SEC Relieves Business Brokers from Broker-Dealer Registration Requirements in Private M&A Transactions

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1 May 13, 2014 Page 1 SEC Relieves Business Brokers from Broker-Dealer Registration Requirements in Private M&A Transactions No-action letter permits M&A Brokers to effect securities transactions and engage in certain related activities, under a series of conditions The limited scope of the relief provided by the Letter will require additional due diligence in order to determine whether the conditions for relief set forth in the Letter are met in a specific transaction. The Division of Trading and Markets (the Division ) of the Securities and Exchange Commission (the SEC ) has recently issued a no-action letter (the Letter ) i providing relief from the broker-dealer registration requirements for business brokers who facilitate certain private M&A transactions involving the sale of securities. The relief is limited in scope and only applies under certain conditions. The Letter resolves a long-standing issue in the area of broker-dealer regulation with respect to the treatment of persons who help facilitate the sale of operating businesses. Prior to the issuance of the Letter, a person facilitating the private sale of a company structured as a sale of securities would generally be understood to be a broker required to register with the SEC, whereas the same person could engage in the same transaction structured as a sale of assets without the requirement to register. The Letter resolves this anomaly by permitting business brokers to facilitate certain private M&A transactions structured as a sale of securities. These brokers may do so regardless of the size of the target company, and may also receive transaction-based compensation, advertise the sale of the company and participate in the negotiation of the transaction. The limited scope of the relief provided by the Letter will require additional due diligence in order to determine whether the conditions for relief set forth in the Letter are met in a specific transaction. Furthermore, the Letter does not affect state law requirements, and therefore market participants must still comply with any applicable state laws related to broker-dealer registration requirements. Barton LLP prepared this publication to provide information on recent legal developments of interest to our readers. This publication is not intended to provide legal advice for a specific situation or to create an attorney-client relationship. We would be pleased to provide such legal assistance as you require on these and other subjects, please contact the named attorney at the end of the publication or your regular firm contact. Copyright 2014 Barton LLP. All Rights Reserved. This publication may not be reprinted or retransmitted, in whole or in part, without the prior written approval of Barton LLP, except that permission is hereby granted to subscribers to photocopy or forward solely for internal use by their attorneys and staff. ATTORNEY ADVERTISING pursuant to New York RPC 7.1. The choice of a lawyer is an important decision and should not be based solely upon advertisements.

2 May 13, 2014 Page 2 Practitioners have viewed the Letter as a partial step towards providing needed clarity with respect to broker-dealer registration requirements. Notably, the Letter does not directly address the issue of broker-dealer registration requirements with respect to private equity fund advisers who receive transaction-based compensation for brokering M&A transactions for portfolio companies, which may be the subject of future guidance from the Division or the SEC. Background A long-standing issue in the area of broker-dealer regulation has concerned the treatment of persons who help facilitate the sale of operating businesses. Section 15(a) of the Securities Exchange Act of 1934 (the Exchange Act ) generally requires anyone engaged in the business of effecting transactions in securities of others to be registered with the SEC. Prior to the issuance of the Letter, a person facilitating the sale of a company structured as a sale of securities would generally be understood to fall within that definition and would therefore be required to register with the SEC as a brokerdealer. This produces the anomalous result that, if the same transaction were structured as a sale of assets, the same person could engage in the same activities, without the requirement to register. Practitioners have taken the view that transaction structure should not be determinative of whether the registration requirement applies, but rather that a distinction should be made between certain private M&A transactions (even if structured as a sale of securities), on the one hand, and traditional retail or institutional brokerage transactions, on the other hand. In particular, practitioners have pointed out that the active role of the buyer and seller in private M&A transactions distinguishes such transactions from the purchase and sale of securities by retail and other investors for passive investment purposes, which is appropriately effected through the services of a registered broker-dealer. ii The Letter addresses this discrepancy by providing relief to certain M&A Brokers under a specified set of circumstances. Scope of Relief The Letter provides relief to M&A Brokers, which the Letter defines as persons engaged in the business of effecting securities transactions solely in connection with the transfer of ownership and control of a privately-held company iii 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 iv the company or the business conducted with the assets of the company. The target company must also be an operating company that is a going concern and not a shell company. v Under the Letter, M&A Brokers may facilitate private M&A transactions without registration as a broker-dealer regardless of the size of the target company, and may engage in the following activities in relation to the transaction: Joint Representation. The M&A Broker may represent either the buyer or the seller, or both, as long as the M&A Broker provides clear written disclosure to, and obtains written consent from, both parties; Group of Buyers. The M&A Broker may facilitate an M&A transaction with a buyer or group of buyers that is formed without the assistance of the M&A Broker; Advertising. The M&A Broker may advertise a company for sale with information such as the description of the business, general location, and price range; M&A Advisory. The M&A Broker may advise the parties to issue securities, or otherwise to effect the transfer of the business by means of securities, or assess the value of any securities sold;

