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Materiality Consultation

Many firms will from time to time seek to expand their business by, for example, adding a new line of business or substantially increasing the scope and size of their existing business that may or may not require a Continuing Membership Application (CMA) for FINRA's approval.

When contemplating a change to its business activities or operations, a firm should think about whether the proposed change: (1) represents a "material change in business operations" as defined in FINRA Rule 1011(m), thereby requiring a CMA in accordance with FINRA Rule 1017; (2) may be effected in line with the thresholds and conditions specified in the safe harbor provision under FINRA IM-1011-1; or (3) requires the firm to seek a mandatory Materiality Consultation or could benefit from a voluntary Materiality Consultation, to be discussed further below.


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What is a "material change in business operations"?


As defined in FINRA Rule 1011(m), 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 SEA Rule 15c3-1.

Notice to Members 00-73 provides guidance on criteria member firms should consider when assessing the materiality of a proposed change. These criteria include:

  • 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;
  • The degree to which the firm's existing financial, operational, supervisory and compliance systems can accommodate the proposed expansion or addition; and
  • Whether the firm can rely on the Safe Harbor for Business Expansions under FINRA IM-1011-1 to effect the change without filing a CMA.


What Are the Different Types of Materiality Consultations?


There are two types of Materiality Consultations—voluntary and mandatory. A voluntary Materiality Consultation is one that a firm voluntarily chooses to request with the MAP Group. A mandatory Materiality Consultation is one that is required by FINRA rules.


Can I have some more detail on Voluntary Materiality Consultations?


Sometimes changes contemplated by a firm do not clearly fall into a CMA category or a category that requires a mandatory Materiality Consultation. A firm may still wonder, "Is this something for which the firm needs approval or is this something that can fit within the framework of the firm's current activities and structure without need for a CMA?" A firm has the option of seeking help with answering this type of question by voluntarily submitting a request for a Materiality Consultation. This consultation allows a firm to seek guidance from MAP Group staff on whether a CMA is required for the proposed business change.

During a voluntary Materiality Consultation, MAP Group staff examine the proposed change based on the criteria above. MAP Group staff may review, among other sources, investor alerts and FINRA's Examination Priorities Letters, in conjunction with the firm's current business model to determine the materiality of a proposed business line. Any change in business operations involving a unique, novel, complex product, business line or platform, or any product considered to be an emerging regulatory issue, may be considered material.

NOTE: If a firm believes that a change in business operations or expansion is not material and the firm does not wish to obtain a written assessment from the MAP Group in a voluntary Materiality Consultation, the firm should document the reasons why it believes the change is not material and retain this as part of its books and records.


Can I have some more detail on Mandatory Materiality Consultations?


Rules 1017(a)(6) and 1017(a)(7) describe the changes in ownership, control or business operations that require a member firm to submit a written request to the MAP Group seeking a materiality consultation and, if required, approval of a CMA. The materiality consultations required by Rule 1017(a)(6) and (7) are mandatory Materiality Consultations.

Specifically, a member firm would be required to file a request for a mandatory Materiality Consultation when a member firm seeks any of the following changes:

  • Rule 1017(a)(6)(B)—any addition of one or more associated persons involved in sales who has a "Covered Pending Arbitration Claim" (as defined in FINRA Rule 1011(c)(1)), unpaid arbitration award or unpaid settlement related to an arbitration, and the member is not otherwise required to file a CMA;
  • Rule 1017(a)(6)(A)—any direct or indirect acquisition or transfer of a member's assets or any asset, business or line of business where the transferring member or an associated person of the transferring member has a "Covered Pending Arbitration Claim" (as defined in Rule 1011(c)(2)), unpaid arbitration award or unpaid settlement related to an arbitration, and the member is not otherwise required to file a CMA;1 or
  • Rule 1017(a)(7)—whenever a natural person seeking to become an owner,2 control person,3 principal or registered person of the member firm has, in the prior five years, one or more "final criminal matters" or two or more "specified risk events.",4 and the member is not otherwise required to file a CMA.5

Where a member firm's contemplated change may fall within Rule 1017(a)(6) or Rule 1017(a)(7), a firm may refer to the following checklists for more detailed information:


How do I start the process?


