Medical Expenses,Condo Fees,and Loans From Elderly Customer Undo Stockbroker

November 14, 2014

Philosopher Soren Kierkegaard captured it perfectly: "Life can only be understood backwards; but it must be lived forwards."  

Much the same can be said for so many regulatory problems that bedevil registered representatives.  In hindsight, you see how one error in judgment led to another and that cascaded into a series of compliance issues that resulted in regulatory problems.  You needed to pay overdue bills, so you borrowed from a customer but you failed to disclose the loan to your firm. Then you couldn't quite pay your taxes and got hit with a lien, which you also didn't disclose to your firm. As your financial predicament grew worse, you failed to timely repay the customer's loans. The customer called your firm to complain. Then came the uncomfortable questions from your compliance department. Afterwards, came the more ominous questions from a regulator. You tried your best to move forward while deftly sidestepping all the obstacles but, in the end, it all crashed down upon you.  

Case In Point

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, Constance Marie Larsen submitted a Letter of Acceptance, Waiver and Consent ("AWC"), which FINRA accepted. In the Matter of Constance Marie Larsen, Respondent (AWC  2013038483201, November 10,2014).

From 1998 until October 2013, Constance Marie Larsen was registered with Pruco Securities, LLC. On September 6, 2013, Larsen resigned after Pruco learned that she had accepted loans from a customer without firm approval and that she had failed to disclose civil judgments to the firm and on her Form U4. 

Four Years Of Borrowing From Elderly Client

The AWC alleges that during a nearly four-year span between August 14, 2008 and July 2, 2012, Larsen requested and accepted seven interest-free loans totaling $16,900 from an elderly customer born in 1923. 

Out Of Sight

Notwithstanding her alleged knowledge of Pruco's prohibitions on borrowing from customers other than family members, the AWC alleges that Larsen also took affirmative steps to hide the loans from Pruco when she deliberately failed to disclose the loans during her firm's online annual compliance process. In addition, during a 2012 branch examination, Larsen falsely told a Pruco examiner that she had not borrowed or lent funds or securities from existing clients. 

Elderly Customer Commplains

Larsen did not make regular payments on the loans until after the elderly customer complained to Pruco.

Financial Woes

During a three-year span between July 10, 2010, and her termination from Pruco on September 6, 2013, the AWC alleges that Larsen willfully failed to timely disclose or to disclose on her Form U4 four civil judgments totaling $56,320.10: 
  • $43,977.85 judgment entered against her by a mortgage lender on June 10, 2010 (first disclosed February 21, 2013);
  • $7,322.75 judgment entered against her by a condominium association on January 30, 2012 (first disclosed on April 25, 2012);  
  • $465 judgment related to a medical expense (not disclosed on U4);  and 
  • $4,544.50 judgment entered against her by a condominium association (not disclosed on U4).
The AWC asserts that Larsen did not disclose the judgments on her Form U4 within thirty days of learning of them, but instead chose to wait until she had worked out a payment plan or otherwise viewed the matter as resolved. 

SIDE BAR: This is not an uncommon scenario, and it is one that I often have presented to me by potential clients of my law practice.  Many registered persons do not become immediately aware of civil judgments or tax liens -- and there are a host of reasons, but the most common appear to be that there was a rancorous divorce ongoing and mail was not being forwarded, or, the registered person thought their lawyer had "worked something out" that wasn't a judgment or lien.  Finally, many registered persons have the misunderstanding that if they learn about a judgment or lien and promptly pay the amount or negotiate a settlement, that they are relieved of the obligation to file compliance and regulatory notices. 

Adding Up The Costs

According to online FINRA BrokerCheck records as of November 14, 2014, Larsen voluntarily resigned on September 6, 2013, following allegations that:

REGISTERED REPRESENTATIVE TOOK LOANS FROM A PRUDENTIAL CLIENT WITHOUT FIRM APPROVAL

According to online FINRA BrokerCheck records as of November 13, 2014, on August 30, 2013, Pruco received a customer complaint seeking $20,609.40 in damages based upon allegations:

THE REP OBTAINED LOANS FROM THE CLIENT WITHOUT APPROVAL FROM PRUDENTIAL. ALSO SHE DID NOT RE-PAY THE FULL AMOUNT OF THE LOANS.

