Self-Regulatory Organizations; Financial Industry Regulatory Authority, Inc.; Order Approving a Proposed Rule Change To Amend FINRA Rule 3240 (Borrowing From or Lending to Customers) To Strengthen the General Prohibition Against Borrowing and Lending Arrangements, 77547-77558 [2024-21622]
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Federal Register / Vol. 89, No. 184 / Monday, September 23, 2024 / Notices
Dated: September 17, 2024.
Edward R. Hawkens,
Chief Administrative Judge, Atomic Safety
and Licensing Board Panel, Rockville,
Maryland.
[FR Doc. 2024–21648 Filed 9–20–24; 8:45 am]
BILLING CODE 7590–01–P
SECURITIES AND EXCHANGE
COMMISSION
[SEC File No. 270–360, OMB Control No.
3235–0409]
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Submission for OMB Review;
Comment Request; Extension Rule
17Ad–15
Upon Written Request, Copies Available
From: Securities and Exchange
Commission, Office of FOIA Services,
100 F Street NE, Washington, DC
20549–2736.
Notice is hereby given that pursuant
to the Paperwork Reduction Act of 1995
(‘‘PRA’’) (44 U.S.C. 3501 et seq.), the
Securities and Exchange Commission
(‘‘Commission’’) has submitted to the
Office of Management and Budget
(‘‘OMB’’) a request for approval of
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Rule 17Ad–15 (17 CFR 240.17Ad–15)
(‘‘Rule 17Ad–15’’) under the Securities
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seq.) (‘‘Exchange Act’’).
Rule 17Ad–15 requires every
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written standards for the acceptance of
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registered transfer agent is also required
to establish procedures, including
written guidelines where appropriate, to
make certain that the transfer agent uses
those standards to determine whether to
accept or reject guarantees from eligible
guarantor institutions. In implementing
these requirements, the Commission
aims to ensure that registered transfer
agents treat eligible guarantor
institutions equitably.
Additionally, Rule 17Ad–15 requires
every registered transfer agent to make
and maintain records in the event the
transfer agent determines to reject
signature guarantees from eligible
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following the date of rejection, a record
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Commission designed these mandatory
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on approximately 40 burden hours per
year per registered transfer agent). The
Commission also estimates the aggregate
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the approximately 315 registered
transfer agents is approximately
$4,019,400 (based on 40 hours annual
burden × $319 hourly wage × 315
respondents). This reflects a decline in
aggregate annual internal cost of
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decrease in the number of registered
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An agency may not conduct or
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Director/Chief Data Officer, Securities
and Exchange Commission, c/o
Oluwaseun Ajayi, 100 F Street NE,
Washington, DC 20549, or by sending an
email to: PRA_Mailbox@sec.gov.
[FR Doc. 2024–21685 Filed 9–20–24; 8:45 am]
PO 00000
SECURITIES AND EXCHANGE
COMMISSION
[Release No. 34–101065; File No. SR–
FINRA–2024–001]
Self-Regulatory Organizations;
Financial Industry Regulatory
Authority, Inc.; Order Approving a
Proposed Rule Change To Amend
FINRA Rule 3240 (Borrowing From or
Lending to Customers) To Strengthen
the General Prohibition Against
Borrowing and Lending Arrangements
September 17, 2024.
I. Introduction
On January 2, 2024, the Financial
Industry Regulatory Authority, Inc.
(‘‘FINRA’’) filed with the Securities and
Exchange Commission (‘‘SEC’’ or
‘‘Commission’’), pursuant to Section
19(b)(1) of the Securities Exchange Act
of 1934 (‘‘Act’’) 1 and Rule 19b–4
thereunder,2 a proposed rule change
(SR–FINRA–2024–001) to amend FINRA
Rule 3240 (Borrowing From or Lending
to Customers).3 As stated in the Notice,
the proposed rule change would
strengthen the general prohibition
against borrowing and lending
arrangements, narrow some of the
existing exceptions to that general
prohibition, amend the immediate
family exception,4 and enhance the
requirements for notifying and obtaining
member firms’ approval of such
arrangements.5
The proposed rule change was
published for public comment in the
Federal Register on January 22, 2024.6
The public comment period closed on
February 12, 2024. The Commission
received comment letters related to this
filing.7 On February 21, 2024, FINRA
consented to an extension of the time
period in which the Commission must
approve the proposed rule change,
disapprove the proposed rule change, or
institute proceedings to determine
whether to approve or disapprove the
proposed rule change to April 19, 2024.8
1 15
U.S.C. 78s(b)(1).
CFR 240.19b–4.
3 See Exchange Act Release No. 99351 (Jan. 16,
2024), 89 FR 3968 (Jan. 22, 2024) (File No. SR–
FINRA–2024–001) (‘‘Notice’’), https://
www.govinfo.gov/content/pkg/FR-2024-01-22/pdf/
2024-01068.pdf.
4 See infra note 28 and accompanying text.
5 See Notice.
6 Id.
7 The comment letters are available at https://
www.sec.gov/comments/sr-finra-2024-001/
srfinra2024001.htm.
8 See letter from Ilana Reid, Associate General
Counsel, FINRA, to Daniel Fisher, Branch Chief,
Division of Trading and Markets, Commission, filed
with the Commission on February 21, 2024. This
letter is available at https://www.finra.org/sites/
2 17
Dated: September 18, 2024.
Vanessa A. Countryman,
Secretary.
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Federal Register / Vol. 89, No. 184 / Monday, September 23, 2024 / Notices
On April 18, 2024, the Commission
published an order instituting
proceedings to determine whether to
approve or disapprove the proposed
rule change.9 On April 26, 2024, FINRA
responded to the comment letters
received in response to the Notice.10 On
July 15, 2024, FINRA consented to an
extension of the time period in which
the Commission must approve or
disapprove the proposed rule change to
September 18, 2024.11 This order
approves the proposed rule change.
II. Description of the Proposed Rule
Change
A. Background
FINRA Rule 3240 generally prohibits,
with exceptions, registered persons from
borrowing money from, or lending
money to, their customers. The rule has
five tailored exceptions,12 available only
when the registered person’s member
firm has written procedures allowing
the borrowing and lending of money
between such registered persons and
customers of the member firm,13 the
borrowing or lending arrangements meet
the conditions applicable to the relevant
exception 14 and, when required, the
registered person notifies the member
firm prior to entering into a borrowing
or lending arrangement and obtains the
member firm’s pre-approval in
writing.15
B. Proposed Rule Change
a. Pre-Existing Borrowing and Lending
Arrangements
1. The General Prohibition on
Borrowing From or Lending to
Customers
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The proposed rule change would
amend the title of FINRA Rule 3240
from ‘‘Borrowing From or Lending to
Customers’’ to ‘‘Prohibition on
default/files/2024-02/SR-FINRA-2024-001Extension1.pdf.
9 See Exchange Act Release No. 99988 (Apr. 18,
2024), 89 FR 31242 (Apr. 24, 2024) (File No. SR–
FINRA–2024–001) (‘‘Order Instituting
Proceedings’’).
10 See letter from Ilana Reid, Associate General
Counsel, Office of General Counsel, FINRA, dated
April 26, 2024, https://www.sec.gov/comments/srfinra-2024-001/srfinra2024001-463852-1226394.pdf
(‘‘FINRA Comment Response’’).
11 See letter from Ilana Reid, Associate General
Counsel, Office of General Counsel, FINRA, to Dan
Fisher, Division of Trading and Markets,
Commission, dated July 15, 2024, https://
www.finra.org/sites/default/files/2024-07/SRFINRA-2024-001-Extension2.pdf.
12 See Rule 3240(a)(2)(A) (the ‘‘immediate family
exception’’); Rule 3240(a)(2)(B) (the ‘‘financial
institution exception’’); Rule 3240(a)(2)(C) (the
‘‘registered person exception’’); Rule 3240(a)(2)(D)
(the ‘‘personal relationship exception’’); Rule
3240(a)(2)(E) (the ‘‘business relationship
exception’’).
13 See Rule 3240(a)(1).
14 See Rule 3240(a)(2).
15 See Rules 3240(a)(3) and 3240(b).
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Borrowing From or Lending to
Customers,’’ and change the title of Rule
3240(a) from ‘‘Permissible Lending
Arrangements; Conditions’’ to ‘‘General
Prohibition; Permissible Borrowing or
Lending Arrangements; Conditions.’’ 16
FINRA stated that the proposed rule
change would make the regulatory
purpose more prominent by
emphasizing that the rule is ‘‘first and
foremost’’ a general prohibition against
borrowing or lending arrangements
between registered persons and their
customers (a ‘‘broker-customer
relationship’’).17
The proposed rule change would also
make substantive changes to FINRA
Rule 3240 to extend the application of
the rule to: (1) borrowing or lending
arrangements that pre-exist the
initiation of a broker-customer
relationship; 18 (2) borrowing or lending
arrangements entered into within six
months after a broker-customer
relationship ends by defining a
‘‘customer’’ to include ‘‘any customer
that has, or in the previous six months
had, a securities account assigned to the
registered person at any member;’’ 19 (3)
indirect borrowing or lending
arrangements with related parties of the
registered person or customer; 20 and (4)
owner-financing arrangements.21 The
Commission describes each aspect of
the proposed rule changes in turn.
Currently, Rule 3240(a) states ‘‘[n]o
person associated with a member in any
registered capacity may borrow money
from or lend money to any customer of
such person. . . .’’ The proposed rule
change would amend Rule 3240(a) to
extend the rule’s general requirements
concerning borrowing and lending
arrangements—including the general
prohibition—to borrowing and lending
arrangements that pre-exist a new
broker-customer relationship.22
Specifically, the proposed rule change
would amend Rule 3240(a) to prohibit
registered persons from initiating a
broker-customer relationship with a
person with whom the registered person
has an existing borrowing or lending
arrangement unless the conditions of
the proposed rule are met.23
16 Proposed Rule 3240 and proposed Rule
3240(a).
17 See Notice at 3969.
18 Proposed Rule 3240(a).
19 Proposed Rule 3240.02.
20 Proposed Rule 3240.05.
21 Proposed Rule 3240.03.
22 See Notice at 3969.
23 Proposed Rule 3240(a).
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b. Expansion of the Definition of
Customer
The proposed rule change would
similarly extend the application of the
rule to borrowing or lending
arrangements entered into within six
months after a broker-customer
relationship ends.24 Specifically, the
proposed rule change would add new
FINRA Rule 3240.02 (Customer) to
define ‘‘customer,’’ for purposes of Rule
3240, as including ‘‘any customer that
has, or in the previous six months had,
a securities account assigned to the
registered person at any member.’’ 25
c. Borrowing and Lending Arrangements
With Related Parties of the Registered
Person or Customer
The proposed rule change would add
new FINRA Rule 3240.05
(Arrangements with Persons Related to
Either the Registered Person or the
Customer) to extend Rule 3240 to
indirect borrowing or lending
arrangements involving related parties
of the customer or registered person.
Specifically, the proposed rule change
would provide that a registered person
instructing or asking a customer to enter
into a borrowing or lending arrangement
with a person related to the registered
person (e.g., the registered person’s
immediate family member or outside
business) or to have a person related to
the customer (e.g., the customer’s
immediate family member or business)
enter into a borrowing or lending
arrangement with the registered person
would present similar conflict of
interest concerns as borrowing or
lending arrangements directly between
the registered person and the
customer.26 Accordingly, the proposed
rule change would expressly state that
such arrangements would not be
consistent with Rule 3240 unless the
conditions set forth in Rule 3240 are
satisfied.27 FINRA stated that the
proposed rule change would address the
potential for customer abuse that arises
in these more indirect borrowing and
lending arrangements.28
d. Owner-Financing Arrangements
The proposed rule change would add
Rule 3240.03 (Owner-Financing
Arrangements) to expressly state that,
for purposes of Rule 3240, borrowing or
lending arrangements include ownerfinancing arrangements.29 For example,
Rule 3240 would apply to situations
24 See
Notice at 3969.
Rule 3240.02.
26 Proposed Rule 3240.05.
27 Id.
28 Notice at 3969.
29 Proposed Rule 3240.03.
25 Proposed
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where a registered person purchases real
estate from their customer, the customer
agrees to finance the purchase, and the
registered person provides a promissory
note for the entire purchase price or
arranges to pay in installments.30
Accordingly, such owner-financing
arrangements would not be consistent
with Rule 3240 unless the conditions set
forth in Rule 3240 are satisfied.
2. The ‘‘Immediate Family’’ Definition
Currently, Rule 3240 has an exception
from the general prohibition for
borrowing or lending arrangements with
a customer who is a member of the
registered person’s immediate family.31
Rule 3240(c) defines ‘‘immediate
family’’ to mean ‘‘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 daughterin-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.’’ 32
FINRA stated that, in order to
‘‘modernize’’ the ‘‘immediate family’’
definition,33 the proposed rule change
would amend the definition to make it
consistent with the definition in FINRA
Rule 3241,34 which addresses similar
potential conflicts of interest to Rule
3240.35 Specifically, the proposed rule
change would amend Rule 3240(c) to
replace ‘‘husband or wife’’ with ‘‘spouse
or domestic partner’’ and include ‘‘step
and adoptive relationships.’’ 36 In
addition, the proposed rule change
would amend the ‘‘any other person’’
clause to limit it to ‘‘any other person
who resides in the same household as
the registered person’’ and who the
registered person ‘‘financially supports,
directly or indirectly, to a material
extent.’’ 37
3. The Close Personal Relationship and
Business Relationship Exceptions
Currently, Rule 3240 has an exception
from the general prohibition for
borrowing or lending arrangements
based on a ‘‘personal relationship with
the customer, such that the loan would
30 See
Notice at 3969.
Rule 3240(a)(2)(A).
32 Rule 3240(c).
33 See Notice at 3970; see also FINRA Rule 3241.
34 See Notice at 3970.
35 See Notice at 3977. FINRA Rule 3241 governs
registered persons who are named a customer’s
beneficiary or hold a position of trust for a
customer. FINRA Rule 3241 and FINRA Rule 3240
are both designed to prevent harm to customers due
to registered persons being in a position of power
and responsibility in their lives. See Notice at 3977
n.56.
36 Proposed Rule 3240(c).
37 Id.
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31 See
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not have been solicited, offered, or given
had the customer and the registered
person not maintained a relationship
outside of the broker-customer
relationship’’ (the ‘‘personal
relationship exception’’).38 Similarly,
the rule’s general prohibition currently
does not apply to borrowing or lending
arrangements based on a ‘‘business
relationship outside of the brokercustomer relationship’’ (the ‘‘business
relationship exception’’).39
The proposed rule change would
narrow the personal relationship
exception to apply only to personal
relationships that are ‘‘bona fide’’ and
‘‘close,’’ and maintained outside of, and
formed prior to, the broker-customer
relationship.40 The proposed rule
change would also narrow the business
relationship exception to borrowing and
lending arrangements that are based on
a ‘‘bona fide business relationship’’
maintained outside of the brokercustomer relationship.41
In addition to narrowing the personal
relationship and business relationship
exceptions, the proposed rule change
would add new Rule 3240.04 (Close
Personal Relationships; Business
Relationships), which would provide a
list of non-exhaustive factors 42 to help
firms evaluate whether a borrowing or
lending arrangement is based on a bona
fide close personal relationship or a
bona fide business relationship. The
non-exhaustive factors in proposed Rule
3240.04 are: ‘‘when the relationship
began, its duration and nature, and any
facts suggesting that the relationship is
not bona fide or was formed with the
purpose of circumventing the purpose
of Rule 3240.’’ 43 Proposed Rule 3240.04
would also provide examples of ‘‘close
personal relationships,’’ including, ‘‘a
childhood or long-term friend or a
godparent, and other similarly close
personal relationships.’’ 44 Additionally,
proposed Rule 3240.04 would provide
an example of a ‘‘business relationship’’
to include ‘‘a loan from a registered
person to a small outside business that
the registered person co-owned for years
for the sole purpose of providing the
business with additional operating
capital.’’ 45
FINRA stated that the proposed rule
change would ‘‘help establish the scope
of the close personal relationship and
business relationship exceptions, focus
3240(a)(2)(D).
3240(a)(2)(E).
40 Proposed Rule 3240(a)(2)(D).
41 Proposed Rule 3240(a)(2)(E).
42 See infra Section II.B.4.e.
43 Proposed Rule 3240.04.
44 Id.
45 Id.
on the most relevant factors when
evaluating whether a close personal
relationship or business relationship
exists, and ensure that members
consider meaningfully the potential
issues involved in the proposed
arrangement.’’ 46
4. Notification and Approval
Requirements
Currently, Rule 3240(b) requires
notification and approval for certain of
the excepted borrowing or lending
arrangements.47 Generally, the
exceptions for borrowing or lending
arrangements involving personal
relationships, business relationships,
and registered persons require member
firm notification and approval. In
contrast, the exceptions for borrowing or
lending arrangements with immediate
family members and financial
institutions do not require member firm
notification and approval. The proposed
rule change would make the following
changes to the notification and approval
requirements.
a. Approval Requirements for the Close
Personal Relationship, Business
Relationship, and Registered Persons
Exceptions
Current Rule 3240(b)(1)(A) provides
that a registered person shall notify the
member firm of borrowing or lending
arrangements made within the personal
relationship exception,48 business
relationship exception,49 or the
registered persons exception 50 prior to
entering into such arrangements, and
that the member firm shall pre-approve
in writing such arrangements.51 The
proposed rule change would amend
Rule 3240(b)(1) to make clear that, while
registered persons cannot proceed with
such arrangements without their
member firm’s prior approval, the
member firm is not required to approve
the arrangement.52 Specifically, the
proposed rule change would delete the
‘‘shall pre-approve’’ language and
instead require the registered person to
provide notice ‘‘prior to entering into
such arrangements’’ or ‘‘prior to the
modification of such arrangements’’ and
‘‘obtain the member’s approval.’’ 53
Further, the proposed rule change
would amend the notification and
approval requirements in Rule
3240(b)(1) to cover borrowing or lending
arrangements that pre-exist the broker-
38 Rule
46 See
39 Rule
47 Id.
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77549
Notice at 3970.
