FINRA is seeking public comment on a much needed overhaul of the regulatory requirements for broker-dealers who specialize in M&A and corporate finance.  The overhaul would be accomplished by creating a new category of broker-dealers to be known as “Limited Corporate Financing Brokers.”  Qualifying broker-dealers would then be subject to a new set of rules which are intended to be more suitably drawn for brokers who limit their business to M&A and corporate finance. The text of the FINRA notice may be found here.

If the proposal is adopted, it should be attractive to investment banking boutiques that limit their business to M&A and corporate finance.  While broker-dealer registration would still be required, the proposed rules would be better suited for the operations of such firms.

Who would be eligible for the new rules?

The proposed definition of “Limited Corporate Financing Brokers” includes broker-dealers who limit their business activities to the following:

  • Advising a company or fund on securities offerings or other capital-raising activities
  • Advising on M&A transactions, including mergers, stock and asset acquisitions, restructurings and going private transactions
  • Advising on the selection of investment bankers
  • Assisting in the preparation of offering materials
  • Providing fairness opinions
  • Identifying and soliciting potential institutional investors (at least $50 million of assets).

A Limited Corporate Financing Broker may not engage in any of the following activities:

  • Carry customer accounts
  • Hold or handle customer funds or securities
  • Fill customer orders to purchase or sell securities, either in an agency or principal capacity
  • Have investment discretion with respect to any customer account
  • Engage in proprietary trading or market-making.

Thus, investment banking boutiques that limit their activity to M&A transactions and capital-raising would qualify for the new rules if they are adopted.  Unlike the recent SEC no-action letter which provided relief limited for firms providing M&A advice on behalf of privately held companies, the new FINRA rules, if adopted, would permit investment banking boutiques to represent and advise both public and privately held companies and funds.

What would be the benefits of the new regulatory scheme?

Under the FINRA proposal, a number of regulatory requirements would be revised with a view to making them more appropriate for broker-dealers who limit their business to corporate finance and M&A matters.  For example, in lieu of the extensive regulatory scheme applicable to communications set forth in FINRA Rule 2110, Limited Corporate Financing Brokers would be subject to a new Rule 221.  The new rule would consist of a principles-based requirement that communications with the public be fair and balanced and not include any false or misleading statements or any projections of future performance.  The detailed requirements set forth in current Rule 2110 regarding contents, review, approval and recordkeeping for public communications would not be applicable.

Similarly, Limited Corporate Financing Brokers would be relieved from some of the detailed specifications set forth for supervision in FINRA Rule 3110.  Certain internal inspection requirements, documentation of review of correspondence and requirements for annual compliance meetings would not be applicable and the Limited Corporate Financing Brokers would have more latitude to implement supervisory procedures suitable for their business operations.  While rules regarding anti-money laundering would remain in effect, under proposed Rule 331, AML compliance testing could be carried out once every two years, rather than annually.

Much of the detail regarding continuing education requirements in FINRA Rule 1250 would not be applicable and Limited Corporate Financing Brokers would simply be required to maintain an educational program “appropriate for the business of the broker.”  In addition, certain capital compliance requirements would no longer be applicable, such as the limitations in FINRA Rule 4110 on dividends or capital withdrawals exceeding 10% of excess net capital.  The information required to be kept about customers under FINRA Rule 4512 would also be significantly streamlined.

Next Steps

The proposal is open for public comment until April 28.  Thereafter, there will  likely be some period of time to consider the comments and prepare a formal proposal that would be submitted to the SEC for approval.  Broker-dealers and others (such as sponsors of private equity funds) who contemplate a possible need to register as a  broker-dealer, should consider the proposal and how it might be improved with a view to designing a regulatory scheme best-suited for those who limit their activities to M&A transactions and corporate finance.