FINRA issued a new Investor Alert last week - Stock-Based Loan Programs: What Investors Need to Know - to educate investors about non-recourse stock-based loan programs, including the risks and rewards of these loans.  Stock-based loans can be tempting for investors who need cash - or who want to tap the value of their portfolios without selling their investments.  But, as recent FINRA disciplinary actions confirm, they can be risky, especially when they involve non-recourse loans from unregistered, unregulated 3rd-party lenders.

"Investors who want to tap into the value of their portfolio through a stock loan program should realize that these programs involve significant risk and cost, and may result in unintended tax consequences."   -- John Gannon, FINRA SVP for Investor Education.

Stock-Based Loan Programs.   These programs allow investors to pledge fully-paid stock as collateral for non-recourse loans from third-party lenders, who are generally unregistered and unregulated.  The programs typically are marketed by financial planners, investment advisers, insurance agents and others, supposedly allow investors to borrow money against a substantial percentage of their portfolio without giving up the benefits of owning the stock.

The investor "pledges" stock he or she owns as collateral to a lender which, in turn, lends cash to the investor cash - often as much as 90% of the value of the stock - for a set period of time, say 2 or 3 years.  The customer agrees to pay interest - often in excess of 10% - and is credited with any dividends paid on the stock the customer had pledged.  At the end of the loan period, the customer typically extends the loan or gets the stock back.

Investors participating in stock-loan programs should realize that whether or not the lender sells the stock during the loan period, the IRS might consider the transfer of the stock to be a taxable event.  As a result, investors might face unexpected tax liabilities and have to pay capital gains taxes upon receipt of the proceeds of the loan or upon the lender's sale of the stock.  To avoid surprises, it's best for investors to ask the following questions and independently verify those answers: 

• Are the lender and promoters registered with FINRA or with bank regulators?
• Does the lender have audited financials?
• What happens to my stock once I pledge it as collateral?
• What benefit does the promoter receive for recommending the program?
• If I purchase a financial product with the proceeds, what are the costs and risks?

Investors have been victims of stock-based loan program scams and when this occurs, they should file a complaint using FINRA's online Investor Complaint Center.   For further details, go to:   [FINRA News Release, 5/26/11]