48 Rule
3240(a)(2)(D).
3240(a)(2)(E).
50 Rule 3240(a)(2)(C).
51 Rule 3240(b)(1)(A).
52 See Notice at 3970.
53 See proposed Rule 3240(b)(1)(A).
49 Rule
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customer relationship. Specifically,
proposed Rule 3240(b)(1)(B) would
require registered persons, prior to the
initiation of a broker-customer
relationship at the member firm with a
person with whom the registered person
has an existing borrowing or lending
arrangement, to notify the member firm
in writing of any existing borrowing or
lending arrangements within the close
personal relationship, business
relationship, and registered persons
exceptions and obtain the member
firm’s approval in writing of the brokercustomer relationship.54
b. Notification and Approval
Requirements for the Immediate Family
Member Exception
Current Rule 3240(b)(2) provides, in
pertinent part, that a member firm’s
written procedures may indicate that
registered persons are not required to
notify the member firm or receive
member firm approval of borrowing or
lending arrangements within the
immediate family exception.55 The
proposed rule change would amend
Rule 3240(b)(2) to apply the same
approach to borrowing or lending
arrangements within the immediate
family exception that pre-exist the
broker-customer relationship.56
Specifically, the proposed rule change
would amend Rule 3240(b)(2) to provide
that the member firm’s procedures may
indicate that registered persons are not
required to notify the member firm or
receive member firm approval of such
arrangements either prior to or
subsequent to initiating a brokercustomer relationship.57 FINRA stated,
however, that Rule 3240(b)(2) implies
that member firms may choose to
require such notice and approval of
those arrangements.58
c. Notification and Approval
Requirements for the Financial
Institution Exception
Current Rule 3240(b)(3) provides, in
pertinent part, that a member firm’s
written procedures may indicate that
registered persons are not required to
notify the member firm or receive the
member firm’s approval of borrowing or
lending arrangements within the
financial institution exception,59
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54 See
proposed Rule 3240(b)(1)(B).
55 Rule 3240(b)(2).
56 See Notice at 3971.
57 See proposed Rule 3240(b)(2).
58 See Notice at 3971 n.21.
59 The ‘‘financial institution exception’’ states that
no person associated with a member firm in any
registered capacity may borrow money from or lend
money to any customer of such person, unless the
customer (i) is a financial institution regularly
engaged in the business of providing credit,
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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.’’ 60 The proposed rule
change would amend Rule 3240(b)(3) to
also cover borrowing or lending
arrangements within the financial
institution exception that pre-exist the
broker-customer relationship.61
Specifically, the proposed rule change
would amend Rule 3240(b)(3) to provide
that the member firm’s written
procedures may also indicate that
registered persons are not required to
notify the member firm or receive the
member firm’s approval of borrowing or
lending arrangements within the
financial institution exception entered
into either prior to or subsequent to
initiating a broker-customer
relationship, 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.62 FINRA stated,
however, that Rule 3240(b)(3) implies
that member firms may choose to
require such notice and approval of
those arrangements.63
d. Notifications in Writing and Record
Retention
Currently, Rule 3240 does not require
that registered persons who must notify
their member firms of borrowing and
lending arrangements to do so in
writing.64 Furthermore, the current rule
does not require member firms to retain
any notices of borrowing and lending
arrangements that they may receive
from registered persons; it only requires
member firms to retain written
approvals.65 The proposed rule change
would require registered persons to
notify their member firms in writing of
those borrowing and lending
arrangements under Rule 3240 that
require notification and approval (i.e.,
the exceptions involving registered
persons, close personal relationships,
and business relationships).66
The proposed rule change would also
amend Rule 3240.01 to require member
firms to retain the written notifications
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. See Rule 3240(a)(2)(B).
60 See Rule 3240(b)(3).
61 See Notice at 3971.
62 See proposed Rule 3240(b)(3).
63 See Notice at 3971 n.21.
64 See id. at 3971.
65 Id.
66 Id.; see proposed Rules 3240(b)(1)(A) and
(b)(1)(B) and proposed Rule 3240.01.
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and approvals records 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.67 The proposed
rule change would also require record
retention of notices and approvals
related to the immediate family and
financial institution exceptions, unless
the member firm’s procedures indicate
that registered persons are not required
to notify the member firm and/or
receive member firm approval.68
e. Reasonable Assessment by Member of
the Risks Created by the Borrowing or
Lending Arrangement
The proposed rule change also would
add new Rule 3240.06 (Obligations of
Member Receiving Notice). Proposed
Rule 3240.06 would require a member
firm, upon receiving written notice
under Rule 3240, to ‘‘perform a
reasonable assessment of the risks
created by the borrowing or lending
arrangement with a customer,
modification to the borrowing or
lending arrangement with a customer, or
existing borrowing or lending
arrangement with a person who seeks to
be a customer of the registered
person.’’ 69 It would further provide that
the member firm make a ‘‘reasonable
determination of whether to approve the
borrowing or lending arrangement,
modification to the borrowing or
lending arrangement, or, where there is
an existing borrowing or lending
arrangement with a person who seeks to
be a customer of the registered person,
the broker-customer relationship.’’ 70 In
the Notice, FINRA stated that a member
firm’s ‘‘reasonable assessment’’ should
consider several non-exhaustive factors,
such as:
(1) any potential conflicts of interest
in the registered person being in a
borrowing or lending arrangement with
a customer;
(2) the length and type of relationship
between the customer and registered
person;
67 See
proposed Rule 3240.01.
Notice at 3971 n.21 (stating that ‘‘Rule
3240.01 would also be amended to provide that the
record-retention requirements are for purposes of
Rule 3240(b), not just Rule 3240(b)(1). As explained
above, Rule 3240(b)(1) requires notice and approval
of arrangements that are within the personal
relationship, business relationship, and registered
persons exceptions. While Rule 3240(b)(2) and (3)
do not expressly require notice and approval of
arrangements within the immediate family member
and financial institution exceptions, those
subparagraphs imply that members may choose to
require such notice and approval of those
arrangements.’’).
69 Proposed Rule 3240.06.
70 Id.
68 See
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(3) the material terms of the
borrowing or lending arrangement;
(4) the customer’s or the registered
person’s ability to repay the loan;
(5) the customer’s age;
(6) whether the registered person has
been a party to other borrowing or
lending arrangements with customers;
(7) whether, based on the facts and
circumstances observed in the member’s
business relationship with the customer,
the customer has a mental or physical
impairment that renders the customer
unable to protect his or her own
interests;
(8) any disciplinary history or indicia
of improper activity or conduct with
respect to the customer or the
customer’s account (e.g., excessive
trading); and
(9) any indicia of customer
vulnerability or undue influence of the
registered person over the customer.71
Moreover, the factors that a member
firm considers ‘‘should allow for a
reasonable assessment of the associated
risks so that the member can make a
reasonable determination of whether to
approve the borrowing or lending
arrangement, modification to the
borrowing or lending arrangement, or,
where there is an existing borrowing or
lending arrangement with a person who
seeks to be a customer of the registered
person, the broker-customer
relationship.’’ 72 FINRA also stated in
the Notice that it ‘‘would expect a
member to try to discuss the
arrangement with the customer[,]’’ as
part of the member firm’s reasonable
assessment of the risks.73
III. Discussion and Commission
Findings
After careful review of the proposed
rule change and the comment letters,
and FINRA’s response to comments, the
Commission finds that the proposed
rule change is consistent with the
requirements of the Exchange Act and
the rules and regulations thereunder
that are applicable to a national
securities association.74 Specifically, as
explained in more detail below, the
Commission finds that the proposed
rule change is consistent with Section
15A(b)(6) of the Exchange Act, which
requires, among other things, that
FINRA rules be designed to prevent
fraudulent and manipulative acts and
practices, to promote just and equitable
principles of trade, and, in general, to
71 See
Notice at 3971.
id.
73 See id. at 3972.
74 In approving this rule change, the Commission
has considered the rule’s impact on efficiency,
competition, and capital formation. See 15 U.S.C.
78c(f).
72 See
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protect investors and the public
interest.75
The proposed rule change would
strengthen the general prohibition
against borrowing and lending
arrangements between registered
persons and their customers.
Specifically, it would narrow the types
of permissible borrowing and lending
arrangements by covering relationships
that pre-exist a new broker-customer
relationship, as well as borrowing or
lending arrangements entered into
within six months after a brokercustomer relationship ends. The
proposed rule change would also extend
the application of the rule to indirect
borrowing and lending arrangements
involving related parties of the customer
or registered person and to ownerfinancing arrangements. In addition, the
proposed rule change would modify the
relationship categories in the immediate
family exception. Furthermore, it would
require borrowing and lending
arrangements based on the close
personal relationship and business
relationship exceptions be ‘‘bona fide.’’
It also would require: registered persons
to notify their member firms in writing
and obtain member firms’ approval of
certain borrowing and lending
arrangements; member firms to retain
records of notices and approvals; and
member firms to conduct a reasonable
assessment of the risks associated with
certain arrangements. Accordingly, and
as explained in more detail below, the
Commission finds that the proposed
rule change is consistent with Section
15A(b)(6) of the Exchange Act. The
Commission addresses the proposed
rule change’s specific provisions, and
any related comments, in turn.
A. The General Prohibition on
Borrowing From or Lending to
Customers
FINRA is proposing to amend the title
of FINRA Rule 3240 to ‘‘Prohibition on
Borrowing From or Lending to
Customers,’’ and change the title of Rule
3240(a) to ‘‘General Prohibition;
Permissible Borrowing or Lending
Arrangements; Conditions.’’
Commenters did not specifically
comment on this proposed rule change.
By emphasizing that FINRA Rule 3240
imposes a general prohibition on
registered persons borrowing from or
lending to their customers, the proposed
rule change highlights the regulatory
purpose of the rule to generally prohibit
borrowing and lending arrangements.
The proposed rule change would also
make several substantive changes to the
general prohibition on borrowing from
75 15
PO 00000
or lending to customers, including
extending the rule to cover borrowing
and lending arrangements that pre-exist
the broker-customer relationship;
extending the rule’s limitations to
borrowing or lending arrangements
entered into within six months after a
broker-customer relationship ends; and,
specifying that certain borrowing and
lending arrangements are covered by the
general prohibition. The Commission
addresses those changes below.
1. Pre-Existing Borrowing and Lending
Arrangements
The proposed rule change would
amend Rule 3240(a) to provide that the
rule’s general requirements concerning
borrowing and lending arrangements—
including the general prohibition—
apply to borrowing and lending
arrangements that pre-exist a new
broker-customer relationship. The
proposed rule change would prohibit
registered persons from initiating a
broker-customer relationship with a
person with whom the registered person
has an existing borrowing or lending
arrangement unless the conditions of
the proposed rule are met.76
Two commenters supported this
change.77 One of these commenters
stated that conflicts of interest would
exist in the relationship irrespective of
whether or not a borrowing or lending
arrangement existed before or after the
broker-customer relationship is
established.78 Thus, the commenter
noted, broadening and applying the
general prohibition to borrowing or
lending arrangements that pre-exist the
broker-customer relationship will
protect investors.79 Another commenter
supported covering borrowing or
lending arrangements that pre-exist
broker-customer relationship to the
extent the proposed rule change would
continue to permit any borrowing or
lending arrangements.80 To the extent
76 See
id. at 3969.
letter from William Jacobson, Clinical
Professor of Law and Director, Cornell Securities
Law Clinic, dated February 12, 2024, at 2, https://
www.sec.gov/comments/sr-finra-2024-001/
srfinra2024001-428040-1059142.pdf (‘‘CSLC’’)
(emphasizing that by extending the prohibition to
situations where financial arrangements pre-date
the formal establishment of a broker-customer
relationship, ‘‘the amendment aims to prevent
potential conflicts of interest or abuses.’’); see also
letter from Joseph C. Pfeiffer, President, Public
Investor Advocate Bar Association, dated February
12, 2024, at 1, https://www.sec.gov/comments/srfinra-2024-001/srfinra2024001-426619-1057382.pdf
(‘‘PIABA’’).
78 PIABA at 1–2.
79 PIABA at 1.
80 See letter from Claire McHenry, President,
North American Securities Administrators
Association, Inc., dated February 12, 2024, at 4,
77 See
U.S.C. 78o–3(b)(6).
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that any borrowing or lending
arrangements are permitted, this
commenter called for strong safeguards
to protect investors from ‘‘predatory
lending or undue influence in a brokercustomer relationship.’’ 81
FINRA stated that the proposed rule
change would strengthen the general
prohibition against borrowing and
lending arrangements by extending the
scope of arrangements to which the rule
would apply to pre-existing
arrangements.82 In addition, FINRA
stated that the proposed rule change
would strengthen the notice and
approval requirements by, among other
things, requiring member firms, upon
receiving notice under the proposed
rule, to conduct a reasonable
assessments of the risks created by a
borrowing or lending arrangement and
make a reasonable determination of
whether to approve it, as described
more fully below.83
The proposed rule change reasonably
extends the general prohibition against
borrowing and lending arrangements to
cover borrowing or lending
arrangements that pre-exist a new
https://www.sec.gov/comments/sr-finra-2024-001/
srfinra2024001-428019-1058522.pdf (‘‘NASAA’’).
81 See id. Specifically, two commenters who
provided comments on specific provisions of the
proposed rule change stated a preference for a broad
prohibition on all borrowing and lending
arrangements. See NASAA at 3–4 (identifying a
complete ban with no exceptions as the most
efficient and effective way to address ‘‘the serious
conflicts inherent in such a relationship and the
potential for investor harm’’); see also letter from
Jenice Malecki, Jacqueline Candela, and Adam
Schreck of Malecki Law, dated February 12, 2024,
at 1, https://www.sec.gov/comments/sr-finra-2024001/srfinra2024001-428039-1058683.pdf
(‘‘Malecki’’) (stating that ‘‘lending arrangements
between registered representatives and their
customers should be strictly prohibited.
Transactions amongst registered representatives and
customers inherently involve parties negotiating
from disparate bargaining positions.’’). In response,
FINRA stated that it considered prohibiting all such
arrangements but rejected the approach because
such arrangements may be mutually beneficial to
the contracting parties. See FINRA Comment
Response at 1–2. FINRA stated also that the
proposed rule change would strengthen the general
prohibition against such arrangements by extending
the scope of arrangements to which the rule would
apply and by narrowing some exceptions. See
FINRA Comment Response at 4. In addition, FINRA
stated that the proposed rule change would
strengthen the notice and approval requirements, as
discussed more fully below. See id. As discussed
herein, FINRA Rule 3240 generally prohibits
registered persons from borrowing money from, or
lending money to, their customers but permits such
arrangements under limited circumstances designed
to minimize the impact of conflicts of interest. The
proposed rule change would strengthen the general
prohibition against borrowing and lending
arrangements between registered persons and their
customers. Accordingly, for the reasons discussed
in detail below, we find that the proposed rule
change is consistent with the public interest and the
protection of investors.
82 See FINRA Comment Response at 4.
83 Id.
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broker-customer relationship. By
extending this general prohibition to
such arrangements, the proposed rule
change reasonably extends the scope of
the rule while preserving the
opportunity for parties to enter into
such arrangements in limited
circumstances and subject to procedural
protections (as discussed below)
designed to minimize the impact of the
potential conflict. For these reasons, the
proposed rule change is reasonably
designed to prevent fraudulent and
manipulative acts and practices, to
promote just and equitable principles of
trade, and, in general, to protect
investors and the public interest.
2. Expansion of the Definition of
Customer
The proposed rule change would add
new FINRA Rule 3240.02 (Customer) to
define ‘‘customer,’’ for purposes of Rule
3240, to include any customer who has,
or in the previous six months had, a
securities account assigned to the
registered person at any member firm.
FINRA stated that the proposed rule
change would extend the rule’s
limitations to borrowing or lending
arrangements entered into within six
months after a broker-customer
relationship terminates.84
One commenter supported this
proposed extension of the rule’s
limitations to borrowing or lending
arrangements, but favored extending the
covered time period to one year as a
stronger anti-evasion measure instead of
the proposed six months.85 The
commenter stated that a one-year
‘‘lookback’’ time period would curtail
attempts to evade this rule and therefore
‘‘enhance investor protection to a
greater degree than the proposed six
month time period.’’ 86 The commenter
further stated that FINRA Rule 4111
(Restricted Firm Obligations) uses a oneyear ‘‘lookback’’ time period.87
In response, FINRA stated that it
proposed to align the new Rule 3240
time period with the six-month time
period in the definition of ‘‘customer’’
in Rule 3241, because Rule 3241
addresses similar potential conflicts of
interest,88 whereas Rule 4111’s one-year
84 See
Notice at 3969.
at 2.
85 PIABA
86 Id.
87 Id.
88 See FINRA Comment Response at 14. Rule
3241.01 defines ‘‘customer’’ as ‘‘any customer that
has, or in the previous six months had, a securities
account assigned to the registered person at any
member.’’ FINRA Rule 3241 governs registered
persons who are named a customer’s beneficiary or
hold a position of trust for a customer. FINRA Rule
3241 and FINRA Rule 3240 are both designed to
prevent harm to customers due to registered
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‘‘lookback’’ time period relates to the
identification of firms with a significant
history of misconduct.89 FINRA stated
that there are costs associated with
extending the general prohibition after
the broker-customer relationship ends.90
Such costs relate to evaluating and
making reasonable determinations on a
host of arrangements about which the
member firm was not previously
notified, as well as costs associated with
continued monitoring for prohibited
borrowing and lending arrangements
with every customer who transfers an
account away from the member firms’
registered persons.91 FINRA stated also
that the six-month time period ‘‘strikes
an appropriate balance between
achieving the regulatory objective of
addressing circumvention of the
proposed rule change and imposing
requirements that are reasonable and
appropriate, including reasonable
requirements on member firms in
tracking transfers of customers’
accounts.’’ 92
The proposed rule change reasonably
extends the rule’s coverage to borrowing
and lending arrangements involving
customers who in the previous six
months had a securities account
assigned to a registered person. As a
result, the proposed rule change
protects investors by broadening the
scope of customer relationships covered
by the rule’s general prohibition and
limited exceptions. Further, the sixmonth limit on how long a broker-dealer
must monitor terminated customer
accounts reasonably balances the
benefits of the rule’s protections with
the burden of complying with the rule’s
requirements for an extended period
after the termination of the brokercustomer relationship. For these
reasons, the proposed rule change is
reasonably designed to prevent
fraudulent and manipulative acts and
practices, to promote just and equitable
principles of trade, and, in general, to
protect investors and the public interest.
persons being in a position of power and
responsibility in their lives. See Notice 3977 n.56.
