Buying a FINRA Broker-Dealer
Buying any business can prove to be complex. Buying a FINRA broker-dealer can be complex and then some. Over the years, Mitch Atkins, while an executive at FINRA and now as a consultant, has analyzed literally hundreds of purchase and sale transactions involving broker-dealers and their assets. For those who have little experience in this space, please take note of this article, as these words of wisdom may save you untold grief.
A FINRA broker-dealer is unlike almost any other business. It is subject to the regulations of FINRA, SEC, MSRB, SIPC, 50 state securities regulators, and the Bank Secrecy Act – just to name a few. What may be considered a logical, reasonable approach in any other business may not directly apply to running a broker-dealer. Broker-dealers (and associated persons of broker-dealers) are subject to FINRA arbitration requirements – and to the jurisdiction of the FINRA arbitration panels. When you buy a broker-dealer, you buy all of its prior problems and history – known and unknown. For better or worse, once the Form BD and U4 are signed, one enters the world of broker-dealer regulation. And the tough regulation comes for a good reason. The members of the public may now entrust their life savings to you. The industry can be very financially rewarding if approached with a good understanding of what it takes to survive long-term in the business.
Start New or Buy Existing?
One of the most important steps in entering the brokerage industry as an owner is determining whether to buy an existing broker-dealer or to start a new one. The FINRA application process can be complex whether forming a new broker-dealer or acquiring one. Either direction can be appropriate. The key in an acquisition is whether one fully understands the history of the target. For example, a broker-dealer that has already been in operation may have obligations that remain hidden to the purchaser until months or even years after the purchase is closed. It is not unusual for a broker-dealer to receive notice of an arbitration filed against it for conduct that occurred years before. When the new owners receive this notice, the initial owners are often long gone. So to be sure that this doesn’t come up, some simply file a FINRA new member application with FINRA, creating a clean broker-dealer. Going through the FINRA application process with a new firm is a clean start for the entity. After FINRA approves this entity, it may grow by purchasing the assets of other FINRA broker-dealers. The assets to be acquired generally consist of the rights to some or all of the customer accounts of that firm. There are potential pitfalls to this approach as well. The FINRA application process in this scenario can be even more complex than a new member application.
But, in the humble opinion of this author, the best and cleanest approach is to form an entirely new broker-dealer. Some might say that this is not the case – especially since an existing broker-dealer has already cleared many of the startup hurtles. And logically this makes sense. For one thing, an existing broker-dealer already has customers, brokers, systems and the most important thing – a FINRA membership. But the reality has been (at least in this author’s experience) that this seemingly logical approach can be like walking a mine field. This is because unforeseen problems often arise after the sale closes. A careful analysis of the history of an acquisition target is critically important to making a determination of whether a purchase makes sense. Nothing less than full, expert due diligence is required. However, a more protective approach is to create a new broker-dealer that then purchase the assets of existing broker-dealers. Either way, one must follow the FINRA application process. We’ll call this FINRA broker-dealer merger and acquisition 101.
Is the FINRA Application Process Different for an Asset Purchase?
An asset purchase, under most circumstances, requires an application under FINRA Rule 1017(a)(3). FINRA must review and approve the sale. And for this reason, both the acquiring firm and the target firm may have to go through the FINRA application process. FINRA requires that a Continuation of Membership Application, or CMA, be filed when, “direct or indirect acquisitions or transfers of 25% or more in the aggregate of the member’s assets or any asset, business or line of operations that generates revenues comprising 25% or more in the aggregate of the member’s earnings measured on a rolling 36-month basis, unless both the seller and acquirer are members of the New York Stock Exchange, Inc.”
In this scenario, before approving the transaction, FINRA will consider the business of the seller, and whether it has made adequate provisions for its outstanding liabilities. Under its rules, FINRA will not approve such a transaction if the owners of the selling broker-dealer receive compensation for an asset sale but fail to make sufficient provisions for its outstanding liabilities. This is particularly the case if the selling broker-dealer has outstanding customer claims – such as arbitration claims or unpaid awards. In some cases, as part of the FINRA application process, applicants are required to place a reasonable sum in an escrow account for the satisfaction of current and future customer claims. This can get somewhat tricky. Reasonable minds can disagree as to how one adequately provides for future claims. See my article about FINRA CMA Arbitration Plans for more information on that.
These questions and the FINRA application process are best addressed by a FINRA CMA expert. FINRA broker-dealer acquisitions can be rewarding if handled properly. If you are considering starting a new FINRA broker-dealer or if you are thinking of purchasing an existing FINRA broker-dealer, contact Mitch Atkins, FINRA’s former Senior Vice President and Regional Director. Mitch Atkins has extensive experience with the FINRA CMA process and particularly with broker-dealer acquisitions. Contact Mitch Atkins, Principal, FirstMark Regulatory Solutions at 561-948-6511.
Simply stated, the Interpretation permits expansion of the “Number of Associated Persons Involved in Sales” as follows: if the broker-dealer has between 1 and 10 persons, 10 additional persons measured on a rolling 12 month basis, and if the broker-dealer has greater than 11 persons, 10 additional persons or a 30 percent increase, whichever is greater, again measured on a rolling 12 month basis. For branch offices, the process works similarly, with 1-5 offices allowed 3 more in 12 months, and 6 or more allowed 3 more or 30 percent, whichever is greater. There is also a provision for an increase in the number of markets made, but very few are actually doing that these days, so we won’t discuss it here.