[Federal Register Volume 80, Number 246 (Wednesday, December 23, 2015)]
[Notices]
[Pages 79969-79983]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2015-32189]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-76675; File No. SR-FINRA-2015-054]
Self-Regulatory Organizations; Financial Industry Regulatory
Authority, Inc.; Notice of Filing of a Proposed Rule Change To Adopt
the Capital Acquisition Broker Rules
December 17, 2015.
Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(``Act,'' ``Exchange Act'' or ``SEA'') \1\ and Rule 19b-4
thereunder,\2\ notice is hereby given that on December 4, 2015,
Financial Industry Regulatory Authority, Inc. (``FINRA'') filed with
the Securities and Exchange Commission (``SEC'' or ``Commission'') the
proposed rule change as described in Items I, II, and III below, which
Items have been substantially prepared by FINRA. The Commission is
publishing this notice to solicit comments on the proposed rule change
from interested persons.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
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I. Self-Regulatory Organization's Statement of the Terms of Substance
of the Proposed Rule Change
FINRA is proposing to create a separate rule set that would apply
to firms that meet the definition of ``capital acquisition broker'' and
elect to be governed under this rule set.
The text of the proposed rule change is available on FINRA's Web
site at http://www.finra.org, at the principal office of FINRA and at
the Commission's Public Reference Room.
II. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
In its filing with the Commission, FINRA included statements
concerning the purpose of and basis for the proposed rule change and
discussed any comments it received on the proposed rule change. The
text of these statements may be examined at the places specified in
Item IV below. FINRA has prepared summaries, set forth in sections A,
B, and C below, of the most significant aspects of such statements.
A. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
1. Purpose
There are FINRA firms that are solely corporate financing firms
that advise companies on mergers and acquisitions,
[[Page 79970]]
advise issuers on raising debt and equity capital in private placements
with institutional investors, or provide advisory services on a
consulting basis to companies that need assistance analyzing their
strategic and financial alternatives. These firms often are registered
as broker-dealers because of their activities and because they may
receive transaction-based compensation as part of their services.
Nevertheless, these firms do not engage in many of the types of
activities typically associated with traditional broker-dealers. For
example, these firms typically do not carry or act as an introducing
broker with respect to customer accounts, handle customer funds or
securities, accept orders to purchase or sell securities either as
principal or agent for the customer, exercise investment discretion on
behalf of any customer, or engage in proprietary trading of securities
or market-making activities.
FINRA is proposing to establish a separate rule set that would
apply exclusively to firms that meet the definition of ``capital
acquisition broker'' (``CAB'') and that elect to be governed under this
rule set. CABs would be subject to the FINRA By-Laws, as well as core
FINRA rules that FINRA believes should apply to all firms. The rule set
would include other FINRA rules that are tailored to address CABs'
business activities.
General Standards (CAB Rule 010 Series)
Proposed CAB Rule 014 provides that all persons that have been
approved for membership in FINRA as a CAB and persons associated with
CABs shall be subject to the Capital Acquisition Broker rules and the
FINRA By-Laws (including the schedules thereto), unless the context
requires otherwise. Proposed CAB Rule 015 provides that FINRA Rule
0150(b) shall apply to the CAB rules. FINRA Rule 0150(b) currently
provides that the FINRA rules do not apply to transactions in, and
business activities relating to, municipal securities as that term is
defined in the Exchange Act.
CAB Rule 016 sets forth basic definitions modified as appropriate
to apply to CABs. The proposed definitions of ``capital acquisition
broker'' and ``institutional investor'' are particularly important to
the application of the rule set.
The term ``capital acquisition broker'' would mean any broker that
solely engages in any one or more of the following activities:
Advising an issuer, including a private fund, concerning
its securities offerings or other capital raising activities;
advising a company regarding its purchase or sale of a
business or assets or regarding its corporate restructuring, including
a going-private transaction, divestiture or merger;
advising a company regarding its selection of an
investment banker;
assisting in the preparation of offering materials on
behalf of an issuer;
providing fairness opinions, valuation services, expert
testimony, litigation support, and negotiation and structuring
services;
qualifying, identifying, soliciting, or acting as a
placement agent or finder with respect to institutional investors in
connection with purchases or sales of unregistered securities; and
effecting securities transactions solely in connection
with the transfer of ownership and control of a privately-held company
through the purchase, sale, exchange, issuance, repurchase, or
redemption of, or a business combination involving, securities or
assets of the company, to a buyer that will actively operate the
company or the business conducted with the assets of the company, in
accordance with the terms and conditions of an SEC rule, release,
interpretation or ``no-action'' letter that permits a person to engage
in such activities without having to register as a broker or dealer
pursuant to Section 15(b) of the Exchange Act.\3\
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\3\ See proposed CAB Rule 016(c)(1).
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A firm would be permitted to register as, or change its status to,
a CAB only if the firm solely engages in one or more of these
activities.
The term ``capital acquisition broker'' would not include any
broker or dealer that:
Carries or acts as an introducing broker with respect to
customer accounts;
holds or handles customers' funds or securities;
accepts orders from customers to purchase or sell
securities either as principal or as agent for the customer (except as
permitted by paragraphs (c)(1)(F) and (G) of CAB Rule 016);
has investment discretion on behalf of any customer;
engages in proprietary trading of securities or market-
making activities; or
participates in or maintains an online platform in
connection with offerings of unregistered securities pursuant to
Regulation Crowdfunding or Regulation A under the Securities Act of
1933.\4\
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\4\ See proposed CAB Rule 016(c)(2).
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The term ``institutional investor'' would have the same meaning as
that term has under FINRA Rule 2210 (Communications with the Public),
with one exception. The term would include any:
Bank, savings and loan association, insurance company or
registered investment company;
governmental entity or subdivision thereof;
employee benefit plan, or multiple employee benefit plans
offered to employees of the same employer, that meet the requirements
of Section 403(b) or Section 457 of the Internal Revenue Code and in
the aggregate have at least 100 participants, but does not include any
participant of such plans;
qualified plan, as defined in Section 3(a)(12)(C) of the
Exchange Act, or multiple qualified plans offered to employees of the
same employer, that in the aggregate have at least 100 participants,
but does not include any participant of such plans;
other person (whether a natural person, corporation,
partnership, trust, family office or otherwise) with total assets of at
least $50 million; and
person acting solely on behalf of any such institutional
investor.
The definition also would include any person meeting the definition
of ``qualified purchaser'' as that term is defined in Section 2(a)(51)
of the Investment Company Act of 1940 (``1940 Act'').\5\
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\5\ See proposed CAB Rule 016(i). FINRA Rule 2210 does not
include ``qualified purchaser'' within its definition of
``institutional investor.''
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Member Application and Associated Person Registration (CAB Rule 100
Series)
The proposed CAB Rule 100 Series sets forth the requirements for
firms that wish to register as a CAB. The proposed CAB Rule 100 Series
generally incorporates by reference FINRA Rules 1010 (Electronic Filing
Requirements for Uniform Forms), and 1122 (Filing of Misleading
Information as to Membership or Registration), and NASD Rules 1011
(Definitions), 1012 (General Provisions), 1013 (New Member Application
and Interview), 1014 (Department Decision), 1015 (Review by National
Adjudicatory Council), 1016 (Discretionary Review by FINRA Board), 1017
(Application for Approval of Change in Ownership, Control, or Business
Operations), 1019 (Application to Commission for Review), 1090 (Foreign
Members), 1100 (Foreign Associates) and IM-1011-1 (Safe Harbor for
Business Expansions). Accordingly, a CAB applicant would follow the
same procedures for membership as any other FINRA applicant, with four
modifications.
[[Page 79971]]
First, an applicant for membership that seeks to qualify
as a CAB would have to state in its application that it intends to
operate solely as such.
Second, in reviewing an application for membership as a
CAB, the FINRA Member Regulation Department would consider, in addition
to the standards for admission set forth in NASD Rule 1014, whether the
applicant's proposed activities are consistent with the limitations
imposed on CABs under CAB Rule 016(c).
Third, proposed CAB Rule 116(b) sets forth the procedures
for an existing FINRA firm to change its status to a CAB. If an
existing firm is already approved to engage in the activities of a CAB,
and the firm does not intend to change its existing ownership, control
or business operations, it would not be required to file either a New
Member Application (``NMA'') or a Change in Membership Application
(``CMA''). Instead, such a firm would be required to file a request to
amend its membership agreement or obtain a membership agreement (if
none exists currently) to provide that: (i) The firm's activities will
be limited to those permitted for CABs under CAB Rule 016(c), and (ii)
the firm agrees to comply with the CAB rules.\6\
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\6\ There would not be an application fee associated with this
request.
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Fourth, proposed CAB Rules 116(c) and (d) set forth the
procedures for an existing CAB to terminate its status as such and
continue as a FINRA firm. Under Rule 116(c), such a firm would be
required to file a CMA with the FINRA Member Regulation Department, and
to amend its membership agreement to provide that the firm agrees to
comply with all FINRA rules.\7\
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\7\ Absent a waiver, such a firm would have to pay an
application fee associated with the CMA. See FINRA By-Laws, Schedule
A, Section 4(i).
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Under Rule 116(d), however, if during the first year following an
existing FINRA member firm's amendment to its membership agreement to
convert a full-service broker-dealer to a CAB pursuant to Rule 116(b) a
CAB seeks to terminate its status as such and continue as a FINRA
member firm, the CAB may notify the FINRA Membership Application
Program group of this change without having to file an application for
approval of a material change in business operations pursuant to NASD
Rule 1017. The CAB would instead file a request to amend its membership
agreement to provide that the member firm agrees to comply with all
FINRA rules, and execute an amended membership agreement that imposes
the same limitations on the member firm's activities that existed prior
to the member firm's change of status to a CAB.\8\
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\8\ To the extent that the rules applicable to the member firm
had been amended since it had changed its status to a CAB, FINRA
would have the discretion to modify any limitations to reflect any
new rule requirements.
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The proposed CAB Rule 100 Series also would govern the registration
and qualification examinations of principals and representatives that
are associated with CABs. These Rules incorporate by reference NASD
Rules 1021 (Registration Requirements--Principals), 1022 (Categories of
Principal Registration), 1031 (Registration Requirements--
Representatives), 1032 (Categories of Representative Registration),
1060 (Persons Exempt from Registration), 1070 (Qualification
Examinations and Waiver of Requirements), 1080 (Confidentiality of
Examinations), IM-1000-2 (Status of Persons Serving in the Armed Forces
of the United States), IM-1000-3 (Failure to Register Personnel) and
FINRA Rule 1250 (Continuing Education Requirements). Accordingly, CAB
firm principals and representatives would be subject to the same
registration, qualification examination, and continuing education
requirements as principals and representatives of other FINRA firms.