89 See FINRA Comment Response at 14. FINRA
Rule 4111 addresses risks from broker-dealers with
a significant history of misconduct, including firms
with a high concentration of individuals with a
significant history of misconduct (‘‘Restricted
Firms’’). For purposes of calculating concentration,
the rule covers persons registered with the member
firm for one or more days within the one year prior
to the date of the annual calculation used for
determining Restricted Firm status. See Regulatory
Notice 21–34 (Sep. 28, 2021), https://www.finra.org/
rules-guidance/notices/21-34.
90 See FINRA Comment Response at 15.
91 See id.
92 See id. at 14 (citing FINRA Regulatory Notice
20–38 (Oct. 2020)).
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3. Borrowing and Lending
Arrangements With Related Parties of
the Registered Person or Customer
The proposed rule change would
extend the rule’s general prohibition to
borrowing or lending arrangements with
related parties of the customer or
registered person that involve conflicts
similar to those presented by borrowing
or lending arrangements directly
between registered persons and their
customers. Specifically, proposed new
FINRA Rule 3240.05 would provide that
a registered person instructing or asking
a customer to enter into a borrowing or
lending arrangement with a person
related to the registered person or to
have a person related to the customer
enter into a borrowing or lending
arrangement with the registered person
would present similar conflict of
interest concerns as borrowing or
lending arrangements between the
registered person and the customer and
would be inconsistent with Rule 3240
unless the conditions set forth in Rule
3240(a) are satisfied. FINRA stated that
the proposed rule change would address
the potential for customer abuse that
arises when a registered person: (1)
‘‘induces a customer to enter into a
borrowing or lending arrangement with
a person or entity related to the
registered person’’ or (2) ‘‘induces a
customer to have a person or entity
related to the customer enter into an
arrangement with the registered
person.’’ 93
Two commenters supported the
proposed rule change.94 One stated that
it is a ‘‘good idea’’ because ‘‘[t]he same
or very similar conflict of interest is
present if a registered representative’s
close family member obtains a loan from
a registered representative’s client just
as if the registered representative
obtained it themselves.’’ 95 The other
commenter stated that the proposed rule
change would close ‘‘potential
loopholes’’ and safeguard against abuses
that may occur ‘‘when a registered
person induces a customer to enter into
financial arrangements with related
individuals.’’ 96
The proposed addition of FINRA Rule
3240.05 reasonably extends the rule to
cover indirect borrowing or lending
arrangements involving parties related
to either the registered person or the
customer, and thus prevents a registered
person from evading the restrictions of
Rule 3240. As such, the proposed rule
change appropriately addresses conflicts
of interest between registered persons
93 Notice
at 3969.
CSLC; PIABA.
95 PIABA at 2.
96 CSLC at 2.
94 See
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and customers that may arise from
certain borrowing or lending
arrangements with related persons and
entities. For these reasons, the proposed
rule change is reasonably designed to
prevent fraudulent and manipulative
acts and practices, to promote just and
equitable principles of trade, and, in
general, to protect investors and the
public interest.
4. Owner-Financing Arrangements
Proposed Rule 3240.03 would include
owner-financing arrangements as
borrowing or lending arrangements that
are covered by Rule 3240.97 For
example, the proposed rule change
would cover situations where a
registered person purchases real estate
from their customer, the customer
agrees to finance the purchase, and the
registered person provides a promissory
note for the entire purchase price or
arranges to pay in installments.98
Commenters did not specifically
comment on this proposed rule change.
By extending Rule 3240 to cover
owner-financing arrangements, the
proposed rule change protects investors
by addressing financing arrangements
that present similar conflicts of interest
and a similar potential for abuse as
other borrowing and lending
arrangements covered by Rule 3240.
Generally prohibiting such financing
arrangements, unless the conditions of
the rule are met, is a reasonable
approach to address the potential risk of
harm associated with this type of
borrowing or lending arrangement. For
these reasons, the proposed rule change
is reasonably designed to prevent
fraudulent and manipulative acts and
practices, to promote just and equitable
principles of trade, and, in general, to
protect investors and the public interest.
B. The ‘‘Immediate Family’’ Definition
Rule 3240’s general prohibition on
borrowing or lending arrangements
provides an exception for arrangements
between a registered person and a
customer who is a member of the
registered person’s immediate family.99
The proposed rule change would update
the ‘‘immediate family’’ definition to
include new relationship categories.100
Specifically, the proposed rule change
would amend Rule 3240(c) to replace
‘‘husband or wife’’ with ‘‘spouse or
97 Proposed
Rule 3240.03.
Notice at 3969 (referencing James K.
Breeze, Letter of Acknowledgment, Waiver and
Consent, Case ID 2008012846501 (June 30, 2009);
Vincenzo G. Covino, Letter of Acknowledgment,
Waiver and Consent, Case ID 2009020793901 (Feb.
9, 2012)).
99 See Rule 3240(a)(2)(A).
100 See Notice at 3970.
98 See
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Fmt 4703
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77553
domestic partner’’ and amend the
definition to include ‘‘step and adoptive
relationships.’’ 101 In addition, the
proposed rule change would amend the
‘‘any other person’’ clause to state that
it only applies to ‘‘any other person who
resides in the same household as the
registered person’’ and who the
registered person ‘‘financially supports,
directly or indirectly, to a material
extent.’’ 102 Commenters supported the
proposed rule change.103
By amending the definition of
‘‘immediate family,’’ the proposed rule
change updates the rule to encompass a
broader set of familial relationships,
while at the same time retaining a
reasonably narrow and clear scope,
which provides more compliance
certainty. In addition, amending the
‘‘any other person’’ clause to restrict the
definition to those individuals who live
with, and are financially supported by,
the registered person is a reasonable
approach to reducing the potential for
the exception to be misused. For these
reasons, the proposed rule change is
reasonably designed to prevent
fraudulent and manipulative acts and
practices, to promote just and equitable
principles of trade, and, in general, to
protect investors and the public interest.
C. The Close Personal Relationship and
Business Relationship Exceptions
Rule 3240 currently includes a
personal relationship exception 104 and
a business relationship exception 105 to
the general prohibition against
registered persons borrowing or lending
to their customers. The proposed rule
change would narrow the personal
relationship exception to apply only to
personal relationships that are ‘‘bona
fide’’ and ‘‘close,’’ and maintained
outside of, and formed prior to, the
broker-customer relationship. The
proposed rule change would also
narrow the business relationship
exception to borrowing and lending
arrangements that are based on a ‘‘bona
fide business relationship’’ outside of
the broker-customer relationship.106
In addition, proposed Rule 3240.04
would provide factors for evaluating
101 Proposed
Rule 3240(c).
102 Id.
103 See, e.g., CSLC at 3 (stating that amending the
‘‘any other person’’ clause would align the
definition with ‘‘practical considerations’’ that
would reduce the potential for misuse. Also stating
that ‘‘[t]he modernization of this definition
showcases a dedication to inclusivity and
adaptability. It also works to strengthen the rule,
making sure it stays relevant to contemporary
society and prevents individuals from exploiting
technicalities.’’); see also PIABA at 2.
104 Rule 3240(a)(2)(D).
105 Rule 3240(a)(2)(E).
106 Proposed Rule 3240(a)(2)(E).
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whether a borrowing or lending
arrangement is based on a bona fide,
close personal relationship or a bona
fide business relationship, including
‘‘when the relationship began, its
duration and nature, and any facts
suggesting that the relationship is not
bona fide or was formed with the
purpose of circumventing the purpose
of Rule 3240.’’ 107 Proposed Rule
3240.04 would also provide examples of
‘‘close personal relationships,’’
including, ‘‘a childhood or long-term
friend or a godparent.’’ 108 Finally,
proposed Rule 3240.04 would provide
as an example of a ‘‘business
relationship,’’ ‘‘a loan from a registered
person to a small outside business that
the registered person co-owned for years
for the sole purpose of providing the
business with additional operating
capital.’’ 109
One commenter supported the
proposed rule change, stating that
replacing the current requirement with
the bona fide relationship requirement
for both the close personal relationship
and business relationship exceptions
‘‘eliminates subjectivity and
ambiguity’’ 110 and ‘‘emphasizes the
genuine and sincere nature of the
relationship, focusing on authenticity
and legitimacy.’’ 111 This commenter
also stated that the factors test
introduced by proposed Rule 3240.04
offer ‘‘clear criteria for evaluation,
emphasizing specific aspects such as the
duration and nature of the relationship
. . ., providing a structured framework
for assessing relationship
legitimacy.’’ 112
Two other commenters opposed the
proposed rule change.113 One stated that
close personal relationships do not
‘‘confer any additional protections from
the kinds of conflicted, exploitative, and
abusive practices that the rules should
be designed to prevent.’’ 114 The other
commenter stated the proposed
amendments to the exceptions would
result in the exceptions being too
subjectively applied because it asks
firms to make judgements of legitimacy
and would be difficult to implement.115
Specifically, the commenter stated that
the term ‘‘bona fide’’ is vague and
ambiguous and that the lack of an
explanation or test to discern what
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107 Proposed
Rule 3240.04.
108 Id.
constitutes a relationship as legitimate
would make it difficult to interpret the
application of the exceptions.116 To
address this issue, the commenter
requested that FINRA provide more
examples of relationships that would
qualify for the close personal
relationship and business relationship
exceptions.117 In addition, this
commenter stated that if the rule’s
intent is to prohibit arrangements when
the personal relationship is formed after
the commencement of the brokercustomer relationship, it should
explicitly say so.118
In response, FINRA stated that it
proposed to narrow the exception and
provide factors that are relevant to
assessing whether a relationship falls
within the scope of either the close
personal or business relationship
exception precisely because it shared
concerns about the scope of these
exceptions. In particular, FINRA stated
that limiting the personal relationship
exception to relationships that are (1)
bona fide, (2) close, and (3) maintained
outside of, and formed prior to, the
broker-customer relationship, ‘‘would
reduce the risk that a registered person
would concoct a personal relationship
with a customer for the purpose of
borrowing from or lending to the
customer, and . . . address concerns
that this exception could be
exploited.’’ 119 In response to the
commenter’s request for clarification
regarding whether the proposed rule
change would cover personal
relationships developed after the
formation of the broker-customer
relationship, FINRA reiterated that
relationships formed after the
establishment of the broker-customer
relationship would not fall within the
proposed close personal relationship
exception, which would only apply to
bona fide, close personal relationships
maintained outside of, and formed prior
to, the broker-customer relationship.120
According to FINRA, the close personal
relationship exception is designed only
to apply where the borrowing or lending
arrangement is less likely to have
resulted from the broker-customer
relationship because the close personal
relationship existed prior to the brokercustomer relationship and does not
involve the two parties being introduced
through the broker-customer
109 Id.
110 CSLC
at 3.
see also PIABA at 2 (commending ‘‘any
effort to limit the exceptions and make very clear
that this conduct is not allowed.’’).
112 CSLC at 3.
113 Malecki; NASAA.
114 See NASAA at 4.
115 See Malecki at 5.
111 Id.;
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116 See
id. at 5–6.
id. at 5–6 (expressing the view that the
existing examples are limited and very specific and
may not be relatable to most broker-customer
relationships).
118 See id. at 5.
119 See FINRA Comment Response at 9.
120 Id.
117 See
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Fmt 4703
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relationship that may involve conflicts
of interest.121
In response to commenter requests for
more examples of close personal and
business relationships, FINRA stated
that the examples described in the
proposed rule change ‘‘add helpful
clarity while giving members the
flexibility to consider factors relevant to
whether these exceptions apply.’’ 122 In
declining to provide additional
examples, FINRA stated that, ultimately,
the applicability of the exceptions
depends on the facts and
circumstances.123 However, to the
extent any particular scenario raises
questions regarding the application of
the rule, FINRA would consider issuing
additional guidance on a case-by-case
basis.124
The proposed rule change reasonably
limits the personal relationship
exception to bona fide, close
relationships maintained outside of, and
formed prior to, the broker-customer
relationship and the business
relationship exception to borrowing and
lending arrangements that are based on
a bona fide business relationship
maintained outside of the brokercustomer relationship. By narrowing
these exceptions in this manner, the
proposed rule change would help
ensure that these exceptions to the
general prohibition are limited to the
types of relationships where the risk to
investors should be reduced. Similarly,
by providing factors for evaluating
whether a borrowing or lending
arrangement is based on a bona fide,
close personal relationship or a bona
fide business relationship, as well as
examples of close personal relationships
and business relationships, the
proposed rule change would help
parties comply with the terms of these
exceptions. For these reasons, the
proposed rule change is reasonably
designed to prevent fraudulent and
manipulative acts and practices, to
promote just and equitable principles of
trade, and, in general, to protect
investors and the public interest.
D. Notification and Approval
Requirements
As stated above, Rule 3240(b) requires
notification and approval for certain
borrowing or lending arrangements.
121 See id. at 9–10 (stating that the situation
where an older or vulnerable customer loans money
to a registered person who had befriended them
after they already formed a broker-customer
relationship, would be outside the scope of the
proposed close personal relationship exception, and
thus, would be prohibited).
122 See id. at 10.
123 See id.
124 See id.
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Generally, the exceptions for borrowing
and lending arrangements involving
personal relationships, business
relationships, and registered persons,
require member firm notice and
approval. The exceptions for borrowing
and lending arrangements with
immediate family members and
financial institutions do not require
member firm notification and approval.
The proposed rule change would amend
the notification and approval
requirements of Rule 3240. We discuss
the proposed changes separately below.
1. Approval Requirements for the Close
Personal Relationship, Business
Relationship, and Registered Persons
Exceptions
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The proposed rule change would
amend Rule 3240(b)(1) to clarify that,
although registered persons are required
to obtain the member firm’s prior
approval of borrowing or lending
arrangements within the close personal
relationship, business relationship, or
registered persons exceptions, the
member firm is not required to approve
such arrangements.125 Specifically, the
proposed rule change would delete
‘‘shall pre-approve’’ from the current
rule and instead require the registered
person to provide notice ‘‘prior to
entering into such arrangements’’ or
‘‘prior to the modification of such
arrangements’’ and to ‘‘obtain the
member’s approval.’’ Two commenters
supported the proposed rule change.126
The proposed rule change would
clarify that a member firm is not
required to pre-approve borrowing or
lending arrangements within the close
personal relationship, business
relationship, or registered persons
exceptions. As such, the proposed rule
change would strengthen an important
existing control on such arrangements,
by explicitly making clear that a
member firm is not required to approve
any such arrangement simply because a
registered person notified the member
firm. For these reasons, the proposed
rule change is reasonably designed to
prevent fraudulent and manipulative
acts and practices, to promote just and
equitable principles of trade, and, in
general, to protect investors and the
public interest.
125 See
Notice at 3970.
126 See CSLC at 4 (stating that the proposed rule
change ‘‘mitigate the risk of a conflict of interest by
clarifying that member firms are empowered to
approve or disapprove a proposed arrangement.’’);
see also Malecki at 6 (stating that ‘‘member firms
should not be able to ‘opt-out’ of reviewing and/or
approving these types of lending/borrowing
transactions with customers.’’).
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2. Notification and Approval
Requirements for the Immediate Family
Member Exception and the Financial
Institution Exception
Current Rule 3240(b)(2) provides, in
pertinent part, that a member firm’s
written procedures may indicate that
that registered persons are not required
to notify the member firm or receive
member firm approval either prior to or
subsequent to entering into borrowing
or lending arrangements with
immediate family members.127
Similarly, current Rule 3240(b)(3)
provides, in pertinent part, that a
member firm’s written procedures may
indicate that registered persons are not
required to notify the member firm or
receive member firm approval of
borrowing or lending arrangements
within the financial institution
exception, 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.’’ 128
The proposed rule change would
amend Rule 3240(b)(2) and Rule
3240(b)(3) to apply the same approach
to borrowing or lending arrangements
within the immediate family exception
and the financial institution exception,
respectively, to such arrangements that
pre-exist the broker-customer
relationship.129 These changes are
intended to correspond to and account
for the fact that, under the proposed rule
change, the general prohibition applies
to borrowing or lending arrangements
that pre-exist the broker-customer
relationship.130
Specifically, to extend these
provisions to pre-existing arrangements,
the proposed rule change would amend
Rule 3240(b)(2) to provide that the
member firm’s written procedures may
indicate that registered persons are not
required to notify the member firm or
receive the member firm’s approval of
pre-existing borrowing or lending
arrangements that would fall within the
immediate family exception prior to
initiating a broker-customer
relationship.131 Similarly, the proposed
rule change would amend Rule
3240(b)(3) to provide that the member
firm’s written procedures may also
indicate that registered persons are not
127 Rule 3240(b)(2). However, as noted above, the
current rule allows a member to require such
notification and approval for borrowing and lending
arrangements with immediate family or financial
institutions if the member firm so chooses. See
Notice at 3971 n.21.
