FINRA has filed with the SEC a proposed rule which would reduce the regulatory burden for broker-dealers that limit their activities to M&A and certain corporate financing transactions.  The proposed rule would create a new category of broker-dealers called “Capital Acquisition Brokers” or “CABs”.  The proposed rule was published in the Federal Register on December 23, 2015 and will become effective after SEC approval, which normally occurs within 45 days after the date of publication. http://www.finra.org/sites/default/files/rule_filing_file/SR-FINRA-2015-054-federal-register-notice.pdf

Purpose of Proposal

The rule was developed based upon FINRA’s earlier release seeking comment on a proposal to create a new category of broker-dealers which limit their business activities to corporate financing.  See FINRA Regulatory Notice 14-09 (February 2014). As FINRA observed at that time, there are a number of broker-dealers which limit their business to advising companies on M&A transactions, raising funds through private placements and evaluating strategic alternatives.  While these firms must generally be registered as broker-dealers because they often receive transaction-based compensation, they do not handle customer funds or securities, do not manage customer accounts and do not engage in market-making or proprietary trading.¹ As a result, some of the requirements set forth in FINRA’s rules are not relevant to their business operations.

Limited Activities

In order to qualify as a Capital Acquisition Broker, a firm must limit its activities to the following:

  • Advising issuers, including private funds, concerning public or private securities offerings;
  • Assisting on the preparation of offering materials;
  • Acting as a placement agent in the sale of unregistered securities to institutional investors (as defined in the FINRA rules) and qualified purchasers (as defined in the Investment Company Act of 1940) through an exempt offering;
  • Advising a company regarding an M&A or restructuring transaction;
  • Providing fairness opinions;
  • Effecting the sale of securities in an M&A transaction involving the transfer of control of a privately held company;
  • Providing negotiation, structuring, valuation or other support for a capital raising or M&A transaction; and
  • Advising on the selection of investment bankers.

Importantly, broker-dealers that act as underwriters or selected dealers in registered public offerings could not qualify as CABs.  However, broker-dealers that limit their activities to advisory services in connection with public offerings could qualify as CABs.

Reduced Regulatory Requirements

Firms that limit their business activities as set forth above and which voluntarily elect to be treated as a Capital Acquisition Broker would be subject to a separate set of rules for CABs.  Important differences between the CAB rules and the FINRA rules applicable to other broker-dealers include:

  • CABs would be subject to a streamlined customer communications rule which dispenses with the process and filing requirements of Rule 2210, and essentially simply requires that communications be fair and balanced and not false or misleading.
  • CABs would not be subject to the rules governing mark-ups, commissions, etc. (Rules 2121, 2122 and 2124).
  • The rules governing supervision by CABs would be somewhat less demanding than the requirements of Rule 3110, and would dispense with the specific requirements in that rule regarding internal inspections, review of transactions, annual compliance meetings and certain documentation requirements.
  • CABs would not be required to have a business continuity plan.
  • CABs would be subject to streamlined requirements regarding the information they must obtain regarding their customers under Rule 4512.

Principal Benefits

Broker-dealers which qualify as CABs should be able to tailor their Written Supervisory Procedures and compliance function to focus on the matters which are of greatest concern to investment banking boutiques.  This should enable these firms to enjoy significant cost savings over time.  This could also help increase the number of firms that offer capital raising services to smaller companies.  Currently registered broker-dealers which wish to convert their status to that of a CAB may apply to do so by submitting an application to FINRA to amend their membership agreement.