CABs also would be subject to FINRA Rule 1230(b)(6) regarding
Operations Professional registration.
Duties and Conflicts (CAB Rule 200 Series)
The proposed CAB Rule 200 Series would establish a streamlined set
of conduct rules. CABs would be subject to FINRA Rules 2010 (Standards
of Commercial Honor and Principles of Trade), 2020 (Use of
Manipulative, Deceptive or Other Fraudulent Devices), 2040 (Payments to
Unregistered Persons),\9\ 2070 (Transactions Involving FINRA
Employees), 2080 (Obtaining an Order of Expungement of Customer Dispute
Information from the CRD System), 2081 (Prohibited Conditions Relating
to Expungement of Customer Dispute Information), 2263 (Arbitration
Disclosure to Associated Persons Signing or Acknowledging Form U4), and
2268 (Requirements When Using Predispute Arbitration Agreements for
Customer Accounts).
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\9\ The SEC has approved FINRA's rule change to adopt rules
relating to payments to unregistered persons for the consolidated
FINRA rulebook. See Regulatory Notice 15-07 (March 2015). FINRA Rule
2040 became effective on August 24, 2015.
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CAB Rules 209 and 211 would impose know-your-customer and
suitability obligations similar to those imposed under FINRA Rules 2090
and 2111. CAB Rule 211(b) includes an exception to the customer-
specific suitability obligations for institutional investors similar to
the exception found in FINRA Rule 2111(b).
Proposed CAB Rule 221 is an abbreviated version of FINRA Rule 2210
(Communications with the Public), essentially prohibiting false and
misleading statements.
Under proposed CAB Rule 240, if a CAB or associated person of a CAB
had engaged in activities that would require the CAB to register as a
broker or dealer under the Exchange Act, and that are inconsistent with
the limitations imposed on CABs under CAB Rule 016(c), FINRA could
examine for and enforce all FINRA rules against such a broker or
associated person, including any rule that applies to a FINRA broker-
dealer that is not a CAB or to an associated person who is not a person
associated with a CAB.
FINRA has determined not to subject CABs to FINRA Rules 2121 (Fair
Prices and Commissions), 2122 (Charges for Services Performed), and
2124 (Net Transactions with Customers), since CABs' business model does
not raise the same concerns that Rules 2121, 2122 and 2124 are intended
to address.
Rule 2121 provides that, for securities in both listed and unlisted
securities, a member that buys for its own account from its customer,
or sells for its own account to its customer, shall buy or sell at a
price which is fair, taking into consideration all relevant
circumstances, including market conditions with respect to the security
at the time of the transaction, the expense involved, and the fact that
the member is entitled to a profit. Further, if the member acts as
agent for its customer in any such transaction, the member shall not
charge its customer more than a fair commission or service charge,
taking into consideration all relevant circumstances, including market
conditions with respect to the security at the time of the transaction,
the expense of executing the order and the value of any service the
member may have rendered by reason of its experience in and knowledge
of such security and the market therefor.
CABs would not be permitted to act as a principal in a securities
transaction. Accordingly, the provisions of Rule 2121 that govern
principal transactions would not apply to a CAB's permitted activities.
CABs would be permitted act as agent in a securities transaction
only in very narrow circumstances. CABs would be allowed to act as an
agent with respect to institutional investors in connection with
purchases or sales of unregistered securities. CABs also would be
[[Page 79972]]
permitted to effect securities transactions solely in connection with
the transfer of ownership and control of a privately-held company to a
buyer that will actively operate the company or the business conducted
with the assets of the company in accordance with the terms and
conditions of an SEC rule, release, interpretation or ``no-action''
letter.
In both instances, FINRA believes that these circumstances either
involve institutional parties that negotiate the terms of permitted
securities transactions without the need for the conditions set forth
in Rule 2121, or involve the sale of a business as a going concern,
which differs in nature from the types of transactions that typically
raise issues under Rule 2121.
Rule 2122 provides that charges, if any, for services performed,
including, but not limited to, miscellaneous services such as
collections due for principal, dividends, or interest; exchange or
transfer of securities; appraisals, safekeeping or custody of
securities, and other services shall be reasonable and not unfairly
discriminatory among customers. As discussed above, CABs typically
provide services to institutional customers that generally do not need
the protections that Rule 2122 offers, since these customers are
capable of negotiating fair prices for the services that CABs provide.
Moreover, CABs are not permitted to provide many of the services listed
in Rule 2122, such as collecting principal, dividends or interest, or
providing safekeeping or custody services.
Rule 2124 sets forth specific requirements for executing
transactions with customers on a ``net'' basis. ``Net'' transactions
are defined as a type of principal transaction, and CABs may not trade
securities on a principal basis. For these reasons, FINRA does not
believe it is necessary to include FINRA Rules 2121, 2122 and 2124 as
part of the CAB rule set.
CAB Rule 201 would subject CABs to FINRA Rule 2010 (Standards of
Commercial Honor and Principles of Trade), which requires a member, in
the conduct of its business, to observe high standards of commercial
honor and just and equitable principles of trade. Depending on the
facts, other rules, such as Rule 2010, may apply in situations in which
a CAB charged a commission or fee that clearly is unreasonable under
the circumstances.
Supervision and Responsibilities Related to Associated Persons (CAB
Rule 300 Series)
The proposed CAB Rule 300 Series would establish a limited set of
supervisory rules for CABs. CABs would be subject to FINRA Rules 3220
(Influencing or Rewarding Employees of Others), 3240 (Borrowing from or
Lending to Customers), and 3270 (Outside Business Activities of
Registered Persons).
Proposed CAB Rule 311 would subject CABs to some, but not all, of
the requirements of FINRA Rule 3110 (Supervision) and, consistent with
Rule 3110, is designed to provide CABs with the flexibility to tailor
their supervisory systems to their business models. CABs would be
subject to many of the provisions of Rule 3110 concerning the
supervision of offices, personnel, customer complaints, correspondence
and internal communications. However, CABs would not be subject to the
provisions of Rule 3110 that require annual compliance meetings
(paragraph (a)(7)), review and investigation of transactions
(paragraphs (b)(2) and (d)), specific documentation and supervisory
procedures for supervisory personnel (paragraph (b)(6)), and internal
inspections (paragraph (c)).
FINRA does not believe that the annual compliance meeting
requirement in FINRA Rule 3110(a)(7) should apply to CABs given the
nature of CABs' business model and structure. FINRA has observed that
most current FINRA member firms that would qualify as CABs tend to be
small and often operate out of a single office. In addition, the range
of rules that CABs would be subject to is narrower than the rules that
apply to other broker-dealers. Moreover, as noted above, CABs would be
subject to both the Regulatory and Firm Element continuing education
requirements. Accordingly, FINRA does not believe that CABs need to
conduct an annual compliance meeting as required under FINRA Rule
3110(a)(7).\10\ The fact that the annual compliance meeting requirement
would not apply to CABs or their associated persons in no way would
reduce their responsibility to have knowledge of and comply with
applicable securities laws and regulations and the CAB rule set.
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\10\ For the same reasons, FINRA does not believe that FINRA
Rule 3110.04 should apply to CABs.
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FINRA does not believe that FINRA Rule 3110(b)(2), which requires
members to adopt and implement procedures for the review by a
registered principal of all transactions relating to the member's
investment banking or securities business, or FINRA Rule 3110(d), which
imposes requirements related to the investigation of securities
transactions and heightened reporting requirements for members engaged
in investment banking services, should apply to CABs. CABs would not be
permitted to carry or act as an introducing broker with respect to
customer accounts, hold or handle customers' funds or securities,
accept orders from customers to purchase or sell securities except
under the narrow circumstances discussed above, have investment
discretion on behalf of any customer, engage in proprietary trading or
market-making activities, or participate in Crowdfunding or Regulation
A securities offerings. Accordingly, due to these restrictions, FINRA
does not believe a CAB's business model necessitates the application of
these provisions, which primarily address trading and investment
banking functions that are beyond the permissible scope of a CAB's
activities.\11\
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\11\ For the same reasons, FINRA does not believe that FINRA
Rule 3110.05 should apply to CABs.
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FINRA does not believe that the requirements of FINRA Rule
3110(b)(6) should apply to CABs. Paragraph (b)(6) generally requires a
member to have procedures to prohibit its supervisory personnel from
(1) supervising their own activities; and (2) reporting to, or having
their compensation or continued employment determined by, a person the
supervisor is supervising.\12\ FINRA also does not believe that FINRA
Rule 3110(c), which requires members to conduct internal inspections of
their businesses, should apply to CABs.
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\12\ FINRA Rule 3110(b)(6)(C)(i) and (ii). FINRA Rule 3110(b)(6)
also requires that a member's supervisory procedures include the
titles, registration status and locations of the required
supervisory personnel and the responsibilities of each supervisory
person as these relate to the types of business engaged in,
applicable securities laws and regulations, and FINRA rules, as well
as a record of the names of its designated supervisory personnel and
the dates for which such designation is or was effective. FINRA Rule
3110(b)(6)(A) and (B). In addition, paragraph (b)(6) requires a
member to have procedures reasonably designed to prevent the
standards of supervision required pursuant to FINRA Rule 3110(a)
from being compromised due to the conflicts of interest that may be
present with respect to an associated person being supervised. FINRA
Rule 3110(b)(6)(D).
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FINRA believes that a CAB's business model, which is geared toward
acting as a consultant in capital acquisition transactions, or acting
as an agent solely in connection with purchases or sales of
unregistered securities to institutional investors, or with the
transfer of ownership and control of a privately-held company, does not
give rise to the same conflicts of interest and
[[Page 79973]]
supervisory concerns that paragraph (b)(6) is intended to address. As
discussed above, many CABs operate out of a single office with a small
staff, which reduces the need for internal inspections of numerous or
remote offices. In addition, part of the purpose of creating a separate
CAB rule set is to streamline and reduce existing FINRA rule
requirements where it does not hinder investor protection. FINRA
believes that the remaining provisions of FINRA Rule 3110, coupled with
the CAB Rule 200 Series addressing duties and conflicts, will
sufficiently protect CABs' customers from potential harm due to
insufficient supervision.\13\
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\13\ For the same reasons, FINRA does not believe that FINRA
Rules 3110.10, .12, .13, or .14 should apply to CABs. FINRA also
believes that it is unnecessary to apply FINRA Rule 3110.15 to CABs,
since the temporary program authorized by the rule expired on
December 1, 2015.
