Disclosures & fees

We discussed the legal definition and characteristics of a broker-dealer in the previous unit. If a business wants to operate as a broker-dealer in any given state, it must register with both the Securities and Exchange Commission (SEC) and each appropriate state administrator. Avoiding registration when it’s required is illegal, potentially leading to significant penalties and fines.

Registration involves divulging company specifics on paperwork and paying filing fees. The required disclosures go on Form BD; click the previous link if you really want to see the form. Spoiler alert: it’s a plain, boring 28-page form. We’ll cover the important aspects of the form in this section.

Required disclosures

One of the main purposes of registration is to alert the state administrator of the existence of a new financial entity operating in their state. Form BD requests much of this information, which includes the business name, EIN (tax reporting number), business address, and contact person (employee the administrator can contact if reaching out to the broker-dealer).

The form also requests for disclosure of other jurisdictions the broker-dealer will be subject to. Jurisdiction is a complex topic that we’ll cover further in depth in a future unit. For now, assume jurisdiction refers to regulators having the authority to regulate the broker-dealer.

As discussed earlier, broker-dealers register federally with the SEC* and with each applicable state administrator (if doing business in their state). Form BD requires disclosure of the other states the broker-dealer is doing business in. For example, let’s assume a financial firm is registering as a broker-dealer in Texas. It would be useful for the Texas state administrator to know if the firm is registered in any other states, as it would provide insight into the scope of its operations.

*Broker-dealers operating intrastate (within one state only) are not eligible to register with the SEC. In order for the federal government to have jurisdiction, business activities must cross state lines. Therefore, broker-dealers located in and only doing business in one state will only be state-registered.

Businesses applying for broker-dealer registration must also disclose their business structure and dynamics. Typical business structures* include corporations, partnerships, and limited liability companies (LLCs). Business dynamics primarily focus on controlling affiliates, which are any persons that maintain a controlling interest (influence) over the business. It’s important the state administrator knows who runs the business. Additionally, the firm must disclose the specific type of products and services they’ll be offering. For example, what types of securities will the broker-dealer be selling to customers?

*Although rare, a broker-dealer could also be registered as a sole proprietorship.

Business history is another disclosure required on Form BD. Qualifications, past legal actions, and any penalties or criminal convictions relating to the business and its controlling affiliates are explicitly requested.

For businesses to qualify for broker-dealer registration, they must meet certain financial requirements (discussed more later on in this unit). These financial requirements are specific to the broker-dealer, not its employees. Additionally, the firm and its controlling affiliates must have a fairly clean record. Past legal events, regulatory actions, and/or criminal cases are usually required to be disclosed.

Legal actions include any court ruling against the firm, like an injunction or enjoinment. Although the SEC and state administrator have regulatory authority over financial persons, they do not have the same legal authority granted to the court system. If the administrator wants any legal action taken (e.g. legally barring a broker-dealer from engaging clients of another broker-dealer, or imprisoning an employee of the broker-dealer for fraud), they must petition the court system. We’ll learn more about the extent of the state administrator’s powers and when they must appeal to the US court system later in this material.

The SEC does not have the power to criminally charge persons or imprison individuals, but they are granted more powers than the state administrator. This is quoted directly from the SEC’s website:

SEC investigations are civil, not criminal. The SEC can charge individuals and entities for violating federal securities laws and seek remedies such as monetary penalties, disgorgement of ill-gotten gains, injunctions, and restrictions on an individual’s ability to work in the securities industry or to serve as an officer or director of a public company, but the SEC cannot put people in jail. [The SEC] may refer potential criminal cases to criminal law enforcement authorities for investigation or coordinate SEC investigations with criminal investigations involving the same conduct. If a person is convicted of a criminal violation of the securities laws, a court may sentence that person to serve time in jail.

Regulatory actions involve any action taken against the business by a regulator. This could include any state administrator, the SEC, FINRA, Commodities Futures Trade Commission (CFTC), or any other regulatory authority related to finance (domestic or foreign). Form BD is especially concerned with the disclosure of rules violations, license suspensions or revocations, and/or false statements made to those regulators. If there’s enough of a bad history for the company or its controlling affiliates, it’s possible the state administrator denies their application for registration.

