Notice2024-21622
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
Primary source
Metadata and text below are from the Federal Register, a public-domain U.S. government work. Always verify the official published version before relying on it for any legal matter.
Published
September 23, 2024
Issuing agencies
Securities and Exchange Commission
Full Text
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<title>Federal Register, Volume 89 Issue 184 (Monday, September 23, 2024)</title>
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[Federal Register Volume 89, Number 184 (Monday, September 23, 2024)]
[Notices]
[Pages 77547-77558]
From the Federal Register Online via the Government Publishing Office [<a href="http://www.gpo.gov">www.gpo.gov</a>]
[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''),
<a href="https://www.govinfo.gov/content/pkg/FR-2024-01-22/pdf/2024-01068.pdf">https://www.govinfo.gov/content/pkg/FR-2024-01-22/pdf/2024-01068.pdf</a>.
\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.
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\6\ Id.
\7\ The comment letters are available at <a href="https://www.sec.gov/comments/sr-finra-2024-001/srfinra2024001.htm">https://www.sec.gov/comments/sr-finra-2024-001/srfinra2024001.htm</a>.
\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 <a href="https://www.finra.org/sites/default/files/2024-02/SR-FINRA-2024-001-Extension1.pdf">https://www.finra.org/sites/default/files/2024-02/SR-FINRA-2024-001-Extension1.pdf</a>.
\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, <a href="https://www.sec.gov/comments/sr-finra-2024-001/srfinra2024001-463852-1226394.pdf">https://www.sec.gov/comments/sr-finra-2024-001/srfinra2024001-463852-1226394.pdf</a> (``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, <a href="https://www.finra.org/sites/default/files/2024-07/SR-FINRA-2024-001-Extension2.pdf">https://www.finra.org/sites/default/files/2024-07/SR-FINRA-2024-001-Extension2.pdf</a>.
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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\
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\16\ Proposed Rule 3240 and proposed Rule 3240(a).
\17\ See Notice at 3969.
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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.
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\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\
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\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\
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\24\ See Notice at 3969.
\25\ Proposed Rule 3240.02.
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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\
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\26\ Proposed Rule 3240.05.
\27\ Id.
\28\ Notice at 3969.
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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.
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\29\ Proposed Rule 3240.03.
\30\ See Notice at 3969.
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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\
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\31\ See Rule 3240(a)(2)(A).
\32\ Rule 3240(c).
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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\
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\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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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\
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\38\ Rule 3240(a)(2)(D).
\39\ Rule 3240(a)(2)(E).
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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\
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\40\ Proposed Rule 3240(a)(2)(D).
\41\ Proposed Rule 3240(a)(2)(E).
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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\
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\42\ See infra Section II.B.4.e.
\43\ Proposed Rule 3240.04.
\44\ Id.
\45\ Id.
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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\
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\46\ See Notice at 3970.
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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.
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\47\ Id.
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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\
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\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).
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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\
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\54\ See proposed Rule 3240(b)(1)(B).
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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\
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\55\ Rule 3240(b)(2).
\56\ See Notice at 3971.
\57\ See proposed Rule 3240(b)(2).
\58\ See Notice at 3971 n.21.
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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\
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\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\
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\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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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\
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\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.'').
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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:
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\69\ Proposed Rule 3240.06.
\70\ Id.
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(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\
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\71\ See Notice at 3971.
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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\
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\72\ See id.
\73\ See id. at 3972.
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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\
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\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).
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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.
---------------------------------------------------------------------------
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, <a href="https://www.sec.gov/comments/sr-finra-2024-001/srfinra2024001-428040-1059142.pdf">https://www.sec.gov/comments/sr-finra-2024-001/srfinra2024001-428040-1059142.pdf</a> (``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, <a href="https://www.sec.gov/comments/sr-finra-2024-001/srfinra2024001-426619-1057382.pdf">https://www.sec.gov/comments/sr-finra-2024-001/srfinra2024001-426619-1057382.pdf</a> (``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, <a href="https://www.sec.gov/comments/sr-finra-2024-001/srfinra2024001-428019-1058522.pdf">https://www.sec.gov/comments/sr-finra-2024-001/srfinra2024001-428019-1058522.pdf</a> (``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, <a href="https://www.sec.gov/comments/sr-finra-2024-001/srfinra2024001-428039-1058683.pdf">https://www.sec.gov/comments/sr-finra-2024-001/srfinra2024001-428039-1058683.pdf</a> (``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), <a href="https://www.finra.org/rules-guidance/notices/21-34">https://www.finra.org/rules-guidance/notices/21-34</a>.
\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
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</html>Indexed from Federal Register on September 23, 2024.
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