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FINRA Continuing Membership Applications: Ownership & Control Changes
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Hi, and welcome to the Oyster Sto podcast. I'm Libby Hall, Director of Communications for Oyster Consulting. One of the most challenging regulatory processes for broker dealers can be filing a continuing membership application or CMA. Whether you're making changes to your ownership, business lines, or control structure, these filings can be complicated and delayed to install your firm's strategic plans. Today, I'm joined by Ed Wagner, our practice lead for governance risk and compliance, along with three of our experts who bring extensive FINRA registration experience: Lisa Robinson, Jonathan Telfair, and Armando Valdez. They'll share what FINRA expects to see, how do we anticipate challenges, avoid common pitfalls, and move through the CMA process more efficiently. Let's get started. Ed.
SPEAKER_00:Well, hello everyone, and welcome. I'm Ed Wegner, and I am the practice lead for governance, risk, and compliance here at CRC Oyster. And we often work with our clients to help them navigate the tricky issues that arise when they go through significant changes to their business. And for broker dealers, this often involves them having to go through FINRA's continuing membership process. Successfully navigating that process can be tricky. And if not done so well, it can cause firms to have significant delays in implementing their changes and making sure that they're meeting their objectives with the change. So we're very fortunate here at CRC Oyster to have a team of consultants who've worked in senior roles in FINRA's membership department. They've helped our clients successfully navigate the CMA process and get the desired approvals in a very timely manner. So today we're going to talk about one specific change that typically requires a CMA, and that's a change in ownership and control. But before jumping into it, I do want to have my colleagues introduce themselves and their backgrounds, including how they help clients through the membership process. So, Lisa, why don't we start with you?
SPEAKER_02:Sure. Thanks, Ned. Hi, everyone. I'm Lisa Robinson. Um prior to joining the company, I spent a little over 25 years at FENRA, of seven of which I was the only senior director in the FENRA membership application program, otherwise known as MAP Group. Um and I really enjoy helping clients here at the company navigate the often complex new member and continuing member application process. Turn it over to Jonathan.
SPEAKER_03:Thanks, Lisa, and thank you, Ed, for the introduction. Um, Jonathan Telfair here um with CRC Oyster, and I've been leading the CRC Oyster application efforts for new member applications and continuing member applications for just about three and a half years now. Um and prior to joining CRC in 2022, I was a uh manager in FINRA's membership application program, where I had the good fortune of um working under Lisa and learning from her as well as working with um our other colleague here, Armando Valdez, um, for two years. And prior to um prior to joining the membership application program as a manager in in 2020, I was a member of Finres Cycle Exam Program for six years. And I'll turn it over to you, Armando.
SPEAKER_04:Hi, my name is Armando Valdez. I am a new consultant to the uh CRC Oyster. Um having come from the FinRES Map Group, uh, where I uh joined about 10 years ago as an analyst uh and um became a manager for the last five of those 10 years in the retail, fintech, and crypto uh group.
SPEAKER_00:Well, excellent. And and thank you all for being here today. So why don't we jump into it? And I guess the first question that I would have is what are the types of things that would trigger a continuing membership application, uh, especially with respect to a change in control?
SPEAKER_02:Sure, I'll take that one. Uh FIMA Rule 1017 outlines when a firm needs to file an application for approval for a change in ownership. Specifically, if there is a change in equity ownership or partnership capital of the firm that results in one person or entity directly or indirect, indirectly owning or controlling 25% or more of the ownership, it will trigger the requirement for the firm to file a CMA with FENRA.
SPEAKER_04:I'm so glad that you mentioned control, Lisa. It's important to know that the rule refers not only to a change in the direct or indirect ownership of the member firm, but also to material changes that result in a person either directly or through the control of an entity in the ownership structure of the firm crossing that 25% threshold. A simple example of a transaction that is material because of a change in control of the firm would be one where a current owner of, let's say, 4% of the total ownership interest of a broker dealer purchases an additional 20% of the ownership from the other two owners and will become the third chair on the firm's board of directors. So while the change in ownership interest, based on just these facts and circumstances, would not by itself be material requirements, since he the current owner only would only then have 24% of the total ownership, as the third chair on the firm's board, he would now control 33% of the board, and therefore uh would be material as far as a change in control of the member firm.
