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Not Borrowing Money From Customers Got Stockbroker Suspended
Written: January 10, 2013

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For the purpose of proposing a settlement of rule violations alleged by the Financial Industry Regulatory Authority (“FINRA”), without admitting or denying the findings, prior to a regulatory hearing, and without an adjudication of any issue, Melanie Susan Smith submitted a Letter of Acceptance, Waiver and Consent (“AWC”), which FINRA accepted. In the Matter of Melanie Susan Smith, Respondent (AWC 2012031053501; January 8, 2013).

Smith first became registered in 1997 and during the relevant time of 2010 through January 9 2012, was registered as a General Securities Representative with FINRA member firm LPL Financial. The AWC asserts that Smith had no prior FINRA disciplinary history.

From The Horse’s Mouth

I don’t like this case for a number of reasons.  As a result, I want to ensure that I do not unfairly prejudice your own analysis of the facts — so, let me quote in unedited fashion the substance of the AWC:

FACTS AND VIOLATIVE CONDUCT

From approximately August 2011 through October 2011, Smith solicited loans from three customers of the Firm. Smith drafted promissory notes in connection with the proposed loans, but the customers determined not to loan her the money and the notes were never signed. Smith did not disclose the proposed loans to the Firm. Moreover, the Firm had a policy prohibiting representatives from borrowing money from customers without permission from the Firm. By attempting to borrow money from her customers, Smith violated FINRA Rule 2010.

Sanctions

In accordance with the terms of the AWC, FINRA imposed upon Smith a ten-business-day suspension from association with any FINRA member in any capacity. In consideration of her sworn financial statement and demonstrated inability to pay a fine, no monetary sanction was imposed.

Bill Singer’s Comment

Since the onset of the Great Recession, registered persons have been financially hit along with the rest of the population, and financial pressures have not discriminated among large or small firms. Amidst a souring economy, the loss of commission business, and the closing of firms and branches, whether employed at Merrill LynchMorgan Stanley, JP Morgan, Wells FargoUBS, or smaller firms, the need for cash pushed many brokers to the limit and prompted arrangements with customers to borrow money. The legacy of those ongoing hard times will likely keep this violation on the front burner at FINRA for years to come.

Here is the current iteration of FINRA’s “Borrowing Rule”:

FINRA Rule 3240: Borrowing From or Lending to Customers

(a) Permissible Lending Arrangements; Conditions

No person associated with a member in any registered capacity may borrow money from or lend money to any customer of such person unless:

(1) the member has written procedures allowing the borrowing and lending of money between such registered persons and customers of the member;

(2) the borrowing or lending arrangement meets one of the following conditions:

(A) the customer is a member of such person’s immediate family;

(B) the customer (i) is a financial institution regularly engaged in the business of providing credit, financing, or loans, or other entity or person that regularly arranges or extends credit in the ordinary course of business and (ii) is acting in the course of such business;

(C) the customer and the registered person are both registered persons of the same member;

(D) the lending arrangement is based on a personal relationship with the customer, such that the loan would not have been solicited, offered, or given had the customer and the registered person not maintained a relationship outside of the broker-customer relationship; or

(E) the lending arrangement is based on a business relationship outside of the broker-customer relationship; and

(3) the requirements of paragraph (b) of this Rule are satisfied.

(b) Notification and Approval

(1) The registered person shall notify the member of the borrowing or lending arrangements described in paragraphs (a)(2)(C), (D), and (E) above prior to entering into such arrangements and the member shall pre-approve in writing such arrangements. The registered person shall also notify the member and the member shall pre-approve in writing any modifications to such arrangements, including any extension of the duration of such arrangements.

(2) With respect to the borrowing or lending arrangements described in paragraph (a)(2)(A) above, a member’s written procedures may indicate that registered persons are not required to notify the member or receive member approval either prior to or subsequent to entering into such borrowing or lending arrangements.

(3) With respect to the borrowing or lending arrangements described in paragraph (a)(2)(B) above, a member’s written procedures may indicate that registered persons are not required to notify the member or receive member approval either prior to or subsequent to entering into such borrowing or lending arrangements, provided that, the loan has been made on commercial terms that the customer generally makes available to members of the general public similarly situated as to need, purpose and creditworthiness. For purposes of this subparagraph, the member may rely on the registered person’s representation that the terms of the loan meet the above-described standards.

