Written By: Roger Brothers and Shawn Harding
Buchman Provine Brothers Smith LLP
Walnut Creek, California
In a recent significant enforcement decision, the Trading and Markets Division of the Securities Exchange Commission (the "SEC") confirmed that private company transaction brokers ("M&A Brokers") are largely exempt from registration with the SEC under Section 15 (a)-(b) of the Securities Exchange Act of 1934 (the "Act").
The No Action Letter
On January 31, 2014, the SEC issued a "No-Action Letter" (the "NAL") which advised that certain M&A Brokers are not required to be registered as "Broker-Dealers" with the SEC (the "SEC Exemption"). The SEC defined an M&A Broker as a party engaged in the business of effecting M&A transactions of privately-held companies (i.e., a company which has not registered securities with the SEC pursuant to Section 12 of the Act) through the purchase, sale, exchange, issuance, repurchase or redemption of a business involving securities or assets.
This recent enforcement decision is an about-face from the SEC's prior modus operandi to the extent that the SEC has taken the position repeatedly that brokers who brokered, negotiated and advised M&A transactions are subject to the traditional broker-dealer ("BD") regulations. According to the NAL, M&A transactions include mergers, acquisitions, business sales and business combinations (i.e., the typical equity or asset transactions contemplated by private companies).
The SEC qualified the SEC Exemption of M&A brokers with the following caveats:
- The M&A Broker will not have the ability to bind the party to an M&A transaction;
- The M&A Broker will not provide financing for the M&A transaction directly or indirectly;
- The M&A Broker will at no time have custody, control or possession of the securities or funds issued or exchanged in the transaction;
- The M&A transaction does not involve a public company; and
- The securities received by the buyer will be restricted securities within the meaning of Rule 144(a)(3) of the Securities Act of 1933.
The issue of M&A Broker regulatory exemptions is also currently being contemplated by the U.S. Congress in pending legislation as well. Presumably, the proposed federal legislation will provide even more clarification on this matter. It is not yet clear what effect, if any, the NAL will ultimately have in light of recent efforts by the 113th U.S. Congress to address this very issue. The text of the NAL tracks very closely to the terms of U.S. House of Representatives legislation H.R. 2274 sponsored by Rep. Huizenga (R-Mich) and passed on January 14, 2014. H.R. 2274 amends the Act to provide for a broad registration exemption in connection with the transfer of ownership of smaller privately held companies (the "House Exemption"). The original text of H.R. 2274 included a notice-based exemption filing procedure. However, at the suggestion of the SEC, the House amended H.R. 2274 to remove the notice registration requirement and the final passed version provides for a broad, qualified exemption instead. Similar to the SEC Exemption, the House Exemption contains several qualifications including the requirements that the privately held company which is the subject of the M&A transaction (a) may not have earnings before interest, taxes, depreciation and amortization in excess of $25MM or gross revenues in excess of $250MM in the fiscal year preceding the M&A transaction and (b) is not obligated to make regulatory filings to the SEC under Section 12 of the Act. A mirror U.S. Senate bill (S.1923 Sponsored by Sen. Manchin (D-WV)) presently sits in the U.S. Senate committee on Banking Housing and Urban Affairs. S.1923 has not yet been presented to the full Senate. This proposed federal legislation does not alter (a) other Federal securities laws, including the SEC's jurisdiction to investigate and bring enforcement actions (b) general securities-related antifraud prohibitions and (c) counterpart state regulation of securities, real estate and business brokerage services. H.R. 2274 and S.1923 will not become law unless or until passed by both the Senate and the House and signed into law by the President.
Actions Applicable to Businesses involved in M&A Activity
The proposed modification of the BD regulations by the SEC and the Congress present a watershed opportunity for M&A and financial industry professionals (collectively, "Business Professionals") to now engage in M&A services without having to file for a registration with the SEC. While the exemptions are quite broad, they are subject to some fairly specific qualifications. In light of these recent developments, it would be prudent for Business Professionals to consider the following:
(1) Confirm the applicability of relevant state law with respect to the proposed M&A activity. For example, Business Professionals engaged in intra-state securities transactions may be required to register with the state in which he/she/it operates (e.g., a California-based Business Professional engaged in intra-state M&A activities may still be required to register with the California Department of Corporations), notwithstanding the proposed federal registration exemptions.
(2) Revise their client engagement agreements in order to require clients to provide written representations and warranties consistent with the limitations set forth in the NAL and proposed legislation (i.e., with regard to client size, unavailability of financing and lack of control, custody or escrow of the transferred assets or securities); and
(3) Include narrowly-tailored representation terms in M&A agreements in order to confirm that the subject M&A transaction does not require M&A Broker registration with the SEC.
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 Rule 144 provides a safe-harbor exemption for the sale of restricted or control securities if a number of conditions are met, including holding period requirements, the availability of information of the issuer, the manner of sale of the securities and the quantity of securities which may be sold. Rule 144 (a) (3) identifies the types of securities transactions that produce restricted securities.