With a non-recourse loan, the lender has limited options if a borrower fails to repay the amount owed. The lender cannot require the borrower to pledge additional securities or otherwise pay back the full amount of the loan.

As with any strategy promising high upside potential with little risk, these programs can involve costs and dangers that investors should know about. These include the potential failure of the lender to return your stock when you repay the loan, possible tax consequences if the Internal Revenue Service considers the transaction a taxable event or sales loads and fees and surrender charges if you use the proceeds to purchase another financial product, such as a fixed or equity-indexed annuity.

FINRA is issuing this Alert to educate investors about non-recourse stock-based loan programs, including risks and rewards and key questions to ask.

Some pitches for these programs promise that you can tap the value of your portfolio for any purpose without incurring the tax consequences of a sale. These programs may be marketed by financial planners, investment advisers, insurance agents, accountants, attorneys and others—as well as by representatives of traditional broker-dealers. In some instances, financial professionals and others offer the program as a way for their customers to raise cash to buy other financial products the professionals sell—such as annuities or other financial products that might or might not be securities—without requiring the customer to sell his or her existing stocks.

Alternatively, the program might be offered as a way to use the same money for two purposes—buying new stock, and then borrowing against that stock and using the proceeds to make another investment, such as an annuity. Different promoters offer stock-based loan programs with varying features. The customer agrees to pay interest, which accrues during the loan term, and is credited with any dividends paid on the stock pledged by the customer. The interest rates charged for the loan can be relatively high, often above 10 percent.

At the end of the loan period, the customer generally has several options:. Depending on the terms of the program, the customer can either use existing stock as collateral or buy new stock to pledge as collateral.

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In some cases, the lender will reduce the interest charges if the customer agrees to a cap on potential gains. For example, in exchange for paying a lower interest rate, a customer might agree to limit any gains to 50 percent above the value of the stock at the time of the loan. To illustrate, suppose a customer owns stock in XYZ Corp.

The customer can then either repay the loan and get back the stock or request that the lender pay the customer the amount by which the value of the stock exceeds the amount due on the loan. While stock-based loan programs could be attractive for some investors, investors should be aware of the following risks and other potential concerns:.

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Failure to perform by lender: In some of the cases FINRA has seen, the lenders offering the non-recourse stock-based loans were not registered with FINRA or regulated by any banking authority. That makes it difficult to ascertain their financial stability or to verify what they are doing with your stock once you transfer it to them.

While the lenders promise to return the stock or pay the profits, if any, at the end of the loan period, there is no assurance that they will be able to do so. In that situation, you would lose that portion of the value of the stock generally 10 percent kept by the lender when the loan was initiated, as well as any profits to which you are entitled. Premature sale of stock: When you pledge your securities as collateral, you generally transfer the stock to the lender, who then has total control over it.

Not only might this result in tax consequences, but you also can lose the benefit of any appreciation of the stock you thought you still owned. Whether or not the lender sells the stock during the loan period, the Internal Revenue Service might consider the transfer of the stock to be a taxable event. That means you might face unexpected tax liabilities and have to pay capital gains taxes upon receipt of the proceeds of the loan or upon the sale of the stock by the lender.

These taxes can be substantial, particularly if you held the stock for a long time and it increased significantly in value. This is a critical issue for those who enter into a stock-based loan program to avoid immediate taxation. Availability of funds to repay loan: Most stock-based loan programs are relatively short-term loans—often as little as two to three years.

If, at the end of the period, you want to pay off your loan balance and get back the exact number of shares of stock pledged, you must have sufficient liquid funds. This can be difficult if you invested the loan proceeds in a long-term investment or a product with a surrender charge or contingent deferred sales charge CDSC , such as a fixed, variable or equity-indexed annuity.

In such instances, you would either have to liquidate the new investment which could mean incurring significant charges and a potential tax liability or tap money from other sources. Lack of adequate investigation by the promoter: Absent adequate due diligence, neither you, your financial professional nor anyone involved in promoting the program can know for certain what the lender actually does with your pledged stock—specifically, whether it holds it for your benefit or sells it—or whether the lender has adequate cash on hand to honor its obligations at the end of the loan term.

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Similarly, the Securities and Exchange Commission has brought actions against promoters of stock-loan programs for failing to perform adequate due diligence of the lender.

