FINRA “Capital Acquisition Broker” Rules are a Solution for Private Equity and Hedge Funds and Private Investment Banking/M&A

November 02, 2016

The U.S. Securities and Exchange Commission (SEC) approved new FINRA rules on August 18, 2016, pertaining to the registration and regulation of “capital acquisition brokers” (CABs) that elect to be governed under this “broker-dealer-lite” rule set (CAB Rules).1 Registration as a CAB is a solution for broker-dealers with limited activities, including: capital raising through private placements of private fund interests; certain additional private placements to institutional investors; private equity fund portfolio transactions; and advice to companies regarding mergers and acquisitions (M&A) and corporate restructuring transactions. 

The CAB Rules were adopted in lieu of the “limited corporate financing broker” rules proposed by FINRA in early 2014,2 which included similar concepts, but received negative comments from the industry.3 The CAB Rules will enter into force on April 14, 2017. On January 3, 2017, FINRA will begin accepting applications for CAB registration from new applicants and existing FINRA members that wish to be re-designated as CABs, and for CAB associated person registration and qualification. 

Streamlined Registration and Regulation 

The CAB Rules are intended to simplify and streamline the registration and compliance burden for firms engaged in raising debt or equity capital in private placements with institutional investors, and advising private equity firms and companies on M&A transactions, as well as other strategic and financial alternatives. 

Private equity managers that wish to receive transaction fees in connection with acquisitions or dispositions of portfolio companies and securities assets may rely on this new registration category. The timing of the new rules is auspicious in light of the SEC’s June 2016 order against Blackstreet Capital Management LLC,4 which is perceived as increasing the apparent risk of receiving transaction-based fees without broker-dealer registration,5 especially with the dearth of further SEC guidance on the impact of offsets and other fee structures. 

The SEC traditionally has not viewed issuers of securities, such as hedge funds and private equity funds, as broker-dealers.6 However, employees and other associated persons of such issuers may be at risk of triggering broker-dealer registration requirements7 if they are not able to rely on the safe harbor from registration provided by Rule 3a4-1 under the Securities Exchange Act of 1934 (Exchange Act), due to (among other things) the number of transactions in any 12-month period or the presence of transaction-based compensation. Hedge funds and private equity funds whose associated persons otherwise are required to be registered with a broker-dealer will now be able to avail themselves of the lighter regulatory requirements under the CAB Rules, in order to raise capital from institutional investors through the sale of limited partnership or limited liability company interests. Further, corporate restructuring consultants that wish to receive transaction-based compensation, as well as M&A advisory firms that do not engage in public offerings of securities but are not able to rely on the SEC’s M&A Brokers no-action letter,8 can take advantage of this less onerous regulatory regime. 

FINRA estimates that the number of member firms that meet the CAB definition ranges from 650 to 750 firms, or between 16 percent and 19 percent of all FINRA member firms. According to FINRA, the CAB Rules will maintain investor protections, while establishing separate, streamlined rules that are tailored to CABs’ business activities, thus reducing the regulatory burden and compliance cost for CABs. FINRA expects that the initial costs associated with electing CAB status will be minimal relative to the cost savings from the CAB Rules. 

What is a CAB? 

CAB Rule 016 defines a CAB as any broker that solely engages in any one or more of the following activities: 

  • Advising an issuer, including a private fund, about securities offerings or other capital raising activities; 
  • Advising a company about the purchase or sale of a business or assets, corporate restructuring, or the selection of an investment banker; 
  • Assisting in the preparation of offering materials; Providing fairness opinions, valuation services, expert testimony, litigation support, and negotiation and structuring services; 
  • Qualifying, identifying, soliciting, or acting as a placement agent or finder for the sale of unregistered securities to institutional investors (emphasis added) or in connection with a change of control of a privately-held company; and
  • Effecting dispositions of a privately-held company to a buyer that will actively operate the company (as provided in the SEC’s M&A Brokers no-action letter).9 

A CAB does not include any broker or dealer that: carries accounts or acts as an introducing broker; holds or handles customers’ funds or securities; accepts orders from customers to purchase or sell securities in the secondary market; has investment discretion on behalf of any customer; engages in proprietary trading of securities or market-making activities; participates in or maintains an online platform in connection with offerings of unregistered securities pursuant to Regulation Crowdfunding or Regulation A; or effects transactions covered by FINRA’s trade reporting rules.10 Accordingly, a registered representative of a dually-registered CAB and investment adviser can only give orders to an executing broker-dealer, whereas a registered representative of a traditional broker is able to effect securities transactions and receive commissions for those transactions.

It is important to remember that FINRA’s definition of a CAB is not determinative of whether a person or entity is required to register with the SEC as a broker-dealer, even if they limit their activities to those performed by CABs. Such a determination remains a separate analysis for each person or entity, based on: the nature of their business; the compensation they receive; and whether the person or entity meets the statutory definition of a broker or a dealer set forth in Sections 3(a)(4) and 3(a)(5), respectively, of the Exchange Act as interpreted by the SEC, its staff, and the courts. Typically, the determining factor for such an analysis is the receipt of transaction-based compensation, including a commission, in connection with such activities.11 

Other factors indicating possible broker or dealer status are: 

  • Soliciting securities transactions; 
  • Holding oneself out as a broker by executing trades; 
  • Acting as a finder in exchange for a transaction fee; 
  • Receiving or holding customer securities or funds; 
  • Assisting others in settling securities transactions; and 
  • Regularly participating in the securities business.12 

