Is It Ever OK for a Broker to Borrow Money from an Investor?

Financial Industry Regulatory Authority (FINRA) Rule 3240 states that investors are not allowed to borrow money from clients, except in a few specific circumstances. In a recent regulatory event, on June 25, 2019, a broker named Fred Brown entered into a FINRA AWC agreement, in which he consented to the findings that he had borrowed $69,000 from a non-family client, which violates Rule 3240. Brown isn’t the first broker who has been sanctioned for obtaining loans from his client. And like so many other brokers in his position, Brown had his own financial issues. For example, at the time of the loan, Brown had filed for bankruptcy and had a tax lien that he allegedly didn’t disclose on a firm questionnaire.

Is it ever acceptable for a broker to borrow from a client?

According to FINRA, there are a few types of circumstances where this is appropriate.

For the following two categories of loans, the firm might not require the broker to obtain written permission beforehand:

1. Brokers can borrow money from clients who are in the business of lending money.

2. Brokers can borrow money from clients who also happen to be immediate family members. After all, borrowing money from your dad doesn’t have quite the same connotations as borrowing from someone with whom you have a strictly business relationship.

Rule 3240 also allows for firms to establish written procedures and rules for brokers who want to borrow money from certain types of client. For these loans, the broker must share the specifics of their loan with their firm, as well as the nature of their relationship with the customer.

3. Brokers can borrow money from other brokers who are registered at the same firm.

4. Brokers can borrow money from clients if they have business outside of their broker-investor relationship.

5. Somewhat confusingly, Rule 3240 also states that a client may loan to a broker if the client and the broker have a personal relationship outside of their client-broker relationship, “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.” That would seem to cover brokers who are friends with their clients — another ethically grey area, and one that seems open to a fairly broad interpretation.

In the Order approving the rule, FINRA stated that Rule 3240 is in line with its goals to “prevent fraud and manipulative practices and to promote just and equitable principles of trade.” So why would a broker borrow money from a client, and risk a regulatory sanction and/or getting in trouble with their firm?

It’s impossible to generalize what motivates brokers who break this rule. FINRA doesn’t share statistics about why brokers who face regulatory action after soliciting a loan from a client borrowed the money — but anyone familiar with the securities industry will tell you that some brokers simply aren’t that good at managing their money. There are, in fact, a significant minority of brokers, like Fred Brown, with tax liens and bankruptcies in their BrokerCheck records. (Tax liens are the IRS’s method of collecting on an unpaid tax debt. These are one of the main types of disclosures that FINRA puts on a broker’s public record, along with customer complaints.)

Brokers are subject to significant fluctuations in their income, in part because a large portion of their income comes from commissions for executing trades. Commissions don’t have federal and states taxes automatically deducted, making it the broker’s responsibility to calculate and pay their taxes. Their “firm” isn’t always strictly an employer in the traditional sense — brokers are required to be registered with a firm before they start investing on behalf of clients, but they’re still often independent contractors. In order to keep on top of their tax payments, independent contractors should file quarterly taxes, and keep accurate records of their payments as well as their expenses. It’s easy for those payments to stack up, and not every broker has the money management skills to keep on top of their tax obligations.

Here are a few examples of brokers that fit this pattern:

· A former broker named Paul Bustamente (CRD #: 4175542), was fired from his role at Empire Asset Management in 2017, following allegations that he had borrowed $20,000 from a client, in violation to the firm’s procedures. Prior to 2017, the only disclosures on his BrokerCheck record are four tax liens, which collectively total $96,306.91. (Bustamente was later barred from acting as a broker by FINRA in 2018, following his failure to respond to a FINRA request for information.)

· Similarly, in November of 2019 a broker named Cody Hawkins-Fitzgerald entered into an AWC agreement with FINRA, in which he consented to the findings that he borrowed $10,000 from an elderly customer in violation of the firm’s policies. The findings also allege that he submitted compliance questionnaires in which he stated that he had not engaged in any lending or borrowing arrangements with any customer. This AWC followed two tax liens that amounted to $108,133.65, and a bankruptcy in 2014.

· David Fleming Jr. also entered into an AWC following FINRA’s findings that he borrowed $35,000 from a customer without receiving pre-approval from his firm, according to his BrokerCheck record accessed on September 1, 2020. He also filed for bankruptcy in 2011.

Again, it’s not a certainty that brokers who break FINRA rules by borrowing from clients have otherwise spotty financial records. But it’s important for investors to remember that these types of brokers exist, and their poor track records are a good reminder that not every broker is a financial genius. If your broker asks to borrow money, it should prompt a visit to their BrokerCheck record, and a careful assessment of their previous transactions in your account.