FINRA Continuing Membership Applications: Ownership & Control Changes

CRC-Oyster: Compliance Risk Concepts / Oyster Consulting

Episode Transcript

SPEAKER_01 (00:11):
Hi, and welcome to the Oyster Sto podcast.
I'm Libby Hall, Director ofCommunications for Oyster
Consulting.
One of the most challengingregulatory processes for broker
dealers can be filing acontinuing membership
application or CMA.
Whether you're making changes toyour ownership, business lines,
or control structure, thesefilings can be complicated and

(00:34):
delayed to install your firm'sstrategic plans.
Today, I'm joined by Ed Wagner,our practice lead for governance
risk and compliance, along withthree of our experts who bring
extensive FINRA registrationexperience: Lisa Robinson,
Jonathan Telfair, and ArmandoValdez.
They'll share what FINRA expectsto see, how do we anticipate

(00:55):
challenges, avoid commonpitfalls, and move through the
CMA process more efficiently.
Let's get started.
Ed.

SPEAKER_00 (01:02):
Well, hello everyone, and welcome.
I'm Ed Wegner, and I am thepractice lead for governance,
risk, and compliance here at CRCOyster.
And we often work with ourclients to help them navigate
the tricky issues that arisewhen they go through significant
changes to their business.
And for broker dealers, thisoften involves them having to go
through FINRA's continuingmembership process.

(01:24):
Successfully navigating thatprocess can be tricky.
And if not done so well, it cancause firms to have significant
delays in implementing theirchanges and making sure that
they're meeting their objectiveswith the change.
So we're very fortunate here atCRC Oyster to have a team of
consultants who've worked insenior roles in FINRA's

(01:45):
membership department.
They've helped our clientssuccessfully navigate the CMA
process and get the desiredapprovals in a very timely
manner.
So today we're going to talkabout one specific change that
typically requires a CMA, andthat's a change in ownership and
control.
But before jumping into it, I dowant to have my colleagues
introduce themselves and theirbackgrounds, including how they

(02:08):
help clients through themembership process.
So, Lisa, why don't we startwith you?

SPEAKER_02 (02:13):
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 Iwas the only senior director in
the FENRA membership applicationprogram, otherwise known as MAP
Group.
Um and I really enjoy helpingclients here at the company

(02:36):
navigate the often complex newmember and continuing member
application process.
Turn it over to Jonathan.

SPEAKER_03 (02:46):
Thanks, Lisa, and thank you, Ed, for the
introduction.
Um, Jonathan Telfair here umwith CRC Oyster, and I've been
leading the CRC Oysterapplication efforts for new
member applications andcontinuing member applications
for just about three and a halfyears now.

(03:06):
Um and prior to joining CRC in2022, I was a uh manager in
FINRA's membership applicationprogram, where I had the good
fortune of um working under Lisaand learning from her as well as
working with um our othercolleague here, Armando Valdez,

(03:29):
um, for two years.
And prior to um prior to joiningthe 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 (03:51):
Hi, my name is Armando Valdez.
I am a new consultant to the uhCRC Oyster.
Um having come from the FinRESMap Group, uh, where I uh joined
about 10 years ago as an analystuh and um became a manager for
the last five of those 10 yearsin the retail, fintech, and

(04:12):
crypto uh group.

SPEAKER_00 (04:14):
Well, excellent.
And and thank you all for beinghere today.
So why don't we jump into it?
And I guess the first questionthat I would have is what are
the types of things that wouldtrigger a continuing membership
application, uh, especially withrespect to a change in control?

SPEAKER_02 (04:31):
Sure, I'll take that one.
Uh FIMA Rule 1017 outlines whena firm needs to file an
application for approval for achange in ownership.
Specifically, if there is achange in equity ownership or
partnership capital of the firmthat results in one person or
entity directly or indirect,indirectly owning or controlling

(04:56):
25% or more of the ownership, itwill trigger the requirement for
the firm to file a CMA withFENRA.