SPEAKER_03:Yeah, that's an excellent point, Armando. Um, and it's not the analysis isn't necessarily always as simple as just the the change in ownership and and the direct ownership percentages, but the change in control is an important factor to consider as well. Um and and another CMA trigger under Rule 1017, which can sometimes come into play when considering um changes in ownership and or changes in control is the transfer of 25% or more of a firm's assets. Um and there's a there's a a detailed analysis that can go into that where firm needs to determine whether or not the assets being transferred or or a business line of operation that is being transferred um that generates 25% or more of a firm's earnings, and it's measured on a 36-month rolling average. Now that often um raises a lot of questions for firms as to how best to measure that. Um but it's usually best to take a more conservative approach, and and if you think you're getting close to that line, something that that you'd want to consult with your risk monitoring analyst at FINRON to see how the how they would view it and hopefully get some guidance from them where available. Um but it's also important to keep in mind that in the context of of these kinds of asset transfers, um, FINRA will importantly look very closely to see if the transferring firm has any pending or unpaid arbitrations. And this is really um this is really where FINRA's uh core mission of customer protection kind of uh crosses over into FINRA Rule 1017. Um and so if there are any unpaid arbitrations or pending arbitrations, um, something a firm should keep in mind um in those scenarios is to provide FINRA with a clear plan for resolving those arbitrations because that's something that FINRA will be very interested in the context of filing a CMA application and and not providing a clear plan will create a hurdle to the MAP group approving that application. So it's important that that firms come prepared with that analysis and with a clearly articulated plan to resolve those those uh arbitrations.
SPEAKER_00:Well, excellent. So let's say you have a client who's determined that they've met that threshold, or at least you know, think that they may have met that threshold. What do you advise them in terms of how to prepare for the filing?
SPEAKER_02:So no matter what your application is for, and Jonathan touched upon this, but I always advise my clients to discuss the change with their FINRA risk monitoring analyst before they even file an application. Again, it's just standard practice, no matter what change you're contemplating. I remember when I was over at the FINRA Mat group and we would receive an application from a firm, one of the first things we do is have a discussion with that firm's designated risk monitoring analyst. And typically, you know, if the if the risk monitoring analyst didn't know anything about the change, um, they they would find that a little surprising. So it's good to just start off on the right note, um, set a good tone and reach out to your RNA first.
SPEAKER_03:Yeah, I agree with that, Lisa. And and you know, we can understand and appreciate, um, so especially having worked inside FINRA, now sort of being on the outside, we can certainly understand and appreciate how approaching FINRA can sometimes be a little bit nerve-wracking for a firm. Um, but you know, it is very important to show that partnership and show that show FINRRA that you want to be transparent. And that's what we can do here at CRC Oyster, having been on both sides of the fence here. We're very good at navigating those conversations and at and shepherding and guiding firms through those conversations with their risk monitoring analysts to show that partnership because it really goes a long way in helping to smooth the process throughout the through the CMA.
SPEAKER_04:Seems like we're all aligned here. Um I was going to suggest that uh the firms uh take advantage of the early firm or pre-file meeting that MAP can set up with uh the review team as well as with the risk monitoring team, especially when the change that the firm is contemplating is with a complex transaction or involves more than one member firm. This is a great way to introduce the transaction to the review teams and gives the firm the ability to then address any questions or issues which came up as part of that meeting, as part of the initial filing, getting ahead of those questions and sort of cutting time in the review of the application.
SPEAKER_02:Yeah, I just wanted to add for that um for that pre-file or early firm meeting with FENRA, we here at CRC Oyster would certainly work with you prior to that call. We'd have a prep call. You know, we're never going to put you in front of FENRA without having a discussion and making sure we're all on the same page. So that's one of the things that we're here to help you with.
SPEAKER_00:Okay. So let's say you're working with a client, they've talked to the risk monitoring analyst and you've had those pre-filing meetings with the membership group, and now it comes time to actually do the filing. What are the important things that firms should uh be thinking about in terms of making sure that they have available and provided in the filing?