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Proposed CAB Rule 313 would require CABs to designate and identify
one or more principals to serve as a firm's chief compliance officer,
similar to the requirements of FINRA Rule 3130(a). CAB Rule 313 would
not require a CAB to have its chief executive officer (``CEO'') certify
that the member has in place processes to establish, maintain, review,
test and modify written compliance policies and written supervisory
procedures reasonably designed to achieve compliance with applicable
federal securities laws and regulations, and FINRA and MSRB rules,
which are required under FINRA Rules 3130(b) and (c). FINRA does not
believe the CEO certification is necessary given a CAB's narrow
business model and smaller rule set.
Proposed Rule 328 would prohibit any person associated with a CAB
from participating in any manner in a private securities transaction as
defined in FINRA Rule 3280(e).\14\ FINRA does not believe that an
associated person of a CAB should be engaged in selling securities away
from the CAB, nor should a CAB have to oversee and review such
transactions, given its limited business model. This restriction would
not prohibit associated persons from investing in securities on their
own behalf, or engaging in securities transactions with immediate
family members, provided that the associated person does not receive
selling compensation.
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\14\ FINRA Rule 3280(e) defines ``private securities
transaction'' as ``any securities transaction outside the regular
course or scope of an associated person's employment with a member,
including, though not limited to, new offerings of securities which
are not registered with the Commission, provided however that
transactions subject to the notification requirements of NASD Rule
3050, transactions among immediate family members (as defined in
FINRA Rule 5130), for which no associated person receives any
selling compensation, and personal transactions in investment
company and variable annuity securities, shall be excluded.''
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Proposed CAB Rule 331 would require each CAB to implement a written
anti-money laundering (``AML'') program. This is consistent with the
SEC's requirements and Chapter X of Title 31 of the Code of Federal
Regulations. Accordingly, the proposed rule is similar to FINRA Rule
3310 (Anti-Money Laundering Compliance Program); however, the proposed
rule contemplates that all CABs would be eligible to conduct the
required independent testing for compliance every two years.
Financial and Operational Rules (CAB Rule 400 Series)
The proposed CAB Rule 400 Series would establish a streamlined set
of rules concerning firms' financial and operational obligations. CABs
would be subject to FINRA Rules 4140 (Audit), 4150 (Guarantees by, or
Flow through Benefits for, Members), 4160 (Verification of Assets),
4511 (Books and Records--General Requirements), 4513 (Records of
Written Customer Complaints), 4517 (Member Filing and Contact
Information Requirements), 4524 (Supplemental FOCUS Information), 4530
(Reporting Requirements), and 4570 (Custodian of Books and Records).
Proposed CAB Rule 411 includes some, but not all, of the capital
compliance requirements of FINRA Rule 4110. CABs would be required to
suspend business operations during any period a firm is not in
compliance with the applicable net capital requirements set forth in
SEA Rule 15c3-1, and the rule also would authorize FINRA to direct a
CAB to suspend its operation under those circumstances. Proposed CAB
Rule 411 also sets forth requirements concerning withdrawal of capital,
subordinated loans, notes collateralized by securities, and capital
borrowings.
CABs would not be subject to FINRA Rules 4370 (Business Continuity
Plans and Emergency Contact Information) or 4380 (Mandatory
Participation in FINRA BC/DR Testing Under Regulation SCI). FINRA does
not believe it would be necessary for a CAB to maintain a business
continuity plan (BCP), given a CAB's limited activities, particularly
since a CAB would not engage in retail customer account transactions or
clearance, settlement, trading, underwriting or similar investment
banking activities. Moreover, FINRA Rule 4380 relates to Rule SCI under
the Exchange Act, which is not applicable to a member that limits its
activities to those permitted under the CAB rule set.
Because CABs would not carry or act as an introducing broker with
respect to customer accounts, they would have more limited customer
information requirements than is imposed under FINRA Rule 4512.\15\
CABs would have to maintain each customer's name and residence, whether
the customer is of legal age (if applicable), and the names of any
persons authorized to transact business on behalf of the customer. CABs
would still have to make and preserve all books and records required
under SEA Rules 17a-3 and 17a-4.
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\15\ See proposed CAB Rule 451(b).
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CAB Rule 452(a) establishes a limited set of requirements for the
supervision and review of a firm's general ledger accounts.
Securities Offerings (CAB Rule 500 Series)
The proposed CAB Rule 500 Series would subject CABs to certain
rules concerning securities offerings. CABs would be subject to FINRA
Rules 5122 (Private Placements of Securities Issued by Members) and
5150 (Fairness Opinions).
Investigations and Sanctions, Code of Procedure, and Arbitration and
Mediation (CAB Rules 800, 900 and 1000)
CABs would be subject to the FINRA Rule 8000 Series governing
investigations and sanctions of firms, other than FINRA Rules 8110
(Availability of Manual to Customers), 8211 (Automated Submission of
Trading Data Requested by FINRA), and 8213 (Automated Submission of
Trading Data for Non-Exchange-Listed Securities Requested by FINRA).
CABs would not be subject to FINRA Rule 8110 (Availability of
Manual to Customers), which requires members to make available a
current copy of the FINRA manual for examination by customers upon
request. If the Commission approves this proposed rule change, the CAB
rule set would be available through the FINRA Web site. Accordingly,
FINRA does not believe this rule is necessary for CABs.
CABs also would not be subject to FINRA Rules 8211 (Automated
Submission of Trading Data Requested by FINRA) or 8213 (Automated
Submission of Trading Data for Non-Exchange-Listed Securities Requested
by FINRA). Given that these rules are intended to assist FINRA in
requesting trade data from firms engaged in securities trading, and
that CABs would not engage in securities trading, FINRA
[[Page 79974]]
does not believe that these rules should apply to CABs.
CABs would be subject to the FINRA Rule 9000 Series governing
disciplinary and other proceedings involving firms, other than the
FINRA Rule 9700 Series (Procedures on Grievances Concerning the
Automated Systems). Proposed CAB Rule 900(c) would provide that any CAB
may be subject to a fine under FINRA Rule 9216(b) with respect to an
enumerated list of FINRA By-Laws, CAB rules and SEC rules under the
Exchange Act. Proposed CAB Rule 900(d) would authorize FINRA staff to
require a CAB to file communications with the FINRA Advertising
Regulation Department at least ten days prior to use if the staff
determined that the CAB had departed from CAB Rule 221's standards.
CABs would be subject to the FINRA Rule 12000 Series (Code of
Arbitration Procedure for Customer Disputes), 13000 Series (Code of
Arbitration Procedure for Industry Disputes) and 14000 Series (Code of
Mediation Procedure).
If the Commission approves the proposed rule change, FINRA will
announce the implementation date of the proposed rule change in a
Regulatory Notice to be published no later than 60 days following
Commission approval. The effective date will be no later than 180 days
following publication of the Regulatory Notice announcing Commission
approval.
2. Statutory Basis
FINRA believes that the proposed rule change is consistent with the
provisions of Section 15A(b)(6) of the Act,\16\ which requires, among
other things, that FINRA rules must be designed to prevent fraudulent
and manipulative acts and practices, to promote just and equitable
principles of trade, and, in general, to protect investors and the
public interest. FINRA believes that the proposed rule change will
improve efficiency and reduce regulatory burden by reducing the range
of rules that apply to capital acquisition brokers given their limited
activities and institutional business model, while maintaining
necessary investor protections.
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\16\ 15 U.S.C. 78o-3(b)(6).
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B. Self-Regulatory Organization's Statement on Burden on Competition
FINRA does not believe that the proposed rule change will result in
any burden on competition that is not necessary or appropriate in
furtherance of the purposes of the Act. FINRA has undertaken an
economic impact assessment, as set forth below, to analyze the
regulatory need for the proposed rulemaking, its potential economic
impacts, including anticipated costs and benefits, and the alternatives
FINRA considered in assessing how to best meet its regulatory
objectives.
Economic Impact Assessment
A. Regulatory Need
As discussed above, many firms solely engage in corporate financing
activities, including advising companies on mergers and acquisitions,
advising issuers on raising debt and equity capital in private
placements with institutional investors, or providing advisory services
on a consulting basis. These firms often register as broker-dealers
because of their activities and because they may receive transaction-
based compensation as part of their services, but unlike traditional
broker-dealers, they do not handle customer funds or securities, carry
or act as an introducing broker with respect to customer accounts, or
provide products and services to retail customers. As a result, many
FINRA rules are not applicable to the business activities of these
firms. The proposed rule change establishes a separate set of
streamlined rules that would apply exclusively to these firms and is
tailored to address their business activities, while maintaining
necessary investor protections.
B. Economic Impacts
The proposed rule change would impact member firms that engage in
CAB-related business activities, discussed above. As a baseline and
based on staff experience, FINRA preliminarily estimates that the
number of member firms that meet this definition would range from 650
to 750 firms.\17\ Thus, it is possible that between 16 and 19 percent
of all FINRA member firms may be eligible to operate under this
proposed rule set.\18\ These firms currently are required to comply
with all applicable FINRA rules. These firms currently may incur costs
to evaluate new FINRA rules and interpretations to ensure that they are
not applicable for their business.
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\17\ FINRA notes that a commenter reported a higher estimate of
906 member firms that would meet the CAB definition based on
information available on BrokerCheck[supreg] (See comment of 3PM).
This estimate is based on the number of firms that report their
business line (in Form BD) only as ``Private Placement,'' ``Other,''
or ``Private Placement'' and ``Other.'' FINRA notes that these
business lines may overlap with some of the business activities of
CABs, but do not exactly correspond to the activities that would
meet the CAB definition.
\18\ There are 4,031 firms that are registered with FINRA as
broker-dealers. Accordingly, 650 and 750 firms account for 16% and
19%, respectively, of the total FINRA membership. See https://www.finra.org/newsroom/statistics (accessed June 29, 2015).
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FINRA anticipates that some firms provide similar services but are
not currently registered as broker-dealers with the SEC or FINRA. For
example, some firms may currently limit activities, such as not
accepting transaction-based compensation for their services, to avoid
broker-dealer registration requirements and attendant costs. Others may
accept transaction-based compensation, but may be relying on SEC no-
action relief to avoid broker-dealer registration.\19\ It is possible
that some of these firms would reconsider their non-registered status
if the new rules were in effect.
---------------------------------------------------------------------------
\19\ See M&A Brokers, 2014 SEC No-Act. LEXIS 92 (January 31,
2014).
