Change of Membership Pursuant to NASD Rule 1017

Presented By: Lisa Sussman

 

Your FINRA membership is governed by a membership agreement (MA), which is a contractual document between your firm and FINRA memorializing the terms of your membership. In addition to being responsible for complying with securities rules and regulations, your MA defines your approved lines of business and your net capital requirement. In many cases, the MA also defines the number of offices and associated persons a firm may have. The MA may also impose certain restrictions on a firm, such as limiting the number of offices, which will be summarized on the MA as well.

Continuance (or change) in membership applications (CMAs) are commonly referred to as a 1017 in the industry. FINRA member firms are required to file this type of application whenever they seek to materially expand their operations or activities. The events that “trigger” a CMA are outlined in NASD Rule 1017.

The first element that would trigger a 1017 is a material change in business operations such as:

    • Market making, underwriting or acting as a dealer for the first time;
    • Adding a business activity that requires a higher minimum net capital;
    • Expansion beyond the safe harbor allowance (more on this in a moment).

Material changes are based on the specific facts and circumstances for each member firm. Generally, FINRA advises firms that whether any particular business expansion, including the addition of a proposed new business line, is a "material change" in a member's operations ultimately depends on an assessment of such factors as the nature of the proposed expansion; the relationship, if any, between the proposed new business line and the firm's existing business; the effect the proposed expansion is likely to have on the firm's capital; the qualifications and experience of the firm's personnel; and the degree to which the firm's existing financial, operational, supervisory, and compliance systems can accommodate the proposed expansion or addition.

Under the rules, members are responsible for deciding whether a particular change is material and notifying FINRA in appropriate situations. Notification may be made in the form of a materiality determination letter sent to your FINRA District office. If a member feels that, based on the factors cited above, the firm’s expansion is not material, the member may summarize this in a letter which the firm may maintain in its files. Alternatively, the firm may write the letter to FINRA to receive a determination.

The second element that would trigger a 1017 is a change of ownership:

  • Merging two FINRA member firms or a direct or indirect acquisition of one member firm by another;
  • Direct or indirect acquisitions or transfers of 25% or more in the aggregate of the member’s assets or any asset, business or line of operation that generates revenues comprising 25% or more in the aggregate of the member’s earnings measured on a rolling 36-month basis, (unless both the seller and acquirer are members of the NYSE).

    Rule 1017  requires a 30 day advance notice of and approval for any merger, acquisition, and changes in equity ownership or partnership capital. The Rule applies to transfers as well as sales of a firm’s assets, including sales and transfers of assets to an affiliated entity. Additionally, Rule 1017(a)(3) requires an application prior to the sale or transfer of 25% or more of the member’s assets or any asset, business line, or operation that generates revenues of 25% or greater of the selling member’s earnings over a rolling 36-month period. The 36-month period is measured backwards from the date that the member initially notifies FINRA of its intent to sell or transfer assets by submitting an application pursuant to Rule 1017

  • 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% or more of the equity or partnership capital for the first time. 

    FINRA requires advance notice but does not require prior approval of changes of ownership or control. The 30-day advance notice requirement specified in NASD Rule 1017(c) is a method of giving the staff prior notice that the change will occur and permits the staff to analyze the change of ownership and render a decision based on the standards of NASD Rule 1014. A member firm may effect the change before the decision is issued, but the FINRA District Office may impose interim restrictions on the member firm that would remain in effect until the application is decided. In the event of a denial or lapse, new owners (if the transaction has been consummated) may not conduct business.

The third element that would trigger a 1017 is modification or removal of a previously imposed restriction or adding registered reps or additional branch offices beyond the safe harbor.

So let’s say your firm is restricted to having 5 reps on its membership agreement and you want to add 5 more; this would require a 1017 because you are restricted to 5 registered reps on your membership agreement.

Safe harbor is interpretive material designed to help firms expand without having to go through the 1017 process. Safe harbor only applies to:

  • Firms that do not have a membership agreement;
  • Firms that do not have certain restrictions on their membership agreement, and;
  • Firms that do not have a disciplinary history.

There are guidelines for safe harbor allowances. But first, a definition of associated persons: Associated persons are persons involved in sales, including all associated persons, whether or not they are registered, who are involved in sales activities with public customers, including sales assistants and cold callers, but excluding clerical, back office, and trading personnel who are not involved in sales activities.

The following types of expansions are NOT considered material under the safe harbor interpretation:

Number of associated persons involved in sales

Safe harbor increase permitted in a one-year period

1-10

10 persons

11 or more

10 persons or a 30% increase (whichever is greater

Number of offices (registered or unregistered)

Safe harbor increase permitted in a one-year period

1-5

3 offices

6 or more

3 offices or a 30% increase (whicheveris greater)

Number of markets made

Safe harbor increase permitted in a one-year period

1 – 10

10 markets

11 or more

10 markets or a 30% increase (whichever is greater

In summary, if a firm seeks to add personnel, business lines or change 25% or more of its ownership, a CMA most likely is required. When in doubt, after consulting the rules, the firm may make its own materiality determination or ask the district for assistance in making one. If the firm relies on its own materiality determination, it must document the reasons why it came to that conclusion. It does not preclude FINRA from overturning the decision. The governing factor in whether or not a firm will be approved is whether or not the firm will continue to meet the 14 membership standards of rule 1014. 

If you have questions on whether changes to your business could require a 1017 filing, please contact your Compliance Partners account manager or one of the compliance specialists at Regulatory Compliance at 603-434-3594.

 

 

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