Open to the Public Investing Faces Sanctions: FINRA Imposes $2.6M Penalty for Securities Lending Violations
Open to the Public Investing Faces Sanctions along with three other broker-dealer firms, has been fined a total of $2.6 million by FINRA for violations related to fully paid securities lending programs. The penalties include over $1 million in restitution to retail customers participating in these programs and an additional $1.6 million in fines for supervisory and advertising violations.
The regulatory action underscores the importance of careful supervision in fully paid securities lending programs, where a clearing firm borrows customers’ fully paid or excess margin securities for a daily fee. Despite contractual agreements to assess the suitability of customers for these programs, Open to the Public Investing and the other firms failed to establish criteria or evaluate appropriateness before enrolling customers. Instead, they automatically enrolled all new customers at account opening.
Additionally, these firms provided customers with misleading disclosure documents, falsely claiming compensation, including a “loan fee,” for lending their securities. The reality was that 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.
Open to the Public Investing Faces Sanctions from
Open to the Public Investing, along with M1 Finance, SoFi Securities, and SogoTrade, has agreed to FINRA’s findings as part of the settlement without admitting or denying the charges.
This regulatory action highlights the need for broker-dealers, especially those like Open to the Public Investing, to establish and enforce a robust supervisory system with documented procedures to assess the suitability of customers for fully paid securities lending before enrollment. Transparency in communications promoting revenue-sharing programs is crucial, and firms must ensure accurate disclosure of customers’ shares in the fees generated from loaned shares. The focus on compliance with FINRA rules and transparent communication is underscored in FINRA’s 2023 Report on Examination and Risk Monitoring Program.
FACTS AND VIOLATIVE CONDUCT
This issue arose during a FINRA examination of firms that provide fully paid securities lending to retail customers.
About Fully Paid Securities Lending Fully paid securities lending involves a clearing firm borrowing a customer’s fully paid or excess margin securities and lending them to a third party, receiving a daily borrowing fee in return. Customer consent is essential before the clearing firm can borrow or lend their securities. Clearing firms, which hold customer securities, operate fully paid lending programs.
If a customer is enrolled, the clearing firm decides which securities to borrow, when, and under what terms. Once the firm identifies a security for borrowing in an enrolled customer’s account, it removes the security, deposits collateral with a trustee, and lends the security to a third party, collecting a daily borrowing fee. The borrowing rate varies, reflecting market conditions. Securities in high demand may yield a higher interest rate.
When a customer wants to sell borrowed securities, the clearing firm recalls them from the third-party borrower. If shares are borrowed over a dividend date, the customer receives a cash payment instead of the dividend, taxed as regular income at a potentially higher rate than qualified dividends. During the securities loan period, customers lose SIPC protection and voting rights for the borrowed shares.
Open to the Public Investing’s Role in Fully Paid Securities Lending Since at least May 2020, Open to the Public Investing has participated in a fully paid securities lending program (FPLP) offered by its clearing firm. In the agreement with the clearing firm, Open to the Public Investing determines customer eligibility for the FPLP sets criteria for participation and decides on compensation for customers when their securities are borrowed. It’s important to note that Open to the Public Investing doesn’t hold customer securities and doesn’t engage directly in borrowing or lending these securities. The third-party borrowing firm also provides collateral to the clearing firm, maintaining the clearing firm’s net capital neutrality.
Public Investing, among four fined firms by FINRA, failed in its supervisory obligations for fully paid securities lending. Customers, at account opening, consented to a Master Securities Lending Agreement (MSLA) allowing the clearing firm to borrow their securities. Public Investing also provided a disclosure document.
Between May 2020 and September 2022, all new customers were automatically enrolled in the Fully Paid Lending Program (FPLP) at account opening, violating FINRA rules.
Over 1.5 million customers were auto-enrolled, generating $2.5 million for Public Investing. However, customers received no share, losing SIPC protection and voting rights. Some faced adverse tax consequences from cash payments instead of dividends. In December 2022, Public Investing allowed opt-out during account opening.
Public Investing enhanced appropriateness criteria in September 2022 and implemented written supervisory procedures by June 2023, addressing previous failures. The fines, totaling $2.6 million, aim at restitution and penalizing supervisory and advertising violations. This enforcement underscores FINRA’s commitment to safeguarding investors and ensuring compliance in fully paid securities lending programs.