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(i) Anticipated Benefits
The proposed rule change would reduce the regulatory burden for
CABs by decreasing the range and scope of current FINRA rules that
would be applicable to them given their limited activities and
institutional business model. For example, as discussed above, the
proposed rule change would establish a streamlined set of conduct
rules. Similarly, the proposed CAB rules would establish a limited set
of supervisory rules that are better designed to provide CABs with the
flexibility to tailor their supervisory systems to their business
models. As discussed above, CABs also would be subject to more limited
customer information requirements than those applicable to other
broker-dealers.
The reduction in these regulatory requirements is anticipated to
reduce compliance costs for member firms that would register as CABs
without diminishing investor protections. These cost savings would
include reduction in costs associated with maintaining FINRA
membership, including ongoing compliance activities such as maintaining
policies and procedures. These firms also would likely benefit from
more focused examinations that are tailored to their business
activities. To avail themselves of these benefits, firms would,
however, be required to maintain their CAB status and as a result limit
their activities to those permitted under the CAB rules.
As discussed above, CAB rules also may encourage non-member firms
that engage in similar kinds of services as CABs to register with
FINRA. FINRA membership would benefit these non-member firms by
allowing them to expand their securities business and
[[Page 79975]]
engage in activities permitted under the CAB rules. FINRA membership
would subject these firms to certain FINRA rules, including conduct
rules, supervisory rules, and rules concerning financial and
operational obligations of the firms. As a result, FINRA membership
would increase regulatory oversight of these firms, thereby enhancing
investor protection of their customers.
(ii) Anticipated Costs
A member firm that seeks to register as a CAB would incur initial
legal and other compliance costs associated with effectively completing
the application to amend its membership agreement to elect CAB status.
Such a firm also would incur administrative costs associated with
updating its policies and procedures. FINRA, however, anticipates that
these costs would likely be minimal relative to the cost savings from
the streamlined CAB rules. As firms would have discretion to determine
whether to apply for the amended status, FINRA anticipates that only
those firms that anticipate net benefits to them would do so.
Non-member firms that choose to register as a CAB would incur
implementation and ongoing costs associated with joining and
maintaining their broker-dealer registrations with FINRA. The initial
implementation costs would include FINRA application fees, costs
associated with adapting technology infrastructure for regulatory data
reporting requirements, as well as other legal or consulting costs
associated with developing policies and procedures to ensure continued
compliance with SEC and CAB rules. The ongoing costs would include
annual fees associated with FINRA membership, costs of maintaining data
reporting, costs of legal work relating to FINRA membership, and other
costs associated with additional compliance activities. FINRA notes,
however, that the proposed rule change would not impose these costs on
non-member firms because registering as a broker-dealer and electing
CAB status is optional. Non-member firms would likely only choose to
register as a CAB broker-dealer and incur these costs if the
anticipated benefits of registering exceed the costs of doing so.
C. Alternatives
In considering how to best meet its regulatory objectives, FINRA
considered several alternatives to particular features of this
proposal. For example, the initial proposal would have allowed CABs to
solicit only institutional investors as that term is defined in FINRA
Rule 2210. As discussed in more detail below, several commenters
suggested that the proposed rule change also allow CABs to provide
products and services to accredited investors or qualified purchasers.
FINRA's regulatory programs have uncovered significant concerns
associated with the ways in which firms sell private placements to
accredited investors. Accordingly, FINRA does not believe it is
appropriate to lower the institutional investor threshold for the CAB
rules to the accredited investor standard.
Nonetheless, FINRA agrees that the definition of institutional
investor under the CAB rules should include qualified purchasers as
that term is defined under the 1940 Act, since qualified purchasers are
required to own significantly more investments than those required for
accredited investors, and as a result qualified purchasers are more
likely to have the resources necessary to protect themselves from
potential sales practice problems. Accordingly, FINRA has revised the
institutional investor definition to include qualified purchasers,
which would allow CABs to offer interests in private funds that are
excluded from the definition of ``investment company'' and thus exempt
from registration under the 1940 Act, such as hedge funds or private
equity funds.
In developing this proposal, FINRA also considered expanding the
scope of permissible activities for CABs. For example, as discussed
below, commenters suggested that FINRA allow CABs to engage in
activities related to the transfer of ownership or control of a
privately-held company consistent with the SEC's M&A Brokers no-action
letter. FINRA agrees that CABs should be permitted to engage in merger
and acquisition transactions to the same extent as an unregistered
broker-dealer pursuant to the M&A Brokers no-action letter and has
revised the definition of CAB to allow such activities.
C. Self-Regulatory Organization's Statement on Comments on the Proposed
Rule Change Received From Members, Participants, or Others
Background
In February 2014, FINRA published Regulatory Notice 14-09 (the
``Notice''), requesting comment on a proposed rule set for firms that
meet the definition of ``limited corporate financing broker''
(``LCFB'') (the ``Notice proposal''). A copy of the Notice is attached
as Exhibit 2a. The comment period expired on April 28, 2014. FINRA
received 51 comments in response to the Notice.\20\ A list of the
commenters in response to the Notice is attached as Exhibit 2b, and
copies of the comment letters received in response to the Notice are
attached as Exhibit 2c.\21\ A summary of the comments and FINRA's
response is provided below.
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\20\ Twenty-one of the comments were short emails or letters
endorsing the comments of 3PM.
\21\ See Exhibit 2b for a list of abbreviations assigned to
commenters.
---------------------------------------------------------------------------
As discussed below, most of the comments opposed the Notice
proposal on the ground that it did not go far enough to relieve LCFBs
of their current regulatory burdens. This concern, combined with the
limitations in activities that the proposal's rules would impose, would
lead most firms commenting on the proposal not to change their status
to an LCFB.\22\
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\22\ As noted above, the proposal would have referred to firms
subject to the proposed rule set as ``limited corporate financing
brokers'' (``LCFBs'') rather than ``capital acquisition brokers''
(``CABs''). Similarly, this discussion refers to the rules proposed
in the Notice as the ``LCFB rules'' rather than the ``CAB rules.''
The CAB rules which are submitted as part of this proposed rule
change have been revised from the prior LCFB rules, but maintain the
same rule numbers as the LCFB rules.
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Application of LCFB Rules to Municipal Securities
LCFB Rule 015 would have stated that the LCFB rules do not apply to
transactions in, and business activities relating to, municipal
securities as defined in Section 3(a)(29) of the Exchange Act. One
commenter noted that some FINRA member firms provide financial advisory
services only to municipalities or municipal agencies, including
recommending the timing and type of offering and to assist in the
selection of an underwriter. The commenter stated that if this type of
firm does not engage in the sale of municipal securities and would
otherwise qualify, it should be eligible to be an LCFB.\23\
---------------------------------------------------------------------------
\23\ See Sutter.
---------------------------------------------------------------------------
LCFB Rule 015 would not prevent an LCFB from engaging in municipal
securities activities. Rather, as revised, it simply would clarify that
FINRA Rule 0150(b) applies to the CAB rules. FINRA Rule 0150(b)
currently provides that the FINRA rules do not apply to transactions
in, and business activities relating to, municipal securities as
defined in the Exchange Act.
Definition of ``Customer''
LCFB Rule 016(d) would have defined the term ``customer'' as ``any
natural person and any entity receiving corporate financing services
from an LCFB.'' It also would have specified that
[[Page 79976]]
the term ``customer'' does not include a broker or dealer.
One commenter stated that this definition is unclear and should be
replaced with other terms, such as ``issuer,'' ``investor,''
``qualified investor,'' and ``intermediary,'' since these terms better
describe the counterparties involved in an LCFB's business.\24\ Two
other commenters recommended that FINRA use the term ``client'' rather
than ``customer.'' \25\ Another commenter suggested that FINRA be
clearer as to what types of corporate financing services a customer may
receive from an LCFB.\26\
---------------------------------------------------------------------------
\24\ See 3PM.
\25\ See Achates and Q Advisors.
\26\ See CFSC.
---------------------------------------------------------------------------
FINRA does not believe it would be appropriate to replace the term
``customer'' with other terms such as issuer, investor, or
intermediary. The meaning of the term ``customer'' depends on the
context in which it is used, such as the requirements to know your
customer or to recommend a suitable investment to a customer. Terms
such as ``issuer'' or ``investor'' would not be appropriate in these
contexts. However, FINRA does believe that the term customer should be
interpreted in a manner consistent with the way it is interpreted under
the FINRA rules. Accordingly, FINRA has revised this term to have the
same definition as it has under the FINRA rules.\27\
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\27\ See FINRA Rule 0160(b)(4) (``The term `customer' shall not
include a broker or dealer'').
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Institutional Investor Definition
LCFB Rule 016(h) would have allowed an LCFB to solicit only
institutional investors. LCFB Rule 016(g) would have defined the term
``institutional investor'' to include banks, savings and loan
associations, insurance companies, registered investment companies,
governmental entities and their subdivisions, employee benefit plans
and qualified plans with at least 100 participants (but not including
the participants themselves), any other person with at least $50
million in assets, and persons acting on an institutional investor's
behalf.
Seven commenters recommended that the LCFB rules allow LCFBs to
offer interests in privately placed companies to accredited investors,
as that term is defined in SEC Regulation D.\28\ One commenter noted
that requiring an LCFB to pre-qualify potential investors to meet the
LCFB rules' definition of institutional investor, rather than the
Regulation D accredited investor definition, would be difficult, since
an LCFB may not know the financial status of a potential buyer, and
could potentially harm an LCFB client seller by diminishing the pool of
prospective investors.\29\ Three other commenters recommended that the
term ``institutional investor'' be replaced with a new term,
``qualified investor,'' which would include ``qualified investors'' as
that term is defined under the 1940 Act.\30\ One commenter questioned
whether an LCFB would be permitted to accept an unsolicited offer from
a non-institutional investor.\31\ Another commenter inquired as to the
documents that FINRA would require an LCFB to retain to confirm an
investor's institutional status.\32\
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\28\ See Achates, LIATI, SFA, Dole, RWI, HighBank, and EYCA. See
also 17 CFR 230.501(a).
\29\ See SFA.
\30\ See 3PM, Q Advisors, and M&A Brokers Letter Attorneys.
\31\ See SFA.
\32\ See EYCF.
