On January 4, 2010, the Financial Industry Regulatory Authority (“FINRA”) issued Regulatory Notice 10-01 (the “Notice”), requesting comments on proposed consolidated FINRA Rules governing FINRA’s membership application process (“MAP”) (the “Consolidated MAP Rules”).1 The effect of the changes would be to increase the involvement of FINRA staff in reviewing changes to broker-dealer operations that are now regarded as routine. The proposals could also have a significant effect on the timing of change in control transactions.
The current MAP rules consist of a series of rules that apply to anyone that is applying for FINRA membership and any FINRA member that is undergoing a change in its ownership, control, or business operations. Included are applicants for broker-dealer registration with FINRA, i.e., new member applications (“NMAs”) that are currently filed with FINRA pursuant to NASD Membership and Registration Rule 1013 (New Member Application and Interview), applications for approval of changes in a firm’s ownership or control or material changes in business operations, i.e., continuing membership applications (“CMAs”), and applications for removal or modification of restrictions on a firm’s membership (“MACs”). CMAs and MACs are currently filed pursuant to NASD Membership and Registration Rule 1017 (Application for Approval of Change in Ownership, Control, or Business Operations) (“Rule 1017”). The Consolidated MAP Rules incorporate the NASD’s MAP rules and analogous New York Stock Exchange (“NYSE”) rules, including NYSE Rule 311 (Formation and Approval of Member Organizations) and NYSE Rule 312 (Changes in Member Organizations).2
The Consolidated MAP Rules are intended to consolidate, revise, update, streamline, and replace current NASD and NYSE rules and related interpretive material. In addition, they include substantive changes that will increase the requirements on FINRA members and applicants for membership to provide certain information to FINRA, and on FINRA members to provide notification of changes in their ownership, control, or operations. This briefing discusses the more significant changes to CMAs and the new notice requirements in proposed FINRA Rule 1170 (Notice of Certain Member Changes and Continuous Access to Affiliate Information) (“Proposed Rule 1170”). The changes to the NMAs are less extensive and generally codify FINRA’s existing practices in connection with its processing of applications for FINRA membership.3
Changes to the CMA Requirements in Rule 1017
One significant change to Rule 1017 that will affect the timing of mergers, acquisitions, and other transactions involving changes in a FINRA member’s ownership or control is a change to the provision permitting FINRA to impose interim restrictions on a member that effects a change in ownership or control pending final FINRA action on the CMA. As Rule 1017 is currently worded, a firm could proceed to effect a change without receiving FINRA approval within 30 days of filing its CMA. However, proposed FINRA Rule 1160 (Continuing Membership Application for Approval of Change in Ownership, Control, or Business Operations) (“Proposed Rule 1160”) specifically provides that a CMA applicant may effect such change before receiving FINRA approval, but only after waiting 30 days from the date of submitting a complete application.4 In addition, under Proposed Rule 1160, if FINRA imposes any interim restrictions on a member that is proceeding to effect the change triggering the CMA without waiting for FINRA approval, such interim restrictions will remain in effect for the applicant, and for all successors to the applicant’s ownership or control, unless removed by final action of FINRA or stayed by the National Adjudicatory Council, the FINRA Board, or the Securities and Exchange Commission (“SEC”).5
Proposed Rule 1160 also expands the criteria under which a CMA filing is required by broadening the reach of Rule 1017 to include direct or indirect changes in the equity ownership, partnership capital, or other ownership interest in a FINRA member that results in one person directly or indirectly owning, controlling, or holding a presently exercisable option to own or control 25 percent or more of the equity, partnership capital, “or other ownership interest” in the member.6 However, Proposed Rule 1160 permits FINRA staff to waive a CMA filing when the change in ownership or control does not result in any practical change in the firm’s business activities, management supervision, assets, liabilities, or ultimate ownership or control.7 The effect of this provision is that FINRA staff will be permitted to waive a CMA filing in the case of corporate reorganizations that involve the creation of a new legal entity but no practical change in the control or operations of the broker-dealer.8
In addition, Proposed Rule 1160 expands the requirement that a firm file a CMA if there is a direct or indirect acquisition of 25 percent or more of its assets or business lines that generate 25 percent or more of its earnings to include divestitures meeting those same percentages.9 However, the rule also permits FINRA to waive the CMA filing if the firm is ceasing its broker-dealer operations, provided that neither the firm nor any of its registered persons is subject to any claim that could be adversely affected by the divestiture.
