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FINRA has extended the deadline for comments to proposed amendments to the Capital Acquisition Broker (CAB) rules for the second time this year. The first deadline was due on March 30 and was then extended to May 15, but the regulator has now extended the deadline even further to June 30, 2020.Â
Capital Acquisition Brokers
CABs are firms that engage in a limited range of activities, essentially acting as placement agents for sales of unregistered securities to institutional investors, and advising companies and private equity funds on capital raising and corporate restructuring. Firms meeting the CAB criteria may elect to be governed by the CAB rules, a simplified rulebook.
CAB status brings many benefits – for example, they’re subject to fewer restrictions on specified activities (such as advertising) and have less burdensome supervisory requirements. However, CABs are not permitted to engage in other broker-dealer activities.
Proposed changes to CAB rules
Secondary transactions
Perhaps the biggest sticking point for many broker-dealers that considered the CAB registration was the prohibition on secondary transactions involving unregistered securities except when the transaction is in connection with the change of control of a privately held company.
Under the proposed amendments, FINRA will expand the ability of a CAB to act as placement agent for secondary trades of unregistered securities. A CAB would be permitted to act as a placement agent in a secondary transaction involving unregistered securities of an issuer for which the CAB had previously acted as a placement agent for such securities. This is providing the purchaser of such securities is an institutional investor, and the new sale falls within a Securities Act exemption from registration, for example Securities Act Rules 144 or 144A.
Institutional investor definition
A CAB may act as a placement agent or finder in the sale of newly-issued unregistered securities to “institutional investors.” The term “institutional investor” for purposes of the CAB rules includes banks, investment companies, large employee benefit plans and “qualified purchasers” under the Investment Company Act of 1940.
FINRA proposes to broaden the definition of institutional investor to include “knowledgeable employees,” a term that includes senior officers and directors of private funds and their advisers. Therefore, expanding the number of people a CAB can provide services to. “Knowledgeable employee” would also include persons performing similar roles at other private issuers for which CABs act as placement agents.
Investment adviser activities
The CAB rules currently do not permit CABs to register as investment advisers. Moreover, associated persons of CABs may not participate in private securities transactions (PSTs), which include the forwarding of orders from investment adviser clients to a third-party broker-dealer for execution. The proposed changes would allow CABs to register as investment advisers, so long as the advisory services are provided only to institutional investors.
Personal investments
The rules don’t require a CAB’s associated person to obtain the CAB’s prior written consent before opening or otherwise establishing a securities account at another financial institution. Nevertheless, some CABs may be involved in transactions, either as advisor or placement agent, that raise insider trading possibilities. CABs that are involved with such transactions must maintain policies and procedures required by the SEC to address insider trading risks.
FINRA proposes to adopt new CAB Rule 321 (Supervision of Associated Persons’ Investments), which would provide that any CAB whose business model creates potential insider trading risks is required to establish, maintain and enforce written policies and procedures that are reasonably designed to mitigate and prevent those risks.
These CABs would be subject to FINRA Rule 3210 and their associated persons would be required to obtain the prior written consent of the CAB to open or otherwise establish at another firm any account in which securities transactions can be effected and in which the associated person has a beneficial interest. They could also request that a broker-dealer or other financial institution, with which the associated person has a securities account, transmit duplicate copies of confirmations and statements from the associated person’s account.
In addition, CABs meeting this description would be subject to FINRA Rule 3110(d) (Supervision), which requires firms to adopt supervisory procedures for the review of securities transactions that are reasonably designed to identify trades that may violate provisions of the Securities Exchange Act of 1934 and SEC and FINRA rules prohibiting insider trading in accounts of the firm’s associated persons and their immediate family members. This also requires these firms to promptly investigate such trades and file written reports of these investigations with FINRA.
The CAB rules technically prohibit associated persons of CABs from investing in unregistered securities, since they prohibit associated persons from participating in PSTs. The PST definition includes direct investments in unregistered securities. Proposed CAB Rule 321 would permit CAB associated persons to invest in unregistered securities notwithstanding the prohibition on PSTs, providing they give prior written notice of all purchases and sales of unregistered securities to their CAB.
Compensation
Finally, FINRA proposes to codify a recently issued staff interpretation of the CAB rules stating that associated persons may be compensated in the form of securities issued by a privately held client, rather than in cash, providing the receipt, exercise or subsequent sale of such securities will not cause the CAB to engage in activities prohibited under CAB Rule 016(c)(2).
How we can help
We can help you navigate through these changes and offer ongoing support.
- Analysis and interpretation of CAB applications
- Broker-dealer registration and ongoing support
- Submission of comment letters on behalf of your firm
Get in touch to find out more.