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As discussed in the Notice, FINRA purposely did not propose to
define ``institutional investor'' based on a more inclusive standard,
such as the definition of ``accredited investor'' in Regulation D under
the Securities Act of 1933. FINRA's regulatory programs have uncovered
serious concerns with the manner in which firms market and sell private
placements to accredited investors. Application of the CAB rules to
firms that market and sell private placements to accredited investors
would require FINRA to expand the applicable conduct rules and other
provisions. Therefore, lowering the threshold of ``institutional
investor'' to the accredited investor standard would frustrate the
purposes of a streamlined rule set.
Nevertheless, FINRA agrees that the definition of ``institutional
investor'' should include persons that meet the definition of
``qualified purchaser'' under the 1940 Act.\33\ Persons that meet the
definition of ``qualified purchaser'' in most cases must own not less
than $5 million in investments, far greater than the minimum assets
required by the accredited investor standard. FINRA believes that it is
much less likely that a CAB would commit the types of sales practice
problems that FINRA has observed in connection with the sale of
Regulation D private placements to accredited investors if an investor
is required to meet the qualified purchaser standard, since a qualified
purchaser likely would have the resources necessary to protect itself
from potential sales practice problems. In addition, by defining
``institutional investor'' to include qualified purchasers, CABs would
be able to offer interests in private issuers, such as hedge funds or
private equity funds, that are excepted from the definition of
``investment company'' pursuant to Section 3(c)(7) of the 1940 Act.
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\33\ See 15 U.S.C. 80a-2(a)(51).
---------------------------------------------------------------------------
Moreover, as discussed below, FINRA has proposed to expand the
permissible activities of CABs to include effecting securities
transactions solely in connection with the transfer of ownership and
control of a privately-held company in accordance with the terms and
conditions of an SEC rule, release, interpretation or no-action
letter.\34\ By expanding CABs' proposed activities to include these
kinds of M&A transactions, CABs would not be limited to selling
ownership or control of a privately-held company only to institutional
investors as defined by the CAB rules, since the SEC's M&A Brokers no-
action letter \35\ does not contain this limitation. FINRA believes
this expansion should address many of the commenters' concerns with the
institutional investor definition.
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\34\ See proposed CAB Rule 016(c)(1)(G).
\35\ See M&A Brokers, 2014 SEC No-Act. LEXIS 92 (January 31,
2014).
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Limited Corporate Financing Broker Definition
The proposed definition of LCFB would have allowed firms meeting
this definition to engage in:
Advising an issuer, including a private fund concerning
its securities offerings or other capital raising activities;
advising a company regarding its purchase or sale of a
business or assets or regarding its corporate restructuring, including
a going-private transaction, divestiture or merger;
advising a company regarding its selection of an
investment banker;
assisting in the preparation of offering materials on
behalf of an issuer;
providing fairness opinions; and
qualifying, identifying, or soliciting potential
institutional investors.
The proposed definition of LCFB would have excluded any broker or
dealer that carries or maintains customer accounts, holds or handles
customers' funds or securities, accepts orders from customers to
purchase or sell securities either as principal or agent for the
customer, possesses investment discretion on behalf of any customer, or
engages in proprietary trading of securities or market making
activities.
Although one commenter felt that the definition of LCFB was
appropriate,\36\
[[Page 79977]]
others recommended that the definition of LCFB be amended specifically
to permit an LCFB to provide valuation services,\37\ expert testimony
and litigation support.\38\ Other commenters recommended that the
definition be clarified to permit LCFBs to engage in negotiation of
transactions,\39\ and to act as a placement agent for a buyer or
seller.\40\ Another commenter urged FINRA to revise the definition so
that it spells out in more detail the types of advice that an LCFB may
provide to a client (e.g., preparing a business for sale, financial
modeling, financial alternatives, evaluating competing offers,
structuring transactions, due diligence and transition issues) and that
it should allow an LCFB to act as a finder (introducing parties to a
transaction).\41\ Others recommended that LCFBs be permitted to provide
research and engage in public company transactions in connection with
their advisory work.\42\
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\36\ See 3PM.
\37\ See CFSC.
\38\ See Sutter and RWI.
\39\ See Q Advisors.
\40\ See Q Advisors and M&A Brokers Letter Attorneys.
\41\ See RWI.
\42\ See Fells and EYCF.
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Commenters also suggested that FINRA allow LCFBs to advise
controlling or minority shareholders in a private business in
connection with the sale of stock,\43\ and that FINRA look to the SEC's
M&A Brokers letter for a description of appropriate LCFB
activities.\44\ The latter commenter also recommended that LCFBs be
allowed to solicit non-institutional investors if both the seller and
buyer are or will be actively involved in running the business (which
also is consistent with the M&A Brokers letter).
---------------------------------------------------------------------------
\43\ See Harris.
\44\ See ABA.
---------------------------------------------------------------------------
FINRA intended to allow CABs to provide valuation, expert
testimony, litigation support, negotiation and structuring services,
and to act as a placement agent for, or finder of, institutional
investors. Accordingly, FINRA has revised the definition of CAB to make
this clearer. FINRA does not agree, however, that CABs should be
allowed to produce research for the investing public. If a CAB produced
research reports, FINRA would need to consider whether to add FINRA
Rule 2241 and potentially other rules to the list of CAB rules, which
currently do not include these rules.
FINRA agrees that CABs should be permitted to engage in M&A
transactions to the same extent as an unregistered broker pursuant to
the M&A Brokers no-action letter. Accordingly, FINRA has revised the
definition of CAB to allow such firms to effect securities transactions
solely in connection with the transfer of ownership and control of a
privately-held company to a buyer that will actively operate the
company in accordance with the terms and conditions of an SEC rule,
release, interpretation or no-action letter that permits a person to
engage in such activities without registering as a broker under Section
15(b) of the Exchange Act.\45\
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\45\ FINRA also revised the list of activities that a CAB may
not engage in to clarify that a CAB may not carry or act as an
introducing broker with respect to customer accounts or participate
in or maintain an online platform in connection with offerings of
unregistered securities pursuant to Regulation Crowdfunding or
Regulation A under the Securities Act of 1933. See proposed CAB Rule
016(c)(2).
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One commenter argued that the term ``limited corporate financing
broker'' itself is problematic because it may confuse clients into
thinking that a firm has reduced its servicing offerings when in fact
they remain unchanged.\46\ In response to this concern, FINRA has
changed the name of this defined term, and the name of the rule set,
from ``limited corporate financing broker'' to ``capital acquisition
broker.''
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\46\ See McCracken.
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New Member and Change of Business Applications
LCFB Rule 112 would have subjected LCFBs to NASD Rule 1013, which
governs new FINRA membership applications. LCFB Rule 112 also would
have required applicants for FINRA membership that seek to qualify as
LCFBs to state in their applications that they intend to operate as an
LCFB.
LCFB Rule 116 would have subjected LCFBs to NASD Rule 1017, which
governs applications for approval of change in ownership, control, or
business operations. Rule 116 also would have allowed an existing FINRA
member firm that seeks to change its status to an LCFB, and that is
already approved to engage in the activities of an LCFB, but which does
not intend to change its existing ownership, control, or business
operations, to file a request to amend its membership agreement or
obtain a membership agreement (if none exists), to provide that: (i)
The member firm's activities will be limited to those permitted for
LCFBs under LCFB Rule 016(h); and (ii) the member firm agrees to comply
with the LCFB rules. Rule 116 further specified that an LCFB that seeks
to terminate its status as such and continue as a FINRA member firm
would have to file an application for approval of a material change in
business operations pursuant to NASD Rule 1017 (a ``CMA''), and would
have to amend its membership agreement to provide that it agrees to
comply with all FINRA rules.
One commenter also recommended that FINRA streamline the new member
and change in membership process for LCFBs, reduce the time period for
decisions, and lower the application fees.\47\ Other commenters stated
that any request to change a firm's membership agreement to elect LCFB
status should be without a fee, and that firms should be allowed to
revert back to their original non-LCFB status without having to file a
change in membership application during the firm's first year of
operation as an LCFB.\48\ Commenters also noted that the proposed
requirement to pay a $5000 fee as part of the CMA in order to buy back
a firm's full broker status is a substantial disincentive to become an
LCFB.\49\
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\47\ See M&A Brokers Letter Attorneys.
\48\ See 3PM and RWI.
\49\ See Achates and RWI.
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FINRA does not agree that it should create a different new member
process for applicants that are not already registered broker-dealers
and that seek to become CABs. Although CABs would be subject to fewer
FINRA requirements than other broker-dealers, FINRA still believes that
it is important for investor protection and industry confidence reasons
that FINRA have an opportunity to vet new CAB firms in the same manner
that FINRA vets other new firm applicants. Similarly, if a firm wishes
to change its ownership, control or business operations, FINRA believes
that it is important that these changes receive the same review as any
other registered firm. FINRA has modified CAB Rule 112, however, to
clarify that a CAB applicant must state in its application that it
intends to operate solely as a CAB.\50\
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\50\ FINRA also has modified CAB Rules 111, 112, 113, 114, and
115 to clarify that they apply to persons applying for membership in
FINRA as a CAB as well as to the CABs themselves.
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CAB Rule 116 already permits an existing FINRA member firm to elect
CAB status by requesting a change in its membership agreement, and
without filing a CMA or paying a filing fee. However, FINRA agrees that
Rule 116 should provide some more flexibility to a CAB that seeks to
revert to its full broker status within the first year after electing
CAB status. Accordingly, FINRA has amended Rule 116 to provide that, if
during the first year following an existing FINRA member firm's
amendment to its membership agreement to elect CAB status, the firm
seeks to terminate its CAB status and
[[Page 79978]]
continue as a FINRA member firm, the firm may notify the Membership
Application Program group of this change without having to file a CMA.
The member firm seeking this change would have to file a request to
amend its membership agreement to provide that the firm agrees to
comply with all FINRA rules, and execute an amended membership
agreement that imposes the same limitations on the firm's activities
that existed prior to the firm's change to CAB status.
Registration Categories
Proposed LCFB Rule 123 would have allowed persons registered with
LCFBs to hold only a limited set of registrations that relate to an
LCFB's business.\51\ The proposal also would have subjected LCFBs to
the Operations Professional (Series 99) registration requirement.
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\51\ Registered principals of LCFBs would have been permitted to
hold the General Securities Principal (Series 24), Limited
Principal--Financial and Operations (Series 27), Limited Principal--
Introducing Broker/Dealer Financial and Operations (Series 28), and
Limited Principal--General Securities Sales Supervisor (Series 9 and
10) registrations. Registered representatives of LCFBs would have
been permitted to hold the General Securities Representative (Series
7), Limited Representative--Direct Participation Programs (Series
22), Limited Representative--Private Securities Offerings (Series
82), and Limited Representative--Investment Banking (Series 79)
registrations.