SPEAKER_04:Well, I think it's important to always, from the perspective of uh of a CMA, yeah, the the approach for that filing is always like, what is the impact of the changes to the broker dealer? And so that goes all the way through from its uh operations, systems, financials, technology. Discuss if there are any changes to the control of the broker dealer. Will the new owner be involved in the day-to-day operations or supervision of the firm? If so, does that new owner have the appropriate FINRA licenses? For example, the Series 24 and the underlying uh license uh to supervise that activity. If there is an owner that the individual is not going to be involved in the day-to-day management, FINRA requires an attestation of non-involvement. Perhaps discuss how FINRA is not putting this directly. And one of the things that FINRA is doing is that they're actually putting this information, uh, that undertaking uh or attestation language in the undertaking section of the membership agreements for the firm once it's approved, documenting representations made by the new owners regarding their involvement. With the introduction of the new owner, will there be any changes to the business lines or products of the firm or technology or systems that the firm will be using? You also want to provide a complete set of transaction documents for the purchase or sale agreements. Uh, this includes all exhibits and disclosure schedules. Um, oftentimes without submitting the exhibits and disclosure schedules referenced in the in the transaction documents, the legal review of those documents cannot be completed and could cause delay, not only the application being accepted by the math group, but in actually uh, you know, perhaps closing by the time that uh the you had anticipated uh or planned to as part of that change. You want to uh provide information regarding the new owners and or and you want to have organizational charts of existing ownership and post-change ownership structure. Um, and it's important that you know the ownership totals 100%. They will also request to know any affiliates uh or entities that will be coming into the under under the same control or ownership as the broker dealer. And you also have to provide the source of funding for the purchase, which may be bank statements or some other type of financial information that sort of evidences the funds are uh and the wherewithal in the future to provide future funds to the broker dealer. And one item which I think um for most simple ownership changes is that you know uh requesting a fee waiver, providing information for why uh, you know, this because the transaction sort of uh does not really have any touch point with the broker dealer, um, or it's not going to impact, have a significant impact to the broker dealer, um, you know, requesting a waiver of the of the fee, I think, is always a good idea and and could result in a free filing.
SPEAKER_00:Well, that's great advice. And I think there's probably a lot of firms out there that that don't know that the opportunity for a fee waiver is out there and wouldn't even know to ask for one. Um another thing that you had mentioned that I think is really important to take note of is you mentioned the attestation that some firms provide. If somebody's gonna say that they're not involved in the day-to-day activity of the firm, it's one of the things that FINRA is likely to look at when they conduct their next examination. So if you are providing those attestations, make sure that the activity that you're engaged in comports with what you said in those attestations. Um so you made the filing, um, and now the application process is underway. And managing and navigating through that process can be very tricky. And I know you guys have each worked on a number of these, and they're all very unique. I was wondering, can you talk about some of the issues that you've seen come up recently that firms should be mindful of in order to make sure that they're prepared for any of these issues that might arise?
SPEAKER_02:Issues that I've been seeing coming up lately really have to do with FINRA digging into details on foreign ownership. So I've seen recently FINRA is getting very specific and asking very specific, detailed information on um owners that are even less than 10% ownership. So let's say you have a 2% owner, the individual appears to be foreign, FINRABAL asks for their primary address or other details on owners that are not going to have any involvement whatsoever in the broker dealer. I even had um one time FINRA asked for the resume of a 2% owner who was not going to have any involvement in the day-to-day operations of the broker dealer. So that was um really interesting to me. Um, but again, that's why we here at CRC Oyster can reach out to FINRA to understand why they need this information or if they really need this information. So that's one of the things that I've seen.
