Securities and Exchange Commission (SEC) Issues Mergers & Acquisitions (M&A) Broker No-Action Letter
The SEC staff recently issued a “no-action” letter stating that certain merger and acquisition intermediaries may, under certain circumstances, effect M&A transactions for private companies without registering as broker-dealers under the Securities Exchange Act of 1934.1 The no-action letter (the “M&A Broker Letter”) represents a significant expansion of prior SEC interpretations in the business broker area.
Under previous SEC guidance, broker-dealer registration was generally required for any intermediary that received transaction-based compensation, provided advice to clients regarding whether to issue securities or assessed the value of securities sold. The prior guidance did not allow unregistered intermediaries to engage in negotiations on behalf of clients in acquisitions, business sales, and business combinations (collectively, “M&A Transactions”). In the 2006 Country Business, Inc. no-action letter, the SEC staff permitted unregistered persons to act as business brokers only for “small businesses,” as defined by the U.S. Small Business Administration. That letter further stated that an unregistered person must have a limited role in negotiations, could not jointly advise buyers and sellers, and could not advertise the sale of securities. In contrast, the new M&A Broker Letter expands the scope of permissible activities for unregistered intermediaries engaging in the business of negotiating private company sales.
The M&A Broker Letter
The M&A Broker Letter defines “M&A Broker” as any person engaged in the business of facilitating securities transactions to transfer the ownership and control of privately-held companies, through the purchase, sale, exchange, issuance, repurchase, or redemption of, or a business combination involving, securities or assets of the company, to a buyer that will actively operate the business of the target company.
Contrary to the prior guidance, the target company need not be a small business; however, it must be a privately-held company that does not have securities registered under Section 12 or file periodic reports under Section 15(d) of the Securities Exchange Act. An M&A Broker that facilitates M&A Transactions between sellers and buyers of privately-held companies will be permitted to advertise the privately-held company for sale with information such as the description of the business, general location, and price range.
An M&A Broker will not have to register as a broker-dealer under the Securities Exchange Act if all of the following conditions are met:
The M&A Broker must not be able to bind a party to the M&A Transaction and must not provide financing for the M&A Transaction.
The M&A Broker may not have custody of, or control, possess or otherwise handle, funds or securities in connection with the M&A Transaction.
The M&A Transaction must not involve a public offering, and no party to the transaction can be a shell company (other than a business combination-related shell company).
If an M&A Broker represents both the buyer and seller, it must obtain informed consent to the joint representation, after disclosure of the arrangement to both parties.
The M&A Broker will not be permitted to form a group of buyers for an M&A Transaction.
Upon completion of the M&A Transaction, the buyer must control and actively operate the business of the target. The M&A Transaction should not result in the transfer of interests to a passive buyer. “Control” will be presumed to exist if the buyer 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% 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 M&A Broker, its officers, directors or employees must not have been barred or suspended from association with a broker-dealer by the SEC, any state or any self-regulatory organization.
Because an M&A Transaction is, by definition, not a public offering, any securities received by a buyer or an M&A Broker in the M&A Transaction will be “restricted securities” pursuant to Rule 144(a)(3) under the Securities Act of 1933.
The M&A Broker Letter clarifies that M&A Brokers will be exempt from the broker-dealer registration requirements of Section 15(a) of the Securities Exchange Act, but other provisions of the federal securities laws, including the anti-fraud provisions, and state laws, continue to apply.
Significantly, the M&A Broker Letter does not address the type of compensation that M&A Brokers may receive. While the incoming letter specifically requested that the SEC staff’s response permit the M&A Broker to receive transaction-based or other compensation, as agreed by the parties, in connection with an M&A Transaction, the M&A Broker Letter is silent regarding any limits on compensation. Given that the M&A Broker Letter specifically enumerates the other conditions that an M&A Broker must meet to avoid broker-dealer registration, it appears that the SEC staff intends to allow M&A Brokers to receive transaction-based compensation.
M&A intermediaries should keep in mind that an SEC no-action letter is not law. No-action relief is a staff interpretation limited to the specific facts detailed in the request, and can be modified or rescinded at any time.
Implications for Private Equity Firms
The M&A Broker Letter does not specifically address private equity firms, so there remains some uncertainty regarding the application of the letter to private equity firms. The new guidance would permit M&A Brokers to be engaged by private equity firms to identify investment opportunities, provided that the acquirer will “actively operate” the business after the acquisition. A private equity fund manager that wishes to rely on the M&A Broker Letter to sell the fund’s stake in a portfolio company may also have a difficult time complying with the prohibition against having custody of securities exchanged in the transaction, and the condition that the M&A Broker must not have the ability to bind a party to an M&A Transaction.
State Law Considerations
Anyone relying on the M&A Broker Letter will also need to consider the broker-dealer registration requirements of the states in which the M&A Broker and target company operate. The M&A Broker Letter does not preempt state law, and some states may still require broker-dealer registration.