulatory Authority (FINRA)-registered personnel.

Loans Between Advisors and Clients

William Shakespeare was on to something when he wrote, ''Neither a borrower nor a lender be.'' That's pretty good advice, especially if you happen to be an investment advisor thinking about asking a client for a loan.

When it comes to loans between investment professionals and their clients, the Financial Industry Regulatory Authority (FINRA) agrees with Shakespeare and has adopted strict and specific regulations governing the practice.

A loan, even if made with the best of intentions, changes the dynamics of any relationship. By definition, a borrower owes a debt to the lender, and the lender has leverage over the borrower. In the financial services industry, impartiality is an important factor. Lending and borrowing between brokers and clients make objectivity more difficult.

Registered investment companies must develop a written policy regarding borrowing and lending between its employees and clients. Further, the policy must be made readily available to all registered personnel.

The policy is to be part of the firm's overall Written Supervisory Procedures (WSP) in the form of a compliance manual. The WSP explains how the firm will supervise personnel (including management), how it will review its business practices, how it polices internal and external communications, and how it handles customer complaints. Details regarding WSP are laid-out in FINRA Rule 3110.

Regulated Loans

Rule 3240

Rule 3240, which comes under the heading of 'Responsibilities Relating to Associated Persons', takes a very dim view of loans between advisors and clients.

FINRA Rule 3240 bans registered individuals or firms from loaning or accepting loans from clients. There are, however, some common sense exceptions to the law.

The first exception allows loans between clients and financial professionals if the client is a member of the advisor's immediate family, which is defined to include nuclear and extended family members. Specifically, father, mother, brother, sister, spouse, grandparents, in-laws, children, grandchildren, cousins, uncles, aunts, nieces, and nephews, as-well-as any person the financial professional supports financially can be exceptions. As long as an advisor is lending to or borrowing from a relatively close relative for a legitimate reason, FINRA will allow the transaction.

The rule also makes an exception for advisors borrowing from financial institutions who might also be clients. In this context, a financial institution means a commercial financial firm, such as a bank, a credit card company, or a credit union that makes loans to the public as part of their business. As long as the institution doesn't alter its lending standards, they are allowed to lend to investment advisors at firms they do business with.

Another straight-forward exemption allows advisors and clients to lend and borrow from each other if they're both part of the same firm. This exemption makes it possible for coworkers to lend money to each other without undue interference from regulators.

The last few exemptions are somewhat more subjective. They allow loans between advisors and clients if the loan is unrelated to the investment advisory business and/or is based on an established relationship unrelated to investing. Supervisors must use discretion when overseeing these transactions.

Notification and Approval Requirements

FINRA requires advisors receive preapproval for some exempted loans.

If a registered representative is seeking a loan from someone who is registered with the same firm, or is claiming the loan they want is based on an outside (noninvestment-related) relationship, they must make a request in writing to their firm prior to accepting or making the loan. The firm must approve the loan in writing before any money changes hands.

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