FINRA Submits Proposed Beneficiary Rule to SEC — But It Benefits Only Brokers

Brokers and their customers often develop strong bonds with each other, especially if they have worked together for many years or if a client (such as a senior investor) has few other social supports. (Indeed, as we have written in the past, senior investors are particularly vulnerable to senior financial exploitation.) Recognizing that some unscrupulous brokers may choose to exploit these close bonds to take advantage of vulnerable investors, the Financial Industry Regulatory Authority (FINRA) is proposing a new rule to limit a registered representative from serving as a customer’s beneficiary or holding a position of trust for a customer. While FINRA maintains that many member firms already prohibit this conduct and crack down on potential conflicts of interest, no standardized rule exists to prevent this sort of exploitation. Thus, FINRA is proposing Rule 3241 (Registered Person Being Named a Customer’s Beneficiary or Holding a Position of Trust for a Customer) and has submitted it to the Securities and Exchange Commission for approval, reports ThinkAdvisor.

The potential adoption of FINRA Rule 3241 (Registered Person Being Named a Customer’s Beneficiary or Holding a Position of Trust for a Customer) is a step in the right direction. However, it doesn’t go far enough in making sure that brokers don’t profit off of exploiting the broker-customer relationship by being named a beneficiary. Let’s take a closer look at this rule and some of the problems with it.

What changes is FINRA proposing? The proposed rule is two-fold:

1. A registered representative cannot be a beneficiary of a customer’s estate or receive a bequest from a customer’s estate — unless the registered representative provides written notice to, and receives approval from, their member firm.
2. A registered representative cannot be named as an executor or trustee and cannot hold a power of attorney on behalf of a customer — unless the registered representative provides written notice to, and receives written approval, from their member firm before acting in that capacity or receiving any fees and the registered representative does not derive financial gain from acting in that capacity except from fees and other charges that are “reasonable and customary for acting in such capacity.”

The full text of the proposed rule can be viewed here.

At first glance, FINRA’s proposal sounds fine. Upon closer examination, however, the proposal is problematic and does not go far enough. There are four major problems with the proposed rule:

First, the fact that brokers can still act as beneficiaries if they receive firm approval is a loophole that will allow brokers to continue to be named as beneficiaries. FINRA should not include this provision, as we wrote back in January 2020 in a comment letter to FINRA, when the self-regulatory organization invited public comment on this proposed rule.

Second, who decides what charges relating to being named power of attorney are “reasonable and customary”? That opens up customers to financial exploitation by unscrupulous brokers.

Third, FINRA still allows brokers to serve as a beneficiary or hold a position of trust if the customer is a member of their immediate family. FINRA defines “immediate family” as “parents, grandparents, mother-in-law or father-in-law, spouse or domestic partner, 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 who resides in the same household as the registered person and the registered person financially supports, directly or indirectly, to a material extent.” However, some brokers will not hesitate to take advantage of their own family members, as we have seen in the case of James Booth. The Connecticut-based broker allegedly ripped off his own cousin as part of a wide-ranging and far-reaching Ponzi scheme.

Fourth, how would a member firm assess whether or not they should approve a broker’s request to be named a beneficiary? On page 11 of its SEC proposal, FINRA lays out eight criteria that the member firm must evaluate when deciding whether or not to allow a registered representative to hold a position of trust with a client:

1. Are there potential conflicts of interest if the registered person were to be named a beneficiary or were to hold a position of trust?
2. How long have the registered person and customer known each other? What is the nature of their relationship?
3. How old is the customer?
4. How large is any bequest relative to the size of a customer’s estate?
5. Has the registered representative received other bequests or been named as a beneficiary on other customer accounts?
6. Does the customer have a mental or physical impairment that renders the customer unable to protect their own interests?
7. Is there any indication of improper activity or conduct regarding the customer or customer’s account (such as excessive trading)?
8. Is there any indication of customer vulnerability or “undue influence” of the registered representative over the client?

While it is admirable that FINRA has laid out these criteria to help brokerage firms make a determination regarding beneficiaries, these are just that: criteria. These guidelines are left up to interpretation by individual member firms, leaving customers open to exploitation if, for example, one member’s firm’s definition of “undue influence” is more lax than another firm’s definition.

FINRA should have had a rule restricting brokers from serving as beneficiaries of clients on the books from its inception, and while it is commendable that they are making strides in this area, the proposed rule change does not go far enough. There is much more that can be done to make sure that investors are protected from broker fraud. It is high time for FINRA to issue a blanket prohibition on brokers acting as beneficiaries to their clients.

If you have questions about FINRA’s proposed Rule 3241 (Registered Person Being Named a Customer’s Beneficiary or Holding a Position of Trust for a Customer) or are afraid that your loved one may have been taken advantage of by a broker acting in a position of trust, don’t hesitate to contact the securities attorneys of Fitapelli Kurta. Call (877) 238–4175, email info@fkesq.com, or visit www.stopbrokerfraud.com for your free case consultation with a securities attorney.