The SEC granted no-action relief to FINRA’s Vice President, Risk Oversight & Operational Regulation, Kris Dailey under the condition that if a broker-dealer were to classify a person in one or more classes of ownership of the broker-dealer as an owner of the firm (and not a customer) for purposes of Rule 15c3-3, and such person’s contributions in the firm as equity capital for purposes of Rule 15c3-1, as set forth below:
- The Broker-Dealer obtains an opinion of independent legal counsel that (a) it is duly formed, validly existing, and in good standing; and (b) its governing documents, such as its Articles of Formation, By-Laws, Operating Agreement or Partnership Agreement as the case may be, are enforceable in accordance with their terms, each in the jurisdiction in which the Broker-Dealer was formed, organized or incorporated.
- Upon request by the SEC or FINRA, the Broker-Dealer must be able to establish that the person is an equity participant in the firm under applicable law in the jurisdiction in which the Broker-Dealer was formed, organized or incorporated.
- The relationship between the person and the Broker-Dealer, and all applicable conditions of the arrangement, must be documented in an executed writing wherein the parties agree and acknowledge certain conditions (see letter for more details).
- The person annually thereafter re-affirms in writing his/her understanding of, and agreement with, the terms and conditions of the executed agreement as referenced in Item 3 above.
- The Broker-Dealer ensures that the person is appropriately registered with its designated examining authority for any activity performed by the person for which registration is required. If the person is not a natural person, each person authorized to perform any activity for which registration is required on behalf of that person must be so registered. Further, the Broker-Dealer has implemented a system of supervisory compliance and controls that applies to such activities of the person and all others authorized to perform such activities on behalf of that person.
Lofchie Comment: This letter deals with the situation where a firm’s “employees”/”owners” are effectively customers of the firm trading their own capital through the firm. The legal status of such arrangements has always been subject to various uncertainties, including as to the capital treatment of the owners’ investments, given that the owners would expect to be able to withdraw their equity when they leave the firm. This letter provides guidance that these arrangements are permissible, at least insofar as the money invested by individual owners may be treated as equity capital, provided, among other things, that (i) the money stays in the firm for at least one year and (ii) the investment is at risk if the firm as a whole were to fail. Although the letter requires that the money stay in the firm for one year, once that period has passed, the letter does not require a specified period between an owner’s notice of the desire to withdraw capital and the withdrawal (although the withdrawal could not throw a firm into capital deficiency).
View Letter in full here (links externally to SEC website).