An Elderly Client, The Stockbroker's Wife, And Gifts Or Loans

October 29, 2014

When it comes to in-house compliance and industry regulatory matters, a loan is a loan and a gift is a gift -- and the two have very different meanings and consequences. As BrokeAndBroker Blog has often reported, Wall Street regulators take a dim view of stockbrokers borrowing from their clients and there are specific rules, regulations, and policies against that practice. On the other hand, gifts often fall into a gray area of something that's not necessarily illegal or prohibited by a regulator but may very well be proscribed in your firm's in-house Written Supervisory Procedures or Employee Handbook. In today's blog we have a case involving both gifts and loans. And an elderly client. And a stockbroker's wife. And some evasion and non-cooperation.

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, James Gregory Nixon submitted a Letter of Acceptance, Waiver and Consent ("AWC"), which FINRA accepted. In the Matter of James Gregory Nixon, Respondent (AWC  2014041097901, October 15, 2014).

Nixon was first registered in 2007 and during the relevant period of October 2012 through April 2014, he was associated with FINRA member firm J.P. Morgan Securities, LLC.

Ask And You Shall Receive . . . a gift

The AWC alleges that sometime in January 2012, Nixon asked an elderly client of his at J.P. Morgan Securities for a $5,000 loan. The client purportedly opted to give the sum to Nixon as a gift rather than in the form of the requested loan. At the time of this transaction, Nixon was purportedly aware that his firm prohibited the receipt of loans or cash gift from customers by registered representatives. Moreover, Nixon failed to disclose the gift or get his firm's approval to accept same.

Ask And You Shall Receive . . . a loan

Around October 11, 2013, Nixon asked the elderly client for another $5,000 loan, which this time the customer agreed to extend in that form.  In accordance with the terms of the loan, Nixon purportedly executed an unsecured promissory note calling for monthly payments of $300.  The AWC asserts that Nixon made only $450 in payments.  The AWC alleges that Nixon failed to notify J.P. Morgan Securities, LLC of the loan or get his firm's approval to accept same.

Stop Asking Already

In February 2014, the AWC asserts that Nixon again asked his elderly client for a loan of unspecified value but was refused. 

A Different Helping Hand

Finally, in October 2012, the AWC alleges that Nixon received a $2,000 gift from another firm customer; however, he again failed to report the cash gift or get his firm's approval. 
In October 2012, Nixon falsely stated on J.P. Morgan Securities' Annual Certification Form that he had not received any cash gifts from customers for the reporting period.  

Compliance Asks Nixon

Sometime in February 2014, J.P. Morgan Securities' Central Supervision Unit flagged an email from the customer who had extended the $2,000 gift in October 2012.  That email appears to have given the impression that the customer's gift was a loan - additionally, the AWC suggests that the email's sender seemed to have entertained a second loan request from Nixon. In the customer's email to Nixon, the AWC alleges that the customer 

suggested in the email that Nixon and "AN" discuss their "financial predicament" with someone. The context of the message implied that "AB" was Nixon's spouse. . .

SIDE BAR: FINRA's written statement is that the customer suggested that Nixon and AN discuss something; however, we are then informed that AB is Nixon's spouse. AN? AB?? Are those two different individuals or is that a typo? I'm guessing the latter.

Nixon was interviewed by J.P. Morgan Securities' Compliance Group and he claimed that the customer's email had been sent in error and was intended for an advisor at another firm who was servicing the same customer. Pointedly, Nixon denied requesting loans or having obtained any funds from firm customers. The AWC then asserts that

When asked his wife's name, Nixon falsely state that it was "CB" although it was actually "AB" . . .

On a Compliance Questionnaire dated March 12, 2014, Nixon purportedly reiterated his understanding of the firm's prohibitions pertaining to customer loans and gifts but, nonetheless, failed to disclose same on the form.  

Not Happy With The Answers

According to online FINRA records as of October 24, 2014, J.P. Morgan Securities "Discharged" Nixon on April 3, 2014, based upon allegations that:


Online FINRA records further disclose that on May 5, 2014, Nixon was "Discharged" by Wunderlich Securities, Inc. based upon allegations that:


Payback, So To Speak

The AWC alleges that Nixon should have disclosed his receipt of the January 2012 $5,000 cash gift from his elderly customer and the October 2012 $2,000 cash gift from a second customer. Similarly, in October 2013, Nixon failed to disclose on the Annual Certification Form his receipt of a $5,000 loan from his elderly customer. FINRA deemed Nixon's conduct to constitute violations of FINRA Rules 3240(a) and 2010. 

In accordance with the terms of the AWC, FINRA imposed upon Nixon a $20,000 fine; an order to pay $4,550 plus interest in restitution to the elderly client; and a 12-month suspension from associating with any member in any capacity.

Bill Singer's Comment

Compliments to both J.P. Morgan Securities and FINRA for this one. Both in-house compliance and the self-regulatory organization seem to have jumped on this one quickly. That earns an additional kudo.

If Nixon had merely borrowed a few bucks from a long-term client or, in fact, there were modest gifts of cash from some customers, that's one thing. In such cases, the stockbroker often fails to realize the need to refrain from taking the funds and/or to disclose the conduct -- none of which excuses the non-reporting but often offers some mitigation. In this case, however, we have many troubling indicia of evasion. The whole mess with the wife's name. The misleading denials of  the loans/gifts on internal reporting forms. The involvement of an elderly client. The failure to repay the loan. Nixon should be thankful that he was only saddled with a 12-month suspension on top of the fine and repayment.

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:

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.
(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.
(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.