I read every regulatory decision the NASD publishes. Why? Well, I guess I just lead a boring life. However, I am frequently among the first to spot developing enforcement trends. Recently, I've noticed three areas that are attracting the NASD's attention: brokers who share in customer losses; brokers who borrow money from clients; and undisclosed settlement of customer complaints.
Applicable NASD Rules
NASD Conduct Rule 2330: Customers' Securities or Funds. This rule prohibits guaranteeing a customer against loss or sharing in profits/losses, except if the arrangement is subject to a prior written authorization from the member firm and from the customer — and provided that sharing of those profits or losses is in direct proportion to any investment the member firm or associated person made alongside the client (with exemptions for immediate family transactions).
NASD Conduct Rule 2370: Borrowing From or Lending to Customers. Prohibits associated persons from setting up borrowing/lending arrangements with a customer, unless the member firm has applicable written procedures and the proposed arrangement is pre-approved in writing by the member firm. Again, there are exemptions for transactions with immediate family, other third-party financial institutions or where there is a pre-existing business relationship outside the broker-client context.
NASD Conduct Rule 3070: Reporting Requirements. Requires prompt reporting of settlement of a customer's claim for damages against an associated person that exceeds $15,000 (or $25,000 when the claim is against the member firm).
Words to the Wise
Many reps are unaware of the rule against borrowing from clients. Worse, since such loans often involve friends or family, brokers may fail to recognize that the transaction involves an account subject to compliance restrictions. Before you borrow from anyone who has an account at your firm, check the rules and speak to your compliance department — even if it is mom.
Also, you should disclose all customer complaints and settlements to your firm — regardless of the amount involved or whether the communication is in writing. Make sure to re-read Form U4 (Item 14I) to understand what needs to be disclosed, when and for how long. There is often a big difference between what you have to tell your firm, what you must disclose on the U4 and what your firm has to file pursuant to NASD Rule 3070.
Here are some cases of a few brokers who broke the rules and got caught* (please see end note):
Suk Ku Lim entered into oral settlement agreements with public customers and did not provide prior notification to his member firm of such settlements. Penalties: fined $10,000; suspended 50 days in all capacities.
Elias Emile Ashooh, borrowed $13,900 from a public customer despite his member firm's written supervisory procedures prohibiting such conduct. Ashooh attempted to borrow an additional $10,750 from the customer, but his member firm did not process the customer's request. Also, Ashooh falsely certified to his member firm that he had no outstanding loans or other financial dealings with customers. Penalties: barred and ordered to pay $13,900 plus interest in restitution.
Jonathan Edward Kruse Sr. engaged in private securities transactions without prior written notice to and approval from his member firm. Also, Kruse settled a customer complaint by purchasing back securities he had sold to the customer without informing his firm. Penalties: fined $25,750 (includes $15,750 disgorgement of financial benefits); suspended one year.
As a defense lawyer, I know that the road to hell is paved with good intentions — and that's how slip-ups with clients that lead to enforcement actions often begin. Perhaps you suddenly realize the deal you offered to a client is not as above board as you thought. So you offer to buy back the problem investments or repay your clients for any losses. But then, because cash is tight, you borrow the money from another client to fund the restitution. And to avoid detection, you don't disclose these machinations to your firm. Don't go down this road or NASD will soon be knocking at your door very soon.
* Note that Offers of Settlement (OS) and Letters of Acceptance, Waiver, and Consent (AWC) are entered into by respondents without admitting or denying the allegations, but consent is given to the described sanctions and to the entry of findings.
Writer's BIO: Bill Singer is a practicing regulatory lawyer and the publisher of RRBDLAW.com