Liquefied Home Equity
In December of 2004, the NASD (predecessor to FINRA) sent out a Notice to Members titled “Liquefied Home Equity-NASD Alerts Members to Concerns When Recommending or Facilitating Investments of Liquefied Home Equity” (“Liquefied Home Equity NTM”). The Liquefied Home Equity NTM was summarized by the NASD as follows:
The rapid increase in home prices over the past several years, in combination with refinancing activity by homeowners, has lead to increasing investment activity by homeowners with equity from their homes. This Notice reminds members that recommending liquefying home equity to purchase securities may not be suitable for all investors and that members and their associated persons should perform a careful analysis to determine whether liquefying home equity is a suitable strategy for an investor. In addition, members should ensure that all communications with the public addressing a strategy of liquefying home equity are fair and balanced, and accurately depict the risks of investing with liquefied home equity. Finally, members should consider whether to employ heightened scrutiny of accounts that they know, or have reason to know, are funded with liquefied home equity.
Specifically, the Liquefied Home Equity NTM points out that the “NASD believes that a recommendation for a homeowner to liquefy home equity for investments poses significant and unique risks for investors” and that “one of the primary concerns of investing liquefied home equity is that the investor may lose his or her home”. Finally, the Liquefied Home Equity NTM points out that “investors may fail to recognize certain potential conflicts of interest, for example, a broker’s interest to capture commissions or fees on investments from the proceeds of liquefied home equity. In addition, if the member or its affiliate is the lender, investors may not understand that they also will be paying compensation to the member or its affiliate for originating and/or servicing the loan.”
The Liquefied Home Equity NTM stated that, in conducting a suitability analysis for a client considering an investment of home equity proceeds, the broker should consider, among other things: "(1) how much equity does the investor have in his or her home; (2) what is the level of equity being liquefied for investments; (3) how will the investor meet his or her increased mortgage obligations . . . (5) what is the investor's risk tolerance with respect to the funds being invested; (6) what is the investor's overall debt burden; and (7) what is the sustainability of the value of the investor's home." Broker dealers and financial advisors who fail to consider these factors violate IM-2310-2 (Fair Dealing with Customers), which prohibits recommending "the purchase of securities or the continuing purchase of securities in amounts which are inconsistent with the reasonable expectation that the customer has the financial ability to meet such a commitment."