The Consolidated Appropriations Act, 2023 (H.R. 2617) was signed into law on December 2022 by President Biden. H.R. 2617 included a new Exchange Act Section 15(b)(13) (the “Act”), which codified an exemption from registration (“Exemption”) for M&A Brokers who meet certain conditions. The M&A Broker Exemption is effective as of March 29, 2023.
The Exemption codifies much of the relief previously provided by the staff of the SEC’s Division of Trading and Markets in its “M&A Brokers” 2014 No-Action Letter (“No-Action Letter”). To that end, both the No-Action Letter and the Exemption allowed for the payment of “success fee compensation” without broker-dealer registration in certain situations, were intended to facilitate small business change-of-control transactions and create cost-saving opportunities for small businesses. However, it should be noted that there are differences in the relief provided by both the Exemption and the No-Action Letter, and ultimately, the Exemption still has limitations not faced by broker-dealers registered with the SEC.
Conditions of the Exemption
The Act defines an ‘M&A broker’ as any broker, or a person associated with a broker, engaged in the business of effecting securities transactions solely in connection with the transfer of ownership of an eligible privately held company, regardless of whether the broker acts on behalf of a seller or buyer, if the broker reasonably believes that:
- Upon consummation of the transaction, any person acquiring securities or assets of the eligible privately held company, will “control” the eligible privately held company or the business conducted with the assets of the eligible privately held company; and directly or indirectly will be active in the management of the eligible privately held company or the business. It should be noted that there is a presumption of control if, upon completion of a transaction, the buyer has the right to vote 25 percent or more of a class of voting securities or the power to sell or direct the sale of 25 percent or more of a class of voting securities; or in the case of a partnership or limited liability company, the buyer has the right to receive upon dissolution, or has contributed, 25 percent or more of the capital.
- If any person is offered securities exchange for securities or assets of the eligible privately held company, such person will, prior to the closing of the proposed transaction, receive or have reasonable access to the most recent fiscal year-end financial statements of the issuer of the securities as customarily prepared by the management of the issuer in the normal course of operations and, information pertaining to the management, business, results of operations for the period covered by the foregoing financial statements, and material loss contingencies of the issuer.
For purposes of the Act, an “eligible privately held company” is defined as a privately held company that meets both of the following conditions:
- Тhe company does not have any class of securities registered, or required to be registered, with the Commission under Section 12 of the Exchange Act, or is required to file periodic information, documents, and reports under subsection (d) of the Exchange Act.
- In the fiscal year ending immediately before the fiscal year in which the services of the M&A broker are initially engaged, (a) the earnings of the company before interest, taxes, depreciation, and amortization, are less than $25,000,000 and/or (b) the gross revenues of the company are less than $250,000,000.
For purposes of this subclause, 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.
There are a number of activities that will result in the loss of the Exemption, should an M&A broker engage in, including:
- Directly or indirectly receiving, holding, transmitting, or having custody of the funds or securities as a part of the transaction.
- Engaging on behalf of an issuer in a public offering of any class of securities that is registered, or is required to be registered, with the Commission under Exchange Act Section 12 or is required to file, periodic information, documents, and reports under subsection (d) of the Exchange Act.
- Engaging in a transaction involving a shell company, other than a business combination related shell company.
- Directly, or indirectly through any of its affiliates, providing financing related to the transfer of ownership of an eligible privately held company.
- Assist any party to obtain financing from an unaffiliated third party without (a) complying with all other applicable laws in connection with such assistance, including, if applicable, Regulation Т (12 C.F.R. 220 et seq.); and (b) disclosing any compensation in writing to the party.
- Represent both the buyer and the seller in the same transaction without providing clear written disclosure as to the parties that the broker represents and obtains written consent from both parties to the joint representation.
- Facilitate a transaction with a group of buyers formed with the assistance of the M&A broker to acquire the eligible privately held company.
- Engaged in a transaction involving the transfer of ownership of an eligible privately held company to a passive buyer or group of passive buyers.
Finally, it should be noted that an M&A broker cannot rely on the exemption if such broker (and as applicable, including any officer, director, member, manager, partner, or employee of such broker) (a) has been barred from association with a broker or dealer by the Commission, any State, or any self- regulatory organization; or (b) is suspended from association with a broker or dealer.
Key Observations and Takeaways
There are a number of observations and takeaways related to M&A brokers and their reliance on the Exemption. A few of those that should be considered include:
- M&A brokers who comply with the conditions of the Exemption will be able to receive success-based compensation for transactions conforming to the requirements set forth in the Act.
- The Exemption does not preempt state registration requirements, and as such, even where an M&A broker is exempt from federal registration as a broker-dealer under either the Exemption or the No-Action Letter, there are over 30 jurisdictions that still require broker-dealer registration and/or reliance on a statutory exemption in the respective states. As such, M&A Brokers will need to determine whether they are subject to broker-dealer registration in the jurisdictions that their clients and contra-parties are located.
- The No-Action Letter and the Exemption are similar but have differences that an M&A Broker should be aware of, especially since the guidance provided by the No-Action Letter is still in effect. A few differences include:
- The No-Action Letter applies to transactions involving privately held companies of any size, the Exemption is limited to transactions involving a change of control over small business entities.
- The No-Action Letter requires that the buyer must “actually” control and actively operate the privately held company, the Exemption only requires that the M&A broker have a reasonable belief that the buyer of the eligible privately held company will control and be actively involved in its management.
- Control is defined as 20% on the No-Action Letter, and 25% on the Exemption.
- M&A brokers relying on the Exemption will remain subject to SEC jurisdiction, including antifraud provisions of the federal securities laws and potential enforcement actions, regardless of the exemption from registration as a broker-dealer.
- The Exemption cannot be relied on by unregistered brokers or finders to identify new sources of capital or otherwise facilitate securities offerings, as the Exemption is limited solely to the M&A activities set forth in the Act.
- The M&A broker definition does not address whether the exemption is available only for entities and their “associated persons,” or, if natural persons may directly rely on the exemption without acting through a corporation, LLC, or some other entity.
- The Exemption may not be of benefit to M&A brokers representing private equity, venture capital and other private funds acquiring and selling operating companies based on the prohibition of transferring interests to “passive” buyers and or purchasers who must “actively operate” the company.