One Size Does Not Fit All: The CAB License Offers Relaxed Regulatory Requirements for Limited Broker Dealers

ICSGroup has received several inquiries over the past several months about the Capital Acquisition Broker (“CAB”) License, its boundaries and requirements, such that I thought I would make it the topic of this month’s regulatory article. This information is most applicable to placement agents, private funds, investment bankers and the compliance professionals who help keep them out of trouble.

The Problem the CAB License is Intended to Address.

Prior to the establishment of the CAB license, all broker-dealers were required to comply with a single set of fairly onerous requirements. Individuals and businesses that limit their activities to capital raising and corporate financing transactions were forced to comply with unnecessary exams and requirements that far exceeded their scope of activity. FINRA has been concerned with individual investors who trade securities via a broker-dealer – and rightfully so. However, a placement agent or investment banker engaged in a private placement does not involve individual investors. These investment professionals also do not need to know the intricacies of swaps and puts in order to perform their jobs. Thankfully, the FINRA rules which became effective in April 2017 created a new category of broker-dealers who will be able to enjoy more relaxed regulatory requirements. 

The Definition of a Capital Acquisition Broker.

CABs are firms that engage in a limited range of activities including advising companies and private equity funds on capital raising and corporate restructuring, and acting as placement agents for sales of unregistered securities to institutional investors generally defined to include certain institutions, any person with total assets of $50 million, and “qualified purchasers” as defined in the Investment Company Act of 1940 (the “1940 Act”). The rule specifically excludes from the definition of a CAB a firm that acts as placement agent for sales of unregistered securities to “accredited investors.”[1]  CABs are subject to a streamlined set of compliance rules in recognition of the limited nature of their business activities.

Many brokers who perform regular broker-dealer activities who also act as placement agents for private placements will find the narrower definition unworkable. The new broker-dealer category will be attractive to a relatively narrow group of firms, primarily M&A boutiques, firms that provide advisory services on corporate financing transactions but do not engage in the sale of securities and firms that limit their selling activities to exempt offerings to institutional accounts. Those firms with limited broker dealer activities as set forth in the new rule – and therefore are the intended beneficiaries of the new rule – will rejoice!

What Relief Is Provided for CABs?

CABs are required to comply with FINRA conduct rules including membership registration and licensing and examination requirements, net capital compliance, preparation of annual audited financial statements, recordkeeping, and SIPC membership. However, the CAB rules do reduce or eliminate a number of requirements that apply to all other FINRA members.

  • Projections. The general FINRA prohibition of predictions or projections of investment performance in communications with the public does not apply to CABs, presumably because of the sophistication of the institutional investors they are permitted to solicit. To date, placement agents for private funds have struggled with this prohibition as many institutional investors expect to review the sponsor’s projections before making an investment decision.
  • Supervision. CABs will be subject to a relaxed set of rules regarding supervisory controls. CABs will have a fair amount of discretion to design a supervisory system appropriate for their business. Registered principals will not be required to review all transactions, conduct routine internal inspections, and provide annual certifications regarding the adequacy of the supervisory systems.
  • Financial and Operational Requirements.  Many of FINRA’s rules on financial responsibility will not be applicable in light of the fact that CABs cannot handle customer funds or securities or engage in proprietary trading.
  • Business Continuity. CABs will not be required to adopt business continuity plans.

How Do Firms Register as Capital Acquisition Brokers?

Broker-dealers who are currently members of FINRA may file a Continuing Membership Application under NASD Rule 1017 when seeking to amend their membership status. New applicants will be able to elect CAB status when submitting their applications for membership. FINRA has estimated that as many as 750 current member firms could be eligible for CAB status.

[1] An accredited investor is any natural person whose individual net worth, or joint net worth with that person’s spouse, exceeds $1,000,000 not including their primary residence.  See 17 CFR § 230.501 for more on accredited investors.