Should You "Buy or Build" Your Broker/Dealer?

While this was true a few years ago, FINRA has changed its rules related to the purchase and sale of broker/dealers. Now the purchase and start-up of a broker/dealer are covered by the same set of rules; therefore many times the process is almost identical in time, money and headaches involved.

Our experience has been that if you start building your own broker/dealer today, the time necessary to receive approval will be almost identical to that necessary to receive approval if you purchased a broker/dealer.

This is a huge misconception. FINRA's awareness and concern about purchased broker/dealers is just as intense as any start-up. Due to the recent regulatory changes brought about by anti-money laundering concerns, FINRA pays close attention to direct, indirect and remote owners and operators of brokerage firms. Their concern regarding the true beneficiary of ownership runs very deep and cannot be avoided. Trying to circumvent FINRA's concern may very well be your organization's first rule violation.

Our extensive experience shows that when you consider all costs of buying an existing broker/dealer, start-up firms are consistently and significantly cheaper in both time and money. The reason is quite simple when you evaluate the two processes. When purchasing a broker/dealer, you must conduct due diligence on the existing firm and negotiate a purchase price. Additionally, a purchase contract must be negotiated to cover the indemnification and clarify the roles, responsibilities and assumptions of liabilities associated with the transaction. Obviously, any such transaction requires significant amounts of your time and focus, and the time and focus of your accountant, attorney, and tax advisor. As with many situations that involve these professionals, there will be a great deal of time and money spent appeasing all of the separate disciplines.

Corporate Structure

• If the broker/dealer entity being considered for purchase is not the appropriate type for your business plan, the consequence and cost of changing the structure may far outweigh the benefits in time and expense.
  
  
• If the broker/dealer is currently an LLC and the LLC is being sold to completely new partners or members, tax laws may require the original partnership to be dissolved and any taxes paid or losses incurred assigned to the prior partners or members. The legal and tax attorney fees alone could eat up any "savings" from buying vs. building your broker/dealer.
  
  
• The time required in accomplishing the transfer for legal and tax purposes is time that could be invested in building a b/d from the ground up.

Location

• If the principals of the new firm do not reside in the same city as the broker/dealer you are purchasing, be prepared to do one of two things: (1) move the broker/dealer; or (2) move the principals.
  
  
• FINRA will not allow anyone to operate, manage or supervise a broker/dealer from a remote location.
  
  
• The process for moving a broker/dealer can be simple or it can be relatively complex, depending upon the FINRA district that handles the transfer. Some districts scrutinize incoming broker/dealers more closely than others, especially if the broker/dealer has any questionable issues, such as a history of being sold or moved, or a disciplinary history.

Audit Expenses

• SEC Rule 17a-5 requires every broker/dealer to have an annual, independent certified audit conducted by an independent accounting firm. Therefore, if you intend to buy an existing broker/dealer, it is important to negotiate a proper split of the audit fees to the selling owners, especially if the sale occurs in the last quarter of the fiscal year.
  
  
• Start-up broker/dealers approved by FINRA within the last quarter of the fiscal year may postpone the requirement for the annual audit until the firm has completed more than a year in operation. Taking advantage of this option can save your broker/dealer up to $5,000.00 in its first year of operation. This option, however, is not available to an organization that has been in operation and has been purchased by new owners.

Travel

• If you wish to purchase an existing broker/dealer (even a shell broker/dealer), you and your partners and/or your attorney should meet the sellers face to face. After all, you are buying any and all liabilities that accumulated during their ownership, even if those liabilities have not yet been booked on the balance sheet of the broker/dealer. Therefore, meeting the sellers, shaking their hands and looking in their eyes are always good ideas. When purchasing a broker/dealer, the expense of travel is rarely considered in the "buy or build" decision.

Liabilities

• When a broker/dealer is purchased, the surviving entity has bought all liabilities, known and unknown, of the broker/dealer being sold. This includes legal liabilities and regulatory liabilities, as well. Regardless of the sale contract, securities regulators will not look to prior owners for the resolution of customer complaints, FINRA arbitrations, or litigation.
  
  
• Remember that all regulatory problems are cumulative. If the firm you are purchasing had a regulatory problem in the past, the next violation, either intentional or unintentional, will escalate the disciplinary action taken against the firm and its principals, regardless of whether they were at the helm of the broker/dealer during the initial violation.

Legal Expenses

• Many individuals who choose to build a broker/dealer rely on their attorneys for advice and assistance through the FINRA process. It is important to understand that FINRA's broker/dealer registration process is not a legal process, but instead, a regulatory and administrative process, with many requirements not found in the NASD/FINRA Rules and Regulations. Compounding this uncertainty is the fact that each FINRA district office handles the registration of broker/dealers differently. Unless your attorney has worked through several broker/dealer start-ups within that FINRA district, you will pay a high price for your attorney to learn on the job.
  
  
• If you buy an existing broker/dealer, you should expect to spend a significant amount of your attorney's time and your money crafting a purchase agreement that is suitable to both you and the seller. The indemnification clauses alone may cost several thousand dollars to draft, present, rewrite and finalize.

While buying an existing broker/dealer does have merit in specific targeted situations, it is the long-held opinion of the experts at B/D Solutions Consulting that if you have a clear vision of the broker/dealer you wish to establish, building your own brand new broker/dealer is the best and most prudent decision you can make.

The following items will greatly assist in building your broker/dealer in the shortest amount of time:

1. Establish a clear vision of the products, services, and operations of your broker/dealer.
   
   
2. Retain the appropriately qualified and registered principals to meet the FINRA regulations related to the products and services you plan to offer.
   
   
3. Acquire adequate funding and sufficient capital to operate the broker/dealer for at least one year in a non-profitable situation.
   
   
4. Appropriately license all owners, both direct and indirect, who have an ownership stake in an operating broker/dealer.

If your organization has these four criteria in place, you are ready to create and establish a brand new broker/dealer. Your next step should be to call B/D Solutions Consulting for a detailed proposal regarding specific costs and procedures.