Permissible Use of Customers' Securities

The customer-securities-lending requirement determines whether and how a BD can lend out customer securities, including in fully-paid lending programs that have become common in retail brokerage. The rule layers customer-protection requirements on top of the customer-protection possession-or-control framework:

• The customer protection rule says fully-paid customer securities must be in good control
• The customer-securities-lending requirement says yes, but the firm can lend them out under specified conditions, with specified disclosures, with specified collateral

Margin Securities: Lending Under the Margin Agreement

A member may not lend a customer's margin securities unless the customer has signed a written authorization permitting the lending. This authorization is typically embedded in the standard margin agreement the customer signs at account opening:

• The hypothecation clause of the margin agreement authorizes the firm to pledge or lend the customer's margin securities
• The customer signs once, at account opening
• Subsequent lending of margin securities does not require renewed authorization

What Lending Means in Margin Context

Margin securities can be loaned to:

• Other customers borrowing them for short sales
• Other firms that have failed to deliver against a sale
• The firm's own short positions

The customer is paid for the lending through the margin-account economics: the customer's debit balance accrues interest at the firm's margin rate, which already reflects the firm's ability to lend out the collateral. There is no separate per-lend payment to the margin customer.

Exam Tip: Gotchas

• Margin securities can be loaned with a one-time written authorization (the margin agreement). Fully-paid securities cannot. The exam tests this distinction: the rules for margin and fully-paid are different, and the one-time-authorization-via-margin-agreement only covers margin securities.

Fully Paid / Excess Margin Securities: The Higher Bar

Borrowing fully paid or excess margin securities ( a "fully paid lending program") is permitted but only under heightened conditions. All four of the following must be satisfied:

The 30-Day FINRA Notice

The 30-day FINRA notice is a gating requirement. The firm cannot launch a fully-paid lending program 1 day after notifying FINRA; it must wait the full 30 days. The notice gives FINRA visibility and allows the regulator to flag concerns before the program goes live.

Appropriateness Review

The "reasonable basis" appropriateness review is more than a generic suitability check. The firm must consider:

• The customer's investment objectives and risk tolerance
• Whether the customer understands the SIPA / SIPC limitation
• Whether the lending economics (incremental income for the customer vs. lending risk) make sense for this customer

A program enrolling all customers indiscriminately, without any appropriateness analysis, violates the customer-securities-lending requirement.

Written Customer Disclosure (the SIPA Gap)

Customers must receive clear, prominent written disclosures including:

• A description of how securities lending works (the firm borrows the securities; the customer retains economic interest in dividends as cash-in-lieu, but loses voting rights and dividend tax treatment during the loan)
• The risks (loss of voting rights, loss of qualified dividend tax treatment, SIPA / SIPC limits)
• The collateral arrangements
• The customer's right to terminate the lending arrangement

The SIPA / SIPC disclosure is the most critical piece. Loaned securities are NOT covered by SIPC; they are protected only by the contractual collateral the firm posts. If the firm fails and the borrower of the securities also fails, the customer has only the collateral to look to.

Daily Collateral

Collateral can be:

• Cash
• Qualified securities (U.S. Treasury obligations or other approved instruments)

The collateral must be at least equal to the market value of the loaned securities and marked to market daily. If the loaned securities appreciate, the firm must post additional collateral; if they depreciate, the firm releases excess collateral back.

Real-world example: Customer agrees to lend 1,000 shares of Apple at $200 = $200,000 market value. The firm posts $200,000 of cash collateral on day 1. By day 5, Apple is at $210, so the position is worth $210,000. The firm must add $10,000 to the collateral pool. By day 10, Apple is at $195, so the position is worth $195,000. The firm releases $15,000 of collateral back to the lending pool.

Exam Tip: Gotchas

• A margin customer's securities can be loaned with a ONE-TIME written authorization (the margin agreement). A fully-paid customer's securities require SEPARATE written authorization PLUS the 30-day FINRA notice plus appropriateness review. Different protection tiers apply.
• Securities loaned out by the firm (with customer consent) are NOT covered by SIPC. They are protected only by the contractual collateral. The customer-securities-lending requirement's written disclosure makes this explicit; it is a SIPA gap that the customer must be told about.
• The 30-day FINRA notice is required BEFORE the firm engages in any fully-paid lending. The clock runs from notice to FINRA, not from the customer's signature on a fully-paid lending agreement.

Disclosure Mandate: Substance Over Form

The customer-securities-lending disclosures cannot be buried in fine print. The customer must receive clear, prominent disclosures that:

• Describe how securities lending works in plain language
• Describe the customer's risks (including the SIPA / SIPC limitation)
• Describe the collateral arrangements
• Describe the customer's right to terminate the lending arrangement at any time

Firms typically provide these disclosures as a separate document, signed by the customer, rather than embedded in a generic account agreement. The customer's signature on the standalone disclosure is what evidences the customer's informed consent.

Exam Tip: Gotchas

• Customer-securities-lending disclosures must be CLEAR and PROMINENT. A disclosure buried in a 50-page account agreement does not satisfy the rule. The exam may probe this around scenarios where the customer signed an account agreement that contained the disclosure but never received a separate document; the rule expects affirmative, separate disclosure.

How the Customer-Securities-Lending Requirement Connects to the Customer-Protection Chain

The customer-securities-lending requirement is one layer in the customer-asset-segregation chain:

1. Customer protection rule (possession or control): Fully paid customer securities must be in good control locations
2. Hypothecation rules: Customer securities may be hypothecated only up to the customer's debit balance, with customer-customer commingling consent and an absolute ban on customer-firm commingling
3. The customer-securities-lending requirement (lending): Customer securities may be lent only with proper authorization, FINRA notice, appropriateness, disclosure, and collateral

Together these rules define what a firm can and cannot do with customer assets. A firm that satisfies customer-protection possession-or-control but lends fully-paid securities without the customer-securities-lending disclosures has a separate violation regardless of how clean its customer-protection position is.