SPEAKER_04 (05:08):
I'm so glad that you mentioned control, Lisa.
It's important to know that therule refers not only to a change
in the direct or indirectownership of the member firm,
but also to material changesthat result in a person either
directly or through the controlof an entity in the ownership
structure of the firm crossingthat 25% threshold.
A simple example of atransaction that is material

(05:29):
because of a change in controlof the firm would be one where a
current owner of, let's say, 4%of the total ownership interest
of a broker dealer purchases anadditional 20% of the ownership
from the other two owners andwill become the third chair on
the firm's board of directors.
So while the change in ownershipinterest, based on just these

(05:51):
facts and circumstances, wouldnot by itself be material
requirements, since he thecurrent owner only would only
then have 24% of the totalownership, as the third chair on
the firm's board, he would nowcontrol 33% of the board, and
therefore uh would be materialas far as a change in control of

(06:11):
the member firm.

SPEAKER_03 (06:12):
Yeah, that's an excellent point, Armando.
Um, and it's not the analysisisn't necessarily always as
simple as just the the change inownership and and the direct
ownership percentages, but thechange in control is an
important factor to consider aswell.
Um and and another CMA triggerunder Rule 1017, which can

(06:36):
sometimes come into play whenconsidering um changes in
ownership and or changes incontrol is the transfer of 25%
or more of a firm's assets.
Um and there's a there's a adetailed analysis that can go
into that where firm needs todetermine whether or not the

(06:58):
assets being transferred or or abusiness line of operation that
is being transferred um thatgenerates 25% or more of a
firm's earnings, and it'smeasured on a 36-month rolling
average.
Now that often um raises a lotof questions for firms as to how
best to measure that.
Um but it's usually best to takea more conservative approach,

(07:23):
and and if you think you'regetting close to that line,
something that that you'd wantto consult with your risk
monitoring analyst at FINRON tosee how the how they would view
it and hopefully get someguidance from them where
available.
Um but it's also important tokeep in mind that in the context

(07:44):
of of these kinds of assettransfers, um, FINRA will
importantly look very closely tosee if the transferring firm has
any pending or unpaidarbitrations.
And this is really um this isreally where FINRA's uh core
mission of customer protectionkind of uh crosses over into

(08:04):
FINRA Rule 1017.
Um and so if there are anyunpaid arbitrations or pending
arbitrations, um, something afirm should keep in mind um in
those scenarios is to provideFINRA with a clear plan for
resolving those arbitrationsbecause that's something that

(08:27):
FINRA will be very interested inthe context of filing a CMA
application and and notproviding a clear plan will
create a hurdle to the MAP groupapproving that application.
So it's important that thatfirms come prepared with that
analysis and with a clearlyarticulated plan to resolve

(08:50):
those those uh arbitrations.

SPEAKER_00 (08:53):
Well, excellent.
So let's say you have a clientwho's determined that they've
met that threshold, or at leastyou know, think that they may
have met that threshold.
What do you advise them in termsof how to prepare for the
filing?

SPEAKER_02 (09:06):
So no matter what your application is for, and
Jonathan touched upon this, butI always advise my clients to
discuss the change with theirFINRA risk monitoring analyst
before they even file anapplication.
Again, it's just standardpractice, no matter what change
you're contemplating.

(09:27):
I remember when I was over atthe FINRA Mat group and we would
receive an application from afirm, one of the first things we
do is have a discussion withthat firm's designated risk
monitoring analyst.
And typically, you know, if theif the risk monitoring analyst
didn't know anything about thechange, um, they they would find

(09:49):
that a little surprising.
So it's good to just start offon the right note, um, set a
good tone and reach out to yourRNA first.

SPEAKER_03 (10:00):
Yeah, I agree with that, Lisa.
And and you know, we canunderstand and appreciate, um,
so especially having workedinside FINRA, now sort of being
on the outside, we can certainlyunderstand and appreciate how
approaching FINRA can sometimesbe a little bit nerve-wracking
for a firm.

