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SEC provides no-action relief from federal registration for M&A brokers in privately held companies transactions

February 14, 2014

After years of inactivity by the SEC and legal uncertainty concerning the federal registration requirements of mergers and acquisition brokers (M&A Brokers), and when legislation addressing the issue is successfully making its way through Congress, the SEC recently issued a no-action letter that represents a significant change in the SEC's position and in the regulatory framework for the registration of M&A Brokers. Essentially, the no-action letter provides that, under certain circumstances described below, an M&A Broker is permitted to effect securities transactions, and receive transaction-based compensation, in connection with the transfer of ownership of a privately held company without the M&A Broker registering as a broker-dealer under section 15(b) of the Securities Exchange Act of 1934 (Exchange Act).

Issued shortly after legislation amending the Exchange Act to exempt from registration brokers who provide services in connection with the transfer of ownership of private companies passed the U.S. House of Representatives (H.R. 2274) and was introduced in the Senate (S. 1923), the SEC Division of Trading and Markets issued its no-action letter which follows many of the provisions of the pending legislation. The Division permits M&A Brokers to facilitate mergers, acquisitions, business sales and business combinations between sellers and buyers of privately held companies. To meet the conditions of the no-action letter, a privately held company is one that does not have securities registered with the SEC and is not subject to the Exchange Act reporting requirements. The allowable activity includes (1) advertising that describes the business, location and price range, (2) participation in the negotiations for the transaction, (3) advice concerning issuing securities, or otherwise to effect the transfer of the business by means of securities, or assessing the value of any securities sold, and (4) receiving transaction-based compensation without imposing any limitation on the amount or type of compensation.

The no-action letter sets forth various conditions that must be met to avoid registration, including: 

  • M&A Brokers may not bind a party.
  • M&A Brokers may not provide financing for the transaction, whether directly or indirectly through any affiliates. M&A Brokers, however, may assist a purchaser with financing through an unaffiliated third party, but must comply with all applicable legal requirements and disclose in writing to its client the receipt of any compensation in connection with the financing. 
  • M&A Brokers may not have custody, control, possession of, or otherwise handle funds or securities issued or exchanged in connection with, the transaction or other securities transactions for the account of others.
  • The transaction may not involve a public offering and no party to the transaction may be a shell company other than a business combination related shell company.
  • If the M&A Broker represents both buyers and sellers, it must provide written disclosure as to the party it represents and obtain written consent from both parties for joint representation. 
  • M&A Brokers can facilitate a transaction with a group of buyers only if the group is formed without the assistance of the M&A Broker.
  • M&A Brokers may not facilitate a transaction that will result in the transfer of interests to a passive buyer.
  • The purchasers of the private company must ultimately control and actively operate the company or business conducted with the assets of the business. The Division indicated that there is a presumption of "control" if the buyer or group of buyers has (a) the right to vote 25% or more of a class of voting securities, (b) the power to sell or direct the sale of 25% or more of a class of voting securities, or (c) in the case of a partnership or limited liability company, the right to receive upon dissolution, or has contributed, 25% or more of the capital.
  • The buyer or group of buyers must actively operate the company or the business conducted with the assets of the company. The no-action letter indicates that a "buyer could actively operate the company through the power to elect executive officers and approve the annual budget or by service as an executive or other executive manager, among other things."
  • Any securities received by a buyer or an M&A Broker will be restricted securities within the meaning of Rule 144(a)(3) under the Securities Act of 1933 (Securities Act).
  • M&A Brokers may not have been barred from association with a broker-dealer by a regulatory authority or be subject to a suspension from association with a broker-dealer.

Many of these conditions parallel conditions in the pending legislation for M&A Broker exemption to registration. Interestingly, the no-action letter appears to provide broader relief from the registration requirement. For example, the no-action letter expressly indicates that there is no limitation on the size of the privately held company that is the subject of the sale. Under the pending bill, the exemption is limited to companies with revenues or earnings of less than $25 million. Moreover, the disclosure requirements are more onerous under the bill.

The no-action letter is a significant step by the SEC toward addressing the substantial costs of registration and the realities of business practices. As described in the letter requesting no action, the private company transactions that are the subject of the request do not pose the risk that, for example, retail sales of equities present to the investing public. There remain, however, many unaddressed and unanswered issues. It seems unlikely that advisers to private equity funds may rely upon the no-action letter because of the conditions that the M&A Broker not have custody, control, possession of or handle securities issued or exchanged in connection with the transaction, and that the M&A Broker not have the authority to bind a party. There is no change in the registration requirements of intermediaries (finders) in private placements and other securities transactions outside of business combinations.

While the no-action letter provides relief from federal registration, M&A Brokers currently may be required to register for such activities with the State of Michigan and other states. The SEC's position, and any Congressional action, however, may prompt states to modify their registration requirements.

For more information regarding this or any other broker-dealer related issue, please contact any of the attorneys in our Broker-Dealers and Investment Advisors Industry Group.