128 Rule 3240(b)(3).
129 See Notice at 3971.
130 See id.
131 See proposed Rule 3240(b)(2).
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required to notify the member firm or
receive member firm approval of preexisting arrangements that would fall
within the financial institution
exception prior to initiating a brokercustomer relationship, provided the
borrowing or lending arrangements meet
the restrictions of the exception set forth
above.132
Two commenters expressed concern
that the proposed rule change would not
require notice and approval of
borrowing or lending arrangements with
immediate family members or financial
institutions.133 One of these
commenters stated that given the risk of
financial exploitation in familial
relationships, FINRA should require ‘‘at
least the same notification and approval
for arrangements with immediate family
as it requires for other registered
persons and ‘close personal’ and
business relationships.’’ 134 The other
commenter concurred, stating that the
proposed rule change disregards
‘‘important considerations about the
perpetrators of financial fraud.’’ 135
In response, FINRA stated that, other
than extending the Rule 3240(b)(2)
obligations to borrowing and lending
arrangements established prior to
initiating a broker-customer
relationship, the proposed rule change
would not amend the existing
immediate family exception or require
notice or approval of borrowing and
lending arrangements with immediate
family members.136 FINRA further
stated that Rule 3240 is not intended to
encourage registered persons to avoid
traditional financing arrangements, but
rather to continue to allow for tailored
exceptions to the general prohibition on
borrowing or lending arrangements in
limited situations where FINRA believes
the likelihood that the registered person
has borrowed from or lent money to a
customer by virtue of the brokercustomer relationship is reduced (e.g.,
certain borrowing or lending
arrangements with immediate family
members and financial institutions).137
FINRA also identified ‘‘examples of
132 See
proposed Rule 3240(b)(3).
NASAA at 4–5; see also Malecki at 6.
134 See NASAA at 5; see also Malecki at 6 (stating
that ‘‘member firms should not be able to ‘opt-out’
of reviewing and/or approving these types of
lending/borrowing transactions with customers,
through their own firm procedures, as it defeats the
purpose of and intent behind Rule 3240 itself’’).
135 Malecki at 3 (stating that ‘‘an ‘immediate’
familial relationship is not a barrier to committing
fraud generally, and it should not be used as an
exception for allowing lending arrangements
between registered representatives and their
customers.’’).
136 See FINRA Comment Response at 7; see also
Notice at 3976.
137 See FINRA Comment Response at 6–7.
133 See
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mutually beneficial borrowing or
lending arrangements between
immediate family members, including
senior family members (e.g., loans to
cover medical expenses, dependent
care, home repairs, etc.).’’ 138 FINRA
recognized that ‘‘[p]ermitting family
members to privately lend with each
other, may also allow family members to
obtain small or short-term loans,
including at an interest rate lower than
commercially available.’’ 139 Further,
FINRA reiterated that a registered
person is prohibited from entering into
a borrowing or lending arrangement
with a customer who is an immediate
family member, including one who is a
senior investor, unless the member firm
adopts written procedures permitting
such arrangements.140 FINRA noted that
members firms may choose to prohibit
all borrowing and lending arrangements,
allow only some of the exceptions, or
impose limitations on the exceptions.141
Finally, FINRA stated that requiring
notice and approval for borrowing and
lending arrangements with immediate
family members ‘‘may invade legitimate
privacy interests because such a
requirement could interfere with or
intrude upon personal or private family
matters.’’ 142 According to FINRA, by
strengthening the general prohibition
and narrowing its exceptions, the
proposed rule change would further
protect all investors, including senior
investors.143
The proposed rule change is not
imposing new obligations on borrowing
and lending arrangements within the
immediate family exception or within
the financial institution exception but
would extend the existing regime to
situations where such financial
arrangements pre-exist the formal
establishment of a broker-customer
relationship. As with all the exceptions
under the rule, a registered person can
only enter into a borrowing or lending
arrangement pursuant to the immediate
family exception or financial institution
exception if the member firm has
adopted written procedures permitting
such an arrangement. A member firm’s
procedures may prohibit all such
arrangements, allow only some of the
excepted arrangements, or impose limits
138 Id.
at 8.
139 Id.
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140 See
id.
141 Id.
142 Id.
143 Id. FINRA further stated that Rule 2010
(Standards of Commercial Honor and Principles of
Trade)—which provides that a member, in the
conduct of its business, shall observe high
standards of commercial honor and just and
equitable principles of trade—protects investors
from unethical behavior and is broad enough to
cover a wide range of unethical conduct. See id.
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on the exceptions, as the member firm
deems appropriate to be reasonably
designed to achieve compliance with
the proposed rule change.144
Accordingly, while not explicitly
required, as part of establishing a
reasonably designed supervisory system
as required under FINRA rules,145
member firms may nevertheless require
notification and approval of
arrangements that fall under the
immediately family exception and
financial institution exception as part of
their written procedures based on their
assessment of the risks associated with
such arrangements.146 By providing
member firms the flexibility to
determine whether or not to allow such
arrangements, and if so, whether to
require notice and approval for such
arrangements, and in particular for
arrangements within the immediate
family exception, FINRA reasonably
balances the potential risk of harm
associated with such arrangements with
the potential benefits of such
arrangements and the potential
associated privacy concerns. Moreover,
as discussed above, the proposed rule
change broadens and strengthens the
application of the rule by, among other
things, covering relationships that preexist a new broker-customer
relationship, as well as borrowing or
lending arrangements entered into
within six months after a brokercustomer relationship ends, which will
add protections to investors, including
those whose arrangements fall within
the immediate family exception. For
these reasons, the proposed rule change
is reasonably designed to prevent
fraudulent and manipulative acts and
practices, to promote just and equitable
principles of trade, and, in general, to
protect investors and the public interest.
3. Notifications in Writing and Record
Retention
As stated above, Rule 3240 does not
require that registered persons who
must notify their member firms of
borrowing and lending arrangements do
so in writing.147 Furthermore, the
current rule does not require member
firms to retain any notices of borrowing
and lending arrangements that they may
receive from registered persons; it only
requires member firms to retain written
approvals.148
The proposed rule change would
require registered persons to notify their
member firms in writing of those
144 See
Rule 3110(b)(1).
145 See Rule 3110(a).
146 See infra Section III.D.4.
147 See Notice at 3971.
148 Id.
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borrowing and lending arrangements
under Rule 3240 that require
notification and approval (i.e., the
exceptions involving registered persons,
close personal relationships, and
business relationships).149 The
proposed rule change would also amend
Rule 3240.01 to require member firms to
retain the written notifications and
approvals records 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.150 The
proposed rule change would also
require record retention of notices and
approvals related to the immediate
family and financial institution
exceptions, unless the member firm’s
procedures indicate that registered
persons are not required to notify the
member firm and/or receive member
firm approval.151
One commenter supported the
proposed rule change.152
By requiring registered persons to give
written notice and requiring member
firms to preserve records of such written
notice—whether required specifically
by the rule or by the member firm’s
written procedures—for at least three
years, the proposed rule change is
reasonably designed to help ensure
compliance with the amended Rule
3240 and its exceptions. For these
reasons, the proposed rule change is
reasonably designed to prevent
fraudulent and manipulative acts and
practices, to promote just and equitable
principles of trade, and, in general, to
protect investors and the public interest.
4. Reasonable Assessment by Member of
the Risks Created by the Borrowing or
Lending Arrangement
The proposed rule change would add
proposed Rule 3240.06, which would
require a member firm, after receiving a
written notice under Rule 3240, to
‘‘perform a reasonable assessment of the
risks created by the borrowing or
lending arrangement with a customer,
modification to the borrowing or
lending arrangement with a customer, or
existing borrowing or lending
arrangement with a person who seeks to
be a customer of the registered
person.’’ 153 The proposed rule change
would also require that the member firm
make a ‘‘reasonable determination of
whether to approve the borrowing or
149 Id.; see proposed Rules 3240(b)(1)(A) and
(b)(1)(B) and proposed Rule 3240.01.
150 See proposed Rule 3240.01.
151 See supra note 68.
152 See CSLC at 4.
153 Proposed Rule 3240.06.
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lending arrangement, modification to
the borrowing or lending arrangement,
or, where there is an existing borrowing
or lending arrangement with a person
who seeks to be a customer of the
registered person, the broker-customer
relationship.’’ 154 FINRA stated that it
expects a member firm’s reasonable
assessment to take into consideration a
non-exhaustive list of factors that may
lead to undue harm to the customer as
a result of a borrowing or lending
arrangement with a registered person.155
One commenter supported the
proposed rule change, stating that a
reasonable assessment could result in
‘‘more questionable arrangements being
scrutinized, leading to improved
investor protection.’’ 156 Two
commenters suggested modifications to
the reasonable assessment
requirement.157 To help regulators
assess and compare approval and
supervision practices across firms, one
of these commenters suggested that the
reasonable assessment provisions
should require a minimum amount of
disclosure and include documentation
of the steps the member firm took to
assess the risk ahead of approving the
loan agreement, the steps the member
firm took to minimize the conflict of
interest, how the member firm
communicated the risk to the customer,
and an outline of supervisory measures
the member firm will take.158 In
addition, this commenter suggested that
a ‘‘reasonable assessment and
determination process should include
an interview (preferably by a
compliance officer) with the customer
outside the presence of the registered
person’’ or, where that is not possible,
a requirement that the member firm
verify that the customer benefits from
the loan and was not pressured into
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154 Id.
155 See Notice at 3971 (listing the following
factors: (1) any potential conflicts of interest in the
registered person being in a borrowing or lending
arrangement with a customer; (2) the length and
type of relationship between the customer and
registered person; (3) the material terms of the
borrowing or lending arrangement; (4) the
customer’s or the registered person’s ability to repay
the loan; (5) the customer’s age; (6) whether the
registered person has been a party to other
borrowing or lending arrangements with customers;
(7) whether, based on the facts and circumstances
observed in the member firm’s business
relationship with the customer, the customer has a
mental or physical impairment that renders the
customer unable to protect his or her own interests;
(8) any disciplinary history or indicia of improper
activity or conduct with respect to the customer or
the customer’s account (e.g., excessive trading); and
(9) any indicia of customer vulnerability or undue
influence of the registered person over the
customer).
156 CSLC at 6.
157 NASAA at 5–6; Malecki at 6.
158 See NASAA at 5–6.
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it.159 Furthermore, this commenter
recommended that the proposed rule
change require the member firm to
apply heightened scrutiny to the
underlying accounts or impose other
appropriate conditions where a firm
approves a borrowing or lending
arrangement, or approves a new brokercustomer relationship where there is a
pre-existing borrowing or lending
arrangement.160 Finally, this commenter
called for the list of factors FINRA
provided in the Notice to be included in
the rule text.161 The other commenter
suggested that a registered person be
‘‘required to disclose to a customer, in
writing, that such arrangements are
presumptively prohibited and to
document the exception under which
the lending arrangement falls’’ and that
member firms should be required to
consult with the customer before
approving a borrowing or lending
arrangement to ensure the customer
receives a full and fair disclosure about
the terms of the arrangement.162 In
addition, this second commenter
recommended that the proposed rule
change require member firms that allow
registered persons to enter lending
arrangements with their customers to
collateralize any such loans that such
member firms approve.163
In response, FINRA stated that FINRA
Rule 3110 (Supervision) requires each
member firm to ‘‘establish and maintain
a system to supervise the activities of
each associated person that is
reasonably designed to achieve
compliance with applicable securities
laws and regulations, and with
applicable FINRA rules.’’ FINRA stated
that member firms could consider
incorporating the commenter’s
suggested supervisory and disclosure
requirements into their systems for
supervising for compliance with Rule
3240, but FINRA is not requiring them
here.164 FINRA did not include the list
159 See id. at 6 (stating that an interview would
help ensure the borrowing or lending arrangement
does not put the customer at risk of undue
influence).
160 Id. at 6 (stating that heightened supervision
would guard against the conflicts of interest that
come with these relationships, and that an
enhanced review of trades and transactions in the
account should at least be required when the
customer is elderly or otherwise vulnerable to
exploitation).
161 See NASAA at 5.
162 See Malecki at 7.
163 See id. at 2–3 (stating that other than
prohibiting borrowing and lending arrangements,
the only way to ensure that a customer is not
harmed is to require member firms to have ‘‘‘skin’
in such arrangements.’’).
164 See FINRA Comment Response at 12. FINRA
also stated that the non-exhaustive list of factors
FINRA expects members to consider address ‘‘many
of the commenters’ concerns,’’ including
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77557
of factors in the rule text, explaining
that given the flexibility firms have to
develop their own supervisory systems
under Rule 3110, ‘‘it is not necessary or
appropriate to prescribe specific
supervisory procedures in Rule
3240.’’ 165 FINRA did, however,
highlight guidance regarding ‘‘the
minimum that should be included in
written supervisory procedures,
including: (1) the specific identification
of the individual(s) responsible for
supervision; (2) the supervisory steps
and reviews to be taken by the
appropriate supervisor; (3) the
frequency of such reviews; and (4) how
such reviews shall be documented.’’ 166
With respect to the suggestion that the
terms of the arrangement should be
discussed with, and disclosed to, the
customer, FINRA reiterated that it
expects a member to consider the
reasonable assessment factors noted
earlier—several of which pertain to the
terms of the arrangement and the nature
of the parties—and to try to discuss the
arrangement with the customer.167
FINRA also stated that regardless of the
terms of a member firm’s supervisory
system, Rule 3110 requires member
firms to follow-up on red flags related
to borrowing or lending arrangements
between registered persons and their
customers.168
Requiring a member firm, after
receiving written notice under Rule
3240, to perform a reasonable
assessment of the risks created by the
borrowing or lending arrangement with
consideration of: (1) any potential conflicts of
interest in the registered person being in a
borrowing or lending arrangement with a customer;
(2) the material terms of the borrowing or lending
arrangement; (3) the customer’s or the registered
person’s ability to repay the loan; (4) the customer’s
age; (5) whether, based on the facts and
circumstances observed in the member’s business
relationship with the customer, the customer has a
mental or physical impairment that renders the
customer unable to protect his or her own interests;
and (6) any indicia of customer vulnerability or
undue influence of the registered person over the
customer. See id. at 13. FINRA further stated that
those factors along with the guidance in FINRA
Regulatory Notice 21–43 (Dec. 2021) would ‘‘help
members evaluate the key risks and conflicts while
giving members appropriate flexibility in evaluating
which factors may apply to a particular situation.’’
See id. at 14.
165 FINRA Comment Response at 12–13 (stating
that ‘‘FINRA rules concerning duties, conflicts and
responsibilities related to associated persons
generally do not set forth specific supervisory
procedures that member firms must adopt to satisfy
the requirements of FINRA’s supervision rule. See
generally Rule 2000 Series (Duties and Conflicts;
Rule 3000 Series (Supervision and Responsibilities
Related to Associated Persons)’’).
166 Id. at 12 (referencing guidance from Notice to
Members 98–96 and Notice to Members 99–45
regarding tailoring the supervisory system to the
member firm’s business).
167 See id. at 14.
168 See id. at 12–13.
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a customer and, based on that
assessment, to make a reasonable
determination of whether to approve the
borrowing or lending arrangement, is
reasonably designed to protect
investors. Whether a specific borrowing
or lending arrangement creates the
potential for a conflict or other abuse
that could harm an investor requires
analysis of the facts and circumstances.
Because of its supervisory obligations, a
broker-dealer is both obligated and best
positioned to analyze the facts and
circumstances related to a borrowing or
lending arrangements between one of its
registered persons and a customer. In
addition, consistent with the flexibility
firms have to develop their own
supervisory systems under Rule 3110,
the member firm is also best positioned
to determine reasonable controls to
supervise for compliance with the
proposed rule change based on its
assessment of the risks involved with a
borrowing or lending arrangement that
falls within one of the five exceptions to
Rule 3240. While not required,
reasonably designed controls could
include the supervisory, disclosure or
other requirements suggested by
commenters (such as providing
disclosure, collateralizing loans between
one of its registered persons and a
customer, interviewing customers, and
applying heightened scrutiny as it
perceives higher risks). As such, the
proposed rule change represents an
important safeguard for protecting
investors from conflicts or other abuses
that could harm them in such
arrangements. Moreover, in exercising
its supervisory obligations under FINRA
Rule 3110, a member firm may always
choose to prohibit or restrict borrowing
and lending arrangements as it sees fit
and in light of the risks presented by an
arrangement. For example, if the brokerdealer determines that the risks to the
customer of lending money to a
registered person cannot be effectively
managed, the proposed rule change
would allow the firm to disapprove or
further restrict the arrangement. For
these reasons, the proposed rule change
is reasonably designed to prevent
fraudulent and manipulative acts and
practices, to promote just and equitable
principles of trade, and, in general, to
protect investors and the public interest.
IV. Conclusion
For the reasons set forth above, the
Commission finds that the proposed
rule change is consistent with Section
15A(b)(6) of the Exchange Act, which
requires, among other things, that
FINRA rules be designed to prevent
fraudulent and manipulative acts and
practices, promote just and equitable
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principles of trade, and, in general,
protect investors and the public
interest.169
It is therefore ordered pursuant to
Section 19(b)(2) of the Exchange Act 170
that the proposal (SR–FINRA–2024–
001), be and hereby is approved.
For the Commission, by the Division of
Trading and Markets, pursuant to delegated
authority.171
Sherry R. Haywood,
Assistant Secretary.
[FR Doc. 2024–21622 Filed 9–20–24; 8:45 am]
BILLING CODE 8011–01–P
SECURITIES AND EXCHANGE
COMMISSION
[Release No. 34–101064; File No. SR–
FINRA–2024–014]
Self-Regulatory Organizations;
Financial Industry Regulatory
Authority, Inc.; Notice of Filing and
Immediate Effectiveness of a Proposed
Rule Change To Amend FINRA Rule
6897(b) (CAT Cost Recovery Fees) To
Implement a Historical Consolidated
Audit Trail Recovery Assessment
September 17, 2024.
Pursuant to Section 19(b)(1) of the
Securities Exchange Act of 1934
(‘‘Act’’) 1 and Rule 19b–4 thereunder,2
notice is hereby given that on
September 5, 2024, the Financial
Industry Regulatory Authority, Inc.
(‘‘FINRA’’) filed with the Securities and
Exchange Commission (‘‘SEC’’ or
‘‘Commission’’) the proposed rule
change as described in Items I and II
below, which Items have been prepared
by FINRA. FINRA has designated the
proposed rule change as ‘‘establishing or
changing a due, fee or other charge’’
under Section 19(b)(3)(A)(ii) of the Act 3
and Rule 19b–4(f)(2) thereunder,4 which
renders the proposal effective upon
receipt of this filing by the Commission.