(10:21):
Um, but you know, it is veryimportant to show that
partnership and show that showFINRRA that you want to be
transparent.
And that's what we can do hereat CRC Oyster, having been on
both sides of the fence here.
We're very good at navigatingthose conversations and at and
shepherding and guiding firmsthrough those conversations with

(10:42):
their risk monitoring analyststo show that partnership because
it really goes a long way inhelping to smooth the process
throughout the through the CMA.

SPEAKER_04 (10:54):
Seems like we're all aligned here.
Um I was going to suggest thatuh the firms uh take advantage
of the early firm or pre-filemeeting that MAP can set up with
uh the review team as well aswith the risk monitoring team,
especially when the change thatthe firm is contemplating is
with a complex transaction orinvolves more than one member

(11:15):
firm.
This is a great way to introducethe transaction to the review
teams and gives the firm theability to then address any
questions or issues which cameup as part of that meeting, as
part of the initial filing,getting ahead of those questions
and sort of cutting time in thereview of the application.

SPEAKER_02 (11:33):
Yeah, I just wanted to add for that um for that
pre-file or early firm meetingwith FENRA, we here at CRC
Oyster would certainly work withyou prior to that call.
We'd have a prep call.
You know, we're never going toput you in front of FENRA
without having a discussion andmaking sure we're all on the

(11:54):
same page.
So that's one of the things thatwe're here to help you with.

SPEAKER_00 (11:58):
Okay.
So let's say you're working witha client, they've talked to the
risk monitoring analyst andyou've had those pre-filing
meetings with the membershipgroup, and now it comes time to
actually do the filing.
What are the important thingsthat firms should uh be thinking
about in terms of making surethat they have available and
provided in the filing?

SPEAKER_04 (12:17):
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 isthe impact of the changes to the
broker dealer?
And so that goes all the waythrough from its uh operations,
systems, financials, technology.
Discuss if there are any changesto the control of the broker

(12:39):
dealer.
Will the new owner be involvedin the day-to-day operations or
supervision of the firm?
If so, does that new owner havethe appropriate FINRA licenses?
For example, the Series 24 andthe underlying uh license uh to
supervise that activity.
If there is an owner that theindividual is not going to be

(13:00):
involved in the day-to-daymanagement, FINRA requires an
attestation of non-involvement.
Perhaps discuss how FINRA is notputting this directly.
And one of the things that FINRAis doing is that they're
actually putting thisinformation, uh, that
undertaking uh or attestationlanguage in the undertaking
section of the membershipagreements for the firm once
it's approved, documentingrepresentations made by the new

(13:24):
owners regarding theirinvolvement.
With the introduction of the newowner, will there be any changes
to the business lines orproducts of the firm or
technology or systems that thefirm will be using?
You also want to provide acomplete set of transaction
documents for the purchase orsale agreements.
Uh, this includes all exhibitsand disclosure schedules.

(13:46):
Um, oftentimes withoutsubmitting the exhibits and
disclosure schedules referencedin the in the transaction
documents, the legal review ofthose documents cannot be
completed and could cause delay,not only the application being
accepted by the math group, butin actually uh, you know,
perhaps closing by the time thatuh the you had anticipated uh or

(14:07):
planned to as part of thatchange.
You want to uh provideinformation regarding the new
owners and or and you want tohave organizational charts of
existing ownership andpost-change ownership structure.
Um, and it's important that youknow the ownership totals 100%.

(14:27):
They will also request to knowany affiliates uh or entities
that will be coming into theunder under the same control or
ownership as the broker dealer.
And you also have to provide thesource of funding for the
purchase, which may be bankstatements or some other type of
financial information that sortof evidences the funds are uh

(14:48):
and the wherewithal in thefuture to provide future funds
to the broker dealer.
And one item which I think umfor most simple ownership
changes is that you know uhrequesting a fee waiver,
providing information for whyuh, you know, this because the
transaction sort of uh does notreally have any touch point with
the broker dealer, um, or it'snot going to impact, have a

(15:10):
significant impact to the brokerdealer, um, you know, requesting
a waiver of the of the fee, Ithink, is always a good idea and
and could result in a freefiling.