Institutional Investors

Under CAB Rule 016(c)(1)(F), CABs may engage in “qualifying, identifying, soliciting, or acting as placement agents or finders” for private funds, but only “with respect to institutional investors” (emphasis added.) “Institutional investor” includes banks, investment companies, other financial institutions, governmental entities, retirement and other qualified plans, other persons or entities with total assets of $50 million and “qualified purchasers” under the Investment Company Act of 1940.13 This definition is functionally identical to that in FINRA Rule 2210 (Communications with the Public), but with the addition of “qualified purchasers.”14 

Accredited investors are not “institutional investors” for purposes of the CAB Rules, and while several commenters advocated including accredited investors as well as qualified purchasers in the definition, FINRA declined to do so, stating that its regulatory programs have “uncovered significant concerns associated with the ways in which firms sell private placements to accredited investors.” Accordingly, FINRA will not permit a CAB to solicit accredited investors for private funds. 

The CAB Rules 

The CAB Rules provide a regulatory system that parallels, but is simpler than, the standard FINRA rules for broker-dealers. For example, CABs are not subject to FINRA’s fair pricing rules, and the CAB advertising rule provides a much simplified prohibition on false and misleading statements. CABs also are not required to: hold annual compliance meetings; review and investigate transactions; have specific documentation and supervisory procedures for supervisory personnel; or conduct internal inspections.15 

CABs are also exempt from the supervisory certification rule,16 the business continuity plan rule and the business continuity and disaster recovery testing rule. Finally, CABs still must implement a written anti-money laundering program, but are only required to conduct independent testing for compliance every two years, rather than annually. 

In many cases, the CAB Rules reference other FINRA rules, and are organized as follows: 

  • CAB Rule 010 Series, General Standards: definitions and applicability provisions. 
  • CAB Rule 100 Series, Member Application and Associated Person Registration: application, registration and qualification provisions. 
  • CAB Rule 200 Series, Duties and Conflicts: general standards of conduct, anti-fraud, suitability, communications and other impermissible activities. 
  • CAB Rule 300 Series, Supervision and Responsibilities Related to Associated Persons: supervision, gifts, outside business activities, private securities activities and anti-money laundering. 
  • CAB Rule 400 Series, Financial and Operational Rules: capital compliance, audit, books and records, and reporting. 
  • CAB Rule 500 Series, Securities Offerings: private placements and fairness opinions. 
  • CAB Rule 800 Series, Investigations and Sanctions. 
  • CAB Rule 900 Series, Code of Procedure. CAB Rule 1000 Series, Arbitration and Mediation. 


1) Order Approving Rule Change as modified by Amendment Nos. 1 and 2 to Adopt FINRA Capital Acquisition Broker Rules, Exchange Act Release No. 78617 (Aug. 18, 2016) 81 FR 57948 (Aug. 24, 2016) (Order Approving File No. SR-FINRA-2015-054). FINRA originally filed the Notice of Filing of a Proposed Rule Change To Adopt the Capital Acquisition Broker Rules in Exchange Act Release No. 76675 (Dec. 17, 2015), 80 FR 79969 (Dec. 23, 2015) (Notice of Filing of File No. SR–FINRA–2015–054) (Notice of Filing).
2) See FINRA Regulatory Notice 14-09 (Feb. 2014).
3) See Notice of Filing, at 80 FR 79975.
4) In re Blackstreet Capital Management, LLC, SEC Release No 34-77959 (June 1, 2016). For further information, please refer to Dechert OnPoint, SEC Charges Private Equity Adviser for Unregistered Brokerage Activity.
5) A Few Observations in the Private Fund Space, David W. Blass, Chief Counsel, Division of Trading and Markets U.S. Securities and Exchange Commission, American Bar Association, Trading and Markets Subcommittee, Washington, D.C., Apr. 5, 2013.
6) Exchange Act Release No. 20943 (May 9, 1984).
7) See, e.g., In the Matter of Ranieri Partners LLC and Donald W. Phillips, Exchange Act Rel. No. 69091 (Mar. 8, 2013). For further information, please refer to Dechert OnPoint, Recent SEC Actions Focus on Broker-Dealer Activity of Private Funds, Highlight Perils, and Generate Controversy.
8) M&A Brokers, SEC No-Action Letter (Jan. 31, 2014).
9) CAB Rule 016(c)(1).
10) CAB Rule 016(c)(2).
11) However, the SEC’s M&A Brokers no-action letter, supra note 8, for example, permits a firm engaged in M&A advisory activity (as specified in the letter) to receive transaction-based compensation provided the firm adheres to the other terms of the letter.
12) See MuniAuction, Inc., SEC No-Action Letter (Mar. 13, 2000); and see Davenport Management, Inc., SEC No-Action Letter (Apr. 13, 1993) and BondGlobe, Inc., SEC No-Action Letter (Feb. 6, 2001).
13) CAB Rule 016(i). 
14) Paraphrased, a “qualified purchaser” under Section 2(a)(51) of the Investment Company Act of 1940 is any natural person or family investment vehicle owning not less than $5,000,000 in investments and any person or group of qualified persons who in the aggregate owns and invests on a discretionary basis, not less than $25,000,000 in investments.
15) CAB Rule 311.
16) CAB Rule 313.

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