The Commission is publishing this
notice to solicit comments on the
proposed rule change from interested
persons.
I. Self-Regulatory Organization’s
Statement of the Terms of Substance of
the Proposed Rule Change
FINRA is proposing to amend FINRA
Rule 6897(b) (CAT Cost Recovery Fees)
to implement a historical Consolidated
Audit Trail (‘‘CAT’’) recovery
169 15
U.S.C. 78o–3(b)(6).
U.S.C. 78s(b)(2).
171 17 CFR 200.30–3(a)(12).
1 15 U.S.C. 78s(b)(1).
2 17 CFR 240.19b–4.
3 15 U.S.C. 78s(b)(3)(A)(ii).
4 17 CFR 240.19b–4(f)(2).
170 15
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assessment designed to permit FINRA to
recoup its contributions to recoverable
historical costs of the National Market
System Plan Governing the
Consolidated Audit Trail incurred prior
to January 1, 2022.5
The text of the proposed rule change
is available on FINRA’s website at
https://www.finra.org, at the principal
office of FINRA and at the
Commission’s Public Reference Room.
II. Self-Regulatory Organization’s
Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule
Change
In its filing with the Commission,
FINRA included statements concerning
the purpose of and basis for the
proposed rule change and discussed any
comments it received on the proposed
rule change. The text of these statements
may be examined at the places specified
in Item IV below. FINRA has prepared
summaries, set forth in sections A, B,
and C below, of the most significant
aspects of such statements.
A. Self-Regulatory Organization’s
Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule
Change
1. Purpose
Background
On July 11, 2012, the Commission
adopted Rule 613 of Regulation NMS,
which required the self-regulatory
organizations to submit a national
market system (‘‘NMS’’) plan to create,
implement and maintain a consolidated
audit trail that would capture customer
and order event information for orders
in NMS securities across all markets,
from the time of order inception through
routing, cancellation, modification, or
execution.6 On November 15, 2016, the
Commission approved the CAT NMS
Plan (‘‘Plan’’ or ‘‘CAT NMS Plan’’).7
Under the CAT NMS Plan, the
Operating Committee has the discretion
to establish funding for Consolidated
Audit Trail, LLC (‘‘CAT LLC’’) to
operate the CAT, including establishing
fees for Industry Members to be assessed
by CAT LLC that would be implemented
5 Pursuant to Section 11.3(b) of the CAT NMS
Plan, FINRA filed a separate proposed rule change
to establish fees assessed to Industry Members,
payable to Consolidated Audit Trail, LLC, related to
recoverable historical CAT costs incurred prior to
January 1, 2022. See File No. SR–FINRA–2024–013.
Unless otherwise specified, capitalized terms used
in this rule filing are defined as set forth in the CAT
NMS Plan and FINRA Rule 6800 Series
(Consolidated Audit Trail Compliance Rule).
6 See Securities Exchange Act Release No. 67457
(July 18, 2012), 77 FR 45722 (August 1, 2012).
7 See Securities Exchange Act Release No. 79318
(November 15, 2016), 81 FR 84696 (November 23,
2016) (‘‘CAT NMS Plan Approval Order’’).
E:\FR\FM\23SEN1.SGM
23SEN1
]]>Agencies
[Federal Register Volume 89, Number 184 (Monday, September 23, 2024)]
[Notices]
[Pages 77547-77558]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2024-21622]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-101065; File No. SR-FINRA-2024-001]
Self-Regulatory Organizations; Financial Industry Regulatory
Authority, Inc.; Order Approving a Proposed Rule Change To Amend FINRA
Rule 3240 (Borrowing From or Lending to Customers) To Strengthen the
General Prohibition Against Borrowing and Lending Arrangements
September 17, 2024.
I. Introduction
On January 2, 2024, the Financial Industry Regulatory Authority,
Inc. (``FINRA'') filed with the Securities and Exchange Commission
(``SEC'' or ``Commission''), pursuant to Section 19(b)(1) of the
Securities Exchange Act of 1934 (``Act'') \1\ and Rule 19b-4
thereunder,\2\ a proposed rule change (SR-FINRA-2024-001) to amend
FINRA Rule 3240 (Borrowing From or Lending to Customers).\3\ As stated
in the Notice, the proposed rule change would strengthen the general
prohibition against borrowing and lending arrangements, narrow some of
the existing exceptions to that general prohibition, amend the
immediate family exception,\4\ and enhance the requirements for
notifying and obtaining member firms' approval of such arrangements.\5\
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ See Exchange Act Release No. 99351 (Jan. 16, 2024), 89 FR
3968 (Jan. 22, 2024) (File No. SR-FINRA-2024-001) (``Notice''),
https://www.govinfo.gov/content/pkg/FR-2024-01-22/pdf/2024-01068.pdf.
\4\ See infra note 28 and accompanying text.
\5\ See Notice.
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The proposed rule change was published for public comment in the
Federal Register on January 22, 2024.\6\ The public comment period
closed on February 12, 2024. The Commission received comment letters
related to this filing.\7\ On February 21, 2024, FINRA consented to an
extension of the time period in which the Commission must approve the
proposed rule change, disapprove the proposed rule change, or institute
proceedings to determine whether to approve or disapprove the proposed
rule change to April 19, 2024.\8\
[[Page 77548]]
On April 18, 2024, the Commission published an order instituting
proceedings to determine whether to approve or disapprove the proposed
rule change.\9\ On April 26, 2024, FINRA responded to the comment
letters received in response to the Notice.\10\ On July 15, 2024, FINRA
consented to an extension of the time period in which the Commission
must approve or disapprove the proposed rule change to September 18,
2024.\11\ This order approves the proposed rule change.
---------------------------------------------------------------------------
\6\ Id.
\7\ The comment letters are available at https://www.sec.gov/comments/sr-finra-2024-001/srfinra2024001.htm.
\8\ See letter from Ilana Reid, Associate General Counsel,
FINRA, to Daniel Fisher, Branch Chief, Division of Trading and
Markets, Commission, filed with the Commission on February 21, 2024.
This letter is available at https://www.finra.org/sites/default/files/2024-02/SR-FINRA-2024-001-Extension1.pdf.
\9\ See Exchange Act Release No. 99988 (Apr. 18, 2024), 89 FR
31242 (Apr. 24, 2024) (File No. SR-FINRA-2024-001) (``Order
Instituting Proceedings'').
\10\ See letter from Ilana Reid, Associate General Counsel,
Office of General Counsel, FINRA, dated April 26, 2024, https://www.sec.gov/comments/sr-finra-2024-001/srfinra2024001-463852-1226394.pdf (``FINRA Comment Response'').
\11\ See letter from Ilana Reid, Associate General Counsel,
Office of General Counsel, FINRA, to Dan Fisher, Division of Trading
and Markets, Commission, dated July 15, 2024, https://www.finra.org/sites/default/files/2024-07/SR-FINRA-2024-001-Extension2.pdf.
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II. Description of the Proposed Rule Change
A. Background
FINRA Rule 3240 generally prohibits, with exceptions, registered
persons from borrowing money from, or lending money to, their
customers. The rule has five tailored exceptions,\12\ available only
when the registered person's member firm has written procedures
allowing the borrowing and lending of money between such registered
persons and customers of the member firm,\13\ the borrowing or lending
arrangements meet the conditions applicable to the relevant exception
\14\ and, when required, the registered person notifies the member firm
prior to entering into a borrowing or lending arrangement and obtains
the member firm's pre-approval in writing.\15\
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\12\ See Rule 3240(a)(2)(A) (the ``immediate family
exception''); Rule 3240(a)(2)(B) (the ``financial institution
exception''); Rule 3240(a)(2)(C) (the ``registered person
exception''); Rule 3240(a)(2)(D) (the ``personal relationship
exception''); Rule 3240(a)(2)(E) (the ``business relationship
exception'').
\13\ See Rule 3240(a)(1).
\14\ See Rule 3240(a)(2).
\15\ See Rules 3240(a)(3) and 3240(b).
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B. Proposed Rule Change
1. The General Prohibition on Borrowing From or Lending to Customers
The proposed rule change would amend the title of FINRA Rule 3240
from ``Borrowing From or Lending to Customers'' to ``Prohibition on
Borrowing From or Lending to Customers,'' and change the title of Rule
3240(a) from ``Permissible Lending Arrangements; Conditions'' to
``General Prohibition; Permissible Borrowing or Lending Arrangements;
Conditions.'' \16\ FINRA stated that the proposed rule change would
make the regulatory purpose more prominent by emphasizing that the rule
is ``first and foremost'' a general prohibition against borrowing or
lending arrangements between registered persons and their customers (a
``broker-customer relationship'').\17\
---------------------------------------------------------------------------
\16\ Proposed Rule 3240 and proposed Rule 3240(a).
\17\ See Notice at 3969.
---------------------------------------------------------------------------
The proposed rule change would also make substantive changes to
FINRA Rule 3240 to extend the application of the rule to: (1) borrowing
or lending arrangements that pre-exist the initiation of a broker-
customer relationship; \18\ (2) borrowing or lending arrangements
entered into within six months after a broker-customer relationship
ends by defining a ``customer'' to include ``any customer that has, or
in the previous six months had, a securities account assigned to the
registered person at any member;'' \19\ (3) indirect borrowing or
lending arrangements with related parties of the registered person or
customer; \20\ and (4) owner-financing arrangements.\21\ The Commission
describes each aspect of the proposed rule changes in turn.
---------------------------------------------------------------------------
\18\ Proposed Rule 3240(a).
\19\ Proposed Rule 3240.02.
\20\ Proposed Rule 3240.05.
\21\ Proposed Rule 3240.03.
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a. Pre-Existing Borrowing and Lending Arrangements
Currently, Rule 3240(a) states ``[n]o person associated with a
member in any registered capacity may borrow money from or lend money
to any customer of such person. . . .'' The proposed rule change would
amend Rule 3240(a) to extend the rule's general requirements concerning
borrowing and lending arrangements--including the general prohibition--
to borrowing and lending arrangements that pre-exist a new broker-
customer relationship.\22\ Specifically, the proposed rule change would
amend Rule 3240(a) to prohibit registered persons from initiating a
broker-customer relationship with a person with whom the registered
person has an existing borrowing or lending arrangement unless the
conditions of the proposed rule are met.\23\
---------------------------------------------------------------------------
\22\ See Notice at 3969.
\23\ Proposed Rule 3240(a).
---------------------------------------------------------------------------
b. Expansion of the Definition of Customer
The proposed rule change would similarly extend the application of
the rule to borrowing or lending arrangements entered into within six
months after a broker-customer relationship ends.\24\ Specifically, the
proposed rule change would add new FINRA Rule 3240.02 (Customer) to
define ``customer,'' for purposes of Rule 3240, as including ``any
customer that has, or in the previous six months had, a securities
account assigned to the registered person at any member.'' \25\
---------------------------------------------------------------------------
\24\ See Notice at 3969.
\25\ Proposed Rule 3240.02.
---------------------------------------------------------------------------
c. Borrowing and Lending Arrangements With Related Parties of the
Registered Person or Customer
The proposed rule change would add new FINRA Rule 3240.05
(Arrangements with Persons Related to Either the Registered Person or
the Customer) to extend Rule 3240 to indirect borrowing or lending
arrangements involving related parties of the customer or registered
person. Specifically, the proposed rule change would provide that a
registered person instructing or asking a customer to enter into a
borrowing or lending arrangement with a person related to the
registered person (e.g., the registered person's immediate family
member or outside business) or to have a person related to the customer
(e.g., the customer's immediate family member or business) enter into a
borrowing or lending arrangement with the registered person would
present similar conflict of interest concerns as borrowing or lending
arrangements directly between the registered person and the
customer.\26\ Accordingly, the proposed rule change would expressly
state that such arrangements would not be consistent with Rule 3240
unless the conditions set forth in Rule 3240 are satisfied.\27\ FINRA
stated that the proposed rule change would address the potential for
customer abuse that arises in these more indirect borrowing and lending
arrangements.\28\
---------------------------------------------------------------------------
\26\ Proposed Rule 3240.05.
\27\ Id.
\28\ Notice at 3969.
---------------------------------------------------------------------------
d. Owner-Financing Arrangements
The proposed rule change would add Rule 3240.03 (Owner-Financing
Arrangements) to expressly state that, for purposes of Rule 3240,
borrowing or lending arrangements include owner-financing
arrangements.\29\ For example, Rule 3240 would apply to situations
[[Page 77549]]
where a registered person purchases real estate from their customer,
the customer agrees to finance the purchase, and the registered person
provides a promissory note for the entire purchase price or arranges to
pay in installments.\30\ Accordingly, such owner-financing arrangements
would not be consistent with Rule 3240 unless the conditions set forth
in Rule 3240 are satisfied.
---------------------------------------------------------------------------
\29\ Proposed Rule 3240.03.
\30\ See Notice at 3969.
---------------------------------------------------------------------------
2. The ``Immediate Family'' Definition
Currently, Rule 3240 has an exception from the general prohibition
for borrowing or lending arrangements with a customer who is a member
of the registered person's immediate family.\31\ Rule 3240(c) defines
``immediate family'' to mean ``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.'' \32\
---------------------------------------------------------------------------
\31\ See Rule 3240(a)(2)(A).
\32\ Rule 3240(c).
---------------------------------------------------------------------------
FINRA stated that, in order to ``modernize'' the ``immediate
family'' definition,\33\ the proposed rule change would amend the
definition to make it consistent with the definition in FINRA Rule
3241,\34\ which addresses similar potential conflicts of interest to
Rule 3240.\35\ Specifically, the proposed rule change would amend Rule
3240(c) to replace ``husband or wife'' with ``spouse or domestic
partner'' and include ``step and adoptive relationships.'' \36\ In
addition, the proposed rule change would amend the ``any other person''
clause to limit it to ``any other person who resides in the same
household as the registered person'' and who the registered person
``financially supports, directly or indirectly, to a material extent.''
\37\
---------------------------------------------------------------------------
\33\ See Notice at 3970; see also FINRA Rule 3241.
\34\ See Notice at 3970.
\35\ See Notice at 3977. FINRA Rule 3241 governs registered
persons who are named a customer's beneficiary or hold a position of
trust for a customer. FINRA Rule 3241 and FINRA Rule 3240 are both
designed to prevent harm to customers due to registered persons
being in a position of power and responsibility in their lives. See
Notice at 3977 n.56.
\36\ Proposed Rule 3240(c).
\37\ Id.
---------------------------------------------------------------------------
3. The Close Personal Relationship and Business Relationship Exceptions
Currently, Rule 3240 has an exception from the general prohibition
for borrowing or lending arrangements 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 registered person
not maintained a relationship outside of the broker-customer
relationship'' (the ``personal relationship exception'').\38\
Similarly, the rule's general prohibition currently does not apply to
borrowing or lending arrangements based on a ``business relationship
outside of the broker-customer relationship'' (the ``business
relationship exception'').\39\
---------------------------------------------------------------------------
\38\ Rule 3240(a)(2)(D).
\39\ Rule 3240(a)(2)(E).
---------------------------------------------------------------------------
The proposed rule change would narrow the personal relationship
exception to apply only to personal relationships that are ``bona
fide'' and ``close,'' and maintained outside of, and formed prior to,
the broker-customer relationship.\40\ The proposed rule change would
also narrow the business relationship exception to borrowing and
lending arrangements that are based on a ``bona fide business
relationship'' maintained outside of the broker-customer
relationship.\41\
---------------------------------------------------------------------------
\40\ Proposed Rule 3240(a)(2)(D).
\41\ Proposed Rule 3240(a)(2)(E).
---------------------------------------------------------------------------
In addition to narrowing the personal relationship and business
relationship exceptions, the proposed rule change would add new Rule
3240.04 (Close Personal Relationships; Business Relationships), which
would provide a list of non-exhaustive factors \42\ to help firms
evaluate whether a borrowing or lending arrangement is based on a bona
fide close personal relationship or a bona fide business relationship.
The non-exhaustive factors in proposed Rule 3240.04 are: ``when the
relationship began, its duration and nature, and any facts suggesting
that the relationship is not bona fide or was formed with the purpose
of circumventing the purpose of Rule 3240.'' \43\ Proposed Rule 3240.04
would also provide examples of ``close personal relationships,''
including, ``a childhood or long-term friend or a godparent, and other
similarly close personal relationships.'' \44\ Additionally, proposed
Rule 3240.04 would provide an example of a ``business relationship'' to
include ``a loan from a registered person to a small outside business
that the registered person co-owned for years for the sole purpose of
providing the business with additional operating capital.'' \45\
---------------------------------------------------------------------------
\42\ See infra Section II.B.4.e.
\43\ Proposed Rule 3240.04.
\44\ Id.
\45\ Id.
---------------------------------------------------------------------------
FINRA stated that the proposed rule change would ``help establish
the scope of the close personal relationship and business relationship
exceptions, focus on the most relevant factors when evaluating whether
a close personal relationship or business relationship exists, and
ensure that members consider meaningfully the potential issues involved
in the proposed arrangement.'' \46\
---------------------------------------------------------------------------
\46\ See Notice at 3970.
---------------------------------------------------------------------------
4. Notification and Approval Requirements
Currently, Rule 3240(b) requires notification and approval for
certain of the excepted borrowing or lending arrangements.\47\
Generally, the exceptions for borrowing or lending arrangements
involving personal relationships, business relationships, and
registered persons require member firm notification and approval. In
contrast, the exceptions for borrowing or lending arrangements with
immediate family members and financial institutions do not require
member firm notification and approval. The proposed rule change would
make the following changes to the notification and approval
requirements.
---------------------------------------------------------------------------
\47\ Id.
