On March 29, 2023, Congress enacted an exemption (the “Exemption”) from registration as a broker-dealer under the Securities Exchange Act of 1934 (the “Exchange Act”) for certain qualifying brokers effecting securities transactions involving transfers of ownership or control of certain privately held companies. The Exemption provides welcome relief for business brokers and smaller investment banks who, for nearly a decade, have been tenuously relying on guidance from the U.S. Securities and Exchange Commission (“SEC”) set forth in a 2014 no-action letter (the “NAL”). On the same day the Exemption became effective, the NAL was withdrawn, effective immediately. While there are similarities between the guidance in the NAL and the Exemption, they are not identical and M&A brokers should understand the differences and structure their activities accordingly.
Under the Exchange Act, “brokers” (generally defined to be anyone effecting transactions in securities for the account of others) are generally required to register with the SEC unless an exemption is available. In 2014, the SEC issued the NAL in which it stated that it would not seek to require the registration of certain qualifying brokers whose activities were limited to effecting transactions in connection with the transfer of ownership of a privately held company, provided that certain conditions were met. In addition to federal securities laws, M&A brokers must also navigate a patchwork of state and territorial broker-dealer registration requirements to determine whether an exemption is available – an exercise that, for the moment, is unaffected by the Exemption.
Overview of the Exemption
Although M&A brokers will continue to need to assess state law requirements, the Exemption provides clearer guidelines regarding when SEC registration will be required. Importantly, the Exemption provides definitional guidance on who will be considered an “M&A broker” for purposes of the Exemption, which was not previously addressed by the NAL. Under the Exemption, an M&A broker is defined as a broker or an associated person “engaged in the business of effecting securities transactions solely in connection with the transfer of ownership of an ’eligible privately held company.’” Further, the broker is required to reasonably believe that upon closing of the transaction, the buyer will control the company and directly or indirectly be active in the management of the company, among other requirements.
The balance of the Exemption statute largely codifies the guidance set forth in the NAL with certain exceptions of which practitioners should be aware. The key differences include:
- Definition of an “eligible privately held company.” The Exemption is only available to M&A brokers for securities transactions involving an “eligible privately held company”, which is generally defined to be any company with EBITDA of less than $25 million and/or gross revenues of less than $250 million, in each case, during 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 NAL did not have the size limitation tests, which largely mirror the 2015 Model Rule of the North American Securities Administrators Association (the “NASAA Model Rule”). Note that these figures will be adjusted for inflation. Additionally, an “eligible privately held company” cannot be subject to SEC reporting requirements.
- Conditions of Relief; Control. The Exemption largely continues the conditions of relief contained in the NAL, but modifies slightly the “control” condition to only require that the M&A broker reasonably believe that the buyer will both control the company or the business conducted with the assets of the company and directly or indirectly be active in the company’s management. “Control” for these purposes will be presumed if the buyer has the right to vote, sell, or direct the sale of at least 25% of the voting securities or, in a partnership or LLC, has the right to receive upon dissolution, or has contributed, at least 25% of the capital.
- Exception for brokers barred or suspended by the SEC. An M&A broker is not entitled to rely on the Exemption if such broker (or, if applicable, any of its officers, directors, or employees) has been barred or suspended by the SEC, any state or self-regulatory organization from association with any broker-dealer.
State Law Requirements for M&A Brokers
The Exemption does not preempt state law. Each U.S. state and territory has its own broker-dealer registration requirements, which may vary from federal law. Although certain states have existing registration exemptions, some of which are based on the NASAA Model Rule (which largely conform with the conditions and limitations of the Exemption), many state securities and so-called “Blue Sky” laws do not provide for express exemption from registration. Accordingly, M&A brokers must continue to monitor and evaluate applicable state securities laws governing broker-dealer registration requirements in connection with their M&A activities.
Considerations Going Forward
While the Exemption provides much needed relief for those M&A brokers who to date have been relying on the NAL, the EBITDA and gross revenue limitations, which were not included in the NAL, may present challenges for M&A brokers who engage in transactions above the applicable thresholds. Conversely, many M&A brokers who had previously registered as a broker-dealer may be able to dispense with compliance costs because their activities fit squarely within the Exemption.
If you need assistance with determining how the new law may affect your business, contact us for a consultation.