Pruco reported that it had settled the complaint on February 7, 2014 in the amount of $31,160.58

FINRA alleged that Larsen 
  • improperly borrowed $16,900 over a period of four years from an elderly customer in violation of FINRA Rule 3240, FINRA Rule 2010, NASD Rule 2370, and NASD Rule 2110. 
  • lied to her firm's branch examiner about the loans and failed to disclose the loans during her firm's online annual compliance process, in violation of FINRA Rule 2010;and 
  • willfully failed to disclose four civil judgments on her Form U4, in violation of Article V, Section 2(c) ofthe FINRA By Laws of the Corporation, FINRA Rule 1122, and FINRA Rule 2010.
In accordance with the terms of the AWC, FINRA imposed upon Larsen a $20,000 fine and a two-year suspension from association with any FINRA member in any capacity

The Impact of Willfulness

The finding of willfully (intentionally) failing to disclose a material fact as required on the Form U4 exposed Larsen to a statutory disqualification, as set forth in the Securities Exchange Act:

(39) A person is subject to a ''statutory disqualification'' with respect to membership or participation in, or association with a member of, a self-regulatory organization, if such person
. . .

(F) has committed or omitted any act, or is subject to an order or finding, enumerated in subparagraph  (D), (E), (H), or (G) of paragraph (4) of section 15(b) of this title, has been convicted of any offense specified in subparagraph (B) of such paragraph (4) or any other felony within ten years of the date of the filing of an application for membership or participation in, or to become associated with a member of, such self- regulatory organization, is enjoined from any action, conduct, or practice specified in subparagraph (C) of such paragraph (4), has willfully made or caused to be made in any application for membership or participation in, or to become associated with a member of, a self-regulatory organization, report required to be filed with a self-regulatory organization, or proceeding before a self-regulatory organization, any statement which was at the time, and in the light of the circumstances under which it was made, false or misleading with respect to any material fact, or has omitted to state in any such application, report, or proceeding any material fact which is required to be stated therein.

As set forth in the AWC, Larsen acknowledged the impact of the "willful" finding:

I understand that this settlement includes a finding that I willfully omitted to state a material fact on a Form U4, and that under Section 3(a)(39)(F) of the Securities Exchange Act of 1934 and Article III, Section 4 of FINRA's By-Laws, this omission makes me subject to a statutory disqualification with respect to association with a member.


Now, let's take an opportunity to review the salient points of FINRA Rule 3240.  See the language of the Rule below with my commentary:

3000. SUPERVISION AND RESPONSIBILITIES RELATING TO ASSOCIATED PERSONS
3200. RESPONSIBILITIES RELATING TO ASSOCIATED PERSONS 
3240. Borrowing From or Lending to Customers 

Bill Singer's Comment: Note that the Rule addresses both borrowing and lending, but that such activities are proscribed here only to the extent that the contra-side of the arrangement is a customer. Member firms can choose to permit registered persons to borrow from or lend to their customers consistent with this rule OR the member may prohibit the practice in whole or in part.  As such, simply because FINRA's Rule sets forth conditions that could permit borrowing/lending does not mean that a given FINRA member is required by the regulator to allow such activity.

(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: 

Bill Singer's Comment: Note that the specific proscription here is from borrowing/lending to any customer of "such person" -- the limitation is on contemplated activity with "your" customer and not merely a customer of your firm.  

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

Bill Singer's Comment: The threshold requirement is that you cannot borrow/lend with your customers unless your member firm has written procedures allowing borrowing/lending between registered persons and customers of the firm.  If there are no written procedures, you can't get around this by walking into someone's office or making a phone call call to some compliance type and getting a verbal "okay."

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

Bill Singer's Comment: Preliminarily, FINRA underscores that the Rule does not merely address borrowing from customers but also lending to them.

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

Bill Singer's Comment: What constitutes an "immediate family" member? Good question, and one that is pointedly answered in section (c), below.  Why is that critical definition not immediately provided here following the first use of the term? Hey, don't get me started with how rules are drafted. Bottom line, one of the five approved categories of your customers with which you can borrow/lend is an immediate family member.

