SEC Approves New Capital Acquisition Broker Rules

August 31, 2016

On August 19, 2016, the Securities and Exchange Commission (“SEC”) approved the new Capital Acquisition Broker rules (the “CAB Rules”). The Financial Industry Regulatory Authority (“FINRA”) proposed the CAB Rules with the goal of minimizing the current regulatory burden on certain limited purpose broker-dealers.

The CAB Rules apply only to firms that are approved for membership in FINRA as a CAB. Notwithstanding the new limited rules, CABs will continue to be subject to the current FINRA By-Laws and will be required to maintain good standing as members of FINRA.

The CAB Rules respond to ongoing industry concerns regarding the incompatibility of the broad scope of current FINRA rules with the limited business activities undertaken by some broker-dealers (e.g., capital raising, mergers and acquisitions, and corporate financing).

What types of firms can become a CAB?
FINRA defines a CAB as any broker that solely engages in 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
    • (i) on behalf of an issuer in connection with a sale of newly issued, unregistered securities to institutional investors, or
    • (ii) on behalf of an issuer or “control person” (as defined in the CAB Rules) in connection with a change of control of a privately held company;
  • 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 Securities Exchange Act of 1934 (“Exchange Act”).

As noted in the release, the term CAB does 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 a principal or as an 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;
  • 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; or
  • effects securities transactions that will require the broker or dealer to report the transaction under the FINRA Rules 6300 Series, 6400 Series, 6500 Series, 6600 Series, 6700 Series, 7300 Series, or 7400 Series.

The CAB Rules indicate that placement agent activity can only be with an “institutional investor," which is defined similarly to the definition found in FINRA Rule 2210. However, an institutional investor under the CAB Rule includes a “qualified purchaser” as defined in Section 2(a)(51) of the Investment Company Act of 1940, but does not include an accredited investor.

FINRA Membership
In order to apply for membership with FINRA as a CAB, a CAB applicant will follow the same New Member Application (“NMA”) procedures for membership as any other applicant.

Each CAB applicant must state in its application that it intends to operate solely as a CAB. In addition, the FINRA Member Regulation Department will also consider whether the applicant’s proposed activities are consistent with the limitations imposed on CABs under the CAB Rules.

Under CAB Rule 116(b), if an existing broker-dealer 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 will not be required to file either an NMA or a Change in Membership Application (“CMA”). Instead, the broker-dealer will be required to file a request to change its FINRA membership agreement or obtain a membership agreement (if none exists currently), which states that:

  • (i) the broker-dealer’s activities will be limited to those permitted for CABs under CAB Rule 016(c), and
  • (ii) the broker-dealer agrees to comply with the CAB rules.

Under CAB Rules 116(c) and (d), an existing CAB can terminate its status as a limited-purpose broker-dealer and continue as a FINRA member. Such a broker-dealer will be required to file a CMA and amend its membership agreement to provide that the broker-dealer agrees to comply with all FINRA rules.

In its approval release, the SEC provided a 12-month grace period for registration as a CAB. If an existing broker-dealer seeks to terminate its CAB registration and continue as a full FINRA member during the first year after filing an amendment to become a CAB, it may notify FINRA of this change without having to file an application for approval of a material change in business operations.

CABs will not be subject to all FINRA Rules. The following is a summary of the key rules to which CABs will be subject.

Registration and Licensing
CAB principals and representatives are subject to the same registrations, qualification examinations, and continuing education requirements as principals and representatives of other FINRA firms. CABs are also subject to FINRA Rule 1230(b)(6) with respect to the Operations Professional registration.

Supervision
CAB Rule 311 subjects CABs to some, but not all, of the requirements of FINRA Rule 3110 (Supervision). CABs will have more flexibility to tailor their supervisory systems to conform more precisely to their limited business activities. For example, CABs will not be subject to the provisions of Rule 3110 that require:

  • annual compliance meetings;
  • review and investigation of transactions;
  • specific documentation and supervisory procedures for supervisory personnel; and
  • internal inspections.

However, they will still be required to comply with the provisions of Rule 3110 concerning the supervision of offices, personnel, customer complaints, correspondence, and internal communications.

In addition, similar to FINRA Rule 3130(a), CAB Rule 313 will require CABs to designate and identify one or more principals to serve as a firm’s chief compliance officer. However, the CAB Rules will not require a CEO certification.

CAB Rule 328 marks an important distinction between CABs and other FINRA broker-dealers by prohibiting any person associated with a CAB from participating in any manner in a private securities transaction as defined in FINRA Rule 3280(e)1.

Suitability Obligations
CAB Rules 209 and 211 impose know-your-customer and suitability obligations similar to those imposed under FINRA Rules 2090 and 2111. The CAB Rules also have a specific exception to the customer-specific suitability obligations for institutional investors similar to the exception found in FINRA Rule 2111(b).

CAB Rules 209 and 211 impose know-your-customer and suitability obligations similar to those imposed under FINRA Rules 2090 and 2111. The CAB Rules also have a specific exception to the customer-specific suitability obligations for institutional investors similar to the exception found in FINRA Rule 2111(b).

Financial and Operational Rules
The CAB Rules establish a streamlined set of rules concerning firms’ financial and operational obligations. These rules are outlined in the CAB Rule 400 Series and include the following 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).

Under CAB Rule 411, which is supposed to be modeled after FINRA Rule 4110, CABs must suspend business operations when the CAB is not in compliance with the applicable net capital requirements under Exchange Act Rule 15c3-1.

The 400 Series of rules also sets forth requirements concerning withdrawal of capital, subordinated loans, notes collateralized by securities, and capital borrowings.

Anti-Money Laundering
CAB Rule 331 requires each CAB to implement a written anti-money laundering program. CAB Rule 331 is similar to FINRA Rule 3310 (Anti-Money Laundering Compliance Program); however, all CABs may conduct the required independent testing every two years, as opposed to the annual testing FINRA Rule 3310 requires.

Implementation Date
As noted in the release, the implementation date of the CAB rules will be announced in a regulatory notice, which will be published shortly. In addition, the implementation date will be no later than 180 days after the publication of the regulatory notice.

For more information about the new CAB Rules, please contact your ACA consultant or Dee Stafford in the Los Angeles office at (310) 322-8840.


This restriction does 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.