Quick Answer
Client assets must stay segregated from the firm's own assets and properly identified in records at all times. Mixing them (commingling) is a violation even if nothing is stolen; taking them for personal use (conversion) is theft. No customer authorization cures unauthorized borrowing, and antifraud liability attaches regardless of any registration exemption.
This section covers a core obligation for securities professionals: keeping client assets separate and safe.
What Does the Commingling Prohibition Cover?
Under the NASAA Statement of Policy on Dishonest or Unethical Business Practices, it is a prohibited practice for a broker-dealer or agent to commingle customer funds or securities with the firm's own assets.
- Commingling means mixing client assets with the firm's proprietary funds or securities in the same account
- Each client's assets must be segregated from the firm's own assets and identifiable in the firm's records; a client-only omnibus or pooled account (permitted by the custody rule) is not commingling, since it still excludes the firm's proprietary assets
- The prohibition applies to both broker-dealers and investment advisers
What Are the Safekeeping Obligations?
Broker-dealers that hold customer securities have specific safekeeping duties:
- Customer securities held in street name must be kept separate from the firm's proprietary holdings in segregated accounts
- Securities held for customers must be properly identified and recorded as belonging to the customer
- Customer free credit balances (uninvested cash) must be properly accounted for and available for withdrawal on demand
- The firm has a duty of safekeeping; it is responsible for the security and proper handling of client assets
What Counts as Misuse of Customer Funds?
It is unlawful for any securities professional to misuse customer funds or securities in any way:
- Conversion (taking client assets for personal use) is the most severe form of misuse: it is essentially theft
- Using customer funds for the firm's own business purposes (even temporarily) constitutes misuse
- An agent borrowing or lending a customer's money or securities is a violation, and the customer's authorization does not cure it. The ban is absolute: no family exception, no bank exception, no affiliate exception
- A broker-dealer (the firm) may hypothecate (pledge) a customer's securities as loan collateral without violating this rule only if it already holds a lien on them or secures the customer's properly executed written consent promptly after the initial transaction. Unlike an agent's borrowing ban, the customer's written consent here is legally operative: it is what makes the pledge lawful
- An investment adviser has narrow, defined exceptions instead of an absolute ban:
- The adviser may borrow from a client only if the client is a broker-dealer, an affiliate of the adviser, or a financial institution engaged in the business of loaning funds
- The adviser may lend to a client only if the adviser itself is a financial institution engaged in the business of loaning funds, or the client is an affiliate of the adviser
- The Uniform Securities Act (USA) antifraud provisions apply to misuse of customer funds, and no exemption shields this conduct
Exam Tip: Gotchas
- Commingling and conversion are different violations. Commingling is mixing client assets with firm assets in the same account (even if no assets are stolen). Conversion is taking client assets for personal use. Both are prohibited, but conversion is the more severe violation. The exam may test this distinction.
- The borrowing/lending exceptions belong to investment advisers, not agents. An agent may never borrow from or lend to a customer, regardless of the customer's relationship to the firm.
- Do not confuse an agent's absolute borrowing ban with a broker-dealer's hypothecation of customer securities. For the agent ban, no consent cures it. For broker-dealer hypothecation, the customer's written consent (or an existing lien) is exactly what makes the pledge lawful.
| Violation | Definition | Severity |
|---|---|---|
| Commingling | Mixing client and firm assets in the same account | Prohibited practice |
| Conversion | Taking client assets for personal use | Theft; criminal violation |
| Borrowing from a customer (agent) | Using client funds, even temporarily and even with the customer's permission | Prohibited practice, no exception |
| Hypothecation (broker-dealer) | Pledging a customer's securities as loan collateral | Lawful only with a lien on the securities or the customer's properly executed written consent |
| Borrowing/lending (investment adviser) | Permitted only with a broker-dealer, financial institution in the lending business, or an affiliate of the adviser | Prohibited outside those narrow exceptions |
What Should You Check on Exam Day?
- Commingling mixes client and firm assets in the same account; it is prohibited even if nothing is stolen. It applies to both broker-dealers and investment advisers.
- Conversion is taking client assets for personal use; it is theft and the more severe violation.
- Broker-dealers must keep customer securities segregated in street name, properly identified, with free credit balances available on demand.
- An agent may never borrow from or lend to a customer, with no exception. A broker-dealer may hypothecate a customer's securities only with a lien or the customer's written consent, which is what makes the pledge lawful.
- USA antifraud provisions cover misuse of customer funds with no exemption.