The SEC Establishes Key Exemption to the Broker-Dealer Registration Requirements for M&A Brokers

On January 31, 2014, the SEC Division of Trading and Markets issued a no-action letter in favor of entities effecting securities transactions in connection with the sale of equity control of private operating businesses (“M&A Broker”).  The SEC stated that it would not require broker-dealer registration for M&A Brokers arranging for the sale of private businesses, in accordance with the facts and circumstances set forth in the no action letter, as described below.

For many years the SEC has maintained a staunch view that any and all activities that could fall within the broker-dealer registration requirements set forth in Section 15(b) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), require registration. See also the SEC Guide to Broker-Dealer Registration (2008) on the SEC website.

In accordance with the SEC Guide to Broker-Dealer Registration, providing any of the following services may require the individual or entity to be registered as a broker-dealer:

  • “finders,” “business brokers,” and other individuals or entities that engage in the following activities:
    • Finding investors or customers for, making referrals to, or splitting commissions with registered broker-dealers, investment companies (or mutual funds, including hedge funds) or other securities intermediaries;
    • Finding investment banking clients for registered broker-dealers;
    • Finding investors for “Issuers” (entities issuing securities), even in a “consultant” capacity;
    • Engaging in, or finding investors for, venture capital or “angel” financings, including private placements;
    • Finding buyers and sellers of businesses (i.e., activities relating to mergers and acquisitions where securities are involved);
  • investment advisers and financial consultants;
  • persons that market real estate investment interests, such as tenancy-in-common interests, that are securities;
  • persons that act as “placement agents” for private placements of securities;
  • persons that effect securities transactions for the account of others for a fee, even when those other people are friends or family members;
  • persons that provide support services to registered broker-dealers; and
  • persons that act as “independent contractors” but are not “associated persons” of a broker-dealer

Beginning with the enactment of the JOBS Act in April 2012, there has been a substantial shift in the broker-dealer registration regulatory framework.

JOBS Act Exemptions to Broker-Dealer Registration Requirements

The JOBS Act created two exemptions to broker-dealer registration: the first under Title II for platforms that facilitate Rule 506 offerings, and the second under Title III for funding platforms that facilitate crowdfunding offerings.

          A.  Exemption under Title II of the JOBS Act – Websites and Platforms for 506 Offerings

Title II of the JOBS Act creates a limited exemption to the broker-dealer registration requirements for certain intermediaries that facilitate Rule 506 offerings.  In particular, the JOBS Act states that with respect to securities offered and sold in compliance with Rule 506 of Regulation D under the Securities Act, broker or dealer registration will not be required solely because:

(A) a person that  maintains a platform or mechanism that permits the offer, sale, purchase, or negotiation of or with respect to securities, or permits general solicitations, general advertisements, or similar or related activities by Issuers of such securities, whether online, in person, or through any other means;

(B) that person or any person associated with that person co-invests in such securities; or

(C) that person or any person associated with that person provides ancillary services with respect to such securities.

Ancillary services are defined as (A) the provision of due diligence services in connection with the offer, sale, purchase, or negotiation of such security, so long as such services do not include, for separate compensation, investment advice or recommendations to Issuers or investors; and (B) the provision of standardized documents to the Issuers and investors, so long as such person or entity does not negotiate the terms of the issuance for and on behalf of third parties and Issuers are not required to use the standardized documents as a condition of using the service.

Finally, the exemption from registration as a broker or dealer also requires that such person and each person associated with such person (A) receives no compensation in connection with the purchase or sale of the security; (B) does not have possession of customer funds or securities in connection with the purchase or sale; and (C) is not subject to statutory disqualification pursuant to Section 3(a)(39) of the Exchange Act (i.e., bad boy provisions).

On February 5, 2013, the SEC issued guidance, via frequently asked questions (FAQs), regarding the exemption from broker-dealer registration under Title II of the JOBS Act. Interestingly, the SEC clarifies that the exemption from broker-dealer registration does not require the drafting or enactment of any rules and accordingly was effective upon signing of the JOBS Act in April 2012 and is fully operational.