(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;

Bill Singer's Comment: In addition to financial institutions engaged in the three covered businesses of providing credit, financing, or loans (such transactions typically include, but are not limited to, mortgages, personal loans, home equity lines of credit, and credit card accounts, and also include lending arrangements with an affiliate of the customer), a registered person could conceivably lend to or borrow from a non-financial institution or human being provided that the contra-party regularly arranges/extends credit (but apparently not also financing or loans -- those seem limited to financial institutions) in the ordinary course of business AND is so acting. Clearly, FINRA is warning you that the contemplated borrowing/lending must be in the ordinary course of business.

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

Bill Singer's Comment: Nothing like owing a co-worker money!  Nonetheless, if the lender/borrower is your customer and also registered at your member, then that satisfies one of the five conditions under this section.

(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 [associated] registered person not maintained a relationship outside of the broker[/]-customer relationship; 

Bill Singer's Comment: If you and your customer have a personal relationship outside of the mere broker-customer relationship (perhaps high-school buddies, weekend softball teammates, or members of the same church) that might qualify as a circumstance in which the loan would be viewed as not springing solely from the broker-client relationship.
or 
(E) the lending arrangement is based on a business relationship outside of the broker-customer relationship;

Bill Singer's Comment: Similar to the "personal" relationship exception, if you have a separate business relationship that of broker-customer (perhaps your customer is a service provider to you in another business or a professional who handles some non-industry business matters for you) that may constitute the fifth condition.
and
(3) the requirements of paragraph (b) of this Rule are satisfied.   

(b) Notification and Approval 

Bill Singer's Comment: It can't be spelled out any plainer: This is about notifying your member AND getting your member's approval.  It's not one or the other.

(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

Bill Singer's Comment: First off, the notification requirement must always be satisfied when your customer is not an immediate family member, a financial institution, or an entity/individual in the business of extending credit.  The other side of that equation, is that you must always first notify your firm of the arrangement, if your customer is another registered person at your firm, or if you are claiming a personal/business relationship exists.  Separately, the contemplated notice is prior to entering into the arrangement.

and the member shall pre-approve in writing such arrangements 

Bill Singer's Comment: The Rule requires the member firm to pre-approve in writing the requested arrangement.  You should not rely upon an oral okay -- and I don't care who at your firm tells you that it's okay to go ahead on the oral say-so. Just watch how that person double-tracks if FINRA asks for a confirmation of that advice.

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.

Bill Singer's Comment: Also, you can't play the old switcheroo.  If you asked for permission to engage in X and you subsequently modify the loan (particularly an extension of the loan's term or repayment), then you have to go through the entire notification and pre-approval in writing protocol.

(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. 

Bill Singer's Comment: If you look back up to the top of the Rule, you will see the provision that would permit lending to or borrowing from customers who are also immediate family members (which still isn't formally defined, as yet, at this point of the Rule). Nonetheless, you may not need to notify your firm or get its prior approval if your customer is an immediate family member provided that your member has a specific written procedure waiving said notice and/or approval.

(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.  

Bill Singer's Comment: As to arrangements involving financial institutions (or credit providing companies/individuals), there is an exemption from the need to give notice or obtain approval provided that the loan will be made on commercial terms generally available to the similarly situated general public (taking into account need, purpose, and creditworthiness). FINRA does not necessarily require you to document those preconditions to your member and your representation may be deemed satisfactory.  The issue here is that you better not be getting a so-called "sweetheart deal."  Bottom line, the arrangement better pass the sniff test.

(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.   

Bill Singer's Comment: Finally -- here it is, the critical definition. Make sure to check the list and note that it can also cover folks whom you provide material support to on a direct or indirect basis.

********************
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. 

Bill Singer's Comment: This language requires your member to preserve the written approvals for at least three years from the date the arrangement terminated or at least three years after the registered person's association has terminated with the member. Be careful not to misinterpret this retention provision: You must retain the pre-approval for three years from the date of the loan's termination or the registered person's termination from the subject member.