A new development has emerged in the series of changes to the regulation of finders (i.e., persons that receive compensation for making an introduction leading to a securities transaction) and mergers and acquisition brokers (M&A Brokers). On March 29, 2023, staff of the U.S. Securities and Exchange Commission (SEC) Division of Trading and Markets withdrew its now ubiquitous 2014 No-Action Letter for M&A Brokers (M&A Broker NAL).[1] The no-action letter allowed certain M&A Brokers to facilitate securities transactions in connection with the transfer and ownership of a privately held company without registering as broker-dealers, if certain conditions were met. However, as part of a bill signed by President Biden just before the new year, Congress in 2022 enacted a new federal exemption for M&A Brokers (Federal M&A Broker exemption) and effectively rendered the M&A Broker NAL obsolete.[2]

Key Changes

• On the same day the Federal M&A Broker exemption took effect, the SEC staff repealed its previous relief for finders that met the definition of “M&A Broker” in the M&A Broker NAL.
• There is a new statutory exemption for M&A Brokers as a result of recent amendments to the Securities Exchange Act of 1934 (the Exchange Act).
• M&A Brokers are exempt from registration as broker-dealers under the new statutory exemption if they meet similar conditions as the SEC staff’s previous relief. However, the statutory exemption includes new elements such as a size limitation for determining eligible companies for M&A Brokers.

Background

The Exchange Act generally defines a broker as any person engaged in the business of effecting securities transactions of others.[3] Section 15(a)(1) of the Exchange Act generally prohibits a broker from “us[ing] the mails or any means or instrumentality of interstate commerce to effect any transactions in, or to induce or attempt to induce the purchase or sale of, any security ... unless such broker ... is registered” with the SEC in accordance with the Exchange Act. Absent an exemption or no-action relief, persons engaging in the business of effecting securities transactions in connection with the purchase or sale of a privately held company, which can include finder activity depending on the facts and circumstances, are required to register as broker-dealers or be associated with a registered broker-dealer.

In 2014, SEC staff issued the M&A Broker NAL stating that it would not recommend enforcement action to the SEC under Section 15(a) of the Exchange Act if an “M&A Broker”[4] effected securities transactions in connection with the transfer of ownership of a privately held company without registering as a broker-dealer pursuant to Section 15(b) of the Exchange Act, provided certain conditions were met.[5] While the M&A Broker NAL provided useful guidance and relief to certain market participants, no-action letters represent the views of SEC staff and have no legal force or effect. As such, they can be amended or withdrawn by SEC staff (as well as overridden by acts of Congress).

In addition to federal broker-dealer registration requirements, states have their own registration requirements for persons conducting broker-dealer related business within that state. In 2015, the North American Securities Administrators Association (NASAA) adopted a model rule exempting certain M&A Brokers from registration (NASAA model rule).[6] The NASAA model rule is substantially similar to the M&A Broker NAL and the Federal M&A Broker exemption,[7] but the model rule has not been widely adopted. This has not prevented a number of states from instituting some form of regulatory oversight for finders or M&A Brokers.

Federal M&A Broker Exemption

The Federal M&A Broker exemption was signed into law on December 29, 2022. Under the new law, M&A Brokers that meet certain conditions are exempt from the Exchange Act’s broker-dealer registration requirements when they effect a change-of-control in an eligible privately held company.[8]

Qualifying Elements of the Federal M&A Broker Exemption

The new Federal M&A Broker exemption includes many of the same elements as the M&A Broker NAL:

• “Control” is defined as the power (directly or indirectly) to direct the management or policies of company, whether through ownership of securities, by contract, or otherwise. Control is presumed if a person owns 25% or more of the company’s voting securities or the right to receive upon dissolution, or has contributed, 25% or more of the capital in the case of a partnership or limited liability company.[9]
• One condition of an “eligible privately held company” is that the company’s securities are not registered or required to be registered with the SEC under Section 12 of the Exchange Act, or that the company is not required to submit reports under Section 15(d) of the Exchange Act.[10]

However, in a departure from the SEC staff’s M&A Broker NAL, the Federal M&A Broker exemption asserts an additional condition on which companies qualify under the definition of “eligible privately held company.” Specifically, eligible privately held companies must meet either or both of the following size limitation thresholds:[11]

1. Prior fiscal year earnings before interest, taxes, depreciation, and amortization (EBITDA) of less than $25 million.
2. Prior fiscal year gross revenues of less than $250 million.[12]