Obtaining previous criminal events related to the firm and its controlling affiliates are a top priority of the state administrator. In particular, Form BD requires the disclosure of any charge, guilty plea, nolo contendere (no contest) plea, or conviction of any felony or securities-related misdemeanor within the past 10 years. If the charge was dropped or the defendant (the broker-dealer or its controlling affiliates) was found not guilty, it won’t affect their registration status. Guilty pleas, nolo contendere (no contest) pleas*, and convictions could easily put the broker-dealer’s registration in jeopardy.

*Test questions typically don’t refer to guilty and no contest pleas. You can expect these to be generally referred to as convictions.

Here’s a summary of the general disclosures required on Form BD:

Basics of the business

• Name
• EIN (tax reporting number)
• Business address
• Contact person

Other jurisdictions

• Disclosure of registration with SEC and other states

Business structure

• Corporation, partnership, sole proprietorship, or LLC

Business dynamics

• Disclosure of controlling affiliates
• Types of products and services to be offered

Business history

• Qualifications (financial and legal)
• Any legal actions against the firm or its controlling affiliates
• Any criminal events related to the firm or its controlling affiliates

Consent to service of process

The consent to service process is a document submitted alongside the registration form that appoints the state administrator as eligible to accept civil (non-criminal) complaints or legal requests on behalf of any registered person. If you’re really curious, click this link to see the actual form. Here’s a snippet of some of the language on the consent to service of process:

[The person signing this form] hereby irrevocably appoints the officers of the Jurisdictions [of the state administrator]… [to] be served any notice, process or pleading in any action or proceeding against it”

The consent to service of process ensures any legal action a registered person is subject to (e.g. a lawsuit or subpoena) is sent to the state administrator. In the US legal system, recipients of legal actions and/or requests must be officially served (physically provided) with the necessary documents. Legal proceedings can’t take place until the recipient is served, which provides an incentive to hide in some circumstances. If you’ve ever seen Pineapple Express, Seth Rogen’s character’s job is to serve legal paperwork (warning: explicit language and material in the linked clip).

Even if a registered person tries to avoid being served a subpoena or lawsuit, they can’t. Lawyers are aware the state administrator can legally be served on behalf of their applicants. This keeps the state administrator aware of any legal proceedings against any person registered in their state, and prevents any issues arising from failure to serve documents.

Submission of the consent of service of process is required for every registered person and security, but only with the initial application. There’s no need to renew this document once it’s been originally filed.

Filing fee

While it seems trivial, filing fees are a testable topic on the Series 66. A filing fee must be paid when an application for registration is submitted. Every state* has its own fee schedule; for example, the Massachusetts state administrator requires a $450 filing fee for a broker-dealer’s initial registration. Registration forms are denied if the required filing fee is not paid.

*Although each state maintains its own fee schedule, the SEC does not charge a registration fee.

When a broker-dealer initially registers, its registration only lasts until the end of the calendar year (December 31st), regardless of when the initial application is submitted. Additionally, a full filing fee must be paid no matter how long the initial registration will last. If a broker-dealer registers on December 20th, their registration only lasts for 11 days (until the end of the year) and they must pay a full year’s filing fee. Unfortunately for applicants, the state administrators never prorate their fees.

To maintain compliance with the state administrator, registered persons must renew their registration (for the next calendar year) before December 31st. If the renewal application is not processed by the end of the year, the person’s registration will lapse (not a good thing). And yes, renewals are also subject to filing fees!

If a person’s registration lapses, they may no longer function in any role requiring registration. For example, a broker-dealer may not execute securities transactions until their registration is renewed (which is a big deal and can result in significant losses in revenue). The same concept applies to all financial professionals registered with the state, which also includes agents, investment advisers, and investment adviser representatives (IARs).

There is one instance the state administrators do not require an additional filing fee - successor firms. If one broker-dealer buys out and takes over another broker-dealer, Form BD must be amended and updated in order to notify the regulators of the change. Although the state administrators require filing fees in almost every instance of paperwork being filed, successor firm updates are free.