Overview of U.S. Securities Laws Applicable to Broker-Dealers

August 12, 2019

The Securities Exchange Act of 1934 (Exchange Act) is the principal law that regulates broker-dealers in the United States. The Exchange Act governs transactions in securities markets and regulates persons who effect such transactions. The individual states also regulate broker-dealer activities within their borders under state securities or “blue sky” laws.

Federal Registration

Broker-dealers registering with the United States Securities and Exchange Commission (SEC) must also separately apply for membership with a self-regulatory organization (SRO). Most broker-dealers, with the exception of members of a national securities exchange that carry no customer accounts and transact virtually all business on that exchange, are required to become members of the Financial Regulatory Authority (FINRA). The firm will apply to become a member of the FINRA.

The SEC has designed the registration process so that applicant review is essentially performed by the FINRA, with SEC oversight. The firm must satisfy the FINRA through the submission of documents and in an interview that the firm is adequately capitalized and that its principals possess the knowledge and experience to operate a broker-dealer in accordance with the Exchange Act and FINRA rules.

State Registration

SEC-registered broker-dealers also must register in each state in which they affect transactions or make offers to sell or to buy securities, unless they are exempt from registration or excluded from the definition of broker-dealer in a particular state by reason of the nature of the transactions engaged in. Persons not having a place of business in a state who effect transactions solely with institutional investors in that state generally are either excluded from the definition of broker-dealer or otherwise exempt from registration under the applicable state law.

In addition to the registration of brokers and dealers, the various states generally require that the employees of brokers and dealers engaged in securities transactions register as agents (also known as salespersons). The definition of agent in most states, however, does not include an individual who represents an issuer solely in offerings of exempt securities or in exempt transactions.

The determination whether the firm or persons selling on its behalf will need to register must be made on a state-by-state basis.

SEC, FINRA and State Registration Process

SEC and FINRA Registration. In order to register as a broker-dealer under the Exchange Act, the firm must file an application on Form BD with the Central Registration Depository (CRD) located in Rockville, Maryland and operated by the FINRA. Form BD is the basic disclosure form in the broker-dealer registration process. The filing of Form BD with the CRD enables the applicant to register simultaneously with the SEC, the FINRA and the states designated by the applicant on the form.

Form BD calls for identification and background information on the applicant, its executive officers, owners and indirect owners. It also seeks to elicit information about any previous court or regulatory agency disciplinary action taken against the applicant and its control persons. This information is then scrutinized by the FINRA; affirmative answers may provide a basis for the FINRA to deny an applicant membership.

Not only must the firm itself register with the FINRA, but all persons associated with the firm who are to function as either principals or representatives must also register. “Principals” are defined as officers of the firm and other management personnel actively involved in the management of the firm’s investment banking or securities business. “Representatives” are generally defined as sales personnel. Employees whose functions are solely clerical or ministerial in nature are exempt from FINRA qualification and registration requirements. Whereas Form BD is used as the registration application for the firm, Form U-4 is used as the application form for the registration of each individual associated with the firm.

The application process with the FINRA entails satisfying the FINRA District Office that the applicant possesses the necessary financial solvency and that its members possess the necessary knowledge and experience to operate a broker-dealer firm in compliance with the FINRA requirements concerning record keeping, supervision and capital adequacy. Brokers located in New York City and certain counties around New York City are assigned to the District No. 10 office located in Manhattan.

Net Capital and Aggregate Indebtedness. The financial solvency of a broker-dealer is regulated through its net capital and aggregate indebtedness. An important factor in determining the amount of net capital to be maintained is whether the broker-dealer will hold customer funds or securities. Following are some of the types of broker-dealers and their net capital requirements.

