The SEC issued a no-action letter on Jan. 31, 2014, which was subsequently revised on Feb. 4, 2014, that permits certain M&A advisors and business brokers who work with privately held companies to avoid registration as broker-dealers pursuant to Section 15(a) of the Exchange Act. Broker-dealer registration is a lengthy and expensive process that subjects brokers to significant rules and regulations.
Historically, M&A advisors or business brokers have been able to avoid registration as broker-dealers only if they conducted their business in such a way that they did not effect transactions in securities in connection with the sale of private companies. While they were able to receive transaction-based compensation, the payment or amount of compensation could not depend on whether the transaction was structured as a sale of securities or a sale of assets.
The so-called M&A Brokers letter operates as an exemption from registration for M&A brokers that effect transactions in securities in connection with the purchase or sale of a business and permits M&A brokers to advertise privately held companies for sale, advise their clients on structuring the transaction, provide valuation advice as to the securities being sold in the transaction and receive transaction-based compensation, without registering as a broker-dealer. The M&A Brokers letter does not, however, exempt finders who introduce passive investors in connection with securities offerings.
The exemption granted pursuant to the M&A brokers letter is limited and only applies if 10 criteria are satisfied:
- The broker cannot have the ability to bind a party to the transaction.
- The broker cannot, directly or indirectly through affiliates, provide financing for the transaction.
- The broker cannot have custody or control of, or otherwise handle funds or securities issued in connection with, the transaction.
- The transaction cannot involve a public offering or a “shell” company.
- If representing both buyers and sellers, the broker must disclose who it represents and obtain consent to joint representations.
- If the transaction involves a group of buyers, the group must have been formed without the involvement of the broker.
- The buyer or group of buyers must control and actively operate the company or the business conducted with the assets of the business. Control will be presumed if the buyer, or buyer group has the right to vote 25% or more of a class of voting securities, has the power to sell or direct the sale of 25% of 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 transaction cannot involve transfers of interests to “passive” buyers.
- Any securities issued in the transaction must be restricted securities under Rule 144(a)(3) of the Securities Act of 1933.
- The broker must not have been barred or suspended from associating with a broker-dealer.
Any reliance on the no-action letter should involve a careful review of all 10 criteria to ensure that a particular broker’s activities are within the confines of the exemption.
State Securities Laws
M&A brokers need to be aware that the no-action letter has no effect on state securities laws, most of which also have broker-dealer regulation and registration requirements. Many states are likely to continue to take the position that M&A brokers are subject to their regulatory regimes notwithstanding the SEC’s revised position at the federal level.