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Acquiring a B/D? Use This Checklist.

Are you considering doing a deal, purchasing a broker/dealer? There are tons of regulatory issues to consider.

The “For Sale” signs are multiplying. This week’s news that Morgan Keegan is on the block serves to underscore the fact that there are a lot of b/d sellers in the current market. Many of them are struggling due to settlements over bad investments, and are looking for partners or acquirers as a result. Others are simply struggling in the wake of the recent economic and financial crises, as compliance and technology costs rise and competition for talent and client assets has increased. The good news is, there are plenty of financial firms out there who have excess capital, want to expand their U.S. footprint and are eager to be on the buying end of the equation.

Perhaps you are one of them. Are you considering doing a deal, purchasing a broker/dealer? Finding the right partner is essential, of course, but once you've cleared that hurdle, there are tons of regulatory matters to consider. Below is a list of key issues to review.

The Architecture of the Deal

Most broker/dealer acquisitions are structured as stock purchases, whether by outright acquisition of stock or through a merger. For certain transactions there may be business, financial, legal, regulatory or tax considerations that could compel the parties to use a different deal structure. But otherwise, structuring the deal as a stock purchase allows the parties to avoid difficult and time-consuming issues that could be triggered by a sale of assets, including transferring individual licenses and customer accounts, obtaining third-party consents and registering the acquirer as a broker/dealer if it isn’t already.

At a very early stage of any potential deal, the acquirer and seller need to consider and decide on a deal structure, even if they leave the door open for changes to that structure down the line. This enables the parties, with their advisers, to identify and address key issues that, if ignored or pushed off, could later delay or even kill the deal.

A Big Little Rule

If you’re planning to do a deal, you are going to need the approval of the Financial Industry Regulatory Authority (FINRA) and should probably review FINRA Rule 1017. That rule requires FINRA approval for any of the following: (i) a merger of a FINRA member with another member, unless both are members of the New York Stock Exchange (NYSE) or the surviving entity will continue to be a member of the NYSE; (ii) a direct or indirect acquisition by a FINRA member of another member, unless the acquiring member is a member of the NYSE; (iii) direct or indirect acquisitions or transfers of 25 percent or more of a FINRA member’s assets or any asset, business or line of operation that generates 25 percent or more of the member’s earnings (on a rolling 36-month basis), unless both the seller and acquirer are members of the NYSE; (iv) a change in the equity ownership or partnership capital of the member that results in one person or entity directly or indirectly owning or controlling 25 percent or more of the equity or partnership capital; or (v) a material change in business operations.

A Rule 1017 application will describe in detail the proposed change in ownership, control or business operations and include a business plan, pro forma financials, an organizational chart, and written supervisory procedures reflecting the change. If the application requests approval of a change in ownership or control, the application also must include the names of the new owners, their percentage of ownership and the sources of their funding for the purchase and recapitalization of the member.

The broker/dealer being acquired has to file the Rule 1017 application with FINRA, which then has 30 days to request additional information and up to 180 days to make its decision. In practice, FINRA often requests supplemental information up to the date of its approval. The time period for approval varies significantly, but FINRA approval ordinarily is received within 60 to 90 days after the filing date.

Under FINRA Rule 1017, a deal solely involving a change in ownership can close after 30 days following filing of the application without receipt of FINRA approval. But in practice, most deals wait to close until receipt of FINRA approval, since, without prior FINRA approval, an acquirer runs the risk that FINRA may later impose potentially burdensome interim post-closing restrictions on the acquired broker/dealer. In a worst-case scenario, it may require an unwinding of the deal. If a deal also involves a material change in business operations, FINRA approval must be obtained before such a change can occur.

Given the information required for the filing and the normal time period for FINRA review, it is crucial that, beginning early in the deal process before signing the purchase agreement, the acquirer and seller work together in preparing the Rule 1017 application. Doing so allows the seller to be in a position to contact appropriate FINRA staff no later than immediately after signing the purchase agreement and thereafter promptly to file the Rule 1017 application, starting the clock on FINRA review and minimizing the risk of potential delay in closing the deal.

