Improper Use of Customer Securities or Funds
Securities professionals have access to customer money and securities. Strict rules govern how they handle these assets and what financial relationships they can have with customers.
Borrowing From Customers
- Associated persons are generally prohibited from borrowing money from or lending money to customers
- This rule prevents exploitation of the trust relationship between a broker and their customer
Five Exceptions (With Firm Approval)
| Exception | Requirement |
|---|---|
| Immediate family members | Loans between the registered representative (rep) and a customer who is an immediate family member |
| Financial institution customer | The customer is a bank or other financial institution lending in the normal course of business |
| Pre-existing personal relationship | A personal relationship existed before the broker-customer relationship |
| Pre-existing business relationship | A business relationship outside the broker-customer relationship already existed |
| Registered person at same firm | Both parties are registered persons at the same member firm |
- All exceptions (except immediate family in some cases) require prior written approval from the member firm
- The rule also covers indirect arrangements: a rep cannot ask a customer to lend to the rep's family member to circumvent the prohibition
Exam Tip: Gotchas
- The borrowing prohibition works both ways. A broker cannot borrow from OR lend to a customer.
- It applies to ALL associated persons, not just the customer's assigned broker.
- "Pre-existing relationship" has a specific meaning. The relationship must have existed BEFORE the broker-customer relationship began. A friendship that develops after opening the account does not qualify.
Sharing in Customer Accounts
Associated persons may NOT share in the profits or losses of a customer account unless ALL of the following conditions are met:
- The customer provides written authorization
- The associated person's employer firm provides written authorization
- Sharing is proportionate to each party's financial contribution to the account
- Exception: Sharing can be disproportionate if the account belongs to an immediate family member
- Example: A broker contributes 30% of the capital but receives 50% of the profits. This is only allowed if the customer is an immediate family member.
Think of it this way: If you and a customer both put money into an account, you can only take out profits matching your share. Put in 30%, take out 30% of the gains. The only time you can take a bigger cut is if the customer is family.
Exam Tip: Gotchas
- Both the customer AND the firm must give written authorization. If only one approves, it is still a violation.
- Proportionate sharing is the default rule. Disproportionate sharing is only allowed for immediate family members.
Custody of Customer Assets
- Firms must segregate customer assets from firm assets (customer money and securities must be kept separate from the firm's own)
- Firms cannot use customer securities as collateral for the firm's own loans (except as permitted under margin rules)
- Misuse of customer funds or securities is one of the most serious violations in the industry
Exam Tip: Gotchas
- Segregation is the key word. Customer assets must be kept separate from firm assets at all times. Using customer securities for the firm's own purposes is a serious violation.