---------------------------------------------------------------------------
a. Approval Requirements for the Close Personal Relationship, Business
Relationship, and Registered Persons Exceptions
Current Rule 3240(b)(1)(A) provides that a registered person shall
notify the member firm of borrowing or lending arrangements made within
the personal relationship exception,\48\ business relationship
exception,\49\ or the registered persons exception \50\ prior to
entering into such arrangements, and that the member firm shall pre-
approve in writing such arrangements.\51\ The proposed rule change
would amend Rule 3240(b)(1) to make clear that, while registered
persons cannot proceed with such arrangements without their member
firm's prior approval, the member firm is not required to approve the
arrangement.\52\ Specifically, the proposed rule change would delete
the ``shall pre-approve'' language and instead require the registered
person to provide notice ``prior to entering into such arrangements''
or ``prior to the modification of such arrangements'' and ``obtain the
member's approval.'' \53\
---------------------------------------------------------------------------
\48\ Rule 3240(a)(2)(D).
\49\ Rule 3240(a)(2)(E).
\50\ Rule 3240(a)(2)(C).
\51\ Rule 3240(b)(1)(A).
\52\ See Notice at 3970.
\53\ See proposed Rule 3240(b)(1)(A).
---------------------------------------------------------------------------
Further, the proposed rule change would amend the notification and
approval requirements in Rule 3240(b)(1) to cover borrowing or lending
arrangements that pre-exist the broker-
[[Page 77550]]
customer relationship. Specifically, proposed Rule 3240(b)(1)(B) would
require registered persons, prior to the initiation of a broker-
customer relationship at the member firm with a person with whom the
registered person has an existing borrowing or lending arrangement, to
notify the member firm in writing of any existing borrowing or lending
arrangements within the close personal relationship, business
relationship, and registered persons exceptions and obtain the member
firm's approval in writing of the broker-customer relationship.\54\
---------------------------------------------------------------------------
\54\ See proposed Rule 3240(b)(1)(B).
---------------------------------------------------------------------------
b. Notification and Approval Requirements for the Immediate Family
Member Exception
Current Rule 3240(b)(2) provides, in pertinent part, that a member
firm's written procedures may indicate that registered persons are not
required to notify the member firm or receive member firm approval of
borrowing or lending arrangements within the immediate family
exception.\55\ The proposed rule change would amend Rule 3240(b)(2) to
apply the same approach to borrowing or lending arrangements within the
immediate family exception that pre-exist the broker-customer
relationship.\56\ Specifically, the proposed rule change would amend
Rule 3240(b)(2) to provide that the member firm's procedures may
indicate that registered persons are not required to notify the member
firm or receive member firm approval of such arrangements either prior
to or subsequent to initiating a broker-customer relationship.\57\
FINRA stated, however, that Rule 3240(b)(2) implies that member firms
may choose to require such notice and approval of those
arrangements.\58\
---------------------------------------------------------------------------
\55\ Rule 3240(b)(2).
\56\ See Notice at 3971.
\57\ See proposed Rule 3240(b)(2).
\58\ See Notice at 3971 n.21.
---------------------------------------------------------------------------
c. Notification and Approval Requirements for the Financial Institution
Exception
Current Rule 3240(b)(3) provides, in pertinent part, that a member
firm's written procedures may indicate that registered persons are not
required to notify the member firm or receive the member firm's
approval of borrowing or lending arrangements within the financial
institution exception,\59\ 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.'' \60\ The proposed rule change would amend Rule
3240(b)(3) to also cover borrowing or lending arrangements within the
financial institution exception that pre-exist the broker-customer
relationship.\61\ Specifically, the proposed rule change would amend
Rule 3240(b)(3) to provide that the member firm's written procedures
may also indicate that registered persons are not required to notify
the member firm or receive the member firm's approval of borrowing or
lending arrangements within the financial institution exception entered
into either prior to or subsequent to initiating a broker-customer
relationship, 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.\62\
FINRA stated, however, that Rule 3240(b)(3) implies that member firms
may choose to require such notice and approval of those
arrangements.\63\
---------------------------------------------------------------------------
\59\ The ``financial institution exception'' states that no
person associated with a member firm in any registered capacity may
borrow money from or lend money to any customer of such person,
unless 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. See Rule 3240(a)(2)(B).
\60\ See Rule 3240(b)(3).
\61\ See Notice at 3971.
\62\ See proposed Rule 3240(b)(3).
\63\ See Notice at 3971 n.21.
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d. Notifications in Writing and Record Retention
Currently, Rule 3240 does not require that registered persons who
must notify their member firms of borrowing and lending arrangements to
do so in writing.\64\ Furthermore, the current rule does not require
member firms to retain any notices of borrowing and lending
arrangements that they may receive from registered persons; it only
requires member firms to retain written approvals.\65\ The proposed
rule change would require registered persons to notify their member
firms in writing of those borrowing and lending arrangements under Rule
3240 that require notification and approval (i.e., the exceptions
involving registered persons, close personal relationships, and
business relationships).\66\
---------------------------------------------------------------------------
\64\ See id. at 3971.
\65\ Id.
\66\ Id.; see proposed Rules 3240(b)(1)(A) and (b)(1)(B) and
proposed Rule 3240.01.
---------------------------------------------------------------------------
The proposed rule change would also amend Rule 3240.01 to require
member firms to retain the written notifications and approvals records
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.\67\ The
proposed rule change would also require record retention of notices and
approvals related to the immediate family and financial institution
exceptions, unless the member firm's procedures indicate that
registered persons are not required to notify the member firm and/or
receive member firm approval.\68\
---------------------------------------------------------------------------
\67\ See proposed Rule 3240.01.
\68\ See Notice at 3971 n.21 (stating that ``Rule 3240.01 would
also be amended to provide that the record-retention requirements
are for purposes of Rule 3240(b), not just Rule 3240(b)(1). As
explained above, Rule 3240(b)(1) requires notice and approval of
arrangements that are within the personal relationship, business
relationship, and registered persons exceptions. While Rule
3240(b)(2) and (3) do not expressly require notice and approval of
arrangements within the immediate family member and financial
institution exceptions, those subparagraphs imply that members may
choose to require such notice and approval of those
arrangements.'').
---------------------------------------------------------------------------
e. Reasonable Assessment by Member of the Risks Created by the
Borrowing or Lending Arrangement
The proposed rule change also would add new Rule 3240.06
(Obligations of Member Receiving Notice). Proposed Rule 3240.06 would
require a member firm, upon receiving written notice under Rule 3240,
to ``perform a reasonable assessment of the risks created by the
borrowing or lending arrangement with a customer, modification to the
borrowing or lending arrangement with a customer, or existing borrowing
or lending arrangement with a person who seeks to be a customer of the
registered person.'' \69\ It would further provide that the member firm
make a ``reasonable determination of whether to approve the borrowing
or lending arrangement, modification to the borrowing or lending
arrangement, or, where there is an existing borrowing or lending
arrangement with a person who seeks to be a customer of the registered
person, the broker-customer relationship.'' \70\ In the Notice, FINRA
stated that a member firm's ``reasonable assessment'' should consider
several non-exhaustive factors, such as:
---------------------------------------------------------------------------
\69\ Proposed Rule 3240.06.
\70\ Id.
---------------------------------------------------------------------------
(1) any potential conflicts of interest in the registered person
being in a borrowing or lending arrangement with a customer;
(2) the length and type of relationship between the customer and
registered person;
[[Page 77551]]
(3) the material terms of the borrowing or lending arrangement;
(4) the customer's or the registered person's ability to repay the
loan;
(5) the customer's age;
(6) whether the registered person has been a party to other
borrowing or lending arrangements with customers;
(7) whether, based on the facts and circumstances observed in the
member's business relationship with the customer, the customer has a
mental or physical impairment that renders the customer unable to
protect his or her own interests;
(8) any disciplinary history or indicia of improper activity or
conduct with respect to the customer or the customer's account (e.g.,
excessive trading); and
(9) any indicia of customer vulnerability or undue influence of the
registered person over the customer.\71\
---------------------------------------------------------------------------
\71\ See Notice at 3971.
---------------------------------------------------------------------------
Moreover, the factors that a member firm considers ``should allow
for a reasonable assessment of the associated risks so that the member
can make a reasonable determination of whether to approve the borrowing
or lending arrangement, modification to the borrowing or lending
arrangement, or, where there is an existing borrowing or lending
arrangement with a person who seeks to be a customer of the registered
person, the broker-customer relationship.'' \72\ FINRA also stated in
the Notice that it ``would expect a member to try to discuss the
arrangement with the customer[,]'' as part of the member firm's
reasonable assessment of the risks.\73\
---------------------------------------------------------------------------
\72\ See id.
\73\ See id. at 3972.
---------------------------------------------------------------------------
III. Discussion and Commission Findings
After careful review of the proposed rule change and the comment
letters, and FINRA's response to comments, the Commission finds that
the proposed rule change is consistent with the requirements of the
Exchange Act and the rules and regulations thereunder that are
applicable to a national securities association.\74\ Specifically, as
explained in more detail below, the Commission finds that the proposed
rule change is consistent with Section 15A(b)(6) of the Exchange Act,
which requires, among other things, that FINRA rules be designed to
prevent fraudulent and manipulative acts and practices, to promote just
and equitable principles of trade, and, in general, to protect
investors and the public interest.\75\
---------------------------------------------------------------------------
\74\ In approving this rule change, the Commission has
considered the rule's impact on efficiency, competition, and capital
formation. See 15 U.S.C. 78c(f).
\75\ 15 U.S.C. 78o-3(b)(6).
---------------------------------------------------------------------------
The proposed rule change would strengthen the general prohibition
against borrowing and lending arrangements between registered persons
and their customers. Specifically, it would narrow the types of
permissible borrowing and lending arrangements by covering
relationships that pre-exist a new broker-customer relationship, as
well as borrowing or lending arrangements entered into within six
months after a broker-customer relationship ends. The proposed rule
change would also extend the application of the rule to indirect
borrowing and lending arrangements involving related parties of the
customer or registered person and to owner-financing arrangements. In
addition, the proposed rule change would modify the relationship
categories in the immediate family exception. Furthermore, it would
require borrowing and lending arrangements based on the close personal
relationship and business relationship exceptions be ``bona fide.'' It
also would require: registered persons to notify their member firms in
writing and obtain member firms' approval of certain borrowing and
lending arrangements; member firms to retain records of notices and
approvals; and member firms to conduct a reasonable assessment of the
risks associated with certain arrangements. Accordingly, and as
explained in more detail below, the Commission finds that the proposed
rule change is consistent with Section 15A(b)(6) of the Exchange Act.
The Commission addresses the proposed rule change's specific
provisions, and any related comments, in turn.
A. The General Prohibition on Borrowing From or Lending to Customers
FINRA is proposing to amend the title of FINRA Rule 3240 to
``Prohibition on Borrowing From or Lending to Customers,'' and change
the title of Rule 3240(a) to ``General Prohibition; Permissible
Borrowing or Lending Arrangements; Conditions.'' Commenters did not
specifically comment on this proposed rule change. By emphasizing that
FINRA Rule 3240 imposes a general prohibition on registered persons
borrowing from or lending to their customers, the proposed rule change
highlights the regulatory purpose of the rule to generally prohibit
borrowing and lending arrangements.
The proposed rule change would also make several substantive
changes to the general prohibition on borrowing from or lending to
customers, including extending the rule to cover borrowing and lending
arrangements that pre-exist the broker-customer relationship; extending
the rule's limitations to borrowing or lending arrangements entered
into within six months after a broker-customer relationship ends; and,
specifying that certain borrowing and lending arrangements are covered
by the general prohibition. The Commission addresses those changes
below.
1. Pre-Existing Borrowing and Lending Arrangements
The proposed rule change would amend Rule 3240(a) to provide that
the rule's general requirements concerning borrowing and lending
arrangements--including the general prohibition--apply to borrowing and
lending arrangements that pre-exist a new broker-customer relationship.
The proposed rule change would prohibit registered persons from
initiating a broker-customer relationship with a person with whom the
registered person has an existing borrowing or lending arrangement
unless the conditions of the proposed rule are met.\76\
---------------------------------------------------------------------------
\76\ See id. at 3969.
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Two commenters supported this change.\77\ One of these commenters
stated that conflicts of interest would exist in the relationship
irrespective of whether or not a borrowing or lending arrangement
existed before or after the broker-customer relationship is
established.\78\ Thus, the commenter noted, broadening and applying the
general prohibition to borrowing or lending arrangements that pre-exist
the broker-customer relationship will protect investors.\79\ Another
commenter supported covering borrowing or lending arrangements that
pre-exist broker-customer relationship to the extent the proposed rule
change would continue to permit any borrowing or lending
arrangements.\80\ To the extent
[[Page 77552]]
that any borrowing or lending arrangements are permitted, this
commenter called for strong safeguards to protect investors from
``predatory lending or undue influence in a broker-customer
relationship.'' \81\
---------------------------------------------------------------------------
\77\ See letter from William Jacobson, Clinical Professor of Law
and Director, Cornell Securities Law Clinic, dated February 12,
2024, at 2, https://www.sec.gov/comments/sr-finra-2024-001/srfinra2024001-428040-1059142.pdf (``CSLC'') (emphasizing that by
extending the prohibition to situations where financial arrangements
pre-date the formal establishment of a broker-customer relationship,
``the amendment aims to prevent potential conflicts of interest or
abuses.''); see also letter from Joseph C. Pfeiffer, President,
Public Investor Advocate Bar Association, dated February 12, 2024,
at 1, https://www.sec.gov/comments/sr-finra-2024-001/srfinra2024001-426619-1057382.pdf (``PIABA'').
\78\ PIABA at 1-2.
\79\ PIABA at 1.
\80\ See letter from Claire McHenry, President, North American
Securities Administrators Association, Inc., dated February 12,
2024, at 4, https://www.sec.gov/comments/sr-finra-2024-001/srfinra2024001-428019-1058522.pdf (``NASAA'').
\81\ See id. Specifically, two commenters who provided comments
on specific provisions of the proposed rule change stated a
preference for a broad prohibition on all borrowing and lending
arrangements. See NASAA at 3-4 (identifying a complete ban with no
exceptions as the most efficient and effective way to address ``the
serious conflicts inherent in such a relationship and the potential
for investor harm''); see also letter from Jenice Malecki,
Jacqueline Candela, and Adam Schreck of Malecki Law, dated February
12, 2024, at 1, https://www.sec.gov/comments/sr-finra-2024-001/srfinra2024001-428039-1058683.pdf (``Malecki'') (stating that
``lending arrangements between registered representatives and their
customers should be strictly prohibited. Transactions amongst
registered representatives and customers inherently involve parties
negotiating from disparate bargaining positions.''). In response,
FINRA stated that it considered prohibiting all such arrangements
but rejected the approach because such arrangements may be mutually
beneficial to the contracting parties. See FINRA Comment Response at
1-2. FINRA stated also that the proposed rule change would
strengthen the general prohibition against such arrangements by
extending the scope of arrangements to which the rule would apply
and by narrowing some exceptions. See FINRA Comment Response at 4.
In addition, FINRA stated that the proposed rule change would
strengthen the notice and approval requirements, as discussed more
fully below. See id. As discussed herein, FINRA Rule 3240 generally
prohibits registered persons from borrowing money from, or lending
money to, their customers but permits such arrangements under
limited circumstances designed to minimize the impact of conflicts
of interest. The proposed rule change would strengthen the general
prohibition against borrowing and lending arrangements between
registered persons and their customers. Accordingly, for the reasons
discussed in detail below, we find that the proposed rule change is
consistent with the public interest and the protection of investors.
---------------------------------------------------------------------------
FINRA stated that the proposed rule change would strengthen the
general prohibition against borrowing and lending arrangements by
extending the scope of arrangements to which the rule would apply to
pre-existing arrangements.\82\ In addition, FINRA stated that the
proposed rule change would strengthen the notice and approval
requirements by, among other things, requiring member firms, upon
receiving notice under the proposed rule, to conduct a reasonable
assessments of the risks created by a borrowing or lending arrangement
and make a reasonable determination of whether to approve it, as
described more fully below.\83\
---------------------------------------------------------------------------
\82\ See FINRA Comment Response at 4.
\83\ Id.
---------------------------------------------------------------------------
The proposed rule change reasonably extends the general prohibition
against borrowing and lending arrangements to cover borrowing or
lending arrangements that pre-exist a new broker-customer relationship.
By extending this general prohibition to such arrangements, the
proposed rule change reasonably extends the scope of the rule while
preserving the opportunity for parties to enter into such arrangements
in limited circumstances and subject to procedural protections (as
discussed below) designed to minimize the impact of the potential
conflict. For these reasons, the proposed rule change is reasonably
designed to prevent fraudulent and manipulative acts and practices, to
promote just and equitable principles of trade, and, in general, to
protect investors and the public interest.
2. Expansion of the Definition of Customer
The proposed rule change would add new FINRA Rule 3240.02
(Customer) to define ``customer,'' for purposes of Rule 3240, to
include any customer who has, or in the previous six months had, a
securities account assigned to the registered person at any member
firm. FINRA stated that the proposed rule change would extend the
rule's limitations to borrowing or lending arrangements entered into
within six months after a broker-customer relationship terminates.\84\
---------------------------------------------------------------------------
\84\ See Notice at 3969.
---------------------------------------------------------------------------
One commenter supported this proposed extension of the rule's
limitations to borrowing or lending arrangements, but favored extending
the covered time period to one year as a stronger anti-evasion measure
instead of the proposed six months.\85\ The commenter stated that a
one-year ``lookback'' time period would curtail attempts to evade this
rule and therefore ``enhance investor protection to a greater degree
than the proposed six month time period.'' \86\ The commenter further
stated that FINRA Rule 4111 (Restricted Firm Obligations) uses a one-
year ``lookback'' time period.\87\
---------------------------------------------------------------------------
\85\ PIABA at 2.
\86\ Id.
\87\ Id.