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Commenters objected to limiting the types of registrations that an
associated person of an LCFB may retain.\52\ Commenters noted that
registered persons may be required to hold other registrations under
state law.\53\ In addition, commenters argued that this restriction
would penalize individuals who may want to change jobs later and return
to a full service broker-dealer, where other registrations would be
required. They favored allowing registered persons to retain their
registrations while employed with an LCFB. Commenters also opposed
requiring LCFBs to employ an Operations Professional.\54\ Two
commenters encouraged FINRA, as part of this process, to re-examine the
permissible scope of activities of various registration categories,
such as Series 22, 62, 79 and 82 registrations.\55\
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\52\ See 3PM, Achates, Signal Hill, Sutter, LIATA, RWI,
HighBank, M&A Brokers Letter Attorneys, and EYCA.
\53\ See 3PM, Achates, Sutter, and Q Advisors.
\54\ See 3PM and M&A Brokers Letter Attorneys.
\55\ See ABA and LeGaye.
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However, one commenter supported the restrictions. It recommended
that LCFB representatives be required to obtain the Series 79
registration, and that LCFB representatives not be permitted to obtain
other registration categories or retain other existing registrations
during the time they are associated with an LCFB.\56\ Another commenter
suggested that LCFB principals and representatives not be permitted to
hold other registrations unless a firm can adequately supervise the
activities covered by those registrations.\57\
---------------------------------------------------------------------------
\56\ See CFSC.
\57\ See Harris.
---------------------------------------------------------------------------
FINRA is persuaded that not allowing registered principals and
representatives to obtain and hold the full range of registration
categories could potentially penalize individuals who have already
obtained those registration categories, and that the limitations of
proposed LCFB Rule 123 also could potentially conflict with state law
requirements. Accordingly, FINRA is amending CAB Rule 123 to eliminate
the prior restrictions on the types of registrations persons associated
with CABs may hold. Associated persons still would only be permitted to
retain registrations that are appropriate to their functions under the
registration rules.
FINRA continues to believe that CABs should be subject to FINRA
Rule 1230(b)(6) regarding Operations Professional (Series 99)
registration. FINRA believes the Operations Professional registration
category enhances the regulatory structure surrounding the specified
(or ``covered'' functions), including contributing to the process of
preparing and filing financial regulatory reports, and has noted that
for some firms the Operations Professional often may be the firm's
Financial and Operations Principal.\58\ FINRA also is not re-examining
the range of permissible activities for principals and representatives
in various registration categories, as those issues are beyond the
scope of this proposed rule change.
---------------------------------------------------------------------------
\58\ See Regulatory Notice 11-33 (July 2011).
---------------------------------------------------------------------------
Continuing Education Requirements
Proposed LCFB Rule 125 would have required any person registered
with an LCFB who has direct contact with customers in the conduct of
the broker's corporate financing activities, and the immediate
supervisors of such persons, to be subject to many of the same
requirements contained in the Firm Element provisions of FINRA Rule
1250. Proposed LCFB Rule 125 would not have subjected persons
registered with an LCFB to the Regulatory Element provisions of FINRA
Rule 1250, however.
One commenter stated that it was not opposed to requiring
registered persons to undergo additional training and continuing
education testing to keep an associated person's registration active,
but proposed that these requirements be imposed only once every two
years.\59\ Another commenter questioned exempting LCFB personnel from
the Regulatory Element requirements of FINRA Rule 1250, and noted that
investment bankers need to keep up with current rules and regulations
as much as other types of brokers.\60\
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\59\ See 3PM.
\60\ See Washington U.
---------------------------------------------------------------------------
Given that FINRA has revised the proposed registration rules to
allow persons registered with a CAB to hold and retain any principal
and representative registrations that are appropriate to their
functions under the registration rules, FINRA believes it is
appropriate to subject associated persons to all of the continuing
education requirements of FINRA Rule 1250, including the Regulatory
Element provisions. FINRA has amended CAB Rule 125 accordingly.
Expungement of Customer Dispute Information
Proposed LCFB Rule 208 (Obtaining an Order of Expungement of
Customer Dispute Information from the Central Registration Depository
(CRD) System) would have subjected LCFBs to FINRA Rule 2080, which sets
forth requirements for members or associated persons seeking to expunge
information from the CRD system arising from disputes with customers.
FINRA did not receive any comments on this proposed rule.
Since the Notice was published, FINRA Rule 2081 (Prohibited
Conditions Relating to Expungement of Customer Dispute Information)
became effective.\61\ FINRA Rule 2081 prohibits members and associated
persons from conditioning or seeking to condition settlement of a
customer dispute on, or otherwise compensating the customer for, the
customer's agreement to consent to, or not to oppose, the member's or
associated person's request to expunge such customer information from
the CRD system. The rule directly addresses any concerns about parties
to a settlement ``bargaining for'' expungement relief as a condition to
settlement and should apply equally to any CAB or its associated
persons seeking to expunge information from the CRD system.
Accordingly, FINRA has amended LCFB Rule 208 also to subject CABs and
their associated persons to FINRA Rule 2081.
---------------------------------------------------------------------------
\61\ See Regulatory Notice 14-31 (July 2014).
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[[Page 79979]]
Know Your Customer and Suitability
Proposed LCFB Rules 209 (Know Your Customer) and 211 (Suitability)
would have included slightly modified versions of the know your
customer (``KYC'') and suitability requirements of FINRA Rules 2090 and
2111. Proposed LCFB Rule 211(b) specified that an LCFB or its
associated person fulfills the customer-specific suitability
obligations for an institutional account, as defined by FINRA Rule
4512(c), if (1) the broker or associated person has a reasonable basis
to believe that the institutional customer is capable of evaluating
investment risks independently, both in general and with regard to
particular transactions and investment strategies involving a security
or securities and (2) the institutional customer affirmatively
indicates that it is exercising independent judgment in evaluating the
broker's or associated person's recommendations. Where an institutional
customer has delegated decision-making authority to an agent, such as
an investment adviser or bank trust department, the rule would have
applied these factors to the agent.
One commenter recommended that proposed LCFB Rule 209 be redrafted
to remove any reference to ``customer,'' instead suggesting that LCFBs
should be required to perform due diligence of issuers, as well as
reviews of investors and intermediaries considering whether to invest
in an issuer to ensure qualified status.\62\ Another commenter argued
that the rule as written is too vague, and that an examiner would be
unable to know if a firm had met its obligations to effectively service
a customer.\63\
---------------------------------------------------------------------------
\62\ See 3PM.
\63\ See Sutter.
---------------------------------------------------------------------------
Commenters also were largely critical of proposed LCFB Rule 211.
One commenter stated that it was inappropriate to require a suitability
analysis before any recommendation, and that the rule was written as if
an LCFB services retail customers. This commenter suggested that any
suitability analysis should only be required before a subscription or
purchase agreement is signed, and only where an investor is not
represented by a qualified intermediary.\64\ Another commenter
encouraged FINRA to more clearly define a ``recommendation'' in this
context and reconsider the definition of ``customer'' under the
proposed rules.\65\
---------------------------------------------------------------------------
\64\ See 3PM.
\65\ See ABA.
---------------------------------------------------------------------------
On the other hand, one commenter stated that LCFBs advise issuers,
and that the KYC and suitability requirements should apply to these
types of firms.\66\ Two other commenters agreed that LCFBs advise both
sell-side and buy-side M&A clients, but do not make recommendations to
customers in the traditional sense.\67\
---------------------------------------------------------------------------
\66\ See RWI.
\67\ See HighBank and CSP.
---------------------------------------------------------------------------
FINRA believes that the KYC and suitability rules should apply to
CABs. The KYC rule requires CABs to use reasonable diligence to know
and retain the essential facts concerning every customer and concerning
the authority of each person acting on behalf of such customer. Facts
essential to knowing a firm's customer are those required to (a)
effectively service the customer, (b) understand the authority of each
person acting on behalf of the customer, and (c) comply with applicable
laws, regulations and rules.
The rule is flexible in that it recognizes that the determination
of what is required to service a particular client will always be based
on the facts and circumstances of a firm's relationship with its
client. Likewise, the fact that a firm's client is a party to an M&A or
other private equity transaction does not alter the need to understand
the authority of each person acting on behalf of the customer, or facts
necessary to comply with applicable laws, regulations and rules. Again,
these facts will depend on each transaction's facts and circumstances,
and the rule recognizes this flexibility.
Likewise, FINRA also believes that CABs should be subject to
suitability requirements. If a CAB does not recommend a securities
transaction, as some commenters assert, then the suitability
requirements would not apply. Likewise, the proposed rule specifies
that a CAB or associated person fulfills the customer specific
suitability requirements for institutional investors if (1) the broker
or associated persons has a reasonable basis to believe that the
institutional investor is capable of evaluating investment risks
independently and (2) the institutional investor affirmatively
indicates that it is exercising independent judgment in evaluating the
broker's or associated person's recommendations. If the institutional
investor has delegated decision-making authority to an agent, these
factors apply to the agent. FINRA believes that this provision largely
addresses concerns expressed by commenters that the proposed rule
applies retail investor requirements to transactions involving
institutional investors. It also recognizes that a CAB or its
associated person may look to an institutional investor's agent if the
investor is represented by an agent.
FINRA has added supplementary material to proposed Rule 211 to
clarify that a CAB still must have a reasonable basis to believe, based
on reasonable diligence, that a recommendation is suitable for at least
some investors. FINRA also has added supplemental material providing
guidance with regard to the institutional investor exemption from the
customer specific suitability requirements. The text of both of these
supplementary materials is taken from similar supplementary materials
that follow FINRA Rule 2111. FINRA believes that these additions will
help clarify the scope of a CAB's suitability responsibilities under
proposed Rule 211.
FINRA also has revised the definition of ``customer'' to reflect
the definition of this term under FINRA Rule 0160(b)(4). As revised,
customer is defined as not including a broker or dealer. FINRA is
making this change to make clear that the definition of customer under
the CAB rules has the same meaning as under the FINRA rules.
Communications With the Public
Proposed LCFB Rule 221 would have required LCFB communications to
meet the general principles-based content standards of FINRA Rule 2210,
although it also would have prohibited LCFB communications from
projecting or predicting performance. Proposed LCFB Rule 221 would not
have required LCFBs to approve communications prior to use, nor would
it have imposed any filing requirements for LCFB communications.
