Capital Acquisition Brokers: Is FINRA’s New Broker-Dealer Category a Good Deal?


On August 18, the U.S. Securities and Exchange Commission (SEC) announced it has adopted new rules proposed by the Financial Industry Regulatory Authority (FINRA) that lessen the requirements for “capital acquisition brokers” (CABs) – firms that serve to advise private placements or mergers and acquisitions and aren’t involved with managing customer accounts or trading securities.

CABs are FINRA members and subject to FINRA bylaws, but in return for limiting their activities, they are held to a relaxed set of rules compared with those of traditional broker-dealers.

Around 16% to 19% of firms currently registered with FINRA are solely engaged in advising clients around financial alternatives, mergers and acquisitions or raising equity capital and debt in private placements.

Though a majority of these firms don’t participate in full-service broker-dealer activities, those who receive transaction-based compensation must still register as FINRA brokers and are subject to all of the rules and regulations of a broker-dealer. FINRA established the CAB category of broker-dealer to address that issue.

What is a Capital Acquisition Broker?

FINRA defines a “capital acquisition broker” as a broker that solely participates in one or more of the following activities:

  • Advising issuers on securities offerings or other capital-raising activities;
  • Advising companies regarding purchase or sale of a business or assets, or regarding corporation restructuring, going private transactions, divestitures and mergers;
  • Advising companies regarding investment banker selection;
  • Assisting issuers in offering materials preparation;
  • 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 for institutional investors regarding the purchase or sale of newly issued unregistered securities;
  • Qualifying, identifying, soliciting or acting as a placement agent or finder for an issuer or control person regarding a change in control of a privately held company (a “control person” being a person with the power to direct the management or policies of a company through security ownership or to direct the voting or sale of 24% or more of a class of securities);
  • 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, in accordance with the SEC rules, rule interpretations and no-action letters.

FINRA rules prohibit CABs from handling or holding client securities or funds, taking customer orders, participating in proprietary trading, engaging in market making activities and serving as the introducing broker on customer accounts.

How Do CAB Rules Differ From FINRA Broker-Dealer Rules?

FINRA’s CAB rules differ from full-service broker-dealer rules in several ways. For example, chief executives of CABs are not required to certify compliance on an annual basis and CABs do not have to conduct annual compliance meetings.

CAB principals are not required to review all investment banking transactions or prohibit supervisors from supervising themselves.

FINRA has exempted CABs from numerous broker-dealer rules, including:

  • FINRA Rule 2121: Fair Prices and Commissions
  • FINRA Rule 2122: Charges for Services Performed
  • FINRA Rule 2124: Net Transactions with Customers
  • FINRA Rule 4370: Business Continuity Plans and Emergency Contact Information
  • FINRA Rule 4380: Mandatory Participation in FINRA BC/DR Testing Under Regulation SCI
  • FINRA Rule 8110: Availability of Manual to Customers
  • FINRA Rule 8211: Automated Submission of Trading Data Requested by FINRA
  • FINRA Rule 8213: Automated Submission of Trading Data for Non-Exchange-Listed Securities Requested by FINRA
  • FINRA Rule 9700s: Procedures on Grievances Concerning the Automated Systems

What Broker-Dealer FINRA Rules Still Apply to CABs?

A number of FINRA’s broker-dealer rules still apply to CAB firms. FINRA rules of conduct, supervision, financial agreements, operational duties, sanctions, investigations and disciplinary proceedings still govern CAB firms, though FINRA has simplified some of these rules for CAB firms.

CABs must designate one or more principals to act as the firm’s chief compliance officer(s), and CAB firm representatives and principals must meet the same registration, qualifying exam and continuing education requirements as the representatives and principals of any broker-dealer firm.

CABs must meet the current net capital requirements defined in Exchange Act Rule 15c3-1. CAB firms are also subject to FINRA’s records maintenance requirements, FOCUS report preparations and audit requirements. CABs must still follow FINRA suitability requirements, rules governing false or misleading statements and a set of simplified rules covering public communications.

CAB firms are subject to the following FINRA rules or simplified versions of these rules:

  • FINRA Rule 2010: Standards of Commercial Honor and Principals of Trade
  • FINRA Rule 2020: Use of Manipulative, Deceptive or Other Fraudulent Devices
  • FINRA Rule 2040: Payments to Unregistered Persons
  • FINRA Rule 2070: Transactions Involving FINRA Employees
  • FINRA Rules 2080-2081: Expungement of Customer Disputes
  • FINRA Rule 2210: Communications with the Public
  • FINRA Rules 2263 and 2268: FINRA Arbitration Requirements
  • FINRA Rule 3110: Supervision
  • FINRA Rule 3130: Annual Certification of Compliance and Supervisory Processes
  • FINRA Rule 3220: Influencing or Rewarding Employees of Others
  • FINRA Rule 3240: Borrowing from or Lending to Customers
  • FINRA Rule 3270: Outside Business Activities of Registered Persons
  • FINRA Rule 3310: Anti-Money Laundering Compliance Program
  • FINRA Rule 4110 Capital Compliance
  • FINRA Rule 5122: Private Placements of Securities Issued by Members
  • FINRA Rule 5150: Fairness Opinions
  • FINRA Rule 12000’s: Code of Arbitration Procedure for Customer Disputes
  • FINRA Rule 13000’s: Code of Arbitration Procedure for Industry Disputes
  • FINRA Rule 14000’s: Code of Mediation Procedure

The freedom in supervisory structure, compensation and business dealings offered by the relaxed CAB rules may seem attractive to some. Unregistered mergers and acquisitions advisors who want to increase their activities beyond those in their M&A letters may benefit from CAB registration. Registration as a CAB firm could also be advisable for private fund advisers who want to receive transaction-based compensation or raise capital via affiliated registered agencies.

Yet CAB firms are still subject to much of the regulation, associated costs and ongoing compliance burdens. CABs are not exempt from trade reporting requirements. In addition, FINRA’s CAB rules limit activities to institutional investors (persons who own at least $5 million in investments or entities that own $25 million in investments).

The rules remove the accredited investor population (those with an annual income of only $200,000, $300,000 for a couple, or $1 million in investments excluding the value of their home).

Cost Benefit Analysis and Burden Help Determine CAB Value

While relaxed rules for CABs are a positive step in recognizing that not all firms are the same, FINRA rules still govern much of the CAB structure while significantly dampening the range of activities a CAB firm can engage in. The benefits must outweigh the limits for the CAB structure to prove valuable. It may be more advisable to remain unregistered or register as a full broker-dealer.

The answer lies in a cost-benefit analysis and the extent of the burden placed on each individual firm. I advise those interested in FINRA CAB registration to first consult with an expert securities lawyer to learn the best option for their particular firm.

FINRA begins accepting applications for CAB registration on January 3, 2017. CAB rules go into effect on April 14, 2017.

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