We’re seeing a disturbing trend of financial advisers borrowing money from their own clients — a prohibited practice in the investment industry. Notwithstanding their claimed financial expertise, many brokers and investment advisers seem to run into personal money problems. Some turn to their clients for a way out.
The adviser’s pitch usually goes something like this: “You’re making 7% in your account, but if you lend me money for my brilliant new business venture, I can pay you 15% or more.” The advisers play on their clients’ trust, and those clients often loan the requested money. From the client’s point of view, it seems like a good business opportunity and they’re also helping someone they like. What could go wrong?
Unfortunately, a lot can go wrong. The money might not be invested in a business, but rather used to pay down the debts of the business, or even the financial adviser’s personal debts. Or, on the off chance the money does go into a business, that business may be already be beyond saving. In some cases, there’s no chance of the adviser paying the interest due, much less the principal, without raising a continuing stream of money from other unsuspecting clients. And that’s how a Ponzi scheme begins.
FINRA Generally Prohibits Brokers from Borrowing Money from Clients
The Financial Industry Regulatory Authority (FINRA), the organization charged with overseeing the conduct of stockbrokers, generally prohibits brokers from borrowing money from their customers. FINRA rule 3240 states that a broker cannot borrow money from a customer unless:
- the firm has written procedures that allow for the borrowing;
- there is a close familial relationship between the customer and broker, or the broker and customer are both registered with the same broker dealer, or the customer is in the business of loaning money, or the loan arises out of a personal or business relationship outside of the broker/customer one; and,
- the broker notifies the firm of the intended loan, and gets the firm’s written pre-approval of the loan.
Additionally, FINRA’s rule 2010 requires that FINRA members always observe high standards of commercial honor and just and equitable principles of trade.
These two rules were invoked in a FINRA enforcement action recently taken against stockbroker Phillip Tibbetts, who entered into a letter of acceptance, waiver, and consent (known as an “AWC”), by which he accepted FINRA’s findings that he borrowed $1,800 from a customer without notifying his member firm employer.
In looking at both the AWC and Mr. Tibbetts’ online Brokercheck report (which, as with all brokers, is available for free on the website), we see that he took a loan from a customer, was accused by the customer of not repaying the loan, initially denied the accusation to his employer and FINRA, then quit his job under the allegation by his employer that he did borrow the money without permission, and finally entered into the AWC with FINRA by which he agreed to not contest FINRA’s conclusion that he borrowed the money in violation of applicable rules and was subjected to the fine and suspension. He is not currently registered in the industry.
Mr. Tibbets’ customer was fortunate to be out just $1,800. We have represented clients who have lost hundreds of thousands of dollars on unpaid loans to brokers.
Registered Investment Advisers Also Are Prohibited from Borrowing Money from Clients
Brokers are not the only people who improperly try to borrow money from clients. Registered Investment Advisers (RIAs) do as well. RIAs are not subject to FINRA rules but are deemed by law to be fiduciaries and are therefore under the obligation to put their clients’ interests ahead of their own. Borrowing money from a client places the adviser in potential a clear conflict of interest. We have handled, and are presently pursuing, cases in which investment advisers have improperly borrowed money from their clients, with the clients’ only hope of being paid back coming through the litigation process.
Your Adviser Asked To Borrow Money – What Do You Do?
If your stockbroker or investment adviser asks you to borrow money, and you’re not family, in the business of loaning money, or do not have a working relationship with him or her outside of being a customer, don’t even consider the request. If you are family, in the loan business, or have an outside relationship, ask to see the firm’s written approval of the loan transaction before you decide whether to loan the money.
And presuming you have loaned your broker or investment adviser money and they’ve started missing interest or principal payments, contact the investor claims lawyers of McCarthy Lebit to discuss how we might be able to help you to recover your losses. Please feel free to use the contact box to the right to email us, or call Hugh Berkson at 1-866-932-1295.
Hugh Berkson is a Securities Attorney with McCarthy, Lebit, Crystal & Liffman, Co. LPA. Hugh is rated AV® Preeminent™ by Martindale-Hubbell®.
He obtained a business degree in Finance from the University of Texas at Austin in 1989, and is a 1994 graduate of Case Western Reserve University School of Law, where he was a member of the Order of the Barristers and received both the American Jurisprudence Award, (National Mock Trial) in 1993 and the Jonathan M. Ault Mock Trial Prize for 1993-1994.