Few transactions cause more regulatory problems than loans from customers to their servicing stockbrokers. If circumstances compel a stockbroker to seek a loan from a customer, the industry has specific rules and regulations governing when and how such borrowing may occur. Frankly, many brokerage firms simply say "NO." Notwithstanding a specific FINRA Borrowing Rule and notwithstanding in-house policies, however, stockbrokers persist in trying to circumvent the prohibitions. If you don't get caught, maybe the detours make sense, but the BrokeAndBroker.com Blog keeps publishing articles about all the clever folks who got caught. Consider yet another FINRA regulatory settlement involving borrowing by a stockbroker.
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, Robert E. Heath submitted a Letter of Acceptance, Waiver and Consent ("AWC"), which FINRA accepted. In the Matter of Robert E. Heath, Respondent (AWC 2015046946301, August 12, 2016).
Although the AWC asserts that Respondent Heath "entered the securities industry more than 15 years ago," online FINRA BrokerCheck records as of August 17, 2016, disclose that Heath was first registered in 1990, about 26 years ago. In pertinent part, BrokerCheck records disclose that from December 2008 to December 2012, Heath was registered with FINRA member firm AXA Advisors, LLC; and, thereafter, from December 2012 to September 2015 with FINRA member firm Presidential Brokerage, Inc.
We're Talkin' Dollars and Sense
The AWC asserts that while associated with AXA on July 20, 2012, Heath borrowed $7,500 from a customer (identified in the AWAC only as "ES"). As set forth in the AWC:
[T[he loan was undocumented, but the orally-agreed-upon terms provided that Heath would make monthly payments to ES equaling six percent simple interest until the loan was repaid. There was no fixed maturity date for the loan.
The AWC alleges that since borrowing the $7,500 from his customer, Heath has not made any payments of principal and has made only one interest payment, which occurred in August 2012.
Rules and Regulations
The AWC asserts that under FINRA Rule 3240, registered representatives are generally prohibited from borrowing money from customers except in limited circumstances, and then only if the member firm has written procedures permitting such borrowing.
Also, the AWC asserts that when the loan was extended in July 2012, AXA Advisors' procedures prohibited its registered representatives from borrowing from customers under any circumstances.
FINRA Takes Charge
FINRA deemed Heath's conduct above to constitute violations of FINRA Rule 3240 and 2010. In accordance with the terms of the AWC, FINRA imposed upon Heath a $5,000 fine; order him to pay $7,500 restitution plus the agreed rate of interest to ES; and suspended him in all capacities for three months.
Bill Singer's Comment
I'm not quite sure why the AWC makes such a point about the oral nature of the loan. If that recitation is merely to convey the essential facts, then that's fine. If it is to suggest that there was something more troubling to FINRA about the "undocumented" nature of the loan, then the self-regulatory should have noted its concerns. From my perspective, an undocumented loan raises more troubling issues. As such, my observation is not so much a criticism as a suggestion of a better approach to presenting such an issue.
One criticism that I do have is why FINRA failed to indicate whether customer ES complained about the non-payment of the loan. The existence or absence of that circumstance does not go to the heart of the alleged violation but, come on, everyone is likely curious as to how this matter may have come to AXA's or FINRA's attention and whether or not Heath and ES has a falling out.
FINRA BrokerCheck Disclosures
Now . . . clear your head of all your purported understandings of the ES and Heath loan. Your head cleared? Good . . . take a deep, cleansing breath and consider the additional facts presented below:
Under the BrokerCheck heading of "Employment Separation After Allegations," we learn that Presidential Brokerage "Discharged" Heath on August 13, 2015. The employer offered this explanation:
THE FIRM WAS CONTACTED BY AN INDIVIDUAL SEEKING ASSISTANCE IN RECOVERING FUNDS PLACED IN AN OUTSIDE INVESTMENT THROUGH SOLICITATION BY THE REP WHILE AT A PRIOR FIRM. NO EVIDENCE OR DOCUMENTATION SURFACED SUPPORTING THE EXISTENCE OF THE INVESTMENT OR THAT THE INVESTMENT WAS SUBSEQUENTLY MADE IN JULY 2012. A CHECK FROM THE CUSTOMER IN THE AMOUNT OF $7500 WAS DEPOSITED INTO A COPRORATE [sic] ACCOUNT UNDER THE CONTROL OF THE REGISTERED REPRESENTATIVE AND WAS SUBSEQUENTLY TRANSFERRED OVER A PERIOD OF SEVERAL DAYS TO HIS PERSONAL BANK ACCOUNT CONSTITUTING A POSSIBLE CONVERSION OF CUSTOMER FUNDS.
Under the heading of "Firm Statement," Presidential Brokerage submitted the following additional commentary::
THE REP DENIED THE ALLEGATION MADE BY HIS FORMER CLIENT THAT THE FUNDS RECEIVED BY HIM WERE INTENDED FOR INVESTMENT PURPOSE, STATING THAT THE FUNDS WERE A PERSONAL LOAN. THE FIRM BELIEVES THIS IS A VIOLATION OF FINRA RULES. THERE IS INSUFFICIENT DOCUMENTATION TO DETERMINE WHICH EXPLANATION IS CORRECT OR WHICH VIOLATION OCCURRED.
In contradistinction to the AWC's fact pattern, Heath's BrokerCheck file asserts that "an individual" (likely ES) contacted Presidential Brokerage about the loan made during Heath's tenure at AXA. At the time of the individual's complaint, Presidential Brokerage was concerned that the cited transaction could have been a "conversion" of funds by the stockbroker. In response, Heath apparently stated that the transaction was, in fact, a loan. At the time of Heath's discharge by Presidential Brokerage, that firm was unable to determine whether a loan or conversion had occurred.
In my opinion, the AWC should have indicated whether ES had complained about the non-payment of the loan, which I consider an exacerbation of the fact pattern and an aspect warranting a more severe penalty than circumstances where a loan has been documented in writing, or had been fully repaid, or the borrower made all required payments and is continuing to do so.