---------------------------------------------------------------------------
In response, FINRA stated that it proposed to align the new Rule
3240 time period with the six-month time period in the definition of
``customer'' in Rule 3241, because Rule 3241 addresses similar
potential conflicts of interest,\88\ whereas Rule 4111's one-year
``lookback'' time period relates to the identification of firms with a
significant history of misconduct.\89\ FINRA stated that there are
costs associated with extending the general prohibition after the
broker-customer relationship ends.\90\ Such costs relate to evaluating
and making reasonable determinations on a host of arrangements about
which the member firm was not previously notified, as well as costs
associated with continued monitoring for prohibited borrowing and
lending arrangements with every customer who transfers an account away
from the member firms' registered persons.\91\ FINRA stated also that
the six-month time period ``strikes an appropriate balance between
achieving the regulatory objective of addressing circumvention of the
proposed rule change and imposing requirements that are reasonable and
appropriate, including reasonable requirements on member firms in
tracking transfers of customers' accounts.'' \92\
---------------------------------------------------------------------------
\88\ See FINRA Comment Response at 14. Rule 3241.01 defines
``customer'' as ``any customer that has, or in the previous six
months had, a securities account assigned to the registered person
at any member.'' FINRA Rule 3241 governs registered persons who are
named a customer's beneficiary or hold a position of trust for a
customer. FINRA Rule 3241 and FINRA Rule 3240 are both designed to
prevent harm to customers due to registered persons being in a
position of power and responsibility in their lives. See Notice 3977
n.56.
\89\ See FINRA Comment Response at 14. FINRA Rule 4111 addresses
risks from broker-dealers with a significant history of misconduct,
including firms with a high concentration of individuals with a
significant history of misconduct (``Restricted Firms''). For
purposes of calculating concentration, the rule covers persons
registered with the member firm for one or more days within the one
year prior to the date of the annual calculation used for
determining Restricted Firm status. See Regulatory Notice 21-34
(Sep. 28, 2021), https://www.finra.org/rules-guidance/notices/21-34.
\90\ See FINRA Comment Response at 15.
\91\ See id.
\92\ See id. at 14 (citing FINRA Regulatory Notice 20-38 (Oct.
2020)).
---------------------------------------------------------------------------
The proposed rule change reasonably extends the rule's coverage to
borrowing and lending arrangements involving customers who in the
previous six months had a securities account assigned to a registered
person. As a result, the proposed rule change protects investors by
broadening the scope of customer relationships covered by the rule's
general prohibition and limited exceptions. Further, the six-month
limit on how long a broker-dealer must monitor terminated customer
accounts reasonably balances the benefits of the rule's protections
with the burden of complying with the rule's requirements for an
extended period after the termination of the broker-customer
relationship. For these reasons, the proposed rule change is reasonably
designed to prevent fraudulent and manipulative acts and practices, to
promote just and equitable principles of trade, and, in general, to
protect investors and the public interest.
[[Page 77553]]
3. Borrowing and Lending Arrangements With Related Parties of the
Registered Person or Customer
The proposed rule change would extend the rule's general
prohibition to borrowing or lending arrangements with related parties
of the customer or registered person that involve conflicts similar to
those presented by borrowing or lending arrangements directly between
registered persons and their customers. Specifically, proposed new
FINRA Rule 3240.05 would provide that a registered person instructing
or asking a customer to enter into a borrowing or lending arrangement
with a person related to the registered person or to have a person
related to the customer enter into a borrowing or lending arrangement
with the registered person would present similar conflict of interest
concerns as borrowing or lending arrangements between the registered
person and the customer and would be inconsistent with Rule 3240 unless
the conditions set forth in Rule 3240(a) are satisfied. FINRA stated
that the proposed rule change would address the potential for customer
abuse that arises when a registered person: (1) ``induces a customer to
enter into a borrowing or lending arrangement with a person or entity
related to the registered person'' or (2) ``induces a customer to have
a person or entity related to the customer enter into an arrangement
with the registered person.'' \93\
---------------------------------------------------------------------------
\93\ Notice at 3969.
---------------------------------------------------------------------------
Two commenters supported the proposed rule change.\94\ One stated
that it is a ``good idea'' because ``[t]he same or very similar
conflict of interest is present if a registered representative's close
family member obtains a loan from a registered representative's client
just as if the registered representative obtained it themselves.'' \95\
The other commenter stated that the proposed rule change would close
``potential loopholes'' and safeguard against abuses that may occur
``when a registered person induces a customer to enter into financial
arrangements with related individuals.'' \96\
---------------------------------------------------------------------------
\94\ See CSLC; PIABA.
\95\ PIABA at 2.
\96\ CSLC at 2.
---------------------------------------------------------------------------
The proposed addition of FINRA Rule 3240.05 reasonably extends the
rule to cover indirect borrowing or lending arrangements involving
parties related to either the registered person or the customer, and
thus prevents a registered person from evading the restrictions of Rule
3240. As such, the proposed rule change appropriately addresses
conflicts of interest between registered persons and customers that may
arise from certain borrowing or lending arrangements with related
persons and entities. For these reasons, the proposed rule change is
reasonably designed to prevent fraudulent and manipulative acts and
practices, to promote just and equitable principles of trade, and, in
general, to protect investors and the public interest.
4. Owner-Financing Arrangements
Proposed Rule 3240.03 would include owner-financing arrangements as
borrowing or lending arrangements that are covered by Rule 3240.\97\
For example, the proposed rule change would cover situations where a
registered person purchases real estate from their customer, the
customer agrees to finance the purchase, and the registered person
provides a promissory note for the entire purchase price or arranges to
pay in installments.\98\ Commenters did not specifically comment on
this proposed rule change.
---------------------------------------------------------------------------
\97\ Proposed Rule 3240.03.
\98\ See Notice at 3969 (referencing James K. Breeze, Letter of
Acknowledgment, Waiver and Consent, Case ID 2008012846501 (June 30,
2009); Vincenzo G. Covino, Letter of Acknowledgment, Waiver and
Consent, Case ID 2009020793901 (Feb. 9, 2012)).
---------------------------------------------------------------------------
By extending Rule 3240 to cover owner-financing arrangements, the
proposed rule change protects investors by addressing financing
arrangements that present similar conflicts of interest and a similar
potential for abuse as other borrowing and lending arrangements covered
by Rule 3240. Generally prohibiting such financing arrangements, unless
the conditions of the rule are met, is a reasonable approach to address
the potential risk of harm associated with this type of borrowing or
lending arrangement. For these reasons, the proposed rule change is
reasonably designed to prevent fraudulent and manipulative acts and
practices, to promote just and equitable principles of trade, and, in
general, to protect investors and the public interest.
B. The ``Immediate Family'' Definition
Rule 3240's general prohibition on borrowing or lending
arrangements provides an exception for arrangements between a
registered person and a customer who is a member of the registered
person's immediate family.\99\ The proposed rule change would update
the ``immediate family'' definition to include new relationship
categories.\100\ Specifically, the proposed rule change would amend
Rule 3240(c) to replace ``husband or wife'' with ``spouse or domestic
partner'' and amend the definition to include ``step and adoptive
relationships.'' \101\ In addition, the proposed rule change would
amend the ``any other person'' clause to state that it only applies to
``any other person who resides in the same household as the registered
person'' and who the registered person ``financially supports, directly
or indirectly, to a material extent.'' \102\ Commenters supported the
proposed rule change.\103\
---------------------------------------------------------------------------
\99\ See Rule 3240(a)(2)(A).
\100\ See Notice at 3970.
\101\ Proposed Rule 3240(c).
\102\ Id.
\103\ See, e.g., CSLC at 3 (stating that amending the ``any
other person'' clause would align the definition with ``practical
considerations'' that would reduce the potential for misuse. Also
stating that ``[t]he modernization of this definition showcases a
dedication to inclusivity and adaptability. It also works to
strengthen the rule, making sure it stays relevant to contemporary
society and prevents individuals from exploiting technicalities.'');
see also PIABA at 2.
---------------------------------------------------------------------------
By amending the definition of ``immediate family,'' the proposed
rule change updates the rule to encompass a broader set of familial
relationships, while at the same time retaining a reasonably narrow and
clear scope, which provides more compliance certainty. In addition,
amending the ``any other person'' clause to restrict the definition to
those individuals who live with, and are financially supported by, the
registered person is a reasonable approach to reducing the potential
for the exception to be misused. For these reasons, the proposed rule
change is reasonably designed to prevent fraudulent and manipulative
acts and practices, to promote just and equitable principles of trade,
and, in general, to protect investors and the public interest.
C. The Close Personal Relationship and Business Relationship Exceptions
Rule 3240 currently includes a personal relationship exception
\104\ and a business relationship exception \105\ to the general
prohibition against registered persons borrowing or lending to their
customers. The proposed rule change would narrow the personal
relationship exception to apply only to personal relationships that are
``bona fide'' and ``close,'' and maintained outside of, and formed
prior to, the broker-customer relationship. The proposed rule change
would also narrow the business relationship exception to borrowing and
lending arrangements that are based on a ``bona fide business
relationship'' outside of the broker-customer relationship.\106\
---------------------------------------------------------------------------
\104\ Rule 3240(a)(2)(D).
\105\ Rule 3240(a)(2)(E).
\106\ Proposed Rule 3240(a)(2)(E).
---------------------------------------------------------------------------
In addition, proposed Rule 3240.04 would provide factors for
evaluating
[[Page 77554]]
whether a borrowing or lending arrangement is based on a bona fide,
close personal relationship or a bona fide business relationship,
including ``when the relationship began, its duration and nature, and
any facts suggesting that the relationship is not bona fide or was
formed with the purpose of circumventing the purpose of Rule 3240.''
\107\ Proposed Rule 3240.04 would also provide examples of ``close
personal relationships,'' including, ``a childhood or long-term friend
or a godparent.'' \108\ Finally, proposed Rule 3240.04 would provide as
an example of a ``business relationship,'' ``a loan from a registered
person to a small outside business that the registered person co-owned
for years for the sole purpose of providing the business with
additional operating capital.'' \109\
---------------------------------------------------------------------------
\107\ Proposed Rule 3240.04.
\108\ Id.
\109\ Id.
---------------------------------------------------------------------------
One commenter supported the proposed rule change, stating that
replacing the current requirement with the bona fide relationship
requirement for both the close personal relationship and business
relationship exceptions ``eliminates subjectivity and ambiguity'' \110\
and ``emphasizes the genuine and sincere nature of the relationship,
focusing on authenticity and legitimacy.'' \111\ This commenter also
stated that the factors test introduced by proposed Rule 3240.04 offer
``clear criteria for evaluation, emphasizing specific aspects such as
the duration and nature of the relationship . . ., providing a
structured framework for assessing relationship legitimacy.'' \112\
---------------------------------------------------------------------------
\110\ CSLC at 3.
\111\ Id.; see also PIABA at 2 (commending ``any effort to limit
the exceptions and make very clear that this conduct is not
allowed.'').
\112\ CSLC at 3.
---------------------------------------------------------------------------
Two other commenters opposed the proposed rule change.\113\ One
stated that close personal relationships do not ``confer any additional
protections from the kinds of conflicted, exploitative, and abusive
practices that the rules should be designed to prevent.'' \114\ The
other commenter stated the proposed amendments to the exceptions would
result in the exceptions being too subjectively applied because it asks
firms to make judgements of legitimacy and would be difficult to
implement.\115\ Specifically, the commenter stated that the term ``bona
fide'' is vague and ambiguous and that the lack of an explanation or
test to discern what constitutes a relationship as legitimate would
make it difficult to interpret the application of the exceptions.\116\
To address this issue, the commenter requested that FINRA provide more
examples of relationships that would qualify for the close personal
relationship and business relationship exceptions.\117\ In addition,
this commenter stated that if the rule's intent is to prohibit
arrangements when the personal relationship is formed after the
commencement of the broker-customer relationship, it should explicitly
say so.\118\
---------------------------------------------------------------------------
\113\ Malecki; NASAA.
\114\ See NASAA at 4.
\115\ See Malecki at 5.
\116\ See id. at 5-6.
\117\ See id. at 5-6 (expressing the view that the existing
examples are limited and very specific and may not be relatable to
most broker-customer relationships).
\118\ See id. at 5.
---------------------------------------------------------------------------
In response, FINRA stated that it proposed to narrow the exception
and provide factors that are relevant to assessing whether a
relationship falls within the scope of either the close personal or
business relationship exception precisely because it shared concerns
about the scope of these exceptions. In particular, FINRA stated that
limiting the personal relationship exception to relationships that are
(1) bona fide, (2) close, and (3) maintained outside of, and formed
prior to, the broker-customer relationship, ``would reduce the risk
that a registered person would concoct a personal relationship with a
customer for the purpose of borrowing from or lending to the customer,
and . . . address concerns that this exception could be exploited.''
\119\ In response to the commenter's request for clarification
regarding whether the proposed rule change would cover personal
relationships developed after the formation of the broker-customer
relationship, FINRA reiterated that relationships formed after the
establishment of the broker-customer relationship would not fall within
the proposed close personal relationship exception, which would only
apply to bona fide, close personal relationships maintained outside of,
and formed prior to, the broker-customer relationship.\120\ According
to FINRA, the close personal relationship exception is designed only to
apply where the borrowing or lending arrangement is less likely to have
resulted from the broker-customer relationship because the close
personal relationship existed prior to the broker-customer relationship
and does not involve the two parties being introduced through the
broker-customer relationship that may involve conflicts of
interest.\121\
---------------------------------------------------------------------------
\119\ See FINRA Comment Response at 9.
\120\ Id.
\121\ See id. at 9-10 (stating that the situation where an older
or vulnerable customer loans money to a registered person who had
befriended them after they already formed a broker-customer
relationship, would be outside the scope of the proposed close
personal relationship exception, and thus, would be prohibited).
---------------------------------------------------------------------------
In response to commenter requests for more examples of close
personal and business relationships, FINRA stated that the examples
described in the proposed rule change ``add helpful clarity while
giving members the flexibility to consider factors relevant to whether
these exceptions apply.'' \122\ In declining to provide additional
examples, FINRA stated that, ultimately, the applicability of the
exceptions depends on the facts and circumstances.\123\ However, to the
extent any particular scenario raises questions regarding the
application of the rule, FINRA would consider issuing additional
guidance on a case-by-case basis.\124\
---------------------------------------------------------------------------
\122\ See id. at 10.
\123\ See id.
\124\ See id.
---------------------------------------------------------------------------
The proposed rule change reasonably limits the personal
relationship exception to bona fide, close relationships maintained
outside of, and formed prior to, the broker-customer relationship and
the business relationship exception to borrowing and lending
arrangements that are based on a bona fide business relationship
maintained outside of the broker-customer relationship. By narrowing
these exceptions in this manner, the proposed rule change would help
ensure that these exceptions to the general prohibition are limited to
the types of relationships where the risk to investors should be
reduced. Similarly, by providing factors for evaluating whether a
borrowing or lending arrangement is based on a bona fide, close
personal relationship or a bona fide business relationship, as well as
examples of close personal relationships and business relationships,
the proposed rule change would help parties comply with the terms of
these exceptions. For these reasons, the proposed rule change is
reasonably designed to prevent fraudulent and manipulative acts and
practices, to promote just and equitable principles of trade, and, in
general, to protect investors and the public interest.
D. Notification and Approval Requirements
As stated above, Rule 3240(b) requires notification and approval
for certain borrowing or lending arrangements.
[[Page 77555]]
Generally, the exceptions for borrowing and lending arrangements
involving personal relationships, business relationships, and
registered persons, require member firm notice and approval. The
exceptions for borrowing and lending arrangements with immediate family
members and financial institutions do not require member firm
notification and approval. The proposed rule change would amend the
notification and approval requirements of Rule 3240. We discuss the
proposed changes separately below.
1. Approval Requirements for the Close Personal Relationship, Business
Relationship, and Registered Persons Exceptions
The proposed rule change would amend Rule 3240(b)(1) to clarify
that, although registered persons are required to obtain the member
firm's prior approval of borrowing or lending arrangements within the
close personal relationship, business relationship, or registered
persons exceptions, the member firm is not required to approve such
arrangements.\125\ Specifically, the proposed rule change would delete
``shall pre-approve'' from the current rule and instead require the
registered person to provide notice ``prior to entering into such
arrangements'' or ``prior to the modification of such arrangements''
and to ``obtain the member's approval.'' Two commenters supported the
proposed rule change.\126\
---------------------------------------------------------------------------
\125\ See Notice at 3970.
\126\ See CSLC at 4 (stating that the proposed rule change
``mitigate the risk of a conflict of interest by clarifying that
member firms are empowered to approve or disapprove a proposed
arrangement.''); see also Malecki at 6 (stating that ``member firms
should not be able to `opt-out' of reviewing and/or approving these
types of lending/borrowing transactions with customers.'').
---------------------------------------------------------------------------
The proposed rule change would clarify that a member firm is not
required to pre-approve borrowing or lending arrangements within the
close personal relationship, business relationship, or registered
persons exceptions. As such, the proposed rule change would strengthen
an important existing control on such arrangements, by explicitly
making clear that a member firm is not required to approve any such
arrangement simply because a registered person notified the member
firm. For these reasons, the proposed rule change is reasonably
designed to prevent fraudulent and manipulative acts and practices, to
promote just and equitable principles of trade, and, in general, to
protect investors and the public interest.
2. Notification and Approval Requirements for the Immediate Family
Member Exception and the Financial Institution Exception
Current Rule 3240(b)(2) provides, in pertinent part, that a member
firm's written procedures may indicate that that registered persons are
not required to notify the member firm or receive member firm approval
either prior to or subsequent to entering into borrowing or lending
arrangements with immediate family members.\127\ Similarly, current
Rule 3240(b)(3) provides, in pertinent part, that a member firm's
written procedures may indicate that registered persons are not
required to notify the member firm or receive member firm approval of
borrowing or lending arrangements within the financial institution
exception, 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.''
\128\
---------------------------------------------------------------------------
\127\ Rule 3240(b)(2). However, as noted above, the current rule
allows a member to require such notification and approval for
borrowing and lending arrangements with immediate family or
financial institutions if the member firm so chooses. See Notice at
3971 n.21.
\128\ Rule 3240(b)(3).
---------------------------------------------------------------------------
The proposed rule change would amend Rule 3240(b)(2) and Rule
3240(b)(3) to apply the same approach to borrowing or lending
arrangements within the immediate family exception and the financial
institution exception, respectively, to such arrangements that pre-
exist the broker-customer relationship.\129\ These changes are intended
to correspond to and account for the fact that, under the proposed rule
change, the general prohibition applies to borrowing or lending
arrangements that pre-exist the broker-customer relationship.\130\
---------------------------------------------------------------------------
\129\ See Notice at 3971.