The SEC also confirmed that the broker-dealer exemption does not pre-empt state law and accordingly, persons acting in reliance on the new exemption must also comply with any and all applicable state securities regulations.

Although the new statutory language appears self-evident, the SEC confirmed that the exemption applies to websites and social media sites as exempt platforms.

Although the SEC states that it interprets “compensation” very broadly to include any direct or indirect economic benefit, it notes that Congress specifically allowed for co-investing and accordingly, profits from such co-investments would not be considered compensation to disqualify this broker-dealer registration exemption.

In addition, not only is it permissible for a venture capital fund or its adviser to operate a website where it lists offerings of securities by potential portfolio companies, co-invests in those securities with other investors, and provides standardized documents, but the SEC believes that this very scenario shall dominate the use of the exemption.  The SEC states, “[A]s a practical matter, we believe that the prohibition on compensation makes it unlikely that a person outside the venture capital area would be able to rely on the exemption from broker-dealer registration.”

Reliance on this new broker-dealer registration exemption is not limited to use by any type of person, as long as they follow the rules, including not receiving compensation in association with the sale of securities.  Persons associated with Issuers, including officers, directors and employees, can rely on the exemption and create websites advertising Rule 506 offerings.

On a technical note, the SEC confirms that the exemption is not an exclusion from the definition of broker-dealer.  Platforms and intermediaries operating under the new Section 4(b) may be (and most likely are) broker-dealers; they are just exempted from registering as such.

                B. Exemption under Title III of the JOBS Act – Crowdfunding Platforms

The JOBS Act and Regulation Crowdfunding create an exemption to broker-dealer registration for “funding portals” that can act as crowdfunding intermediaries.  Funding portals will be required to be registered with the SEC and to follow all such registration and ongoing rule and reporting requirements and will be required to be members of FINRA.

The JOBS Act defines a funding portal as “any person acting as an intermediary in a transaction involving the offer or sale of securities for the account of others, solely pursuant to Section 4(6) of the Securities Act of 1933” (i.e., the new crowdfunding section)—provided, however, that a funding portal intermediary may not:

(i) offers investment advice or recommendations;

(ii) solicit purchases, sales, or offers to buy the securities offered or displayed on its website or portal;

(iii) compensate employees, agents or other persons for such solicitation or based on the sale of securities displayed or referenced on its website or portal; or

(iv) hold, manage, possess, or otherwise handle investor funds or securities (hopefully the SEC rules will provide guidance on who can provide these functions and the mechanics of those functions).

An in-depth discussion of the proposed rules and regulations affecting funding portals is beyond the scope of this blog.

SEC No-Action Letter – M&A Brokers

On January 31, 2014, the SEC Division of Trading and Markets issued a no-action letter in favor of entities effecting securities transactions in connection with the sale of equity control of private operating businesses (“M&A Broker”).  The SEC stated that it would not require broker-dealer registration for M&A Brokers arranging for the sale of privately held businesses, in accordance with the facts and circumstances set forth in the no-action letter.  The no-action letter does not cover the facilitation of sales, mergers or acquisitions of publicly held operating or shell companies, which activities still require broker-dealer registration.

The SEC defined “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 or the business conducted with the assets of the company.”  The buyer would not have to be involved in daily operations but could “actively operate the company through the per to elect executive officers and approve the annual budget or by service as an executive…”

The SEC defined “privately held company” as “a company that does not have any class of securities registered, or required to be registered with the Commission 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.”  The SEC specifically states that the no-action letter does not cover “shell” companies.

The SEC no-action letter provides an exemption for M&A brokers that facilitate mergers, acquisitions, business sales, and business combinations between sellers and buyers of privately held companies.  M&A Brokers may advertise the sale of businesses including descriptions of the business, location and price range.

