The Situation: Congress recently amended the Securities Exchange Act of 1934 (the “Exchange Act”) to exempt certain “M&A brokers” from registering as broker-dealers with the US Securities and Exchange Commission (“SEC”).
The IS Issue: While the new exemption essentially codifies inactivity relief previously granted by the SEC’s Division of Trade and Markets, its terms are narrower than the previous relief, and only apply to M&A transactions for small entity issuers . The new legislation also does not satisfy state law registration requirements for M&A brokers.
Looking Ahead: After the SEC previously granted inaction relief, several states took action to provide similar relief at the state level. It remains to be seen whether they and other states will amend their current requirements or enact new laws or regulations exempting M&A brokers from state registration requirements to match the new federal statutory exemption.
Included in the Consolidated Appropriations Act of 2023 (HR 2617) at page 1080 (the “Act”), which President Biden signed into law on December 29, 2022, is a provision exempting brokers who facilitate small business M&A from registration with the SEC. Section 501 of Title V of Division AA of the Act amends Section 15(b) of the Exchange Act by adding a new subsection 15(b)(13), which provides an exemption (the “New Exemption”) from registration with the SEC in regarding that. – known as “M&A brokers” who meet the conditions of the exemption. A person who meets the conditions of the New Exemption may receive commissions for his brokerage services—a hallmark of broker-dealer status that generally requires registration with the SEC—without having to register with the SEC as a broker-dealer. The New Exemption aims to facilitate small business change of control transactions and create cost saving opportunities for small businesses.
Terms of the New Statutory Exemption
For the purposes of the New Exemption, an “M&A broker” is essentially defined as a broker (and its associates) engaged in the business of effecting securities transactions wholly in connection with the transfer of ownership of an “eligible private company” through the securities or assets of dispose of an eligible privately held company, if the broker reasonably believes:
- Once the transaction is consummated, the buyer will acquire “control” (eg, the right to vote or order the sale of 25% of shares) of the eligible privately held company or business carried on with its acquired assets , and will be active. in the management of the business (by, for example, electing executive officers, approving the annual budget, or serving as executive or other executive manager); and
- Any purchaser, before being legally bound to complete the transaction, has obtained reasonable access to various disclosure documents, including, among others, the company’s most recent fiscal year-end financial statements, as well as well as information relating to the issuer’s management, business, results of operations, and material loss events.
To be an “eligible privately held company”, the acquired company must (i) not have any class of securities registered with the SEC pursuant to Section 12 of the Exchange Act or subject to the filing obligations of Section 15(d); and (ii) in the fiscal year prior to the hiring of the M&A broker, (a) earnings of less than $25 million before interest, taxes, depreciation and amortization and/or (b) gross income of less than $250 million.
The New Exemption contains a list of activities that would prevent the M&A broker from benefiting from the exemption. These activities include, among others:
- Directly or indirectly, to receive, hold, transmit or keep the funds or securities of the parties involved in the transaction;
- Engaging in a transaction involving a shell company, other than a shell company involving a business combination formed solely for the purposes of the transaction;
- Directly, or indirectly through any of its affiliates, provide funding to a party to the transaction;
- Assist any party in obtaining financing from an unaffiliated third party without (i) complying with all other laws applicable to such assistance, including, if applicable, Regulation T; and (ii) disclose any compensation in writing to the party;
- Representing both the buyer and the seller in the same transaction without providing written disclosure of the parties being represented and obtaining the written consent of both parties to the joint representation;
- Assist in establishing a buyer group to acquire the eligible privately held company;
- 648/2012 Text relevant to the EEA Participating in a transaction involving the transfer of ownership of an eligible privately held company to a passive buyer or a group of passive buyers; and
- Binding party in a transfer of ownership of an eligible privately held company.
In addition, to qualify for the New Exemption, the M&A broker or its associates cannot be barred from association with a broker or dealer by the SEC, any state, or any self-regulatory organization (ie, an exchange or FINRA) or on suspension from association with a broker or dealer.
Prior SEC Inaction Relief Remains in Effect in the Area
The New Exemption is similar to the relief previously provided by the SEC’s Division of Trade and Markets staff in its 2014 “M&A Brokers” No-Action Letter (the “SEC No-Action Letter”), but there are some significant differences. For example, while the SEC’s No Action Letter applies to transactions involving private companies of any size, the New Exemption is limited to transactions involving a change of control of small business entities. However, the New Exemption expressly provides that it does not limit the SEC’s authority to exempt anyone from any provision of the Exchange Act, so M&A brokers should still be able to rely on the SEC’s No-Action Letter if they are engaged in M&A . transactions involving large private issuers and meet the conditions for that relief.
Additionally, the SEC’s No Action Letter puts into relief, in part, the fact that “[a]Any securities acquired 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 of 1933 (the “Securities Act”) because the securities. issued in a transaction not involving a public offering.” Although new Section 15(b)(13) does not expressly address the status (ie, restricted or otherwise) of any security transferred in a transaction facilitated by an M&A broker pursuant to the New Exemption, the holder will, however, be required to determine, as part of its compliance with the Securities Act, whether or not any securities it acquires in such transaction are restricted securities. private property and be actively involved in its management, the SEC No Action Letter requires that the purchaser must Seriouslyactively control and operate the privately held company.
Congress Didn’t Overturn State Securities Laws
What is important is that the New Exemption does not appear to prohibit state law broker registration or other requirements. Following the 2014 No Action Letter, the North American Association of Securities Administrators (“NASAA”), an association representing state and local securities regulators in the United States, Canada and Mexico, developed a model rule (the “Model Rule”) for its a state would accept, exempting certain M&A brokers from state broker registration. As of November 2020, at least 19 states had adopted some form of exemptive relief, based on the Model Rule, the SEC’s No-Action Letter, or a combination of the two.
The terms of the Model Rule, the SEC No Action Letter, and the New Exemption differ from each other. For example, the Model Rule does not incorporate many of the restrictions on M&A broker activities found in those other exemptions. Similarly, like the New Exemption, the Model Rule only requires that the M&A broker have a “reasonable belief” that the buyer will control and be actively involved in the management of the eligible privately held company that does not require control and actual management as required by the SEC No Action Letter. The Model Rule also differs from the others in that it defines “control” of a privately held company as a voting interest of at least 20% in the company, instead of a voting interest of at least 25% to constitute “control”. for registration under the Exchange Act. purposes. Finally, unlike the SEC No Action Letter but similar to the New Exemption, the Model Rule places limits on the size of the privately held acquired company ($25 million in earnings or $250 million in gross income). It remains to be seen whether any of the various states will adopt new exemptions or amend their existing M&A broker exemptions to match the terms of the New Exemption.
Therefore, even when an M&A broker is exempt from federal registration as a broker-dealer under the New Exemption or the SEC No Action Letter, the M&A broker should assure itself that it does not need to register with any particular state as a result. for its M&A broker activity in that state or with residents of that state.
The New Exemption is in effect 90 days after its enactment (ie March 29, 2023).
Three Key Takeaways
- Congress has enacted a new conditional statutory exemption from federal broker-dealer registration for M&A brokers who facilitate change-of-control transactions involving certain small private companies.
- M&A brokers facilitating change-of-control transactions involving larger private issuers may rely on the SEC staff’s 2014 M&A Broker Inaction Letter to avoid having to register with the SEC as a broker-dealer.
- Because the new exemption does not preempt state laws, persons relying on the new statutory exemption to avoid registration with the SEC will need to determine whether they are subject to broker-dealer registration under applicable state laws.
The content of this article is intended to provide a general guide to the subject. Specialist advice should be sought about your specific circumstances.