Letters requesting a mandatory or voluntary Materiality Consultation, along with any relevant supporting documentation, must be uploaded via the FINRA Gateway under the Materiality Consultation section. For technical assistance please contact the Gateway Business Application Support (GBAS) group at (800) 321-6273.

When considering a change that requires a mandatory Materiality Consultation, your firm should proceed to submit a Materiality Consultation letter describing its position as to whether or not the proposed change should be deemed material in nature.

When considering any other potentially material change to your firm's business, you should first speak with your firm's assigned Risk Monitoring Analyst (RMA), who can offer sound guidance on the key issues the MAP Group would generally be interested in regarding the potential impact to your firm and relevant areas to incorporate into the analysis portion of your Materiality Consultation submission, should you choose to submit one. If, after careful assessment of a proposed change in accordance with the above rules and guidance, a member firm believes the proposed change does not constitute a material change or there is uncertainty as to the materiality of the proposed change, the firm can choose to submit a voluntary Materiality Consultation letter describing its position as to why the proposed change should not be deemed material in nature.


What should a Materiality Consultation submission cover?


For a mandatory Materiality Consultation, the linked checklists above provide guidance concerning what to include in a mandatory Materiality Consultation submission.

For a voluntary Materiality Consultation filing, the submission should include, but is not limited to, the following, in conjunction with the guidance set forth in Notice to Members 00-73:

  • A description of the proposed change in business sufficient for staff to understand the scope of the business and how it will be conducted;
  • Why the firm believes that the proposed new business or product is similar in scope or nature to their existing business;
  • The anticipated impact the change will have to the firm's supervisory structure;
  • Any impact the proposed change will have to the firm's capital or liquidity;
  • The nature and scope of updates required to written supervisory procedures, systems and firm operations;
  • Any recent disciplinary matters that relate to the proposed activities as well as how the firm's overall regulatory history may impact the ability of the firm to effectively conduct the activity; and
  • Any relevant documentation to support the proposal.


Once submitted, what is the Materiality Consultation process?


For all Materiality Consultations (voluntary or mandatory), once the request is filed via FINRA Gateway, the matter is assigned to a MAP Group examiner who will review the filing with the firm and may consult with the firm's RMA and other internal experts as needed. The MAP Group examiner will issue a communication to the firm at the completion of the process.


How long does the Materiality Consultation process take?


A Materiality Consultation letter is not a formal application such as the CMA and as such there is no rule-based timeframe. However, the MAP Group works with the firm and other FINRA staff, as appropriate, to ensure the Materiality Consultation letter is reviewed as quickly and efficiently as possible.


Is there a fee to file a Materiality Consultation?


There is no fee associated with filing a Materiality Consultation (voluntary or mandatory).

 


1. See Rule 1017(a)(6)(A).

2. Rule 1017(a)(7) defines "owner," for purposes of Rule 1017(a)(7), to have the same meaning as "direct owner" and "indirect owner" on the Uniform Application for Broker-Dealer Registration (Form BD), Schedules A and B, as amended from time to time.

3. Rule 1017(a)(7) defines "control person" to mean a person who would have "control" as defined on Form BD, as amended from time to time.

4. See Rule 1011(h) (defining "final criminal matter"); Rule 1011(p) (defining "specified risk event"). The definitions of "final criminal matter" and "specified risk event" are based on criminal events, arbitration awards, civil judgments, arbitration settlements, civil litigation settlements, civil judicial actions, and regulatory actions, as described in the definitions, that are disclosed, or are or were required to be disclosed, on Form BD, the Uniform Application for Securities Industry Registration or Transfer (Form U4), the Uniform Termination Notice of Securities Industry Registration (Form U5), and the Uniform Disciplinary Action Reporting Form (Form U6)). 

5. Rule 1017(a)(7) does not apply when the member is not otherwise required to file an eligibility proceeding application for approval of the same contemplated association.