However, the SEC set forth certain limitations and restrictions on the M&A broker exemption.  In particular:

(i) M&A Brokers cannot bind parties to a transaction;

(ii) M&A Brokers cannot directly or indirectly provide financing for M&A transactions;

(iii) M&A Brokers cannot have custody, control or possession of or otherwise handle funds or securities issued or exchanged in connection with an M&A transaction;

(iv) No M&A transaction can involve a public offering.  Any offering or sale of securities must be conducted in compliance with an applicable exemption from registration.  No party to any M&A transaction may be a shell company.

(v) To the extent M&A Brokers represent both buyers and sellers, they must provide clear written representations as to whom they are representing and must obtain written consent from both parties for joint representation.

(vi) If the M&A transaction involves a buyer group, the M&A Broker may not be involved in forming the group;

(vii) The buyer or group of buyers will control and actively operate the company or business.  The buyer will be considered to have control if it has the power, directly or indirectly, to direct management or policies of the company, whether through ownership of securities, by contract or otherwise.  The necessary control will be presumed if, upon completion of the transaction, the buyer or group of buyers has the right to vote 25% or more of the securities, has the power to sell or direct the sale of 25% or more of the securities, or in the case of a limited partnership or LLC, has the right to receive upon dissolution or has contributed 25% of more of the capital.

(viii) No M&A transaction can result in the transfer of interests to a passive buyer or group of buyers;

(ix) Any securities received by the buyer or M&A Broker in the transaction will be restricted within the meaning of Rule 144;

(x) The M&A Broker, and if an entity, each officer director or employee of the M&A Broker: (a) has not been barred from association with a broker-dealer by the SEC or any state or any self-regulatory organization; (b) is not suspended from association with a broker-dealer.

Finally, the SEC specifically limits the scope of the no-action letter to the federal broker-dealer registration requirements.  M&A Brokers will still need to comply with state law requirements and both federal and state anti-fraud laws.

The Author

Laura Anthony, Esq.
Founding Partner
Legal & Compliance, LLC
Corporate, Securities and Going Public Attorneys

Securities attorney Laura Anthony and her experienced legal team provides ongoing corporate counsel to small and mid-size private companies, OTC and exchange traded issuers as well as private companies going public on the NASDAQ, NYSE MKT or over-the-counter market, such as the OTCQB and OTCQX. For nearly two decades Legal & Compliance, LLC has served clients providing fast, personalized, cutting-edge legal service. The firm’s reputation and relationships provide invaluable resources to clients including introductions to investment bankers, broker dealers, institutional investors and other strategic alliances. The firm’s focus includes, but is not limited to, compliance with the Securities Act of 1933 offer sale and registration requirements, including private placement transactions under Regulation D and Regulation S and PIPE Transactions as well as registration statements on Forms S-1, S-8 and S-4; compliance with the reporting requirements of the Securities Exchange Act of 1934, including registration on Form 10, reporting on Forms 10-Q, 10-K and 8-K, and 14C Information and 14A Proxy Statements; Regulation A/A+ offerings; all forms of going public transactions; mergers and acquisitions including both reverse mergers and forward mergers, ; applications to and compliance with the corporate governance requirements of securities exchanges including NASDAQ and NYSE MKT; crowdfunding; corporate; and general contract and business transactions. Moreover, Ms. Anthony and her firm represents both target and acquiring companies in reverse mergers and forward mergers, including the preparation of transaction documents such as merger agreements, share exchange agreements, stock purchase agreements, asset purchase agreements and reorganization agreements. Ms. Anthony’s legal team prepares the necessary documentation and assists in completing the requirements of federal and state securities laws and SROs such as FINRA and DTC for 15c2-11 applications, corporate name changes, reverse and forward splits and changes of domicile. Ms. Anthony is also the author of, the OTC Market’s top source for industry news, and the producer and host of, the securities law network. In addition to many other major metropolitan areas, the firm currently represents clients in New York, Las Vegas, Los Angeles, Miami, Boca Raton, West Palm Beach, Atlanta, Phoenix, Scottsdale, Charlotte, Cincinnati, Cleveland, Washington, D.C., Denver, Tampa, Detroit and Dallas.

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