Misuse of Customer Assets

The misuse-of-customer-assets prohibition is the most direct trust-violation rule in the FINRA conduct rules. A registered person who borrows from a customer's account, promises to cover losses, or splits profits without authorization violates the rule even if the customer was not financially harmed and even if the customer agreed.

The Improper-Use Prohibition

No member or associated person may make improper use of a customer's securities or funds. The rule applies to any control over customer assets, including discretionary authority, beneficial-interest authority, and operational handling.

"Improper use" includes:

• Unauthorized borrowing of customer securities or funds for any purpose, including short-term loans the registered person intends to repay
• Pledging or rehypothecating customer assets beyond authorized margin obligations under the SEC customer-protection rule
• Commingling customer assets with the associated person's own accounts, or using customer cash for the firm's own purposes (such as payroll or firm trading), which the SEC customer-protection rule does not allow
• Using customer assets for personal purposes, including paying personal expenses or trading for the registered person's own account

Exam Tip: Gotchas

• The improper-use prohibition reaches even short-term unauthorized borrowing. A registered person who "borrows" $5,000 from a customer's account on Monday and repays it on Friday violates the rule. Intent to repay is irrelevant.
• The improper-use prohibition sits alongside the SEC customer-protection rule. That rule lets a firm use customer credit balances only for the customer-related debit items in its reserve formula, so using customer cash for the firm's own expenses can breach both rules. FINRA can bring its own charges without waiting for the SEC to act.

The Prohibition Against Guarantees

No member or associated person may guarantee a customer against loss in connection with any securities transaction or any securities account.

• The prohibition covers express guarantees ("I will cover any loss") and implicit promises (verbal or written assurances that loss is impossible)
• A guarantee is a violation regardless of whether a loss ever occurs. A rep who tells a customer "you cannot lose money on this trade" violates the guarantee prohibition even if the trade is profitable
• A guarantee is a violation regardless of whether the firm's policies allow it. Individual reps cannot guarantee loss prevention even if the firm has not specifically prohibited it

Limited Safe Harbors

A member firm (not the associated person personally) may, on an after-the-fact basis:

• Reimburse a customer for transaction losses (subject to applicable reporting, e.g., reporting as a settlement on the customer's account history)
• Correct a bona fide error (an operational mistake by the firm or its agents)

The safe harbors apply only to the firm acting as a corporate entity. A registered person's personal promise to cover losses is never within the safe harbor.

Think of it this way: The firm can pay the customer back after a trade goes wrong. The rep cannot promise upfront that the firm or the rep will pay if a trade goes wrong. The first is a settlement; the second is a guarantee.

Exam Tip: Gotchas

• A rep cannot orally promise to "cover any losses" on a recommended trade, even if the rep intends to keep the promise. The guarantee prohibition makes a guarantee a violation regardless of whether a loss ever occurs.
• An after-the-fact firm reimbursement is allowed; a pre-trade promise is not. The exam tests this distinction. The firm can settle a complaint by writing a check; the rep cannot promise the check before the trade.

The Sharing-in-Customer-Accounts Prohibition

The general prohibition: No member or associated person may share, directly or indirectly, in the profits or losses of a customer's account.

The Two-Part Exception

A registered person may share if both authorizations are obtained in advance:

1. Prior written authorization of the member firm
2. Prior written authorization of the customer

Plus the Proportionality Requirement

Even with both written authorizations, the registered person's share of profits and losses must be in direct proportion to the registered person's financial contribution to the account. This is an exact match, not a ceiling: a rep who funds 60% but takes 40% still fails the test for a non-family customer. A 10% contribution paired with a 50/50 split fails for the same reason.

The Immediate-Family Exception to Proportionality

The proportionate-contribution requirement does NOT apply to accounts of the registered person's immediate family.

• "Immediate family" for sharing-in-account purposes is defined broadly to include parents, spouse or domestic partner, children, siblings, in-laws, and others. Use the same broad definition tested under the borrowing/lending requirement
• The family member must still grant the authorization, and the firm must still approve in writing

Exam Tip: Gotchas

• Sharing requires BOTH written approvals AND proportional contribution (for non-family customers). A rep who funds 10% of an account but agrees to a 50/50 profit split violates the sharing prohibition even with both consents in writing.
• The immediate-family exception waives proportionality, not firm approval. The rep still must obtain prior written firm consent to share in a parent's or spouse's account, even though contribution proportionality no longer applies.

What Should You Check on Exam Day?

• Do you know the improper-use prohibition reaches even short-term unauthorized borrowing a registered person intends to repay?
• Can you state that a guarantee against loss is a violation regardless of whether a loss ever occurs, even if the trade turns out profitable?
• Can you distinguish a firm's after-the-fact reimbursement of a loss, which is allowed, from a rep's pre-trade promise to cover losses, which is not?
• Do you know sharing in a customer's account requires prior written authorization from both the firm and the customer, plus proportionate financial contribution?