SPEAKER_00 (15:20):
Well, that's great advice.
And I think there's probably alot of firms out there that that
don't know that the opportunityfor a fee waiver is out there
and wouldn't even know to askfor one.
Um another thing that you hadmentioned that I think is really
important to take note of is youmentioned the attestation that
some firms provide.
If somebody's gonna say thatthey're not involved in the
day-to-day activity of the firm,it's one of the things that

(15:43):
FINRA is likely to look at whenthey conduct their next
examination.
So if you are providing thoseattestations, make sure that the
activity that you're engaged incomports with what you said in
those attestations.
Um so you made the filing, um,and now the application process
is underway.

(16:04):
And managing and navigatingthrough that process can be very
tricky.
And I know you guys have eachworked on a number of these, and
they're all very unique.
I was wondering, can you talkabout some of the issues that
you've seen come up recentlythat firms should be mindful of
in order to make sure thatthey're prepared for any of
these issues that might arise?

SPEAKER_02 (16:23):
Issues that I've been seeing coming up lately
really have to do with FINRAdigging into details on foreign
ownership.
So I've seen recently FINRA isgetting very specific and asking
very specific, detailedinformation on um owners that

(16:45):
are even less than 10%ownership.
So let's say you have a 2%owner, the individual appears to
be foreign, FINRABAL asks fortheir primary address or other
details on owners that are notgoing to have any involvement

(17:08):
whatsoever in the broker dealer.
I even had um one time FINRAasked for the resume of a 2%
owner who was not going to haveany involvement in the
day-to-day operations of thebroker dealer.
So that was um reallyinteresting to me.
Um, but again, that's why wehere at CRC Oyster can reach out

(17:34):
to FINRA to understand why theyneed this information or if they
really need this information.
So that's one of the things thatI've seen.

SPEAKER_03 (17:44):
Right.
Yeah, that's right, Lisa.
And you know, it's important tonote that this is a change for
FINRA, how they've how they'vepreviously kind of conducted
these reviews and and the waythey've viewed incoming owners.
Um, and sort of up until veryrecently, um FINRA has kind of

(18:06):
drawn a line at 10%, right?
The the uh any owners of of lessthan 10% of the broker dealer,
um, oftentimes they would kindof allow for the the firm to
provide an attestation regardingwhat what due diligence they've

(18:27):
done on those individuals interms 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 thisis Finris sort of taking cues
from Washington on some of theyou know the the more hot button

(18:47):
current hot button items of theadministration.
And so to Lisa's point, they'rereally digging in on the
identities of anybody cominginto ownership of a broker
dealer, regardless of how smallor insignificant their their
share of ownership might be.

(19:08):
And in many respects, it's alsothat inquiry is start is also
taking on sort of an anti-moneylaundering um aspect to it.
And of course, this is you know,this is again one of very
important to FINREN, kind oftheir core mission of market
integrity um and customerprotection.

(19:29):
And and so you can understandhow it dovetails, it's just it's
a new approach, kind of giventhe granularity that they're
looking at these things um atand the lens that they're
passing these things throughnow, particularly in the context
of these ownership changeapplications and the the level
of the AML uh due diligence thatthat they're doing.

(19:51):
They may even go so far as todig into AML procedures of the
of a firm, which would besomething that would be
completely.
unrelated to an ownership changetypically speaking um but
because of the this this sort ofnew um this new this new
initiative um to dig to dig muchmore deeply into into owners and

(20:16):
in particular into foreignownership um and anybody who may
have a have an indirect tie to abroker dealer um the map group
has even started to dig intothese AML procedures um of
broker dealers on on the CMAsand and again this is not
something we've we've been usedto seeing historically um but

(20:39):
we're seeing a lot of recentlyanother area is is sort of the
cybersecurity um Finn was askingabout the cybersecurity controls
and the sorry uh in the firmsystems and technology and
procedures to understand uh thatthose controls are adequate
based on sort of the riskassessment for that firm uh with

(21:00):
the foreign touch point thequestions can go from firms
serving uh where the firmservers including servers
provided through a third partyvendor are located with a very
in-depth uh review of any andany answer that's that does is
not the US I I think that youknow they're asking for you know