  • A full-service broker or dealer that carries customer or broker or dealer accounts and receives or holds funds or securities for those accounts … $250,000.
  • Other dealers … $100,000.
  • A broker or dealer that introduces transactions and accounts of customers or other brokers or dealers to another registered broker or dealer that carries such accounts on a fully disclosed basis, if the introducing broker or dealer receives but does not hold customer or other broker or dealer securities … $50,000.
  • A broker or dealer engaged in the sale of redeemable shares of registered investment companies and certain other share accounts … $25,000.
  • A broker or dealer that does not receive, directly or indirectly, or hold funds or securities for or owe funds or securities to customers and does not carry accounts of, or for, customers, and is not covered by categories (i) – (iv) above. This category is frequently used by broker-dealers engaged solely in effecting private placements … $5,000.

Examinations. Every person engaged in the investment banking or securities business of the firm who is to function as a principal must be registered as a supervisory principal. Principals include sole proprietors, officers and directors, general partners, managers of limited liability companies and managers of branch officers designated offices of supervisory jurisdiction. Unless the broker-dealer is a sole proprietorship, it must have at least two registered supervisory principals.

Business Plan. The application submitted to the FINRA district office will include a business plan describing the business the firm proposes to conduct. The elements of the business plan include:

  • an organization and ownership chart;
  • financial statements;
  • a monthly projection of income and expenses for the first 12 months of operation;
  • a description of the securities to be sold and the expected categories of customers;
  • a description of the firm’s business facilities;
  • a list of contractual commitments;
  • a description of the firm’s financial controls, supervisory procedures and record-keeping facilities; and
  • a continuing education training plan.

Supervisory Procedures Manual. The firm will be required to prepare a supervisory procedures manual for review by the FINRA as part of the registration process. The manual identifies the supervisory principals and designates responsibility for supervisory functions.

Securities Investor Protection Corporation. All broker-dealers registered under Section 15(b) of the Exchange Act engaged in business within the United States are required to be members of the Securities Investor Protection Corporation (SIPC). SIPC is a nonprofit corporation which was created to administer the Securities Investor Protection Act, a federal law which provides insurance for customers of brokerage firms. Broker-dealers whose principal business, taking into account the business of affiliated entities, is conducted outside the United States, and its territories and possessions, may be excluded from membership.

Fidelity Bond Requirements. All firms that are required to become SIPC members must carry a blanket fidelity bond that meets FINRA requirements as to form, amount and type of coverage. Basically, members must carry a fidelity bond in an amount equal to at least 120 percent of their required minimum net capital, with a minimum bond of $25,000, to cover losses caused by the misconduct of officers and employees, including breaches of the duty of fidelity, misplacement or forgery of securities or other instruments and fraudulent trading.

State Registration. Broker-dealers must register in every state in which they conduct business and must cause their agents soliciting customers or effecting transactions in the state to be licensed in the state, unless there is an exemption available under state law. Registration in most states may be commenced through the CRD by designating states to which copies of the Form BD should be forwarded and by depositing appropriate fees with the CRD. States that do not accept filing on the CRD include Alabama, California, Hawaii, Michigan and West Virginia. However, many of the states that accept filing of the Form BD through CRD also require additional documentation filed directly with the state.

Regulatory Filing Fees

SEC Fees. There is no separate fee for registering a broker-dealer with the SEC.

FINRA Fees. The initial FINRA registration fee for self-clearing firms is $5,000, and for all other firms is $3,000. In addition, there are examination fees ($150 per examination), fees to register principals and representatives ($85 initially, and $10 annually, per person) and fingerprint card processing fees ($24.50 per person).

  • A. Blue Sky Fees. Fee for registering broker-dealers in the states range from a low of $75 in Utah to a high of $800 in New York, with most falling between $200 and $300, inclusive. Fees for registering agents range from $13 in Colorado to $235 in Texas, with most around $50.
  • B. Securities Investor Protection Corporation. Although SIPC has in the past assessed broker-dealers based upon their gross revenues from the securities business, and may do so again in future years, the rate of assessment has recently been a flat $150 per year.

A reasonable estimate of time to register a broker-dealer is three to six months from first filing with the FINRA, although in some cases the process may take less than three months or more than a year.

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