A recently issued SEC no-action letter provides further clarity on the applicability of broker-dealer registration requirements to merger and acquisition brokers (M&A brokers). The no-action letter is issued as Congress considers legislation to exempt certain M&A brokers from broker-dealer registration requirements. The Small Business Mergers, Acquisitions, Sales, and Brokerage Simplification Act of 2013 amends the Securities Exchange Act of 1934 to allow M&A brokers who perform services in connection with the transfer of ownership of smaller privately held companies to register with the Securities and Exchange Commission (SEC) by filing an electronic notice.
The SEC regulates the activities of brokers (“any person engaged in the business of effecting transactions in securities for the account of others”) and dealers (“any person engaged in the business of buying and selling securities for his own account”). The SEC’s chief objective in regulating broker-dealers is to prevent securities fraud. Broker-dealers are required to register with the SEC and are subject to ongoing reporting requirements. The cost of compliance with this regulatory scheme may deter some smaller broker-dealers from registering.
M&A brokers argue that they should be exempt from regulation because their activities do not entail the risk of securities fraud the SEC aims to prevent. This position was rejected by the United States Supreme Court in a pair of landmark cases issued in 1985. (Landreth Timber Company v. Landreth, 471 U.S. 681 (U.S. 1985); Gould v. Ruefenacht, 471 U.S. 701 (U.S. 1985). Since that defeat, the ABA and other trade groups have lobbied in favor of an explicit exception to the broker-dealer registration requirements for “entities or individuals involved solely in the match-making to permit merger and acquisition brokerage activities.” (See Report and Recommendations of the Task Force on Private Placement Broker-Dealers, American Bar Association (2005)). According to the report, “the vast preponderance of this activity occurs by non-registered persons and there is little history to warrant a requirement for full broker-dealer registration.”
The Jan 31, 2014 no-action letter expands the safe harbor for unregistered broker-dealers engaged in connection with the purchase or sale of privately-held companies. The safe harbor applies to M&A Brokers (defined as “a person engaged in the business of effecting securities transactions solely in connection with the transfer of ownership of ownership and control of a privately-held company . . . to a buyer that will actively operate the company or the business conducted with the assets of the company”) that facilitate “M&A Transactions” (defined as “mergers, acquisitions, business sales, and business combinations”). Certain conditions must be met to fall within the scope of the no-action letter:
1. The M&A Broker will not have the ability to bind a party to an M&A Transaction.
2. An M&A Broker will not directly, or indirectly through any of its affiliates, provide financing for an M&A Transaction. An M&A Broker that assists purchasers to obtain financing from unaffiliated third parties must comply with all applicable legal requirements, including, as applicable, Regulation T (12 CFR 220 et seq.), and must disclose any compensation in writing to the client.
3. Under no circumstances may an M&A Broker have custody, control, or possession of or otherwise handle funds or securities issued or exchanged in connection with an M&A Transaction or other securities transactions for the accounts of others.
4. No M&A Transaction may involve a public offering. Any offering or sale of securities will be conducted in compliance with an applicable exemption from registration under the Securities Act of 1933 (the “Securities Act”). No party to any M&A Transaction may be a shell company, other than a “business combination related shell company.”
5. To the extent an M&A Broker represents both buyers and sellers, it will provide clear written disclosure as to the parties it represents and obtain written consent from both parties to the joint representation.
6. An M&A Broker will facilitate an M&A Transaction with a group of buyers only if the group is formed without the assistance of the M&A Broker.
7. The buyer, or group of buyers, in any M&A Transaction will, upon completion of the M&A Transaction, control and actively operate the company or the business conducted with the assets of the business. A buyer, or group of buyers collectively, would have the necessary control if it has the power, directly or indirectly, to direct the management or policies of a company, whether through ownership of securities, by contract, or otherwise.6 In addition, the buyer, or group of buyers, must actively operate the company or the business conducted with the assets of the company.
8. No M&A Transaction will result in the transfer of interests to a passive buyer or group of passive buyers.
9. Any securities received by the buyer or M&A Broker in an M&A Transaction will be restricted securities within the meaning of Rule 144(a)(3) under the Securities Act because the securities would have been issued in a transaction not involving a public offering.
10. The M&A Broker (and, if the M&A Broker is an entity, each officer, director or employee of the M&A Broker):
(i) has not been barred from association with a broker-dealer by the Commission, any state or any self-regulatory organization; and
(ii) is not suspended from association with a broker-dealer.
This Densborn Blachly LLP publication should not be construed as legal advice or legal opinion on any specific facts or circumstances. The contents are intended for general informational purposes only, and you are urged to consult your own lawyer on any specific legal questions you may have concerning your situation.