One commenter recommended that the proposed rule's content
standards include a ``realistic approach'' to setting fair and balanced
content standards to meet the realities of representing issuers of
securities.\68\ Another commenter argued that the proposed rule does
not sufficiently protect investors, and that it should require new
firms to file communications with FINRA and require registered
principals to approve firm communications prior to use.\69\ Another
commenter argued that the cost of archiving emails for three years and
reviewing emails periodically is burdensome.\70\
---------------------------------------------------------------------------
\68\ See 3PM.
\69\ See CFSC.
\70\ See Colonnade.
---------------------------------------------------------------------------
FINRA believes that proposed CAB Rule 221 is already sufficiently
general to take into account the institutional nature of CABs' business
models. However, FINRA recognizes that firms may need to include
projections of an issuer's performance in communications that are sent
to prospective investors,
[[Page 79980]]
such as pro forma financial statements related to a business
acquisition or combination. For this reason, FINRA has removed the
prohibition on predictions or projections of performance. The proposed
rule would continue to prohibit communications from implying that past
performance will recur or making any exaggerated or unwarranted claim,
opinion or forecast.
FINRA does not believe it is necessary to include either principal
pre-use approval or filing requirements for CABs given the
institutional nature of their business. CABs will be required to
supervise communications, but FINRA intends to allow CABs the
flexibility to determine the best means of such supervision given each
firm's business model. LCFBs will be subject to the SEC's record-
keeping requirements for emails under Exchange Act Rules 17a-3 and 17a-
4, which FINRA has no authority to alter.
Engaging in Impermissible Activities
Proposed LCFB Rule 240 provided that, upon finding that an LCFB or
associated person of an LCFB has engaged in activities that require the
firm to register as a broker or dealer under the Exchange Act, and that
are inconsistent with the limitations imposed on LCFBs under LCFB Rule
016(h), FINRA may examine for and enforce all FINRA rules against such
a broker or associated person, including any rule that applies to a
FINRA member broker-dealer that is not an LCFB or to an associated
person who is not a person associated with an LCFB. One commenter
argued that an LCFB that engages in impermissible activities should be
given a defined remedial period and process for any unintentional
activities of an LCFB until the rules have been in place for a while,
given the potential for rule ambiguity.
FINRA does not believe it is necessary to include within the rule a
specific remedial period for engaging in impermissible activities.
FINRA believes that unintentional violations during a transition period
are best handled through the examination and enforcement process on a
case-by-case basis. Accordingly, FINRA is not proposing to amend the
rule.
Outside Business Activities of Registered Persons
Proposed LCFB Rule 327 would have required LCFBs to be subject to
FINRA Rule 3270 (Outside Business Activities). One commenter urged
FINRA to clarify an LCFB's supervisory responsibilities when an
associated person engages in private securities transactions away from
the firm under NASD Rule 3040, and an LCFB's supervisory obligations
when an associated person either is also registered with an affiliated
or unaffiliated full-service broker-dealer or refers a customer to a
full-service firm in return for a referral fee.\71\
---------------------------------------------------------------------------
\71\ See CFSC.
---------------------------------------------------------------------------
An associated person of a CAB would not be permitted to engage in
private securities transactions away from the firm, since such
activities would be beyond the scope of permissible activities for a
CAB under proposed CAB Rule 016(c).\72\ However, in order to make this
restriction more clear, FINRA has added CAB Rule 328, which would
expressly prohibit associated persons of CABs from engaging in private
securities transactions as defined in FINRA Rule 3280(e).
---------------------------------------------------------------------------
\72\ See CAB Rule 014 (``Persons associated with a capital
acquisition broker shall have the same duties and obligations as a
capital acquisition broker under the Capital Acquisition Broker
rules'').
---------------------------------------------------------------------------
For the same reasons, an associated person of a CAB also would not
be allowed to register with an affiliated or unaffiliated full-service
broker-dealer. An associated person could receive a fee for referring
business to another broker-dealer, provided that the proposed
transaction would be permissible for the CAB to conduct itself.
Anti-Money Laundering Compliance Program
Proposed LCFB Rule 331 would require an LCFB to develop and
implement a written AML program reasonably designed to achieve and
monitor its compliance with the requirements of the Bank Secrecy Act
and the Department of Treasury regulations thereunder. The AML program
would have to meet many of the same standards that full-service broker-
dealers must meet under FINRA Rule 3310, except that the program would
provide for independent testing for compliance no less frequently than
every two years, rather than every year.
Five commenters stated that AML audits should not be required for
LCFBs, since such firms receive no customer deposits and have no
customer accounts.\73\ Another commenter argued that LCFBs should only
have to implement a customer identification program (``CIP'') for
issuers and intermediaries with which the LCFB does business, and for
investors where there is no intermediary.\74\ However, another
commenter stated that there is no reason to exempt an LCFB from the
one-year AML testing requirement.\75\
---------------------------------------------------------------------------
\73\ See Growth Venture, Signal Hill, Q Advisors, CSP, and
LeGaye.
\74\ See 3PM.
\75\ See CFSC.
---------------------------------------------------------------------------
Because the Bank Secrecy Act imposes AML obligations on all broker-
dealers, FINRA does not believe it has the authority to exempt CABs
from the requirement to adopt and implement an AML program. However,
due to the limited nature of CABs' securities transactions, FINRA
believes it is appropriate to allow CABs to conduct independent
compliance testing of their AML programs every two years rather than
every year.
Capital Compliance
Proposed LCFB Rule 411 would impose on LCFBs certain requirements
imposed on full-service broker-dealers under FINRA Rule 4110 (Capital
Compliance). Unless otherwise permitted by FINRA, an LCFB would have to
suspend all business operations during any period in which it is not in
compliance with the applicable net capital requirements set forth in
Exchange Act Rule 15c3-1. The proposed rule also would authorize FINRA
to issue a notice pursuant to FINRA Rule 9557 directing a non-compliant
LCFB to suspend all or a portion of its business. The proposed rule
would impose requirements related to withdrawal of equity capital,
subordinated loans, and notes collateralized by securities and capital
borrowings similar to provisions in FINRA Rule 4110.
Numerous commenters recommended that FINRA either eliminate or
substantially reduce net capital requirements for LCFBs,\76\ and that
FINRA overhaul the net capital and FOCUS reporting requirements to
better apply these requirements to LCFBs' business model.\77\
---------------------------------------------------------------------------
\76\ See Growth Venture and LIATI.
\77\ See 3PM, Colonnade, Bridge 1, CMC, McCracken, RWI, M&A
Brokers Letter Attorneys, IMS, and Stonehaven.
---------------------------------------------------------------------------
The SEC, however, sets these standards under its net capital rules
and FINRA believes that the SEC would have to adjust its net capital
requirements before FINRA could alter the net capital requirements that
it imposes under its rules. In this regard, FINRA has clarified the CAB
rules to note that CABs would be required to file supplemental FOCUS
reports pursuant to FINRA Rule 4524 as FINRA may deem necessary or
appropriate for the protection of investors or in the public interest.
Audit
Numerous commenters urged FINRA to work with the SEC and the Public
Company Accounting Oversight Board (``PCAOB'') to carve out LCFBs from
the
[[Page 79981]]
requirement to produce audited financial statements.\78\ Two commenters
recommended that, as an alternative to an audit, LCFBs' financials
could be subject to an AICPA ``review.'' \79\ Another commenter
recommended that audits not be required unless a firm has 20 or more
employees or $10 million in net revenues.\80\
---------------------------------------------------------------------------
\78\ See 3PM, Achates, Colonnade, Growth Venture, Signal Hill,
Sutter, LIATA, Bridge 1, Q Advisors, Dole, McCracken, HighBank, CSP,
M&A Brokers Letter Attorneys, LeGaye, and IMS.
\79\ See Achates and RWI.
\80\ See Anderson.
---------------------------------------------------------------------------
FINRA believes that it does not have the authority to reduce or
eliminate the requirement to obtain audited financial statements.
Fidelity Bonds
The proposal would subject LCFBs to FINRA Rule 4360, which requires
each member firm required to join the Securities Investor Protection
Corporation (``SIPC'') to maintain blanket fidelity bond coverage that
provides against loss and have insuring agreements covering at least
six enumerated areas. The minimum required fidelity bond amount varies
depending on a firm's net capital requirements, but in any case it must
be at least $100,000.
Some commenters argued this requirement should not apply to LCFBs,
since fidelity bonds protect against theft of a customer's funds.
Because LCFBs may not accept or hold customer funds, these commenters
argue that the bond requirement makes no sense.\81\ One commenter noted
that an LCFB that issues a fairness opinion should be required to carry
a larger fidelity bond than $100,000.\82\
---------------------------------------------------------------------------
\81\ See 3PM, Colonnade, Growth Venture, LIATI, Bridge 1, Q
Advisors, Dole, McCracken, RWI, HighBank, CSP, LeGaye, IMS, and
Stonehaven.
\82\ See Sutter.
---------------------------------------------------------------------------
In response to these comments, FINRA has determined not to subject
CABs to FINRA Rule 4360 because of CABs' unique business model. CABs'
clients would be limited to issuers of unregistered securities,
institutional investors, and parties to a transaction involving the
change of control of a privately held company. CABs would act as agent
only in transactions in which funds flow directly from a purchaser of
securities to the issuer or shareholder of such securities, and would
not carry or act as an introducing broker in connection with customer
accounts. In addition, CABs would belong to a separate FINRA membership
category that would make them unique among all other FINRA member
firms. For these reasons, FINRA believes it would be appropriate not to
require CABs to maintain a fidelity bond under Rule 4360.
SIPC Dues
Thirteen commenters argued that an LCFB should not have to pay dues
to SIPC on the ground that an LCFB would not carry or act as an
introducing broker with respect to customer accounts or hold or handle
customer funds.\83\
---------------------------------------------------------------------------
\83\ See 3PM, Anderson, LIATI, Bridge 1, Q Advisors, Dole,
McCracken, RWI, HighBank, CSP, LeGaye, IMS, and Stonehaven.
---------------------------------------------------------------------------
Almost all persons registered as brokers or dealers under Section
15(b) of the Exchange Act must be members of SIPC.\84\ Because these
requirements are imposed by statute, FINRA has no authority to exempt
any CAB from SIPC membership.
---------------------------------------------------------------------------
\84\ See Section 3(a)(2)(A) of the Securities Investor
Protection Act, 15 U.S.C. 78ccc(a)(2)(A). The only exceptions to
this requirement are for: (i) Firms whose principal business is
conducted outside the United States, as determined by SIPC; (ii)
firms whose business as a broker or dealer consists exclusively of
(I) the distribution of open-end investment companies or unit
investment trusts; (II) the sale of variable annuities; (III) the
business of insurance; or (IV) advising investment companies or
insurance company separate accounts; and (iii) firms that are
registered as brokers or dealers solely for the purpose of trading
security futures on an exchange.