\130\ See id.
---------------------------------------------------------------------------
Specifically, to extend these provisions to pre-existing
arrangements, the proposed rule change would amend Rule 3240(b)(2) to
provide that the member firm's written procedures may indicate that
registered persons are not required to notify the member firm or
receive the member firm's approval of pre-existing borrowing or lending
arrangements that would fall within the immediate family exception
prior to initiating a broker-customer relationship.\131\ Similarly, the
proposed rule change would amend Rule 3240(b)(3) to provide that the
member firm's written procedures may also indicate that registered
persons are not required to notify the member firm or receive member
firm approval of pre-existing arrangements that would fall within the
financial institution exception prior to initiating a broker-customer
relationship, provided the borrowing or lending arrangements meet the
restrictions of the exception set forth above.\132\
---------------------------------------------------------------------------
\131\ See proposed Rule 3240(b)(2).
\132\ See proposed Rule 3240(b)(3).
---------------------------------------------------------------------------
Two commenters expressed concern that the proposed rule change
would not require notice and approval of borrowing or lending
arrangements with immediate family members or financial
institutions.\133\ One of these commenters stated that given the risk
of financial exploitation in familial relationships, FINRA should
require ``at least the same notification and approval for arrangements
with immediate family as it requires for other registered persons and
`close personal' and business relationships.'' \134\ The other
commenter concurred, stating that the proposed rule change disregards
``important considerations about the perpetrators of financial fraud.''
\135\
---------------------------------------------------------------------------
\133\ See NASAA at 4-5; see also Malecki at 6.
\134\ See NASAA at 5; see also Malecki at 6 (stating that
``member firms should not be able to `opt-out' of reviewing and/or
approving these types of lending/borrowing transactions with
customers, through their own firm procedures, as it defeats the
purpose of and intent behind Rule 3240 itself'').
\135\ Malecki at 3 (stating that ``an `immediate' familial
relationship is not a barrier to committing fraud generally, and it
should not be used as an exception for allowing lending arrangements
between registered representatives and their customers.'').
---------------------------------------------------------------------------
In response, FINRA stated that, other than extending the Rule
3240(b)(2) obligations to borrowing and lending arrangements
established prior to initiating a broker-customer relationship, the
proposed rule change would not amend the existing immediate family
exception or require notice or approval of borrowing and lending
arrangements with immediate family members.\136\ FINRA further stated
that Rule 3240 is not intended to encourage registered persons to avoid
traditional financing arrangements, but rather to continue to allow for
tailored exceptions to the general prohibition on borrowing or lending
arrangements in limited situations where FINRA believes the likelihood
that the registered person has borrowed from or lent money to a
customer by virtue of the broker-customer relationship is reduced
(e.g., certain borrowing or lending arrangements with immediate family
members and financial institutions).\137\ FINRA also identified
``examples of
[[Page 77556]]
mutually beneficial borrowing or lending arrangements between immediate
family members, including senior family members (e.g., loans to cover
medical expenses, dependent care, home repairs, etc.).'' \138\ FINRA
recognized that ``[p]ermitting family members to privately lend with
each other, may also allow family members to obtain small or short-term
loans, including at an interest rate lower than commercially
available.'' \139\ Further, FINRA reiterated that a registered person
is prohibited from entering into a borrowing or lending arrangement
with a customer who is an immediate family member, including one who is
a senior investor, unless the member firm adopts written procedures
permitting such arrangements.\140\ FINRA noted that members firms may
choose to prohibit all borrowing and lending arrangements, allow only
some of the exceptions, or impose limitations on the exceptions.\141\
Finally, FINRA stated that requiring notice and approval for borrowing
and lending arrangements with immediate family members ``may invade
legitimate privacy interests because such a requirement could interfere
with or intrude upon personal or private family matters.'' \142\
According to FINRA, by strengthening the general prohibition and
narrowing its exceptions, the proposed rule change would further
protect all investors, including senior investors.\143\
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\136\ See FINRA Comment Response at 7; see also Notice at 3976.
\137\ See FINRA Comment Response at 6-7.
\138\ Id. at 8.
\139\ Id.
\140\ See id.
\141\ Id.
\142\ Id.
\143\ Id. FINRA further stated that Rule 2010 (Standards of
Commercial Honor and Principles of Trade)--which provides that a
member, in the conduct of its business, shall observe high standards
of commercial honor and just and equitable principles of trade--
protects investors from unethical behavior and is broad enough to
cover a wide range of unethical conduct. See id.
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The proposed rule change is not imposing new obligations on
borrowing and lending arrangements within the immediate family
exception or within the financial institution exception but would
extend the existing regime to situations where such financial
arrangements pre-exist the formal establishment of a broker-customer
relationship. As with all the exceptions under the rule, a registered
person can only enter into a borrowing or lending arrangement pursuant
to the immediate family exception or financial institution exception if
the member firm has adopted written procedures permitting such an
arrangement. A member firm's procedures may prohibit all such
arrangements, allow only some of the excepted arrangements, or impose
limits on the exceptions, as the member firm deems appropriate to be
reasonably designed to achieve compliance with the proposed rule
change.\144\ Accordingly, while not explicitly required, as part of
establishing a reasonably designed supervisory system as required under
FINRA rules,\145\ member firms may nevertheless require notification
and approval of arrangements that fall under the immediately family
exception and financial institution exception as part of their written
procedures based on their assessment of the risks associated with such
arrangements.\146\ By providing member firms the flexibility to
determine whether or not to allow such arrangements, and if so, whether
to require notice and approval for such arrangements, and in particular
for arrangements within the immediate family exception, FINRA
reasonably balances the potential risk of harm associated with such
arrangements with the potential benefits of such arrangements and the
potential associated privacy concerns. Moreover, as discussed above,
the proposed rule change broadens and strengthens the application of
the rule by, among other things, covering relationships that pre-exist
a new broker-customer relationship, as well as borrowing or lending
arrangements entered into within six months after a broker-customer
relationship ends, which will add protections to investors, including
those whose arrangements fall within the immediate family exception.
For these reasons, the proposed rule change is reasonably designed to
prevent fraudulent and manipulative acts and practices, to promote just
and equitable principles of trade, and, in general, to protect
investors and the public interest.
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\144\ See Rule 3110(b)(1).
\145\ See Rule 3110(a).
\146\ See infra Section III.D.4.
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3. Notifications in Writing and Record Retention
As stated above, Rule 3240 does not require that registered persons
who must notify their member firms of borrowing and lending
arrangements do so in writing.\147\ Furthermore, the current rule does
not require member firms to retain any notices of borrowing and lending
arrangements that they may receive from registered persons; it only
requires member firms to retain written approvals.\148\
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\147\ See Notice at 3971.
\148\ Id.
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The proposed rule change would require registered persons to notify
their member firms in writing of those borrowing and lending
arrangements under Rule 3240 that require notification and approval
(i.e., the exceptions involving registered persons, close personal
relationships, and business relationships).\149\ The proposed rule
change would also amend Rule 3240.01 to require member firms to retain
the written notifications and approvals records 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.\150\ The proposed rule
change would also require record retention of notices and approvals
related to the immediate family and financial institution exceptions,
unless the member firm's procedures indicate that registered persons
are not required to notify the member firm and/or receive member firm
approval.\151\
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\149\ Id.; see proposed Rules 3240(b)(1)(A) and (b)(1)(B) and
proposed Rule 3240.01.
\150\ See proposed Rule 3240.01.
\151\ See supra note 68.
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One commenter supported the proposed rule change.\152\
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\152\ See CSLC at 4.
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By requiring registered persons to give written notice and
requiring member firms to preserve records of such written notice--
whether required specifically by the rule or by the member firm's
written procedures--for at least three years, the proposed rule change
is reasonably designed to help ensure compliance with the amended Rule
3240 and its exceptions. For these reasons, the proposed rule change is
reasonably designed to prevent fraudulent and manipulative acts and
practices, to promote just and equitable principles of trade, and, in
general, to protect investors and the public interest.
4. Reasonable Assessment by Member of the Risks Created by the
Borrowing or Lending Arrangement
The proposed rule change would add proposed Rule 3240.06, which
would require a member firm, after receiving a written notice under
Rule 3240, to ``perform a reasonable assessment of the risks created by
the borrowing or lending arrangement with a customer, modification to
the borrowing or lending arrangement with a customer, or existing
borrowing or lending arrangement with a person who seeks to be a
customer of the registered person.'' \153\ The proposed rule change
would also require that the member firm make a ``reasonable
determination of whether to approve the borrowing or
[[Page 77557]]
lending arrangement, modification to the borrowing or lending
arrangement, or, where there is an existing borrowing or lending
arrangement with a person who seeks to be a customer of the registered
person, the broker-customer relationship.'' \154\ FINRA stated that it
expects a member firm's reasonable assessment to take into
consideration a non-exhaustive list of factors that may lead to undue
harm to the customer as a result of a borrowing or lending arrangement
with a registered person.\155\
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\153\ Proposed Rule 3240.06.
\154\ Id.
\155\ See Notice at 3971 (listing the following factors: (1) any
potential conflicts of interest in the registered person being in a
borrowing or lending arrangement with a customer; (2) the length and
type of relationship between the customer and registered person; (3)
the material terms of the borrowing or lending arrangement; (4) the
customer's or the registered person's ability to repay the loan; (5)
the customer's age; (6) whether the registered person has been a
party to other borrowing or lending arrangements with customers; (7)
whether, based on the facts and circumstances observed in the member
firm's business relationship with the customer, the customer has a
mental or physical impairment that renders the customer unable to
protect his or her own interests; (8) any disciplinary history or
indicia of improper activity or conduct with respect to the customer
or the customer's account (e.g., excessive trading); and (9) any
indicia of customer vulnerability or undue influence of the
registered person over the customer).
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One commenter supported the proposed rule change, stating that a
reasonable assessment could result in ``more questionable arrangements
being scrutinized, leading to improved investor protection.'' \156\ Two
commenters suggested modifications to the reasonable assessment
requirement.\157\ To help regulators assess and compare approval and
supervision practices across firms, one of these commenters suggested
that the reasonable assessment provisions should require a minimum
amount of disclosure and include documentation of the steps the member
firm took to assess the risk ahead of approving the loan agreement, the
steps the member firm took to minimize the conflict of interest, how
the member firm communicated the risk to the customer, and an outline
of supervisory measures the member firm will take.\158\ In addition,
this commenter suggested that a ``reasonable assessment and
determination process should include an interview (preferably by a
compliance officer) with the customer outside the presence of the
registered person'' or, where that is not possible, a requirement that
the member firm verify that the customer benefits from the loan and was
not pressured into it.\159\ Furthermore, this commenter recommended
that the proposed rule change require the member firm to apply
heightened scrutiny to the underlying accounts or impose other
appropriate conditions where a firm approves a borrowing or lending
arrangement, or approves a new broker-customer relationship where there
is a pre-existing borrowing or lending arrangement.\160\ Finally, this
commenter called for the list of factors FINRA provided in the Notice
to be included in the rule text.\161\ The other commenter suggested
that a registered person be ``required to disclose to a customer, in
writing, that such arrangements are presumptively prohibited and to
document the exception under which the lending arrangement falls'' and
that member firms should be required to consult with the customer
before approving a borrowing or lending arrangement to ensure the
customer receives a full and fair disclosure about the terms of the
arrangement.\162\ In addition, this second commenter recommended that
the proposed rule change require member firms that allow registered
persons to enter lending arrangements with their customers to
collateralize any such loans that such member firms approve.\163\
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\156\ CSLC at 6.
\157\ NASAA at 5-6; Malecki at 6.
\158\ See NASAA at 5-6.
\159\ See id. at 6 (stating that an interview would help ensure
the borrowing or lending arrangement does not put the customer at
risk of undue influence).
\160\ Id. at 6 (stating that heightened supervision would guard
against the conflicts of interest that come with these
relationships, and that an enhanced review of trades and
transactions in the account should at least be required when the
customer is elderly or otherwise vulnerable to exploitation).
\161\ See NASAA at 5.
\162\ See Malecki at 7.
\163\ See id. at 2-3 (stating that other than prohibiting
borrowing and lending arrangements, the only way to ensure that a
customer is not harmed is to require member firms to have ```skin'
in such arrangements.'').
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In response, FINRA stated that FINRA Rule 3110 (Supervision)
requires each member firm to ``establish and maintain a system to
supervise the activities of each associated person that is reasonably
designed to achieve compliance with applicable securities laws and
regulations, and with applicable FINRA rules.'' FINRA stated that
member firms could consider incorporating the commenter's suggested
supervisory and disclosure requirements into their systems for
supervising for compliance with Rule 3240, but FINRA is not requiring
them here.\164\ FINRA did not include the list of factors in the rule
text, explaining that given the flexibility firms have to develop their
own supervisory systems under Rule 3110, ``it is not necessary or
appropriate to prescribe specific supervisory procedures in Rule
3240.'' \165\ FINRA did, however, highlight guidance regarding ``the
minimum that should be included in written supervisory procedures,
including: (1) the specific identification of the individual(s)
responsible for supervision; (2) the supervisory steps and reviews to
be taken by the appropriate supervisor; (3) the frequency of such
reviews; and (4) how such reviews shall be documented.'' \166\ With
respect to the suggestion that the terms of the arrangement should be
discussed with, and disclosed to, the customer, FINRA reiterated that
it expects a member to consider the reasonable assessment factors noted
earlier--several of which pertain to the terms of the arrangement and
the nature of the parties--and to try to discuss the arrangement with
the customer.\167\ FINRA also stated that regardless of the terms of a
member firm's supervisory system, Rule 3110 requires member firms to
follow-up on red flags related to borrowing or lending arrangements
between registered persons and their customers.\168\
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\164\ See FINRA Comment Response at 12. FINRA also stated that
the non-exhaustive list of factors FINRA expects members to consider
address ``many of the commenters' concerns,'' including
consideration of: (1) any potential conflicts of interest in the
registered person being in a borrowing or lending arrangement with a
customer; (2) the material terms of the borrowing or lending
arrangement; (3) the customer's or the registered person's ability
to repay the loan; (4) the customer's age; (5) whether, based on the
facts and circumstances observed in the member's business
relationship with the customer, the customer has a mental or
physical impairment that renders the customer unable to protect his
or her own interests; and (6) any indicia of customer vulnerability
or undue influence of the registered person over the customer. See
id. at 13. FINRA further stated that those factors along with the
guidance in FINRA Regulatory Notice 21-43 (Dec. 2021) would ``help
members evaluate the key risks and conflicts while giving members
appropriate flexibility in evaluating which factors may apply to a
particular situation.'' See id. at 14.
\165\ FINRA Comment Response at 12-13 (stating that ``FINRA
rules concerning duties, conflicts and responsibilities related to
associated persons generally do not set forth specific supervisory
procedures that member firms must adopt to satisfy the requirements
of FINRA's supervision rule. See generally Rule 2000 Series (Duties
and Conflicts; Rule 3000 Series (Supervision and Responsibilities
Related to Associated Persons)'').
\166\ Id. at 12 (referencing guidance from Notice to Members 98-
96 and Notice to Members 99-45 regarding tailoring the supervisory
system to the member firm's business).
\167\ See id. at 14.
\168\ See id. at 12-13.
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Requiring a member firm, after receiving written notice under Rule
3240, to perform a reasonable assessment of the risks created by the
borrowing or lending arrangement with
[[Page 77558]]
a customer and, based on that assessment, to make a reasonable
determination of whether to approve the borrowing or lending
arrangement, is reasonably designed to protect investors. Whether a
specific borrowing or lending arrangement creates the potential for a
conflict or other abuse that could harm an investor requires analysis
of the facts and circumstances. Because of its supervisory obligations,
a broker-dealer is both obligated and best positioned to analyze the
facts and circumstances related to a borrowing or lending arrangements
between one of its registered persons and a customer. In addition,
consistent with the flexibility firms have to develop their own
supervisory systems under Rule 3110, the member firm is also best
positioned to determine reasonable controls to supervise for compliance
with the proposed rule change based on its assessment of the risks
involved with a borrowing or lending arrangement that falls within one
of the five exceptions to Rule 3240. While not required, reasonably
designed controls could include the supervisory, disclosure or other
requirements suggested by commenters (such as providing disclosure,
collateralizing loans between one of its registered persons and a
customer, interviewing customers, and applying heightened scrutiny as
it perceives higher risks). As such, the proposed rule change
represents an important safeguard for protecting investors from
conflicts or other abuses that could harm them in such arrangements.
Moreover, in exercising its supervisory obligations under FINRA Rule
3110, a member firm may always choose to prohibit or restrict borrowing
and lending arrangements as it sees fit and in light of the risks
presented by an arrangement. For example, if the broker-dealer
determines that the risks to the customer of lending money to a
registered person cannot be effectively managed, the proposed rule
change would allow the firm to disapprove or further restrict the
arrangement. For these reasons, the proposed rule change is reasonably
designed to prevent fraudulent and manipulative acts and practices, to
promote just and equitable principles of trade, and, in general, to
protect investors and the public interest.
IV. Conclusion
For the reasons set forth above, the Commission finds that the
proposed rule change is consistent with Section 15A(b)(6) of the
Exchange Act, which requires, among other things, that FINRA rules be
designed to prevent fraudulent and manipulative acts and practices,
promote just and equitable principles of trade, and, in general,
protect investors and the public interest.\169\
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\169\ 15 U.S.C. 78o-3(b)(6).
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It is therefore ordered pursuant to Section 19(b)(2) of the
Exchange Act \170\ that the proposal (SR-FINRA-2024-001), be and hereby
is approved.
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\170\ 15 U.S.C. 78s(b)(2).
For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\171\
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\171\ 17 CFR 200.30-3(a)(12).
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Sherry R. Haywood,
Assistant Secretary.
[FR Doc. 2024-21622 Filed 9-20-24; 8:45 am]
BILLING CODE 8011-01-P