Consents, Notices and Approvals

Early in the deal process, the acquirer should identify all governmental and self-regulatory bodies (SROs) regulating the acquired broker/dealer and its affiliates. For example, a broker/dealer may own an affiliate that is a registered investment advisor, triggering requirements to obtain pre-closing consents to assignment of investment advisor agreements due to change of control. Or a broker/dealer or one of its affiliates may be registered with the Commodity Futures Trading Commission and a member of the National Futures Association, triggering filing requirements with those bodies.

If the target company has foreign operations, each of these could require its own regulatory filings and approvals. In each of these instances, and others, identification of the regulatory requirements early in the process allows the acquirer and the seller sufficient lead time for preparing filings and undertaking consent processes required before closing.

Due Dilly

In addition to conducting general due diligence, any acquirer of a broker/dealer needs to review the specific due diligence items unique to broker/dealers. This means an acquirer and its counsel must know specifically what items relating to broker/dealer due diligence should be reviewed and have the expertise to analyze and understand the information made available.

Any due diligence checklist needs to be tailored to cover specific broker/dealer concerns. By way of example, items requiring specific attention, among others, include the Form BD, Forms U4 and (as applicable) U5 for registered persons, FOCUS reports, membership agreements with FINRA and other SROs, subordinated loan filings, written supervisory procedures, other written policies, internal compliance memoranda, correspondence with the Securities and Exchange Commission and other regulators, written results of regulatory examinations, foreign regulatory filings, and customer complaints.

The acquirer must have a top notch due diligence team, which should include a mix of inside personnel and specialized outside experts. Good coordination and communication between team members is essential, as is a clear process for review. Mistakes of oversight or failures of communication during the due diligence process may not manifest themselves until after closing, when remediation of problems, even if possible, may be difficult and expensive for the acquirer.

The Deal Agreements

The purchase agreement must be drafted by the acquirer’s counsel to address special broker/dealer concerns. Specific representations and warranties covering broker/dealer regulatory compliance and enforcement issues, as well as covenants and closing conditions keyed to required regulatory filings and notices, should be included in any well-drafted agreement. In addition, specific closing conditions relating to the target’s broker/dealer business, including, for example, the continuation of regulatory licenses and/or key employee or client relationships, may need to be negotiated and included in the purchase agreement. Ancillary agreements, including key employee/employment agreements, restrictive stock agreements and/or non-compete agreements, may be critical to safeguard the acquirer’s interests in the to-be-acquired business and will need to be negotiated and finalized before closing and, in some instances, prior to signing the purchase agreement.

Closing the Deal

After signing the purchase agreement, the parties need to move the deal forward expeditiously to closing. Designating the right point persons to interact with regulators and help facilitate regulatory review and approval of the deal is critical. Regular weekly or even more frequent status calls among representatives of the acquirer and seller and their respective counsel allows the parties to monitor progress toward closing, hold individuals accountable for assigned tasks, identify problems or delays early on, and fashion solutions, as needed, to keep the deal on track. In addition, the 2 to 3-month period before closing (which may extend longer) will be a critical period for the acquirer’s operational and technology people to continue the work necessary to facilitate a successful post-closing operational and technology integration. Promptly following the closing, the acquirer will need to amend the target broker/dealer’s Form BD change of ownership and any other changes resulting from the closing of the deal and make any other post-closing regulatory filings identified by the parties.


Given the rapidly changing economic and regulatory financial services environment, we can expect continued increasing broker/dealer M&A activity. Attention early in the process to the unique regulatory concerns impacting broker/dealer M&A will increase the probability of parties successfully navigating a path to closing and, ultimately, a successful acquisition.

Ed Mason is a partner with Foley & Lardner LLP in Chicago, representing buyers and sellers in broker-deal M&A transactions. He can be reached at [email protected].

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