Lesson 11.3: Prohibited Activities

Special Concerns and Expectations for Senior Clients (LO 11.f)

  • FINRA and other regulators address financial exploitation of seniors and other individual customers.
  • FINRA defines impacted accounts as those for:
    • Individuals age 65 and older, or
    • Individuals age 18 and older whom the member reasonably believes has a mental or physical impairment that renders them unable to protect their own interests.
  • FINRA defines financial exploitation as:
    • The wrongful or unauthorized taking, withholding, appropriation, or use of funds or securities; or
    • Any act or omission of an act taken by a person to obtain control through deception, intimidation, or undue influence over the specified adult's money, assets, or property, or to convert the specified adult's money, assets, or property.
    • This includes any act aligning with this definition done through the use of a power of attorney, guardianship, or any other authority.
  • To prevent potential exploitation, the rules regarding the accounts of seniors and other specified adult customers require:
    • Member firms and associated persons must make reasonable efforts to obtain the name and contact information for a trusted contact person.
    • Member firms are permitted, but not required, to place temporary holds on disbursements from customer accounts when there is a reasonable belief of financial exploitation.

Trusted Contact Person

  • A reasonable effort to obtain the name and contact information for a trusted contact person must be made when:
    • Opening a customer's account, or
    • Updating the account information for an existing account.
  • The member firm is not prohibited from opening an account when the customer fails or refuses to provide the information, as long as the member firm took reasonable efforts to obtain such information.
  • Asking the customer to provide the name and contact information for a trusted contact person constitutes a reasonable effort.
  • When the customer has provided the name and contact information for a trusted contact person, the member firm must disclose in writing to the customer that the member or an associated person is authorized to contact the trusted contact person and disclose certain information about the customer's account.
  • FINRA notes that the trusted contact person is intended to be a resource for the member firm in administering the customer's account, protecting assets, and responding to possible financial exploitation.
  • Examples of when a member could contact a trusted contact person:
    • A member is unable to contact a customer after multiple attempts and could contact a trusted contact person to inquire about the customer's current contact information.
    • A member firm suspects that the customer may be suffering from Alzheimer's disease, a form of dementia, or a form of diminished capacity and could reach out to the trusted contact person.
    • A member believes possible financial exploitation of the customer is occurring and before placing a temporary hold on a disbursement, the member could contact a trusted contact person to discuss the facts.

Temporary Holds on Disbursements and Review

  • If the member firm reasonably believes that financial exploitation has occurred, is occurring, has been attempted, or will be attempted, it can place a temporary hold on disbursements of funds or securities.
  • The rule does not require the member firm to take this action but allows it to do so at its discretion.
  • The hold can be no longer than 15 business days under the rule.
  • A state regulator or agency of jurisdiction, however, can terminate the hold sooner or extend the hold longer.
  • If a member firm places a temporary hold on disbursements, it must immediately initiate an internal review of the facts and circumstances that caused the member to initiate the temporary hold on the disbursements.
  • The rule requires the member to provide notification of the hold and the reason for the hold to the trusted contact person and all parties authorized to transact business in the account no later than two business days after the date the hold was initiated.
  • A member firm is not required to provide notification to the trusted contact person or a party authorized to transact business in the account if the trusted contact person or party is unavailable, or the member reasonably believes that the trusted contact person or party is the perpetrator of the financial exploitation.

Improper Use of Customer Assets (LO 11.g)

  • Anytime that funds or securities of a customer are used in any way other than what was intended by the customer, improper use has occurred.
  • All such uses are prohibited.
  • FINRA expects member firms to detect and investigate red flags that alert the firm to improper use of customer funds.
  • Firms can generate exception reports to indicate red flags, such as conflicting information in new account applications and suspicious transfers of funds between unrelated accounts.
  • The BD is expected to implement reasonable systems and controls to enable the supervisory review of customer accounts to thwart, among other things, the falsification of new account applications and other records to take advantage of vulnerable customers.
  • Examples of red flags:
    • Suspicious activity involving transfers and disbursements in customer accounts
    • Activity in the account of a deceased person
    • Excessive customer complaints
    • Exception reports showing discrepancies regarding more than one address, a street address not matching a city or a ZIP code provided, or a telephone area code not matching an address provided.
Borrowing From or Lending to Customers
  • The most common example of improper use of customer assets is borrowing or lending, even with consent.
  • Borrowing without consent is indistinguishable from stealing.
  • Taking (borrowing) a customer's funds for either the firm's or the representative's own use is prohibited.
  • Lending a customer's securities for the purpose of short sales when no loan consent agreement has been signed by the customer is another way in which improper use might occur.
  • Borrowing and lending arrangements can be permitted under certain circumstances.
  • Firms that permit lending arrangements between representatives and customers must have written procedures in place to monitor such activity.
  • Registered persons who wish to borrow money from or lend money to customers are, in most cases, required to provide prior written notice of the proposed arrangement to the firm, and the firm must approve the arrangement in writing.
  • The Conduct Rules permit the following five types of lending arrangements:
    1. There is an immediate family relationship between the representative and the customer (no notice or approval is needed).
    2. The customer is in the business of lending money (e.g., a bank) (no approval is needed).
    3. The customer and the representative are both registered persons with the same firm (firm approval required).
    4. The customer and the representative have a personal relationship outside the broker-customer relationship (firm approval required).
    5. The customer and the representative have a business relationship outside the broker-customer relationship (firm approval required).
  • A representative's BD must have procedures in place allowing for borrowing or lending arrangements with customers, or such arrangements are not allowed. If the firm does not allow for such arrangements, then a representative may not enter into such an arrangement.
Guarantees and Sharing in Customer Accounts
  • BDs, investment advisers, and RRs may not guarantee any customer against a loss or guarantee a gain.
  • All such guarantees, or anything intended to convey a guarantee, are prohibited.
  • Member firms and representatives are also prohibited from sharing in profits or losses in a customer's account.
  • An exception is made if a joint account has received the member firm's prior written approval and the RR shares in the profits and losses only to the extent of his proportionate financial contribution to the joint account.
  • Contribution to the account cannot be measured in knowledge or expertise, only in dollars.
  • The firm, however, may share in a loss if the loss was due to an error made by the firm.
  • Exceptions to this proportion rule are made when sharing in a joint account with immediate family members.
  • In these instances, directly proportionate sharing of profits and losses is not mandatory.
  • Immediate family members include parents, in-laws, spouses, children, and any relative to whom the officer or employee in question contributes financial support.
  • Financial support is broadly defined to include anyone who is living in the same residence.
  • Firms cannot have joint accounts with customers.

Limitations on Nonregistered Personnel (LO 11.h)

  • Nonregistered employees of BDs have a limited scope of activities.
  • Some of the activities permitted for a nonregistered employee of a BD are as follows:
    • Responding to general, noninvestment questions (What are your hours of operation? May I leave a message for . . . ? Where is the restroom?)
    • Providing literature on request, setting appointments, inviting prospects to a seminar, and similar activities
  • Nonregistered (or nonlicensed) persons may not engage in investment banking or other securities business (opening an account, soliciting trades, etc.).
  • Nonregistered persons may handle customer money and securities.
  • Nonregistered persons handling customer assets must be fingerprinted.
  • Even after successfully passing the SIE, you are not registered until you have passed a top-off exam.
  • You are limited to the activities allowed a nonlicensed person.
  • Performing functions of a representative before licensing is a good way to be barred from the industry.