(c) Definition of Immediate Family

The term “immediate family” means parents, grandparents, mother-in-law or father-in-law, husband or wife, brother or sister, brother-in-law or sister-in-law, son-in law or daughter-in-law, children, grandchildren, cousin, aunt or uncle, or niece or nephew, and any other person whom the registered person supports, directly or indirectly, to a material extent.

Supplementary Material: 

.01 Record Retention. For purposes of paragraph (b)(1) of this Rule, members shall preserve the written pre-approval for at least three years after the date that the borrowing or lending arrangement has terminated or for at least three years after the registered person’s association with the member has terminated.

Three Issues

Now that you have the exact words of accusation and allegation from the AWC and the current “Borrowing Rule,” let’s discuss why I don’t like this case.

  1. The AWC charges Smith with having “solicited loans” from three customers.  In connection with such loan solicitation, she purportedly drafted promissory notes. As best I can interpret all of that, Smith engaged in conduct that was inpreparation to borrow, in contradistinction to actually borrowing. Not only did money never change hands in this case, but the requisite promissory notes were never executed.
  2. Before the promissory notes were signed, the customers apparently backed out. Why is that important to a legal analysis of this case? As a lawyer, I want to determine whether there was a meeting of the minds such that there was a done deal here.  I just don’t see that  because the proposed lenders backed out when the refused to sign off on the proposed notes.
  3. If, in fact, Smith had borrowed money from customers, then, clearly, she would have violated her employer’s policy requiring prior approval of such loans. The thing is, however, that Smith didn’t borrow money — consequently, how did she violate her firm’s policy? Yeah, I know it’s the spirit of the thing and, yeah, I agree, she should have gotten prior permission before drafting up the promissory notes that never got signed.  On the other hand, how many folks go to jail for buying marijuana that turns out to be oregano or cocaine that turns out to be powdered milk?

What’s The Point?

Take a look at the wording of the currentBorrowing Rule: “No person associated with a member in any registered capacity may borrow money from or lend money to any customer of such person unless . . .” You note that the prohibition is against borrowing or lending money?  Did Smith actually borrow a penny from any customer?

Now to be fair and professional, FINRA found that Smith violated its Rule 2010, which imposes an obligation upon registered persons to “observe high standards of commercial honor and just and equitable principles of trade.”  Oh yeah, we’re all familiar with Wall Street‘s honored high standards of honor and equity. Yeah, right.

To the extent that FINRA can truly look me or anyone else in the eye and say with a straight face that Smith’s proposed loan transaction was dishonorable, hey, good luck with that. To the extent that the sanctimonious self-regulatory organization would prefer to discuss this case on more appropriate grounds, I would return to the analysis of the Borrowing Rule, and would suggest that there might be some merit if this AWC were premised upon this language:

(b) Notification and Approval

(1) The registered person shall notify the member of the borrowing or lending arrangements described in paragraphs (a)(2)(C), (D), and (E) above prior to entering into such arrangements and the member shall pre-approve in writing such arrangements.. .

Even I will concede that Smith didn’t notify her firm of the borrowing arrangements prior to entering into such arrangements; however, there’s still the interpretive problem that she never actually entered into any borrowing arrangement. FINRA’s Borrowing Rule contemplates that an actual loan occurred and that the registered person failed to obtain prior firm approval for that loan. All of which presents us with the conundrum of whether you can properly charge a registered person with failing to provide prior notice to an employer firm about a proposed loan that never happened.  The way I read the rule, that ain’t what it says.

As “Street Sweeper” readers know, I have a penchant for using the expression: If my aunt were a man, she’d be my uncle.  This is yet another classic example of that point. If Smith had borrowed money from customers and failed to obtain prior approval from her firm for that transaction, I would concur that there had been a violation of FINRA’s Borrowing Rulerules – except,you know, she didn’t borrow money and the promissory notes were never signed.

When all is said and done, I truly don’t understand why FINRA is so heavy-handed in this case. As if, what — the totality of the circumstances here didn’t warrant the self-regulatory organization simply admonishing Smith as to the appearance of impropriety with her proposed transaction and extracting an undertaking from her that, henceforth, she will first seek her firm’s approval? On top of whatever personal stress this woman was enduring, she deserved having FINRA come down on her like a ton of bricks and force her to incur legal fees and the humiliation of a suspension?

See these “Street Sweeper” borrowing columns:


 
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