FINRA Fines Four Firms $2.6M for Securities Lending Violations

FINRA Fines Four Firms —M1 Finance LLC, Open to the Public Investing, Inc., SoFi Securities LLC, and SogoTrade, Inc. The total penalty amounts to $2.6 million, comprising over $1 million in restitution to retail customers participating in fully paid securities lending programs. Additionally, fines totaling $1.6 million were imposed on the firms for their supervisory and advertising violations.

Ensuring the careful supervision of fully paid securities lending programs is crucial for FINRA member firms. Bill St. Louis, FINRA’s Executive Vice President and Head of Enforcement, emphasizes the importance of safeguarding investors and providing restitution for harmed customers.

In fully paid securities lending, a clearing firm borrows a customer’s fully paid or excess margin securities, lending them to a third party for a daily borrowing fee. Customers opting for this program allow the clearing firm to decide which securities to borrow, when, and under what terms. The daily borrowing fee collected is typically shared among the clearing firm, the introducing broker-dealer, and the customer who owns the borrowed security.

It’s essential to note that when shares are borrowed over a dividend date, customers receive payments in lieu of dividends, subject to a higher tax rate than qualified dividends. As part of its commitment to investor protection, FINRA will persist in enforcing rules and ensuring restitution for affected customers.“

Four broker-dealer firms recently faced sanctions from FINRA due to their failure in establishing, maintaining, and enforcing a supervisory system, along with written supervisory procedures. These procedures were meant to reasonably oversee their fully paid securities lending offerings. Despite contractual agreements with their clearing firms to assess the suitability of customers for fully paid securities lending, these firms neglected to establish criteria or evaluate appropriateness before enrolling customers. Instead, they automatically enrolled all new customers at account opening.

Furthermore, the firms provided customers with disclosure documents containing misleading information, claiming customers would receive compensation, including a “loan fee,” for lending their securities. In reality, customers received no compensation. The restitution of over $1 million is intended to compensate customers whose securities were lent out over a dividend date, potentially leading to adverse tax consequences due to their involvement in fully paid securities lending programs.

M1 Finance, Open to the Public Investing, Inc., SoFi Securities, and SogoTrade have agreed to FINRA’s findings as part of the settlement, without admitting or denying the charges.

For more information on disciplinary actions, FINRA publishes details on its Disciplinary Actions Online database, along with a summary of monthly disciplinary actions against firms and individuals for violations of FINRA rules, federal securities laws, and the rules of the Municipal Securities Rulemaking Board on its Monthly Disciplinary Actions page.

What FINRA Fines Four Firms Means to You

These AWCs address crucial aspects of broker-dealers’ compliance with FINRA Rules related to fully paid and excess margin securities lending. These issues were emphasized in FINRA’s 2023 Report on Examination and Risk Monitoring Program.

• When the firm shares or offers communications promoting revenue sharing programs, like fully paid lending, to retail investors, it must ensure these communications transparently disclose program terms and conditions. This includes clearly stating the portion of fees customers can expect to receive.
• In cases where the firm involves retail customers in a program, it must address two key aspects. Firstly, it needs to outline how the firm assesses the program’s suitability for the customer, especially in instances of autoenrollment. Secondly, it should ensure accurate disclosure of the customer’s share in the fees generated from loaned shares.

Firms offering fully paid lending to their customers can expect that FINRA will be focused on

The firm must have a robust supervisory system, including documented procedures, to assess each customer’s suitability for fully paid lending before enrollment. If the firm automatically enrolls customers or assumes all customers are eligible, FINRA may inquire further.

whether the firm’s MSLA, written disclosures, and other documents and customer communications accurately reflect the terms and conditions of participating in fully paid lending — in particular, the compensation the customer will receive for their securities loans