Investor Alert: Stock-Based Loan Programs

The Financial Industry Regulatory Authority (FINRA) has issued an Investor Alert to educate investors about non-recourse stock based loan programs, including the risks and rewards. The release warns investors, who may be tempted to tap into the value of their portfolio through a stock loan program without selling their investments, that such stock based loan programs are risky especially if they involve non-recourse loans from unregistered, unregulated third party lenders. FINRA also warns that such these programs can lead to unexpected tax consequences.

Stock based loan programs allow investors to pledge fully paid stock as collateral for non-recourse loans from a third party lender, who is usually unregistered and unregulated. Such programs are marketed by financial planners, investment advisers and insurance agents, allowing investors to borrow money against a portion of their portfolio without giving up ownership of the stock. For example, the investor pledges stock as collateral to the lender, who will lend up to as much as 90% of the value of the stock for a designated time of a couple of years or so. The investor then has to pay interest of 10% or more during the period and any dividends paid on the pledged stock. When the term of the loan is up, the investor can extend the loan or get the stock back, among other things.

FINRA warns that the IRS might consider the transfer of the stock to be a taxable event, whether or not the lender sells the stock, resulting in the investor having to pay capital gains taxes upon receiving proceeds of the loan or upon the sale of the stock.

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