3 May 13, 2014 Page 3 Compensation. The M&A Broker may receive transaction-based or other compensation, as agreed by the parties; and Negotiation. The M&A Broker may participate in the negotiations of the transaction. Conditions to Relief The Letter sets forth the following conditions, each of which must be met in order for the above-described relief to be available: No Ability to Bind Parties. The M&A Broker will not have the ability to bind a party to a transaction; No Provision of Financing. The M&A Broker will not directly, or indirectly through affiliates, provide financing for the transaction. An M&A Broker that assists purchasers to obtain financing from unaffiliated third parties must comply with all applicable legal requirements and must disclose any compensation in writing to the client; No Custody Over Funds. The M&A Broker will not have custody, control, or possession of or otherwise handle funds or securities issued or exchanged in connection with the transaction or another securities transaction for the account of others; No Public Offering. The transaction will not involve a public offering. Any offering or sale of securities will be conducted in compliance with an applicable exemption from registration under the Securities Act of 1933 (the Securities Act ); No Shell Companies. No party to the transaction will be a shell company, other than a business combination related shell company; vi Disclosure and Consent for Joint Representation. If an M&A Broker represents both buyers and sellers, it will provide clear written disclosure as to the parties it represents and obtain written consent from both parties to the joint representation; No Assistance to Form a Group. An M&A Broker may facilitate a transaction involving a group of buyers only if the group is formed without the assistance of the M&A Broker; Buyer Must Control and Actively Operate the Target. The buyer (or group of buyers), upon completion of the transaction, will control vii and actively operate viii the company or the business conducted with the assets of the business; No Passive Buyer. The transaction will not result in the transfer of interests to a passive buyer or group of passive buyers; Restricted Securities. Any securities received by the buyer or M&A Broker in the transaction will be restricted securities within the meaning of Rule 144(a)(3) under the Securities Act; and No Prohibited Persons. The M&A Broker (and, if the M&A Broker is an entity, each officer, director or employee of the M&A Broker): (i) has not been barred from association with a broker-dealer by the SEC, any state or any self-regulatory organization; and (ii) is not suspended from association with a broker-dealer. Other provisions of the federal securities laws, including the anti-fraud provisions, as well as all applicable state laws, will also continue to apply.

4 May 13, 2014 Page 4 Conclusion Practitioners have viewed the Letter as a partial step towards providing needed clarity with respect to broker-dealer registration requirements for different marketplace participants such as placement agents, finders, business brokers and private fund advisors. This need for clarity, especially with respect to private fund advisors, was the subject of last year s much-noted public comments by David Blass, Chief Counsel of the Division. ix We note, however, that the Letter does not address the issues related to private fund advisors that Mr. Blass cited as problematic and in need of clarification. These issues, including with respect to the capital raising and investment banking activities engaged in by such private fund advisors or their affiliates or personnel, as well as the brokering of transactions for portfolio companies and the marketing of interests in their funds to investors, may be the subject of future guidance from the Division or the SEC. In addition, potential legislation with respect to M&A brokers has also been under consideration by Congress, although it is unclear if and in what form such bills might become law. x Finally, market participants should bear in mind the limited scope of the relief provided to M&A Brokers under the Letter. Any person intending to rely on the Letter should review its contents carefully and should undertake due diligence in order to determine whether the conditions under the Letter will be met with respect to a proposed transaction. For example, additional diligence may be required to determine that a target company has no securities registered or required to be registered under Section 12 of the Exchange Act and to determine whether the buyer in a proposed transaction will in fact obtain control and actively operate the target company subsequent to the transaction. Furthermore, the Letter does not affect state law requirements, and therefore market participants must still comply with any applicable state laws related to broker-dealer registration requirements. Endnotes i The Letter can be viewed at: ii See Page 2 of the Request for No-Action Letter attached to the Letter. iii A privately-held company is defined as a company that does not have any class of securities registered, or required to be registered, with the SEC under Section 12 of the Exchange Act, or with respect to which the company files, or is required to file, periodic information, documents, or reports under Section 15(d) of the Exchange Act. iv A buyer could actively operate the company through the power to elect executive officers and approve the annual budget or by service as an executive or other executive manager, among other things. v A shell company is defined as a company that: (1) has no or nominal operations; and (2) has: (i) no or nominal assets; (ii) assets consisting solely of cash and cash equivalents; or (iii) assets consisting of any amount of cash and cash equivalents and nominal other assets. In this context, a going concern need not be profitable, and could even be emerging from bankruptcy, so long as it has actually been conducting business, including soliciting or effecting business transactions or engaging in research and development activities. vi A business combination related shell company is defined as a shell company (as defined in Securities Act Rule 405) that is: (1) formed by an entity that is not a shell company solely for the purpose of changing the corporate domicile of that entity solely within the United States; or (2) formed by an entity that is not a shell company solely for the purpose of completing a business combination transaction (as defined in Securities Act Rule 165(f)) among one or more entities other than the shell company, none of which is a shell company. vii A buyer, or group of buyers collectively, would have the necessary control if it has the power, directly or indirectly, to direct the management or policies of a company, whether through ownership of securities, by contract, or otherwise. The necessary control will be presumed to exist if, upon

5 May 13, 2014 Page 5 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. viii A buyer could actively operate the company through the power to elect executive officers and approve the annual budget or by service as an executive or other executive manager, among other things. ix The comments can be viewed at: x See H.R th Cong. ( ), passed by the House on January 14, 2014, and S th Cong. ( ), introduced in the Senate on that same day.

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