Federal and state securities laws generally require that persons engaged in the business of effecting securities transactions for the accounts of others be registered as brokers. We have previously written about the difficulty of squaring the broker definition in private offerings (where the notion of “effecting a transaction” does not fit the practical reality of the mechanics of the private sale), related SEC staff views and court decisions with respect to so-called “finders” and other broker status considerations (including how the meanings of “engaged in the business” and “solicitation” lack clarity), and how engaging unregistered intermediaries can create legal and regulatory risk.
Corporate M&A activity has led to similar questions and regulatory considerations. Since 2014, though, many parties intermediating M&A transactions have relied on an SEC staff “no action” letter (2014 NAL) that provided important clarity for what had been a grey area in the broker regulatory landscape. The 2014 NAL also partially solved an incongruous result for firms facilitating asset sales, which generally do not include securities activity, versus those facilitating stock sales, which is securities activity and does raise broker status concerns for intermediaries.
The 2014 NAL did not, however, preempt US state or territorial laws regarding broker registration. In 2015, NASAA, an association comprised of state and provincial securities regulators in the US, Canada, and Mexico, adopted a “model rule” intended to help codify the 2014 NAL. Only a handful of US states have adopted a version of the model rule. In some other states, there are exemptions or definitional exclusions for persons engaged in the state solely with institutional investors or in a de minimis number of transactions in any year. As a result, state-level broker registration remains an important consideration for M&A brokers, even if an exemption exists at the federal level.
Key Elements of the New Federal Exemption
The term “M&A broker” means a broker, and any person associated with a broker, engaged in the business of effecting securities transactions solely in connection with the transfer of ownership of an eligible privately held company, regardless of whether the broker acts on behalf of a seller or buyer, through the purchase, sale, exchange, issuance, repurchase, or redemption of, or a business combination involving, securities or assets of the eligible privately held company.
As described in greater detail below, eligible privately held companies are limited to those either with prior-year EBITDA of less than $25 million or prior-year gross revenues of less than $250 million.
The broker relying on the exemption must reasonably believe that, upon consummation of the transaction, any person acquiring securities or assets of the eligible privately held company, acting alone or in concert will:
- Control the eligible privately held company or the business conducted with the assets of the eligible privately held company; and
- Directly or indirectly, be active in the management of the eligible privately held company or the business conducted with the assets of the eligible privately held company, including without limitation, for example, by electing executive officers, approving the annual budget, serving as an executive or other executive manager.
In addition, if the person selling the eligible privately held company will receive securities from the buyer, prior to becoming legally bound to consummate the transaction, the seller must receive or have reasonable access to the most recent fiscal year-end financial statements of the issuer of the securities used as part or all of the purchase consideration, as customarily prepared by the management of the issuer in the normal course of operations and, if the financial statements of the issuer are audited, reviewed, or compiled, any related statement by the independent accountant, a balance sheet dated not more than 120 days before the date of the offer, and information pertaining to the management, business, results of operations for the period covered by the foregoing financial statements, and material loss contingencies of the issuer.
“Eligible privately held company” means a privately held company that:
- Does not have any class of securities registered, or required to be registered, with the Commission under Exchange Act Section 12 or with respect to which the company files, or is required to file, periodic information, documents, and reports under Exchange Act Section 15(d); and
- In the fiscal year ending immediately before the fiscal year in which the services of the M&A broker are initially engaged with respect to the securities transaction, the company meets either or both of the following conditions (determined in accordance with the historical financial accounting records of the company): EBITDA is less than $25 million or the gross revenues of the company are less than $250 million.
The required “control” means the power, directly or indirectly, to direct the management or policies of a company, whether through ownership of securities, by contract, or otherwise. There is a presumption of control if, upon completion of a transaction, the buyer or group of buyers:
- Has the right to vote 25% or more of a class of voting securities or the power to sell or direct the sale of 25% or more of a class of voting securities; or
- In the case of a partnership or limited liability company, has the right to receive upon dissolution, or has contributed, 25% or more of the capital.
- The new federal exemption largely tracks the 2014 NAL. There are also significant similarities to the related 2015 NASAA model rule. However, nuances among the three require careful consideration. For example, the required level of control is 25% in the new federal exemption and the 2014 NAL, but only 20% in the NASAA model rule. The new federal exemption also includes the EBITDA and revenue limits referenced above, as does the NASAA model rule, but those are not included in the 2014 NAL. The requirement to provide prior-year financials with regard to securities used by the buyer as consideration for the purchase tracks that of the model rule, but is new compared to the 2014 NAL.
- The new federal exemption relates to broker status and registration at the federal level. However, the individual states also regulate the activity of securities brokers. Several states will likely decline or neglect to adopt similar exemptions, particularly given that only a handful have adopted some form of the model rule. Many states have an exemption, or exclusion from the definition of broker or dealer, for a person with no place of business in the state whose only transactions in the state are with institutional investors (as defined by the state) and a de minimis number of other persons during the course of a year. Buyers and sellers in eligible M&A transactions will not always qualify as institutional investors. This patchwork of exemptions would only perpetuate what is already a quagmire of regulatory and compliance concerns for buyers, sellers, and intermediaries. Absent alignment, this could require that M&A brokers that are exempt at the federal level serve only those companies resident in particular states and limit their activity to deals that only involve buyers in those same jurisdictions.
