Recent No-Action Letter is a Relief for M&A Brokers
By Mark F. Costley and Frances V. Ryan
A no-action letter recently issued by the SEC’s Division of Trading and Markets is a welcome development in the private equity world as it permits “M&A Brokers,” subject to conditions, to provide advice regarding certain types of mergers and acquisition transactions (“M&A Transactions”), participate in the negotiation of the transaction, and receive transaction-based compensation, without registering as broker-dealers pursuant to Section 15(b) of the Securities Exchange Act. The letter goes far beyond the SEC’s previous guidance on permitted activities for unregistered intermediaries.
In the letter, an M&A Broker is defined as a “person engaged in the business of effecting securities transactions solely in connection with the transfer of ownership and control of a privately held company… through the purchase, sale, exchange, issuance, repurchase, or redemption of, or a business combination involving, securities or assets of the company to a buyer who will actively operate the company or the business conducted with the assets of the company.” The letter permits, subject to conditions, M&A Brokers to facilitate the sale of privately held businesses by way of mergers, acquisitions, business sales, and combinations, without regard to the size of the transaction. Significantly, the relief does not restrict the type of compensation the M&A Broker can receive.
The relief is subject to a number of conditions, including the following:
The M&A Broker does not have the ability to bind a party to an M&A Transaction.
An M&A Broker may not directly, or indirectly through any of its affiliates, provide financing for an M&A Transaction. However, subject to certain conditions, the M&A Broker may arrange financing with unaffiliated third parties.
An M&A Transaction may not involve a public offering.
Under no circumstances will 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 transaction for the account of others.
An M&A Broker may only facilitate an M&A Transaction with a group of buyers only if the group is formed without the assistance of the M&A Broker.
The M&A Broker, its officers, directors, and employees may not have been barred from association with a broker-dealer by the SEC, any state or other U.S. jurisdiction or any self-regulatory organization, or is not suspended from association with a broker dealer.
The letter does not provide any relief for the transfer of interests to a passive buyer or a group of passive buyers. An M&A Transaction must result in a buyer or a group of buyers who control and actively operate the company or the business conducted with the assets of the business. A buyer, or group of buyers will satisfy the control requirement if they have the power, directly or indirectly, to direct the management or policies of a company, whether through ownership of securities, by contract, or otherwise. Control will be presumed to exist if, upon completion of the transaction, the buyer or group of buyers 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.
While the no-action letter does not address important issues related to the sale of interests in private equity funds by persons or firms that are not registered as broker-dealers, it does provided needed clarity for private funds as to when they can pay M&A Brokers for participating in M&A Transactions without incurring regulatory and other risks that may be created when engaging in securities transactions with parties that are not registered as broker-dealers. Hopefully, the letter is the foundation for other initiatives to improve the broker-dealer regulatory scheme and also to assist in the creation of capital for privately-held companies.
 M&A Brokers (SEC No-Action Letter, January 31, 2014, Revised February 4, 2014).
 The SEC Staff previously issued two letters providing limited relief in this area. Country Business, Inc. (SEC No-Action Letter, November 8, 2006), and International Business Exchange Corporation (SEC No-Action Letter, December 12, 1986). A person seeking to rely on those letters could not engage in negotiations on behalf of a client, advise the client whether to issue securities, or assess the value of any securities sold. Transactions were limited to the sale of 100% of the equity of the company to be acquired. The letters also left unclear whether alternative fee arrangements were permissible in connection with the sale of larger businesses.
 These risks include potential rescission rights that arise when a securities transaction is effected in violation of the Exchange Act. The laws of various states may still provide purchasers in M&A Transactions rescission rights.
A Cautionary Tale for Private Equity Funds Investing in the European Union
By Robin Sampson
A private equity fund made a major investment in a foreign manufacturer in 2005, and its majority investment gave it various supervisory and governance rights (such as the right to elect or remove the portfolio company’s governing body). In 2007 the PE reduced its stake, and it exited the investment entirely in 2009. According to the European Commission (and quite probably without the knowledge of the PE fund), from 1998 to 2008 the portfolio company and nearly a dozen other manufacturers were engaged in a cartel to undermine the competitive pricing of underground and submarine high voltage power cables. Collectively, the cartel participants were fined nearly 302 million euros earlier this month. The portfolio company and its former investor are jointly and severally liable for more than 104 million euros as their part of the cartel fine.
The European Courts have declined, in this and other cases, to give financial investors a pass when it comes to policing the behavior of their portfolio companies. As long as a parent company has the power to exercise decisive control over its subsidiary and exercises that power (by, for example, electing the subsidiary board, directing the subsidiary’s economic activities, and conforming the portfolio company’s policies to its own strategic goals), then the conduct of the subsidiary likely will imputed to the parent, whether or not the parent directed or even knew of any suspicious conduct. One could imagine a purely passive minority investment where the issue of control could be refuted, but where a private equity owns (directly or indirectly) most or all of the equity of its portfolio company, that fund will be presumed to exercise decisive influence over its subsidiary. That presumption will be very difficult, and perhaps impossible, to overcome.
So, what’s an investor to do?
This tale is a reminder that rigorous pre-acquisition due diligence, focusing on antitrust risks, is a must for private equity funds investing in Europe. Upon acquisition and periodically throughout the life of the investment a majority financial investor should revisit and reinforce its antitrust compliance programs, at both the portfolio company and fund levels. And an investor in multiple industry segments might not want to rely on a “one size fits all” compliance program. Instead, a private equity fund should tailor its compliance checks to the specific industry and competitive risks of each investment.