(21:21):
physical street addresses forthe locations uh and also uh
when there are no changes in thebusiness model and no changes to
the vendors of the firm no otherchanges other than an ownership
change involving a foreign ownersomewhere above the the the
broker dealer um you know theseare the types of uh kind of

(21:42):
questions that are sort ofcreeping up uh in that part of
that review right that's rightand I mean it's even extending
into questions about access tobooks and records and again kind
of going back to this idea of ofnew foreign owners coming into a
a firm's ownership structure wewe're seeing questions about

(22:05):
whether or not that anindividual again regardless of
how small their their percentageof of ownership might be whether
or not they would have access tobooks and records of the firm
and so you know these are allthings that we're we're
encountering on on our filingsand and we can help to navigate

(22:27):
for prospective clients to helpmove through some of these
questions and and even get outin in front of them because the
questions are always evolvingand the initiatives from the map
group are always changing.
We bring that expertise and thatperspective to all of our client
engagements and in a way that wehope helps to make for the most

(22:49):
effective and efficient filingsfor our clients.

SPEAKER_00 (22:53):
No that's all terrific information and you if
you think about it I mean beingprepared for these types of
questions that come up aroundthings like cybersecurity and
AML, foreign ownership arethings that firms and clients
probably aren't going to beaware of and might not be
prepared to respond to and sothat might cause some delays

(23:13):
unless they have somebody thatcan help navigate them through
the process and get themprepared for those types of
answers.
And I'm wondering kind offollowing on that um are there
things that you're seeing thatyou know in terms of the process
that might not be included intheir published guidance so that
firms should be aware of beprepared for dot dot dot Lisa do

(23:36):
you want to take that one?

SPEAKER_02 (23:37):
Yeah sure I think a lot of the things that we're
talking about here today um Idon't think has been included in
the published guidance.
Perhaps things are just changingso quickly um maybe FINRA just
hasn't had a chance to updatethe guidance um but again that's

(24:00):
why we're here to help with thisum we keep up to date on the new
requirements coming out of themap group and of course we call
FINRA and question things thatmight seem to be a bit off or
misplaced as we receive ourrequest letters from FINRA.

SPEAKER_04 (24:20):
No that's terrific and I think that kind of
expertise and familiarity withthe process can be really
helpful in those areas and youknow in speaking to all you
about um different clients thatyou've worked with and I know
you've said it's important tomake sure that you're on point
and to try to avoid discussingissues that might bring you down

(24:41):
a rabbit hole um especially ifthey don't pertain to um the the
change or the application arethere some ways that firms can
steer clear of those types ofissues well I I find like a I
think a common uh rabbit hole uhthat that sometimes occurs in
these types of changes inownership is where the firm is

(25:03):
caught in a rabbit hole oftrying to prove that the change
will not impact the brokerdealer.
For example, you may have a newowner but let's say that's in
the crypto industry entering theownership structure Vinra will
have a million questions wantingto understand what what the role
of that of the new crypto ownerwill will have on the on the

(25:24):
broker dealer.
But the answer could be assimple as like we don't
anticipate anything to happen inthe near future you know in the
you know the forward period forthe application is still 12
months.
So the idea is that well wedon't anticipate anything to
happen in that 12 months but thequestions will keep coming and
so uh firms uh you know findthemselves in a position where
they where they have to keeptrying to prove that nothing is

(25:47):
going to change in the nearterm.
And I think it it's important tobe able to push back a little
bit on those types of questionsand and being able to to you
know provide representations asto what the firm anticipates is
going to happen within the next12 months and representations
that you know the firm will youknow reach out to the risk

(26:07):
monitoring analyst should thingschange and you know they
determine that there will besome kind of change in the
future and just beingtransparent with FINRA and I
think again going back to thepushing back you know every
question that comes on anapplication should be tied to
the standards relative to theapplication.