SPEAKER_03:Right. Yeah, that's right, Lisa. And you know, it's important to note that this is a change for FINRA, how they've how they've previously kind of conducted these reviews and and the way they've viewed incoming owners. Um, and sort of up until very recently, um FINRA has kind of drawn a line at 10%, right? The the uh any owners of of less than 10% of the broker dealer, um, oftentimes they would kind of allow for the the firm to provide an attestation regarding what what due diligence they've done on those individuals in terms of vetting them to make sure that there's no bad actors. And as Lisa's pointed out, recently they've been going much deeper on that. And and you know, this is this is Finris sort of taking cues from Washington on some of the you know the the more hot button current hot button items of the administration. And so to Lisa's point, they're really digging in on the identities of anybody coming into ownership of a broker dealer, regardless of how small or insignificant their their share of ownership might be. And in many respects, it's also that inquiry is start is also taking on sort of an anti-money laundering um aspect to it. And of course, this is you know, this is again one of very important to FINREN, kind of their core mission of market integrity um and customer protection. And and so you can understand how it dovetails, it's just it's a new approach, kind of given the granularity that they're looking at these things um at and the lens that they're passing these things through now, particularly in the context of these ownership change applications and the the level of the AML uh due diligence that that they're doing. They may even go so far as to dig into AML procedures of the of a firm, which would be something that would be completely. unrelated to an ownership change typically speaking um but because of the this this sort of new um this new this new initiative um to dig to dig much more deeply into into owners and in particular into foreign ownership um and anybody who may have a have an indirect tie to a broker dealer um the map group has even started to dig into these AML procedures um of broker dealers on on the CMAs and and again this is not something we've we've been used to seeing historically um but we're seeing a lot of recently another area is is sort of the cybersecurity um Finn was asking about the cybersecurity controls and the sorry uh in the firm systems and technology and procedures to understand uh that those controls are adequate based on sort of the risk assessment for that firm uh with the foreign touch point the questions can go from firms serving uh where the firm servers including servers provided through a third party vendor are located with a very in-depth uh review of any and any answer that's that does is not the US I I think that you know they're asking for you know physical street addresses for the locations uh and also uh when there are no changes in the business model and no changes to the vendors of the firm no other changes other than an ownership change involving a foreign owner somewhere above the the the broker dealer um you know these are the types of uh kind of questions that are sort of creeping up uh in that part of that review right that's right and I mean it's even extending into questions about access to books and records and again kind of going back to this idea of of new foreign owners coming into a a firm's ownership structure we we're seeing questions about whether or not that an individual again regardless of how small their their percentage of of ownership might be whether or not they would have access to books and records of the firm and so you know these are all things that we're we're encountering on on our filings and and we can help to navigate for prospective clients to help move through some of these questions and and even get out in in front of them because the questions are always evolving and the initiatives from the map group are always changing. We bring that expertise and that perspective to all of our client engagements and in a way that we hope helps to make for the most effective and efficient filings for our clients.
SPEAKER_00:No that's all terrific information and you if you think about it I mean being prepared for these types of questions that come up around things like cybersecurity and AML, foreign ownership are things that firms and clients probably aren't going to be aware of and might not be prepared to respond to and so that might cause some delays unless they have somebody that can help navigate them through the process and get them prepared for those types of answers. And I'm wondering kind of following on that um are there things that you're seeing that you know in terms of the process that might not be included in their published guidance so that firms should be aware of be prepared for dot dot dot Lisa do you want to take that one?
SPEAKER_02:Yeah sure I think a lot of the things that we're talking about here today um I don't think has been included in the published guidance. Perhaps things are just changing so quickly um maybe FINRA just hasn't had a chance to update the guidance um but again that's why we're here to help with this um we keep up to date on the new requirements coming out of the map group and of course we call FINRA and question things that might seem to be a bit off or misplaced as we receive our request letters from FINRA.
SPEAKER_04:No that's terrific and I think that kind of expertise and familiarity with the process can be really helpful in those areas and you know in speaking to all you about um different clients that you've worked with and I know you've said it's important to make sure that you're on point and to try to avoid discussing issues that might bring you down a rabbit hole um especially if they don't pertain to um the the change or the application are there some ways that firms can steer clear of those types of issues well I I find like a I think a common uh rabbit hole uh that that sometimes occurs in these types of changes in ownership is where the firm is caught in a rabbit hole of trying to prove that the change will not impact the broker dealer. For example, you may have a new owner but let's say that's in the crypto industry entering the ownership structure Vinra will have a million questions wanting to understand what what the role of that of the new crypto owner will will have on the on the broker dealer. But the answer could be as simple as like we don't anticipate anything to happen in the near future you know in the you know the forward period for the application is still 12 months. So the idea is that well we don't anticipate anything to happen in that 12 months but the questions will keep coming and so uh firms uh you know find themselves in a position where they where they have to keep trying to prove that nothing is going to change in the near term. And I think it it's important to be able to push back a little bit on those types of questions and and being able to to you know provide representations as to what the firm anticipates is going to happen within the next 12 months and representations that you know the firm will you know reach out to the risk monitoring analyst should things change and you know they determine that there will be some kind of change in the future and just being transparent with FINRA and I think again going back to the pushing back you know every question that comes on an application should be tied to the standards relative to the application.
