Since 2014, many private company mergers and acquisitions intermediaries have chosen not to register as broker-dealers. That’s because a 2014 SEC no-action letter took the position that intermediaries that limited their activities to representing private companies in M&A deals were not required to register with the SEC as broker-dealers. But as a no-action letter, the relief provided was limited to the specific facts presented, and the letter implied that such relief would not be available to any intermediary that engaged in any of several listed activities. Greater certainty may be on the way, however, in the form of a small part of proposed legislation recently passed by the House of Representatives that would effectively codify the SEC’s 2014 no-action position and even expand on it.
Section 15(a) of the Securities Exchange Act of 1934 requires any broker-dealer engaging in interstate commerce to register with the SEC and be subject to its regulatory regime. The term “broker” is defined broadly in Section 3(a)(4) of the Exchange Act to include any person who effects transactions in securities on behalf of others, and the SEC has historically interpreted the meaning of “effects transactions in securities” to include anyone engaged in significant aspects of a securities transaction, including solicitation, negotiation and execution. The inclusion of a transaction based or success fee has long been interpreted as a strong presumption that the intermediary receiving the fee must register as a broker-dealer.
So is an acquisition of a company considered to be a securities transaction such that intermediaries should have to register as broker-dealers? The broker-dealer regulations were designed to prevent abuses in the form of high pressure selling tactics and third party custody of funds, two aspects that typically don’t apply to M&A deals. Moreover, in a typical M&A transaction, unlike a stock trade, the acquiror usually engages in its own exhaustive due diligence of the target and the intermediary does not custody funds. Nevertheless, the U.S. Supreme Court thought otherwise and in 1985 opined that an M&A transaction involving a target’s stock is a securities transaction, and consequently many M&A advisors began registering as broker dealers.
The 2014 No-Action Letter
In the 2014 no-action letter, the SEC Division of Trading and Markets stated that it would not recommend enforcement action to the SEC if an intermediary were to effect securities transactions in connection with the transfer of ownership of a privately-held company. The letter listed a bunch of deal activities that would make the relief unavailable, however, including providing financing for the deal, custodying funds or securities, arranging for a group of buyers and sale of a company to a “passive” buyer.
Financial CHOICE Act of 2017
On June 8, 2017, the U.S. House of Representatives passed the Financial CHOICE Act of 2017, which repeals or modifies significant portions of Dodd-Frank but also includes a broad range of important provisions aimed at facilitating capital formation pro-growth policies generally, including an exemption from broker dealer registration for private company M&A intermediaries. Like the 2014 no-action letter, the Financial CHOICE Act would deny the exemption to any broker intermediating an acquisition of a shell company or a transaction involving the public offering of securities or engaging in the custody of funds or securities. But unlike the 2014 no-action letter, the Financial CHOICE Act would not exclude brokers that put together groups of buyers or provide acquisition financing, or intermediate a sale of a company to a passive acquiror. One feature present in the Financial CHOICE Act that was not included in the 2014 no-action letter is a size of target test. Specifically, under the Financial CHOICE Act, the exemption is only available if the target has gross revenues below $250 million and EBITDA below $25 million in the fiscal year ending immediately before the fiscal year in which the services of the M&A broker are initially engaged with respect to the transaction.
The legislation has moved to the Senate, and hopefully any final version would include some form of private company M&A broker-dealer registration exemption. Of particular significance in the proposed legislation is the apparent allowance for a non-registered broker to organize groups of buyers which would enable private equity club deals. Nevertheless, even if the legislation passes, private company intermediaries should consider carefully the consequences of non-registration (or withdrawal of those already registered). These would include complications under certain state regulatory regimes and exclusion from the possibility of intermediating public company deals or deals involving targets exceeding either the gross revenue or EBITDA thresholds.