- The new federal exemption merely says that an M&A broker that fits within new Section 15(b)(13) need not register with the SEC. Importantly, exempt M&A brokers will remain subject to SEC jurisdiction, including antifraud provisions of the federal securities laws and potential enforcement actions. The same would likely be true for those states that adopt a similar exemption.
- The new federal exemption does not address the receipt of transaction-based compensation, commissions, or other variable or success-based compensation by the relying broker. Nevertheless, this must be permissible, otherwise the exemption is useless.
- The new federal exemption is limited solely to the prescribed M&A activities, and therefore does not permit unregistered brokers to identify new sources of capital or otherwise facilitate securities offerings. In particular, new Section 15(b)(13) does nothing to clarify the use of unregistered “finders.” Back in October 2020, the SEC proposed a conditional exemption to permit natural persons to engage in limited securities activities as “finders” on behalf of private issuers without registering as brokers. However, the SEC never adopted that exemption and the agency is unlikely to do so at this point.
- The M&A broker definition in new Section 15(b)(13) maintains the “engaged in the business” element from Exchange Act Section 3(a)(4). This is always a “facts and circumstances” determination and will likely continue to result in questions about whether an exemption is even needed for instances of brokering activity that is not regularly occurring.
- The M&A broker definition does not address whether the exemption is available only for entities and their “associated persons,” or, instead, if natural persons may directly rely on the exemption without acting through a corporation, LLC, or some other entity. Individuals should be able to rely on the new federal exemption, although past action by the SEC has suggested that the staff may consider this distinction to be important.
- “Associated person” also is not defined in the exemption, but this should be read broadly, as is currently the case in the registered broker context, including officers, employees, and others engaged in the relying broker’s business or controlled or under common control with the relying broker.
- Questions related to sufficient control often arise related to the 2014 NAL and that will likely continue with the new federal exemption. This often comes up in the context of private fund acquisitions or dispositions of portfolio companies. The examples in new Section 15(b)(13) are not exhaustive, so it is possible to satisfy the control prong in other ways.
- The new federal exemption similarly prohibits transferring interests to “passive” buyers and purchasers must “actively operate” the company. These prongs of the exemption should be carefully considered in the context of PE, VC, and other private funds acquiring and selling operating companies.
- Parties contracting with exempt M&A brokers relying on new Section 15(b)(13) should seek representations and warranties related to compliance with the applicable provisions, including the absence of any disqualifying factors. Likewise, exempt M&A brokers should consider the prospective terms of any particular transaction they anticipate intermediating to ensure that it fits within the parameters of new Section 15(b)(13).
- The M&A broker definition refers to activity involving the securities or assets of the eligible privately held company. One could read this to suggest that brokering the sale of assets requires a broker registration or a related exemption. Instead, we think this is an unfortunate carryover from the 2014 NAL that similarly refers to securities or assets in the scope of activity. We believe this was intended to be read as not limiting the M&A broker’s activity solely to securities, given that these intermediaries typically handle both categories and often do not know the scope of the engagement until after they have commenced their services. A person who acts as broker with respect to the sale of assets only and not securities would not meet the definition of broker under Exchange Act Section 3(a)(4) and, therefore, would not need the new exemption.
- Statements by a US Representative Bill Huizenga, a sponsor of H.R.2617, suggest that the prior-year $25 million EBITDA and $250 million gross revenues limits were designed to limit the exemption to broker-dealers handling smaller deals in local communities. Mr. Huizenga (rightly) believed that federal regulation of M&A brokers imposes very substantial initial costs and ongoing regulatory costs ultimately borne by the sellers and/or buyers using the professional services of registered brokers. Thus, one of his goals for the exemption was to reduce the cost of M&A transactions involving smaller businesses by removing “unwarranted” regulatory costs, and allowing privately-owned business sellers and buyers to engage unregistered M&A brokers rather than investment bankers at larger registered broker-dealers. Exempting certain M&A brokers from federal registration is likely to reduce their overall regulatory costs. However, the true impact of the new exemption remains to be seen, in part because most intermediaries able to rely on the new federal exemption are likely already able to rely on the 2014 NAL. The most significant impact may result from the dollar limits on eligible privately held companies.
The new federal M&A broker exemption is helpful, but it is far from a panacea for M&A brokers or buyers or sellers using these unregistered intermediaries.
It will be important for the SEC to proactively issue guidance about the new federal exemption (e.g., related to the control and active operation prongs), and not solely in the context of examinations and enforcement actions. Alternatively, SEC staff may withdraw the 2014 NAL, perhaps by the effective date of new Section 15(b)(13). SEC staff has also issued separate NALs to non-US parties that intermediate M&A transactions involving US targets. Like the 2014 NAL, the staff may consider whether to rescind those non-US-focused NALs. We also expect that the new law will motivate states to adopt corresponding exemptions. The fact that new Section 15(b)(13) more closely tracks the NASAA model rule than the 2014 NAL should facilitate state adoptions.
Parties that have previously intermediated M&A transactions in reliance on the 2014 NAL should consider the differences between its terms and those of the new federal exemption. New entrants into this space, and businesses and buyers seeking to use those intermediaries, should also carefully examine the new exemption to ensure proper reliance.
 If adopted, the October 2020 proposed SEC finder exemption would have only been available to natural persons. The Commission did not provide insight as to why they limited the proposed exemption in this manner. Our sense is that it was to discourage proposed “Tier II Finders” from establishing businesses, with employees or agents, to engage in finder activity.
 The Hill, “Bipartisan bill will help level the playing field for small businesses” (July 2021)
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