Bad Actor Disqualification

Consistent with both the M&A Broker exemption and NASAA model rule, the Federal M&A Broker exemption is not available if the M&A Broker or any of the M&A Broker’s officers, partners, directors, or employees have been barred from associating with a broker-dealer by the SEC, any state, or any self-regulatory organization.[13]

Excluded Activities

The Federal M&A Broker exemption also provides certain excluded activities that would prevent an M&A Broker from relying on the statutory exemption if it has engaged in any of the provided activities, which include:[14]

• Transmitting or having custody of securities transacted by the parties.
• Engaging on behalf of a public issuer, or an issuer required to submit reports to the SEC.
• Engaging on behalf of a “shell company” (as defined under the new statutory amendment).
• Providing financing for the transfer of ownership of an eligible privately held company.
• Assisting any party to obtain financing from an unaffiliated third party without meeting specific conditions.
• Representing both the buyer and seller in the same transaction without clear disclosure and consent from the parties.
• Facilitating a transaction by forming a group of buyers.
• Engaging in a transaction involving a passive ownership interest (i.e., without a change-of-control).
• Binding a party to a transfer of ownership of an eligible privately held company.

Withdrawal of the M&A Broker NAL

Citing Congress’s creation of the new statutory Federal M&A Broker exemption, the SEC staff withdrew its M&A Broker NAL on March 29, 2023, effective immediately. In doing so, the SEC staff noted that the new exemption allows M&A Brokers “to engage in conduct that is largely similar to that discussed in the M&A Broker Letter, subject to certain additional conditions and limitations,” and therefore it was appropriate to withdraw the M&A Broker NAL.[15]

Takeaways

The codification of an M&A Broker exception into section 15(b)(13) to the Exchange Act will provide M&A Brokers, privately held companies, and other market participants additional assurance that they can engage in certain M&A activity without running afoul of the Exchange Act’s broker-dealer registration requirement. In light of the SEC’s withdrawal of the staff no-action relief, anyone acting in reliance of the no-action position should carefully consider the implications of the Federal M&A Broker exemption and ensure compliance. In addition to examining the federal requirements for broker-dealer registration, issuers, M&A brokers, privately held companies and other market participants should continue to consider whether certain M&A activity may trigger state registration requirements. While the NASAA model rule and the Federal M&A Broker exemption are similar, fewer than ten states have adopted the NASAA model rule. Therefore, activities that are permissible under the Federal M&A Broker exemption may still be prohibited without registering as a broker-dealer in many states.

Endnotes

[1] See Letter from Emily Westerberg Russell, Chief Counsel and Associate Director, Division of Trading and Markets, SEC to Faith Colish, Esq., et al. re: M&A Brokers (Mar. 29, 2023) (No-Action Withdrawal).

[2] See Consolidated Appropriations Act, 2023, H.R. 2617, 117th Cong. § 501 (2022) (“H.R. 2617”) (codified in Sec. 15(b)(13)of the Exchange Act, 15 U.S.C. 78(b)(13)).

[3] Specifically, section 15 U.S.C. § 78c(a)(4) defines “broker” generally as “any person engaged in the business of effecting transactions in securities for the account of others.” Section 15(a) of the Exchange Act requires persons engaged in the business of effecting transactions in securities to be registered as a broker or dealer or associated with a registered broker or dealer.

[4] The M&A Broker NAL defines “M&A Broker” 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 that will actively operate the company the business conducted with the assets of the company.

[5] See No-Action Withdrawal at 3.

[6] See NASAA Model Rule Exempting Certain Merger & Acquisition Brokers (“M&A Brokers”) From Registration, Adopted September 29, 2015.

[7] The NASAA Model rule tracks the M&A Broker NAL, but there is a minor difference between the two. For example, the control threshold in the NASAA Model Rule is 20% compared to 25% in the Federal M&A Broker exemption and M&A Broker NAL.

[8] See 15 U.S.C. § 78o(b)(13).

[9] 15 U.S.C. § 78o(b)(13)(E)(ii).

[10] Id. § 78o(b)(13)(E)(iii)(I).

[11] Id. § 78o(b)(13)(E)(iii)(II).

[12] H.R. 2617 states that the Commission, may by rule modify the dollar figures if the Commission determines that such a modification is necessary or appropriate in the public interest or for the protection of investors. See H.R. 2617 at 1082.

[13] 15 U.S.C. § 78o(b)(13)(C).

[14] Id. § 78o(b)(13)(B).

[15] See No-Action Withdrawal at 1.