The final significant change to the CMA requirements is that Proposed Rule 1160 incorporates the definition of a material change in business operations (which requires a CMA) to include settling or clearing transactions for its own business for the first time, settling or clearing transactions for other broker-dealers for the first time, carrying accounts of customers for the first time, or any change in the firm’s exemptive status under SEC Rule 15c3- 3 (Customer Protection—Reserves and Custody of Securities).10
Proposed Rule 1170 (Notice of Certain Member Changes and Continuous Access to Affiliate Information)
The most significant change in the Consolidated MAP Rules is Proposed Rule 1170, which imposes the new requirement that firms provide FINRA with notice of certain changes and continuous access to information on affiliates. According to the Notice, FINRA believes that certain transactions and/or patterns of expansion, though not triggering a CMA, may be material events in the sense that they may have an impact on a firm’s supervisory and compliance infrastructure and/or finances. FINRA is therefore proposing to require notification in order to maintain effective oversight of member firms by identifying potential regulatory issues.11 Proposed Rule 1170 requires a firm to provide timely, prior written notice of certain significant changes in its business 30 days prior to the event’s occurrence (or as soon as possible if circumstances make it impracticable to meet the 30-day time period), notwithstanding that such changes may not trigger a CMA filing. These events include:
- Direct or indirect acquisitions or divestitures of 10 percent or more in the aggregate of the member’s assets, or any asset, business, or line of operation that generates revenues comprising 10 percent or more in the aggregate of the member’s revenues;
- Direct or indirect acquisitions or divestitures of 10 percent or more of the member’s shares, partnership interests, or other ownership interests, by any one person or by a control group;
- The addition, removal, or subsequent modification of a business relationship between the member and an affiliate requiring disclosure under proposed FINRA Rule 1121;
- A change or loss of the member’s key personnel (such as its CEO, CFO, COO, CCO, or any individual with similar status or functions);
- A change in the member’s service bureau, clearance activities (other than those that would require a CMA pursuant to Proposed Rule 1160), or method of bookkeeping or recordkeeping, or utilizing an outside service provider;
- The expansion of business: (a) requiring an infusion of capital that is 25 percent or more of the member firm’s net capital, as calculated from the ending date of the member’s previous FOCUS filing period, or (b) requiring additional licenses, registrations, memberships, or approvals as required by a selfregulatory organization or other regulatory agency;
- The expansion of business adding products or services that would be new in terms of the type of investments, transactions, or risks from those business products or services offered by the member firm since the time of the last approval of a membership application;
- Increasing the number of sales personnel, office locations, or markets made, beyond the scope of the safe harbor provisions of Proposed Rule 1160;
- The listing of the member firm (on an identified or anonymous basis) on any facility or medium that is designed to solicit offers or inquiry with respect to the possible purchase of the member in whole or in part, or the transfer of some or all of the member’s assets; or
- The discovery of any existing or impending condition(s) that the member firm reasonably believes could lead to capital, liquidity, or operational problems, or the impairment of recordkeeping, clearance, or control functions.
Upon receipt of a notice of items (5) through (8), or item (10), Proposed Rule 1170 would permit FINRA staff to determine whether such event would substantively affect the business or resources of the member and, in the public interest, require the member to submit a CMA. Proposed Rule 1170 also clarifies that the disclosure of an event under the rule does not obviate a member’s obligation to make a CMA filing should the member determine, or have a reasonable basis to believe, that the event requires such a filing.
Additionally, proposed FINRA Rule 1170 requires a member firm, upon request by FINRA, to submit promptly any affiliate information that the member firm or applicant would otherwise be required to provide under FINRA’s membership rules. This provision essentially incorporates NYSE Rule 416 (Questionnaires and Reports) and its related supplementary material, which requires NYSE member organizations to provide financial and operational reports for affiliated organizations if requested.
The comment period on the Notice expires on March 5, 2010.