---------------------------------------------------------------------------
Other Comments
Commenters had a number of other observations and recommendations
regarding the proposed rule set, which FINRA addresses below.
One commenter recommended that FINRA relieve LCFBs from the
requirement to review and file hard copies of employees' stock trading
records.\85\ Another commenter recommended that FINRA impose the
requirements of NASD Rule 3050 on LCFBs.\86\ NASD Rule 3050 imposes
certain obligations on a member firm that knowingly executes a
transaction for the purchase or sale of a security for the account of a
person associated with another member firm, or any account over which
such associated person has discretionary authority, and on an
associated person who opens an account with another member firm. Among
other things, upon written request by the employer member firm, the
associated person must request that the executing member firm transmit
duplicate account confirmations, statements or other information.
---------------------------------------------------------------------------
\85\ See Colonnade.
\86\ See CFSC.
---------------------------------------------------------------------------
The CAB rules would not apply NASD Rule 3050 to CABs. FINRA
believes that, due to the limited institutional activities of CABs and
their associated persons, it is not necessary to impose this rule's
obligations on CABs.
Three commenters urged FINRA to eliminate or reduce its assessments
on LCFBs due to the limited level of FINRA oversight of these
firms.\87\ FINRA derives its revenues from a number of sources, many of
which are user fees, such as fees imposed on firms that file
communications with FINRA's Advertising Regulation Department, or
public offerings with FINRA's Corporate Financing Department. CABs
would not be subject to many of these user fees since they would not be
subject to these filing requirements. However, CABs would be subject to
fees and assessments that apply to all FINRA member firms, such as the
gross income assessment or the new member filing fees. FINRA believes
that it is appropriate to impose these more generalized assessments on
CABs to cover the costs of regulating and examining CAB activities.
---------------------------------------------------------------------------
\87\ See Anderson, RWI, and LeGaye.
---------------------------------------------------------------------------
One commenter expressed concern that the proposed rule set will
lead to differing interpretations of rules, and will create an uneven
playing field with full-service broker-dealers. This commenter believes
that the proposed rule set is contrary to FINRA's mission of market
integrity and investor protection, and that FINRA and the industry
would be better served by expanding existing rules rather than creating
a new rule set.\88\
---------------------------------------------------------------------------
\88\ See CFSC.
---------------------------------------------------------------------------
FINRA staff strives to interpret all of its rules in a consistent
manner, and it will make similar efforts to interpret rules
consistently if the proposal is approved. To the extent a CAB rule
requires compliance with an existing FINRA rule that applies to full-
service broker-dealers, the staff anticipates that it will interpret
the CAB rule in the same manner as the corresponding FINRA rule. If the
CAB rule differs from its FINRA rule counterpart, the staff intends to
interpret the rule consistently with respect to all CABs. FINRA does
not agree that the proposed rule set would be contrary to FINRA's
mission of market integrity and investor protection. FINRA has
carefully crafted the rule set to include rules that should apply to
all broker-dealers, or to broker-dealers that engage in M&A and other
private equity activities with institutional investors, while excluding
from the proposal rules that have no applicability to CABs' business
model, or that would impose unnecessary burdens given the kinds of
activities in which CABs engage.
One commenter suggested that the Federal Trade Commission Red Flag
Rules should apply to LCFBs. This
[[Page 79982]]
commenter noted that LCFBs may be in possession of confidential and
sensitive information concerning their customers, and that these
customers could be exposed to risks resulting from identity theft.\89\
The proposal would not impact whether a CAB is subject to the Red Flag
Rules adopted pursuant to the Fair Credit Reporting Act of 1970, as
amended.\90\ The application of the Red Flag Rules depends on whether a
broker or dealer falls within the requirements of the SEC's Regulation
S-ID.\91\
---------------------------------------------------------------------------
\89\ See RWI.
\90\ Pub. L 91-508, 84 Stat. 1114 (1970), codified at 15 U.S.C.
1681-1681x.
\91\ 17 CFR 248 Subpart C. See also Securities Exchange Act
Release No. 69359 (April 10, 2013), 78 FR 23637 (April 19, 2013).
---------------------------------------------------------------------------
One commenter noted that the proposed rule set omits FINRA Rule
5150 (Fairness Opinions) and a reference to information barriers, such
as the guidance provided in NASD Notice to Members 91-45 (July 1991).
The commenter also recommended that FINRA clarify that the proposed
rule set would apply only to broker-dealers whose enterprise-wide
activities fit within the definition of LCFB, and not to affiliates of
large financial conglomerates, even if the LCFB itself only engages in
activities permissible for an LCFB.\92\
---------------------------------------------------------------------------
\92\ See Washington U.
---------------------------------------------------------------------------
FINRA agrees that FINRA Rule 5150 should apply to a CAB that
provides a fairness opinion that is subject to that rule. Although this
rule generally applies to fairness opinions that are provided or
described to public shareholders, it is possible that a CAB could serve
as an advisor in connection with a public offering of securities and
provide a fairness opinion in connection with the offering. In such a
case, it would make sense to require the same disclosures regarding
potential conflicts of interest in connection with the fairness
opinion. Accordingly, FINRA is adding new CAB Rule 515 (Fairness
Opinions), which would subject CABs to FINRA Rule 5150.
NASD Notice to Members 91-45 was a joint memorandum prepared by the
National Association of Securities Dealers, Inc., the New York Stock
Exchange, and a committee of the Securities Industry Association that
explained the minimum elements of adequate information barrier policies
and procedures pursuant to the requirements of the Insider Trading and
Securities Fraud Enforcement Act of 1988. To the extent a CAB deals
with information that would trigger application of this statute or any
other insider trading law, the CAB would be required to have in place
adequate information barriers necessary to meet these requirements.
FINRA disagrees that a CAB may not be affiliated with a broker-
dealer that engages in activities that are not permitted for CABs. As
discussed previously, the CAB rules would prohibit both a CAB firm and
its associated persons from engaging in activities that are not
permitted under the definition of CAB. However, FINRA does not believe
that it would be inconsistent for an affiliate of a CAB to engage in a
wider array of activities; in those cases, the affiliate would be
subject to all FINRA rules, and not the CAB rules.
One commenter urged FINRA to collaborate with the North American
Securities Administrators Association (``NASAA'') to further reduce
regulatory burdens on LCFBs.\93\ FINRA cooperates with NASAA
representatives on securities regulatory issues, and expects that its
staff will continue to discuss matters of mutual interest regarding
CABs with NASAA representatives in the future.
---------------------------------------------------------------------------
\93\ See M&A Brokers Letter Attorneys.
---------------------------------------------------------------------------
Another commenter requested that FINRA confirm that LCFBs may serve
as ``chaperones'' for non-U.S. broker-dealers under Exchange Act Rule
15a-6 by performing activities that are described in Rule 15a-6(a)(3)
and related no-action letters. The same commenter recommended that
FINRA confirm with the states that an LCFB would be eligible for an
exemption from state business broker licensing laws, to the extent that
they exempt other registered broker-dealers.\94\
---------------------------------------------------------------------------
\94\ See EYCF.
---------------------------------------------------------------------------
FINRA is not prepared at this time to confirm that all activities
listed in Rule 15a-6(a)(3) and related no-action letters would be
permissible for a CAB. For example, these activities include effecting
securities transactions and issuing all required confirmations and
statements, which appear to be activities beyond what would be
permitted under the CAB definition. Likewise, the question of whether a
CAB would be subject to a particular state's business broker licensing
laws would be better directed to that state.
Another commenter recommended that FINRA work with the SEC, NASAA,
the Commodity Futures Trading Commission, the National Futures
Association, and the industry to develop a unified simple regulatory
approach to regulating broker-dealer activities on the basis of risk
rather than on transaction-based compensation.\95\ The commenter's
suggestion is beyond the scope of this proposed rulemaking and would
likely require changes to the federal securities laws.
---------------------------------------------------------------------------
\95\ See IMS.
---------------------------------------------------------------------------
III. Date of Effectiveness of the Proposed Rule Change and Timing for
Commission Action
Within 45 days of the date of publication of this notice in the
Federal Register or within such longer period (i) as the Commission may
designate up to 90 days of such date if it finds such longer period to
be appropriate and publishes its reasons for so finding or (ii) as to
which the self-regulatory organization consents, the Commission will:
(A) By order approve or disapprove such proposed rule change, or
(B) institute proceedings to determine whether the proposed rule
change should be disapproved.
IV. Solicitation of Comments
Interested persons are invited to submit written data, views and
arguments concerning the foregoing, including whether the proposed rule
change is consistent with the Act. Comments may be submitted by any of
the following methods:
Electronic Comments
Use the Commission's Internet comment form (http://www.sec.gov/rules/sro.shtml); or
Send an email to [email protected]. Please include
File Number SR-FINRA-2015-054 on the subject line.
Paper Comments
Send paper comments in triplicate to Secretary, Securities
and Exchange Commission, 100 F Street NE., Washington, DC 20549-1090.
All submissions should refer to File Number SR-FINRA-2015-054. This
file number should be included on the subject line if email is used. To
help the Commission process and review your comments more efficiently,
please use only one method. The Commission will post all comments on
the Commission's Internet Web site (http://www.sec.gov/rules/sro.shtml). Copies of the submission, all subsequent amendments, all
written statements with respect to the proposed rule change that are
filed with the Commission, and all written communications relating to
the proposed rule change between the Commission and any person, other
than those that may be withheld from the public in accordance with the
provisions of 5 U.S.C. 552, will be available for Web site viewing and
printing in the Commission's Public Reference Room, 100 F Street NE.,
[[Page 79983]]
Washington, DC 20549, on official business days between the hours of 10
a.m. and 3 p.m. Copies of such filing also will be available for
inspection and copying at the principal office of FINRA. All comments
received will be posted without change; the Commission does not edit
personal identifying information from submissions. You should submit
only information that you wish to make available publicly. All
submissions should refer to File Number SR-FINRA-2015-054 and should be
submitted on or before January 13, 2016.
For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\96\
---------------------------------------------------------------------------
\96\ 17 CFR 200.30-3(a)(12).
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Robert W. Errett,
Deputy Secretary.
[FR Doc. 2015-32189 Filed 12-22-15; 8:45 am]
BILLING CODE 8011-01-P