What the SEC’s No-Action Letter Means for M&A Brokers

Axial | March 25, 2014 Expert

On January 31, 2014, the Securities and Exchange Commission issued a no-action letter, providing “M&A Brokers” relief from broker-dealer registration requirements in limited circumstances.

In other words, the SEC will not recommend enforcement action against unregistered brokers that facilitate a securities transaction, involving the transfer of control of a privately-held company “to a buyer that will actively operate the company,” as long as certain conditions are met.

The no-action letter brings clarity and legitimacy to an industry and profession long hampered by uncertainty and impractical interpretive guidance – finally, making clear the activities in which unregistered brokers may engage in.

To bypass the registration, M&A brokers must abide by a certain set of conditions. One of the most critical conditions is that the buyer(s) “will, upon completion of the M&A Transaction, control and actively operate the company or the business conducted with the assets of the business.”

Accordingly, M&A Brokers must evaluate each transaction on this two-part test – does the buyer have control, and is that exercised through active management of the company?  The SEC provides further guidance – control is presumed if the buyer “has the right to vote 25% or more of a class of voting securities.”

As long as these conditions are met, unregistered brokers may:

  • represent both buyers and sellers of private companies

  • advertise the business

  • negotiate the transaction, and

  • receive transaction-based compensation without any limitation as to the size of the transaction.

This emphasis on control and active owners underscores the intent of the SEC’s no-action letter – to offer relief when a buyer is not a passive investor and in need of the protection broker-dealer registration is intended to provide.  Active owners will protect themselves by learning about the target through due diligence, and, therefore, are not as susceptible to questionable solicitation tactics and conflicts of interest that originally created the regulation.

The SEC’s no–action letter also represents a shifting mindset that may serve as a harbinger of things to come in private M&A securities regulation.  First, it is an acknowledgment by the SEC that not all securities transactions are created equal, and neither are all intermediaries.  Different protections are required along the spectrum of financial transactions, especially when different financial players are involved.  Second, it marks a move away from the SEC’s historical focus on transaction-based compensation as the hallmark indicator of broker registration.

Together, there is a reasonable basis to believe the SEC might provide future relief from broker-dealer registration for private equity fund sponsors that receive transaction-based fees for facilitating securities transactions for their portfolio companies.

Such a relief from the costly registration requirements should bolster middle market and lower-middle market M&A.  Eliminating these costs, historically passed onto buyers and sellers of companies, will unlock value in transactions and promote a more efficient flow of capital. And, an increase in compliance will decrease the legal risks associated with unregistered brokers illegally facilitating securities transactions.

In the meantime, on Capitol Hill, the United States Congress is having a conversation about simplifying registration requirements for M&A Brokers.  On January 14, 2014, the House unanimously passed H.R. 2274 to amend the Securities Exchange Act of 1934, and the same version of that bill is now in the Senate Banking, Housing, and Urban Affairs Committee.

The SEC interprets the laws of Congress, and until a bill is passed into law, the no-action letter serves as interpretive guidance, effectively granting M&A Brokers relief from broker-dealer registration, subject to the conditions therein.

It is important to note, that M&A Brokers should proceed with caution – relief is transaction-based and state regulations will still apply.

Disclaimer: The views of the author should not be construed as legal advice. 

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