Continuance in Membership Applications (CMAs)
FINRA requires advance notice through the submission of an application pursuant to NASD Rule 1017, but does not require prior FINRA approval of changes of ownership or control. The 30-day advance notice requirement specified in NASD Rule 1017(c) is a method of giving the staff prior notice that the change will occur and permits the staff to analyze the change of ownership and render a decision based on the standards of NASD Rule 1014 . A member firm may effect the change before the decision is issued, but the FINRA MAP Group may impose interim restrictions on the member firm that would remain in effect until the application is decided. In the event of a denial or lapse, new owners (if the transaction has been consummated) may not conduct business.
The NASD Membership Rules provide that certain types of business changes contemplated by members require the submission of an application pursuant to NASD Rule 1017 and approval of the application by FINRA. The Rule applies to transfers as well as sales of a member firm's assets, including sales and transfers of assets to an affiliated entity. Additionally, NASD Rule 1017(a)(3) requires an application prior to the sale or transfer of 25 percent or more of the member firm's assets or any asset, business line or operation that generates revenues of 25 percent or greater of the selling member firm's earnings over a rolling 36-month period. The 36-month period is measured backwards from the date that the member firm initially notifies FINRA of its intent to sell or transfer assets by submitting an application pursuant to NASD Rule 1017. (See Notice to Members 04-10 for more information).
The Rule also requires an application and prior approval of "material changes" in operations of a member firm. These changes are all subject to review and approval by FINRA. Also, member firms operating pursuant to a restriction agreement (see "Membership Agreement" section of "How to Become a Member") must request and obtain prior FINRA approval to remove or modify the restriction. FINRA's membership program is administered by the Department of Member Regulation of FINRA, through its MAP Group.
In an effort to add greater clarity to the process and still preserve flexibility in applying the Rule to individual situations, FINRA staff 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 (See IM-1011-1 ); and (2) provide a non-inclusive definition of the term "material change" that would alert member firms to some of the types of business expansions that can be expected to trigger the need to file an application (See NASD Rule 1011(k) ).
If a member firm is undergoing an organizational change, it may affect the ways in which the member firm interacts with FINRA, such as the continuing membership application and system-related privileges. In order to make the member firm's transition easier, FINRA has compiled this checklist of steps to consider.
The biggest factor that causes a delay in processing an application to conclusion (both for business expansions and restriction removal requests) is whether sufficient information is supplied to support the request. In each and every case, FINRA staff is required to verify that the proposed expansion meets each of the 14 criteria for membership (NASD Rule 1014), although pains are taken to target the inquiry and limit the scope of analysis as narrowly as possible in each case consistent with FINRA's obligations under the Rules.
To assist member firms in filing complete applications, FINRA has published a resource entitled A Guide to Areas of Inquiry in Continuing Membership Applications and Applications to Remove or Modify Restrictions (CMA Guide). The CMA Guide provides detailed guidance about the information that FINRA staff needs in order to evaluate certain common types of applications. Firms contemplating business changes, including expansions, are encouraged to review this publication prior to submitting an application.
In the event that the FINRA MAP Group denies an application relating to a change of ownership, the MAP Group will issue a denial letter indicating the time frame under which the Applicant may appeal. NASD Rule 1017(k) requires that an Applicant for approval of a change of ownership that has exhausted its appeals must, within 60 days:
(1) submit a new application (i.e., with new owners);
(2) unwind the transaction; or
(3) file a Form BDW.
Failure to comply with this requirement may provide basis for suspension or cancellation of the firm's FINRA membership.
With respect to CMAs, if there is a proposed transaction closing date that is distant from the time of the MAP Group staff's review, will the staff delay or alter its review?
Generally, the proposed transaction closing date should not delay or alter the CMA review process. The applicants have the burden of production to update all application information as it changes. Applicants should be aware of the fact that delays on their part in producing information due to "closing" issues may in turn delay completion of FINRA's review of the application.
Is NASD Rule 1017 applicable if the change of ownership occurs in increments of less than 25 percent?
NASD Rule 1017 is not limited to changes that occur all at once. The Rule is triggered when the change, whether in increments or otherwise, results in one person or entity owning or controlling 25 percent or more of the equity or partnership capital of the member firm for the first time.
When FINRA staff learns of a change of ownership or control through the course of an examination, when does the clock begin to run?
When the staff learns of a change of ownership or control through the course of an examination, the staff will send a letter to the firm notifying them that, pursuant to NASD Rule 1017, member firms are required to give at least 30 days prior written notification of a change of ownership or control, among other things, through the submission of an application pursuant to NASD Rule 1017 and that their failure to submit such an application to FINRA constitutes a violation of NASD Rule 1017(c). The 45-day clock (or 180-day clock if additional information and/or a membership interview is required) begins on the date the application is filed with FINRA as set out in NASD Rule 1012(a)(4).
May "control" extend to persons or entities that are not shown as owners or managers but who may affect the management or direction of the member firm?
Yes. Persons who are not owners or managers could be considered control persons. The staff will document and explain its basis for concluding a control relationship and the Applicant will be given an opportunity to respond.
If a member firm currently operating without a written Membership Agreement adds a business line to its operations, is the firm required to give notice under NASD Rule 1017?
Under NASD Rule 1017(a), a firm must file an application for approval of a material change in its business operations and may not effect such change prior to receiving FINRA approval. Depending on the facts and circumstances, an addition of a business line to its operations may or may not be material whether or not the member is operating with a written Membership Agreement.
What is the effect on the CMA process where the only notice given of the CMA event is the filing of the Form BD Amendment?
Receipt of a Form BD Amendment does not constitute "notice" under the NASD Rule 1010 Series. If the FINRA MAP Group staff learns of a change in ownership in this way, it will send a letter to the member firm stating that it is required to comply with NASD Rule 1017(a) and has failed to provide at least 30 days prior written notice through the submission of an application under NASD Rule 1017. Upon receipt of an application, the clock will start in accordance with NASD Rule 1012(a) .
Do all business expansions require FINRA approval?
Only those changes specified by NASD Rule 1017 require FINRA approval. The purpose is to ensure that FINRA is able to verify that significant changes in a firm's business or method of operation are accompanied by appropriate corresponding enhancements to supervisory, compliance, financial and internal control systems and that appropriate personnel are qualified to handle the expansion. This, in turn, ensures that member firms will continue to meet all of the standards and criteria for membership in FINRA.
What is a "material change" in business that would trigger a review under NASD Rule 1017?
It depends on the specific facts and circumstances in each case. Generally, FINRA has advised member firms that whether any particular business expansion, including the addition of a proposed new business line, is a "material change" in a member firm's operations ultimately depends on an assessment of such factors as: the nature of the proposed expansion; the relationship, if any, between the proposed new business line 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 expansion or addition. Under the Rules, member firms are responsible for deciding whether a particular change is material and submitting an application to FINRA pursuant to NASD Rule 1017 in appropriate situations. Member firms are free to consult with FINRA staff about individual situations, but they are not required to do so. (See NASD Rule 1011(k)).