BUILDING A BROKER-DEALER
In this section, and those following, I will guide you through some of the steps on how to become a broker-dealer. You may wish to first read my segment above covering the scenarios when buying a broker-dealer firm makes sense for the purchaser. The flipside of that discussion is essentially that there are more reasons to create a broker-dealer from scratch despite the fact that the limited reasons for buying, if present, are enough to foreclose on the whole concept of becoming a broker-dealer via the building process.
The terms “Broker-Dealer Registration” and the act of creating or becoming or building a broker-dealer are interchangeable. An individual or entity seeking to build a broker-dealer will submit to FINRA a New Member Application or “NMA.”
The reasons why it may be better to create a broker-dealer rather than buying one include:
(a) The purchaser has no need to conduct business during the FINRA “Continuing Membership Application” period.
(b) The purchaser has tried but cannot locate a broker-dealer entity that already has the required FINRA permission to conduct the business the purchaser needs to conduct in order to make purchasing a broker-dealer viable.
(c) The individual or entity building a broker-dealer ends up with a “clean” broker-dealer having no hidden liabilities vis a vis FINRA or customers.
(d) Notwithstanding the potential for doing business during the purchase application (CMA) mentioned elsewhere, creating a broker-dealer is almost always less expensive.
I can lead you through the process of becoming a broker-dealer until FINRA approval is granted. The NMA process has a 180-day window for FINRA approval, although I will strive to shorten this period substantially to the best of my abilities.
For the complete story, please subscribe to receive my free PDF: “Buying vs. Building a Broker-Dealer: A Clear Perspective on What’s Right for You… and When”
I could write a book about this, or at least a blog. For now, here is a concise but educational overview of the FINRA New Member Application. First, after digesting this overview, refer to the next entry below for my “5 Must–Haves Before Building a Broker-Dealer,” as I will not cover those topics in great detail here.
In a striving-to-be-perfect world (my world as I hope to live and work in it) it should take no more than 30 days to prepare the FINRA New Member Application. FINRA is allotted 180 days within which to approve or deny the application.
The good news is that FINRA will, in one form or another, let you know an application is headed for denial within the first 60 days 99.9% of the time. The better news is that I will tell you that the application is headed for denial before we begin to prepare it 100% of the time, provided you give me accurate answers to all my questions during our initial calls.
I’m on your team, but I will play the devil’s advocate because that’s simply the best way to get you where you need to be. We’ll then address the “5 Must-Haves” below. If we’re not tripped up or held off after that discussion, we’ll address the legal entity formation, funding of the application, filing of the “Form BD” (explained elsewhere), and receiving of entitlements from FINRA in order to enter information into the FINRA Gateway system.
In and around all of the preceding items, my staff and I will be working on the following: Your broker-dealer’s Written Supervisory Procedures (“WSP” or “WSPs”), Anti-Money Laundering Plan (“AML”), Business Continuity Plan (“BCP”), Continuing Education Plan and Needs Analysis (“CE Plan”) and a good number of other forms of documentation and information and documentation gathering to help inform FINRA of your good intentions.
From the point of submission and acceptance of the initial application materials, other than our collective work on items that we know must also be obtained and provided to FINRA, but not required with the initial application submission, we will then morph into the role of reacting to FINRA as we go thru the application in a more back and forth, question and answer, request and provide format.
The end result will be approval by FINRA and your new broker-dealer receiving its “FINRA Membership Agreement” – a document that is essentially the closest FINRA gets to actually providing you with a “Broker-Dealer License.”
Much is needed to ensure a successful FINRA New Member Application. For me, the top 5 “must haves” are:
(1) Principals with the Proper Experience: FINRA requires that your broker-dealer’s supervisory staff personnel have either one year of direct experience or two years of indirect experience. Having been a Chief Compliance Officer (a “CCO”) for a year at another broker-dealer would align with one year of direct experience, provided that your experience at the previous broker-dealer was equal to or greater than that which would be required at your new broker-dealer. A CCO at a private placement, investment banking firm may not have any experience that would qualify him or her as a CCO at a firm conducting institutional trading and market making. So think about substance (duties) over form (title). Two years assisting a Chief Compliance Officer or simply evidencing the knowledge needed combined with time spent in a particular area in a sales role, for example, in many cases would satisfy the two year indirect experience requirement. I can help you see what experience you do have in the light that FINRA would view that experience. It’s not slight of hand, just something that I do.
(2) Principals with the proper licenses: While seemingly inherent in the conversation on experience directly above, depending upon the type of broker-dealer you’re creating your principals’ current licenses may not be those required for the new broker-dealer business as envisioned. It is always a good idea to answer the licensing question as early as possible before filing the New Member Application (“NMA”) with FINRA. Interestingly, I work with many principals who are entering the application process just days or weeks after their licenses have lapsed (2 years following their last registration) and it’s not a sure bet FINRA will waive the (re)testing requirement. FINRA has recently approved changes to the exam requirements (effective 10/1/2018) and it is possible this change will make the waiver process an even poorer bet.
(3) Initial and Ongoing Funding: Part of the overall vetting process by FINRA within the New Member Application (“NMA”) will be to identify where the funds to operate the broker-dealer firm come from and this begins, in one sense, prior to the application being filed and continues up to and including FINRA approval of the application. In order for a New Member Application to be accepted the applicant must show it has the required minimum net capital amount in the bank (in the applicant’s bank account) and evidence this fact by providing bank statements, which themselves provide support for the submission by the applicant of the required Financial Statement (more on this below, see FINOP). At the end of the application process the applicant must provide similar evidence that this time includes the minimum net capital but, in addition, an amount equal to a full twelve months’ worth of fixed expenses (fixed expenses, contingent expenses, and various forms of revenue are developed and sent to FINRA with the initial application). Note that the twelve month funding required amount is not offset by contingent revenue. This is an important point.
(4) Financial Wherewithal within the Ownership Structure: Simply put, evidence of the owner’s or owners’, or ownership organization’s ability to fund the ongoing operations must be provided with the initial application - for the most part. All sources of funding must be documented and to the extent a direct owner has not possessed his, her or its funding for a sufficient period of time (usually three months, but this is not etched in stone) additional proof of where those funds came from would be required. This “look through” process can lead up several levels of ownership (if applicable) and multiple parties will need to provide three or more months’ worth of (potentially personal) bank or other financial statements. Clearly, a thorough conversation prior to even formulating the FINRA New Member Application materials is advisable.
(5) Patience and Willingness to Provide Information and Documentation: FINRA often times is accused of being invasive. For the most part the accusation is without merit. I have been involved in numerous FINRA New Member Application processes, which have run the gamut of business conducted and ownership configuration and I rarely have complained of this myself. One surely needs somewhat of a Stoic philosophy during the application process (what doesn’t kill you makes you stronger, etc). On the other hand I have experienced invasive requests less than 1% of the time by my calculation, and pushed back against such requests with success. Ultimately, while FINRA does “fast track” certain applications, most applicants should expect the process to run its course in the timeframe allotted to FINRA per the rules, and to diligently handle the continuous back and forth, question and answer, request and provide process that is the New Member Application. To be blunt, the application is always yours to lose. My role as I see it is to gain from you, and provide to you thereafter, a sense of comfort so that approval of the application is the smallest step away from acceptance of the application.
May potential builders (as well as buyers) of broker-dealer firms are surprised to learn that individuals, as long as they do not place themselves in a position requiring securities brokerage licensing, can, indeed, become and remain passive owners, whether directly or indirectly. Like most other businesses, individuals can provide funding while others provide sweat and no how. That’s it.