Continuing Membership Guide

 

CMA Requirements

Change of Ownership or Control

 

FINRA requires advance notice in the form of an application (as specified in Rule 1017)—but does not require prior approval—of changes of ownership or control. The 30-day advance application requirement specified in NASD Rule 1017(c) gives FINRA prior notice and an opportunity to conduct a preliminary analysis of the change based on NASD Rule 1014. A firm may effect the change before the final, written decision is issued, but the FINRA MAP Group may impose interim restrictions that would remain in effect until the application is decided. In the event of a denial, lapse or withdrawal of the application, the new owners (if the transaction has been consummated) may not conduct business.

Firms also are required to file an application and obtain prior approval of mergers and acquisitions, as specified in Rule 1017. Additionally, Rule 1017(a)(3) requires an application and approval prior to the sale or transfer of 25 percent or more of a firm’s assets or any asset, business line or operation that generates revenues of 25 percent or greater of the selling firm’s earnings over a rolling, 36-month period. The 36-month period is measured backwards from the date the firm initially files an application with FINRA seeking approval of its intent to sell or transfer assets. (See NTM 04-10 for more information).

 

Checklist for Organizational Change: Mergers, Acquisitions and Successions

If your firm is undergoing an organizational change, it may affect the ways in which you interact with FINRA, such as your membership application and system-related privileges. To make your firm's transition easier, we have compiled a checklist of steps to consider.

 

Changes in or Expansions of the Business

 

Rule 1017 also requires an application for and prior approval of "material changes" in the operations of a firm. These changes are all subject to review and approval by FINRA. Also, firms operating under a restriction (see “Membership Agreement” section of “How to Become a Member”) must request and obtain prior FINRA approval to remove or modify the restriction.

In an effort to add more clarity to the application process while still preserving flexibility in applying Rule 1017 to individual situations, FINRA developed amendments that (1) create a "safe harbor" for certain changes that would be presumed not to be material and therefore not require an application, and (2) provide definitions of the changes that are "material,” per se, and that would trigger the need to file an application. (Note: This definition of “material change” is not all-inclusive.) See the section below for more information.

 

An Important Note on Business Expansions: Material Changes and Safe Harbors

When contemplating expansions to their business activities, firms should determine whether the proposed expansion (1) represents a material change in business operations as defined in Rule 1011(k), thereby requiring an application for FINRA approval; or (2) may be effected in line with the safe harbor provisions of IM-1011-1. Each of these is briefly discussed below. See the guidance in NTM 00-73 regarding the factors to consider in determining whether a proposed change is material.

 

A. Material Changes in Business Operations

Many firms will, from time to time, seek to expand their business, either by adding a new line of business or by substantially increasing the scope and size of the existing business. NASD Rule 1017(a)(5) requires that a firm file an application for approval of a material change in business operations as defined in Rule 1011(k).

As defined in Rule 1011(k), the term "material change in business operations" includes, but is not limited to:

  • removing or modifying a membership agreement restriction;
  • market making, underwriting or acting as a dealer for the first time; and
  • adding business activities that require a higher minimum net capital under SEC Rule 15c3-1.

 

Member firms must determine whether a proposed business expansion is material. If so, FINRA must approve it pursuant to Rule 1017.

Whether or not to characterize a proposed expansion as “material” ultimately depends on an assessment of all relevant facts and circumstances, including the following:

  • the nature of the proposed expansion;
  • the relationship, if any, between the proposed new business activity or expansion and the firm's existing business;
  • the effect the proposed expansion is likely to have on the firm's capital;
  • the qualifications and experience of the firm's personnel; and
  • the degree to which the firm's existing financial, operational, supervisory and compliance systems can accommodate the proposed business expansion.

See NTM 00-73 for more information.

 

B. Safe Harbor for Business Expansions

Certain types of expansions are presumed not to be material and, thus, do not require an application for FINRA approval (see IM 1011-1, the "safe-harbor" provision). The safe harbor applies to:

  • firms that do not have a membership agreement;
  • firms that have a membership agreement that does not contain a restriction on the types of expansions otherwise permitted by the safe harbor; and
  • firms that do not have a disciplinary history as defined in the safe harbor.

 

The three types of expansions permitted are certain increases in the number of associated persons involved in sales, the number of offices (registered or unregistered) and the number of markets made:

 

Business Expansion

Safe Harbor Increase 

Permitted in 12-Month Period

I. Associated Persons Involved In Sales  
1 - 10 10 persons
11 or more The greater of 10 persons or 30%
II. Number of Offices  
1 - 5 3 offices
6 or more The greater of 3 offices or 30%
III. Number of Markets Made  
1 - 10 10 markets
11 or more The greater of 10 markets or 30%

 

Expansions in each area are measured on a rolling, 12-month basis. Firms are required to keep records of increases in personnel, offices and number of markets made to document compliance with the safe harbor.

 

If a firm relies on the safe harbor without going through the CMA process, FINRA still will review its expansions during the next cycle examination or when a CMA is filed for another purpose. The examiner or analyst will check to see if the safe harbor was used appropriately.


Note: Proposed expansions outside of the scope of the safe-harbor provisions are not necessarily material changes in the firm's business operations. For expansions beyond the safe-harbor limits, a firm is obliged to determine whether the proposed expansion requires an application under Rule 1017. Firms may, but are not required to, consult with the FINRA MAP Group in making this determination. FINRA recommends that firms present their requests for a consultation to their District Offices in writing, and address the impact of the proposed change on the firm in accordance with the criteria provided in NTM 00-73.

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