Unlike broker-dealers, many of the financial professionals promoting non-recourse stock-based loan programs are not licensed brokers or registered broker-dealers and are not required to make certain that securities transactions are suitable for their customers. Dealing with unlicensed, unregistered financial professionals increases your risk. Possible conflicts of interest: FINRA is aware of stock-based loans being promoted by financial professionals as a way to free up cash for their customers to purchase products offered by the professional.

Be aware of the possibility that a broker or other financial professional might recommend a stock-based loan program to generate commissions on the new products you purchase with the loan proceeds.

Restrictions on the use of the loan proceeds: Loans secured by the pledge of certain securities, including most stock, are generally considered margin loans. Federal Reserve Board regulations restrict the use of those proceeds, including limiting the purchase of securities with the proceeds. As a result, stock-based loan customers may not be able to use the proceeds of the loans in the same way they could if they simply the sold the stock.

High costs and high interest charge: You can walk away if the stock drops, but it can be harder to profit if the stock rises. The bottom line is that while a non-recourse stock loan program might sound good at first blush, these programs involve significant risk, can be costly and can result in unintended tax consequences. The best step you can take to protect yourself is to ask questions and independently verify the answers.

When considering a stock loan program, be sure to ask:.

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If you suspect that you are being scammed or simply have questions about a stock-based loan program that seems a little too good to be true, call FINRA at or file a complaint or question using FINRA's online Investor Complaint Center. Get Rid of Debt Save for Retirement Get Help with a Broker Dispute Control Spending Start an Emergency Fund Save for College Deal with Losing a Job Deal with Identity Theft Protect My Employees From Scams.

FINRA Home About FINRA Newsroom Contact Site Preferences. You are here Home For Investors Investor Alerts Investor Alerts. What Are Non-Recourse Stock-Based Loan Programs? Who Markets Stock-Based Loan Programs? How Do Non-Recourse Stock-Based Loan Programs Work? At the end of the loan period, the customer generally has several options: Extend the loan —If allowed, the customer can renew the loan for an additional fixed time period.

Get the stock back —The customer can get the stock back by paying off the loan balance plus accrued interest and less any dividends paid. Cash in on any upside profits —If the value of the pledged stock has i ncreased above the total amount due on the loan, including interest, then the customer can elect to receive a cash payment equal to this profit—meaning the current value of the stock, minus the amount the customer owes the lender.

In this last scenario, the lender cannot try to recover any of the loaned amount or interest from the customer. What Are the Risks and Other Considerations? While stock-based loan programs could be attractive for some investors, investors should be aware of the following risks and other potential concerns: How Can I Protect Myself? When considering a stock loan program, be sure to ask: Are the lender and promoters registered with FINRA or with bank regulators?

Use FINRA BrokerCheck to verify the registration and licensing status of the lender and any promoter or other intermediary in the transaction—and to check their backgrounds.

You can also verify whether the entity extending the loan is a regulated bank or credit union by visiting the website of the Federal Financial Institutions Examination Council. Be extremely wary of borrowing from an entity that is neither a brokerage firm nor a bank. Does the lender have audited financials? If the lender is publicly traded, you can review its financial statements to independently assess its financial strength, including whether it has sufficient cash reserves to return pledged collateral to borrowers who pay their loans.

What happens to my stock once I pledge it as collateral? Verify who owns the stock, who receives dividend payments and whether and how dividend payments get credited to your loan balance and what tax consequences, if any, the loan might entail. Separately check with an independent tax professional to ask about your particular tax situation. What benefit does the promoter receive for recommending the program? This is especially important if the financial professional touting the program or his or her firm receives compensation on any financial product you purchase with the proceeds of the loan.

If you purchase a financial product with the proceeds: What are the costs and risks? Ascertain whether the product involves upfront sales charges, ongoing fees, potential surrender charges or back-end loads, some combination of these or other costs. Ask about any sort of holding period and whether you will have to pay to cash out of the investment when the loan comes due.

How easy or difficult is it to sell the investment? What are the specific risks of that investment? Where to Turn for Help If you suspect that you are being scammed or simply have questions about a stock-based loan program that seems a little too good to be true, call FINRA at or file a complaint or question using FINRA's online Investor Complaint Center.

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