SPEAKER_00 (26:25):
If you don't understand why something is
being asked or the relevance tothe application you know it it's
okay to reach out to FINRA youknow in you when you have
questions like this and theyshould be able to tell you why
that question is uh is relevantto the review um it's uh so I
think that you know that thoseare some of the ways to sort of
avoid uh the pitfalls of therabbit holes one of the the

(26:49):
areas um that FINRA spends a lotof time on and is closely
related to change of ofownership and control is funding
and sources of capital.
What should firms expect FINRRAto want to see with regards to
how they're funding it and whatthe sources their capital are?

SPEAKER_03 (27:06):
You know as a general rule on on the funding
question um as a general ruleFINRA is going to expect to see
the the most recent three monthsof bank statements to evidence
source of funds.
This can change depending on anapplication and every
application's kind of facts andcircumstances can be different

(27:28):
but that's sort of the generalguideline um that that clients
should expect and you know weknow sometimes either
individuals or entities don'twant FINRA to see their bank
account statements for whateverreason but there's this is this
is a a hard and fast requirementthe vast majority of the time

(27:52):
and nothing can be redacted.
So this is one area that that'seasy for FINRA to dig in on and
clients should be prepared andand manage the expectation that
they're going to have to betransparent with their source of
funds.
One exception to this can bewhen you have an incoming owner

(28:17):
that's a a publicly tradedcompany for instance um and in
those situations we've had somewe've had success um pointing
FINRA to to that company's um10Q or 10k filings you know the
their publicly availablefinancial financial filings can

(28:38):
often satisfy FINRA'srequirements in those instances
that they that they're able toadequately source funds.

SPEAKER_04 (28:47):
And for furthermore to to that um it's common for
the um the review of the sourceof funds to actually not occur
until much later in theapplication review sometimes
causing a lot of questions orlast minute questions that cause
delays and sort of requirementthat then all of a sudden you uh

(29:08):
you find yourself need toprovide additional statements or
or or provide a narrative umdescribing the source of the
funds that are being usedproviding that narrative at the
start where you um walk throughwhat you know what the source of
the funds that are in theaccount are are are from you
know how whether they're fromthe day-to-day operations of

(29:29):
that entity or capital raise andproviding the documentation to
support um uh the representationuh is a great way to get ahead
of those questions and uh atleast be prepared to answer
those when when they come up uhand uh in some ways we'll cut
time uh from the review of thatapplication excellent well you

(29:53):
know we talked earlier um in theconsiderations before filing an
application about the role ofthe risk monitoring analyst and
that's the individual at FINRAthat knows the most about the
firm they're the ones that areresponsible for the firm on an
ongoing basis.

SPEAKER_00 (30:08):
So I would anticipate that they would be
involved in this process to someextent.
So can you talk a little bitabout the role of the risk
monitoring analyst and whetheror not their role has changed
over the last several years asFINRA is restructured.

SPEAKER_04 (30:24):
Well you know like you said risk monitoring comes
into the application with themost knowledge about the firm
usually so the one of the firstthings that the map uh group
will do is reach out to the riskmonitoring analyst uh who will
then share information with MAPon as to any concerns or any
recent history the map teamshould be aware of.

(30:46):
And it in many ways it's thisinformation from the risk team
that uh creates the scope forthe review of that application.

SPEAKER_02 (30:54):
It brings into scope uh again uh recent uh issues
that the firm may have had andso they do have a lot of input
on on sort of the the what riskthe change may have on the
application yeah I would agreewith that uh definitely Armando
the risk monitoring team canplay a significant role in any

(31:16):
application and they certainlywork closely with the map team I
have seen uh requests from themap group recently that have
been taking on more of anexamination feel I don't know if
that is due to the restructuringum but it is noticeable I

(31:36):
believe across the board um butagain that's why we here at CRC
Oyster are available to help younavigate this process and to
actually be your voice withFINRA on your new and continuing
member applications.

SPEAKER_00 (31:53):
Well absolutely and I really want to thank you all
for your time today.
Sharing your experience and thethings that you've learned in
helping clients through thisprocess is really valuable.
And we appreciate your timetoday.
Take care.

SPEAKER_01 (32:10):
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