SPEAKER_00:If you don't understand why something is being asked or the relevance to the application you know it it's okay to reach out to FINRA you know in you when you have questions like this and they should be able to tell you why that question is uh is relevant to the review um it's uh so I think that you know that those are some of the ways to sort of avoid uh the pitfalls of the rabbit holes one of the the areas um that FINRA spends a lot of time on and is closely related to change of of ownership and control is funding and sources of capital. What should firms expect FINRRA to want to see with regards to how they're funding it and what the sources their capital are?
SPEAKER_03:You know as a general rule on on the funding question um as a general rule FINRA is going to expect to see the the most recent three months of bank statements to evidence source of funds. This can change depending on an application and every application's kind of facts and circumstances can be different but that's sort of the general guideline um that that clients should expect and you know we know sometimes either individuals or entities don't want FINRA to see their bank account statements for whatever reason but there's this is this is a a hard and fast requirement the vast majority of the time and nothing can be redacted. So this is one area that that's easy for FINRA to dig in on and clients should be prepared and and manage the expectation that they're going to have to be transparent with their source of funds. One exception to this can be when you have an incoming owner that's a a publicly traded company for instance um and in those situations we've had some we've had success um pointing FINRA to to that company's um 10Q or 10k filings you know the their publicly available financial financial filings can often satisfy FINRA's requirements in those instances that they that they're able to adequately source funds.
SPEAKER_04:And for furthermore to to that um it's common for the um the review of the source of funds to actually not occur until much later in the application review sometimes causing a lot of questions or last minute questions that cause delays and sort of requirement that then all of a sudden you uh you find yourself need to provide additional statements or or or provide a narrative um describing the source of the funds that are being used providing that narrative at the start where you um walk through what you know what the source of the funds that are in the account are are are from you know how whether they're from the day-to-day operations of that entity or capital raise and providing the documentation to support um uh the representation uh is a great way to get ahead of those questions and uh at least be prepared to answer those when when they come up uh and uh in some ways we'll cut time uh from the review of that application excellent well you know we talked earlier um in the considerations before filing an application about the role of the risk monitoring analyst and that's the individual at FINRA that knows the most about the firm they're the ones that are responsible for the firm on an ongoing basis.
SPEAKER_00:So I would anticipate that they would be involved in this process to some extent. So can you talk a little bit about the role of the risk monitoring analyst and whether or not their role has changed over the last several years as FINRA is restructured.
SPEAKER_04:Well you know like you said risk monitoring comes into the application with the most knowledge about the firm usually so the one of the first things that the map uh group will do is reach out to the risk monitoring analyst uh who will then share information with MAP on as to any concerns or any recent history the map team should be aware of. And it in many ways it's this information from the risk team that uh creates the scope for the review of that application.
SPEAKER_02:It brings into scope uh again uh recent uh issues that the firm may have had and so they do have a lot of input on on sort of the the what risk the change may have on the application yeah I would agree with that uh definitely Armando the risk monitoring team can play a significant role in any application and they certainly work closely with the map team I have seen uh requests from the map group recently that have been taking on more of an examination feel I don't know if that is due to the restructuring um but it is noticeable I believe across the board um but again that's why we here at CRC Oyster are available to help you navigate this process and to actually be your voice with FINRA on your new and continuing member applications.
SPEAKER_00:Well absolutely and I really want to thank you all for your time today. Sharing your experience and the things that you've learned in helping clients through this process is really valuable. And we appreciate your time today. Take care.
SPEAKER_01:If you found today's discussion helpful don't forget to subscribe for more episodes where we dive into industry strategies and best practices. For more information about our experts and our services visit our website at oysterlc.com Thanks for listening