On August 18, 2016, the United States Securities Exchange Commission (SEC) approved rule changes proposed by the Financial Industry Regulatory Authority (FINRA) to create “Capital Acquisition Broker” (CAB) as a new classification of corporate financing firms that advise companies on mergers and acquisitions, advise issuers on raising debt and equity capital in private placements with institutional investors, or provide advisory services on a consulting basis to companies that need assistance analyzing their strategic and financial alternatives. Subject to an important limitation, CABs may also engage in activity involving identification, qualification, solicitation, or acting as placement agent or finder on behalf of an issuer in connection with the sale of newly issued unregistered securities, and they may effect securities transactions solely in connection with the transfer of ownership and control of a privately held company. CABs will be broker-dealers registered with the SEC, and will be FINRA member firms. They will be subject to FINRA By-Laws and several “core” FINRA rules applicable to all members. Otherwise, they will operate according to a new rule set tailored specifically to limited CAB business activity, and which is intended to streamline and reduce FINRA conduct and operational rule requirements. CABs will be limited solely to activities described in the new rules, none of which involves any traditional broker-dealer activity.
The creation of CAB status at least partially addresses longstanding legal and regulatory uncertainty faced by firms engaged in the facilitation of mergers and acquisition transactions involving the purchase or sale of securities, or that facilitate private placement securities transactions. As noted above, firms electing to register with FINRA as CABs will be able to engage in various activities, for which they may receive transaction-based compensation.
However, the newly approved FINRA registration status for CABs will not resolve uncertainty in all corporate financing and capital formation activities. Most notably, a key limitation on permissible activities of a CAB in connection with capital formation involving the sale of newly-issued unregistered securities, as, for example, acting as placement agent, limits CAB activity on behalf of an issuer to “institutional investors,” as that term is now defined in the new FINRA rule set. This limitation makes CAB status unattractive for a segment of the financial intermediary community engaged in facilitating exempt private placements to “accredited investors,” who will not satisfy the “institutional investor” condition. The CAB institutional investor limitation will also cause issuers to question the utility of engaging a CAB. Private fund sponsors, for example, regularly undertake exempt private offerings to “accredited investors,” who in many cases will not also be institutional investors as defined in the new FINRA rules. The new FINRA rules, however, will preclude a CAB from facilitating sales on behalf of a fund that admits investors who, although qualifying as accredited investors for purposes of Regulation D under the Securities Act of 1933, do not meet the more stringent “institutional investor” standard that is now part of the CAB rule set. SEC approval of FINRA “Capital Acquisition Broker” status clearly does not open a door to greater regulatory certainty for intermediaries generally.
In practical terms, it may be most attractive to those firms that are already FINRA members and wish to switch to CAB status and the new less burdensome rule set to govern their limited activities. On the other hand, M & A firms, and other investment banking or financial intermediary firms that became registered broker-dealers and FINRA members in order to receive transaction-based compensation without any activity restriction will most certainly maintain their status. The question for all others contemplating CAB status is whether to embrace the necessary institutional business model that is said by FINRA to be the basis for the new rule set. FINRA has signaled the possibility of future revision of the institutional investor definition, depending on the need to expand it, as well as an assessment of CAB investment activities. As a practical matter now, however, the institutional investor limitation on sales activity effectively precludes CAB involvement on behalf of an issuer in a typical private placement.
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Susan M. Kurz
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