On August 18, 2016, the Securities and Exchange Commission (the “SEC”) approved a proposal by the Financial Industry Regulatory Authority, Inc. (“FINRA”) for instituting a separate set of rules (the “CAB Rules”) for broker-dealers that meet the definition of a “capital acquisition broker” (“CAB”). While these new rules offer some regulatory relief for broker-dealers seeking to engage in limited capital raising activities they may not entice many private placement firms, if currently exempt, to register or, if currently registered, to convert from full-fledged FINRA membership.
In its proposal to the SEC, FINRA created a new category of “capital acquisition broker” to ease regulation of firms that exclusively deal with corporate financing, mergers and acquisitions advice, raising debt and equity capital in private placements with institutional investors, and/or providing advisory consulting services for companies in need of assistance with strategic and financial alternatives. FINRA recognized that such firms do not engage in many of the types of activities typically associated with traditional broker-dealers (e.g., they do not act as introducing brokers 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). Although CABs will be subject to a separate set of membership application rules, they will still be governed by FINRA’s By-Laws and the general FINRA rules that apply to all member firms.
A CAB applicant will follow modified procedures for membership – e.g., it will have to state in its application that it intends to operate solely as a CAB; and an existing FINRA firm can change its status to a CAB without either a New Member Application (“NMA”) or a Change in Membership Application (“CMA”). Further, if during the first year following an existing FINRA member’s decision to become a CAB the firm seeks to terminate its status as such and continue as a full FINRA member, the CAB may notify FINRA of this change without having to file an application for approval of a material change in business operations. FINRA’s staff may approve the membership applications of a new CAB within 180 days of its filing.
There are many restrictions on the business conducted by CABs. Associated persons of a CAB are prohibited from participating in any manner in a “private securities transaction” (transactions outside the regular course or scope of an associated person’s employment for which no selling compensation is received). A CAB is not permitted to act on a principal basis in a securities transaction, but may qualify, identify, solicit or act as a placement agent or finder in securities transactions on behalf of an issuer in connection with a sale of newly-issued, unregistered securities to institutional investors or on behalf of an issuer or control person in connection with a change of control of a privately-held company.
CABs may only effect securities transactions for the transfer of ownership and control of a privately-held company to a buyer that will actively operate 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. FINRA indicated that these narrow circumstances will either involve institutional parties that are generally capable of negotiating fair prices or involve the sale of a business as a going concern. Further, CABs are not permitted to collect principal, dividends or interest, or providing safekeeping or custody services. CABs are also prohibited from engaging in “chaperoning” activities that enable foreign broker-dealers to serve U.S. clients without registration.