The Consolidated Appropriations Act, 2023 (the Act), signed into law by President Biden on Dec. 29, 2022, included a long-awaited federal exemption from registration with the Securities and Exchange Commission (SEC) for brokers engaged in merger and acquisition (M&A) transactions among certain privately held companies (the Exemption). There has long been an issue, particularly with smaller privately held companies, including venture capital and private equity-backed lower middle market companies, hiring unregistered brokers or finders to assist with M&A transactions in exchange for a success fee. The SEC has historically taken the position that the payment of success fees to anyone for assisting with finding a buyer or investor to consummate a transaction involving the sale of securities would require registration as a broker-dealer. The discussions throughout the past have been around the issue of whether an exemption should apply to someone that simply acts as a finder without further involvement in the transaction and why a registered broker-dealer would be required if a sale transaction involved the sale of securities but would not be required for a sale of assets. As to the latter point, basing the registration requirements on the form of the transaction rather than substance seemed to most practitioners to be an unnecessary distinction. These smaller companies, however, need assistance in sale transactions and can not afford the often prohibitively expensive fees of larger registered broker-dealers, nor are those larger firms generally interested in working on the smaller transactions.
In 2014, the staff of the SEC provided limited relief in what has become known as the “M&A Brokers” no-action letter i (the M&A Brokers Letter).¹ The Exemption generally codifies the relief previously provided by the M&A Brokers Letter; however, there are significant differences that should be considered by an M&A broker and any company considering hiring an M&A Broker in considering whether the broker should rely on the new Exemption or the M&A Brokers Letter, which is explicitly contemplated within the Exemption. The Exemption, which was originally contemplated by Congress even before the SEC staff’s issuance of the M&A Brokers Letter, becomes effective March 29, 2023.²
M&A Broker Definition
Section 501 of Title V of Division AA of the Act amends Section 15(b) of the Securities Exchange Act of 1934, as amended (the Exchange Act), by adding a new subsection (13), Registration Exemption for Mergers and Acquisition Brokers. Pursuant to Section 15(b)(13), “an M&A broker shall be exempt from registration under this section.” The term “M&A broker” is defined to mean a broker and any associated person of the 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, through the “purchase, sale, exchange, issuance, repurchase or redemption of or a business combination” involving securities or assets of the eligible privately held company. In order to claim the Exemption, the M&A broker must “reasonably believe” that:
- Upon consummation of the transaction, any buyer of the eligible privately held company, acting alone or in concert, will control the eligible privately held company or the business conducted with its acquired assets and, directly or indirectly, will be active in the management of the eligible privately held company or the business conducted with the acquired assets, including without limitation, for example, by electing executive officers, approving the annual budget, serving as an executive or other executive manager or carrying out such other activities as the SEC may, by rule, determine to be in the public interest; and
- Any buyer will, prior to becoming legally bound to consummate the transaction, receive or has 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 its operations and if the issuer’s financial statements are audited, any related statement by the auditor, a balance sheet dated not more than 120 days before the date of the offer and information pertaining to the management, business, results of operations and material loss contingencies of the issuer.
The term “eligible privately held company” means a privately held company that: (i) does not have any class of securities required to be registered with the SEC pursuant to Section 12 of the Exchange Act or with respect to which the company files or is required to file, periodic information, documents and reports under Section 15(d) and (ii) in the fiscal year immediately before the engagement of the M&A broker, has (a) earnings of less than $25 million before interest, taxes, depreciation and amortization and/or (b) gross revenues of less than $250 million. The SEC is permitted to modify the dollar figures if the SEC determines that such a modification is necessary or appropriate in the public interest or for the protection of investors.
Section 15(b)(13)(B) precludes an M&A broker from relying on the Exemption if the broker engages in any of the following:
- Directly or indirectly, in connection with the M&A transaction, receives, holds, transmits or has custody of the funds or securities to be exchanged by the parties to the transaction.
- Otherwise engages on behalf of an issuer in a public offering of securities registered, or required to be registered, with the SEC under Section 12 of the Exchange Act or with respect to which the issuer files, or is required to file, periodic information, documents and reports under Section 15(d) of the Exchange Act.
- Engages in a transaction involving a shell company, other than a business combination-related shell company formed solely for purposes of the transaction.
- Directly or indirectly through any of its affiliates, provides financing to a party to the transaction.
- Assists any party to obtain financing from an unaffiliated third party without (i) complying with all other applicable laws in connection with such assistance, including, if applicable, Regulation T, and (ii) disclosing any compensation in writing to the party.
- Represents both the buyer and the seller in the same transaction without providing clear written disclosure as to the parties represented and obtaining written consent from both parties to the joint representation.
- Facilitates a transaction with a group of buyers formed with the assistance of the M&A broker to acquire the eligible privately held company.
- Engages in a transaction involving the transfer of ownership of an eligible privately held company to a passive buyer or group of passive buyers.
- Binds a party to a transfer of ownership of an eligible privately held company.
In addition, the Exemption is not available to a broker, including any officer, director, member, manager, partner or employee of such broker who (i) has been barred from association with a broker or dealer by the SEC, any state or any self-regulatory organization or (ii) is suspended from association with a broker or dealer.
Reliance on the Exemption or the M&A Brokers Letter
As noted above, while the Exemption generally codifies the M&A Brokers Letter, there are significant differences that should be considered by a broker and any company considering hiring a broker to facilitate an M&A transaction in determining whether the broker should rely on the Exemption or the M&A Brokers Letter. First, the Exemption is limited to transactions by eligible privately held companies, that are, companies with earnings of less than $25 million in the preceding fiscal year and/or companies with gross revenues of less than $250 million during the preceding fiscal year. The M&A Brokers Letter applies to transactions involving privately held companies regardless of earnings or revenue limits. Second, the Exemption requires that the M&A broker “reasonably believe” that the buyer of the eligible privately held company will control and be actively involved in its management, while the M&A Brokers Letter requires that the buyer must actually control and actively operate the privately held company. Finally, the M&A Brokers Letter conditions relief, in part, on the fact that any securities received by the buyer or M&A broker in an M&A transaction will be “restricted securities” within the meaning of Rule 144(a)(3) under the Securities Act of 1933 (the Securities Act) because the securities would have been issued in a transaction not involving a public offering. Even though the Exemption does not expressly address the status of securities transferred in the M&A transaction covered by the Exemption, the buyer should nonetheless determine its compliance with the Securities Act and whether the securities received are restricted securities.
Given the differences between the Exemption and the M&A Brokers Letter, it remains to be seen whether the SEC staff will withdraw the M&A Brokers Letter or otherwise modify the conditions of the no-action letter. In addition, as the Exemption does not preempt state blue sky laws regulating M&A brokers, such brokers must continue to adhere to applicable state laws and regulations. However, as some states previously amended their requirements for M&A brokers following the issuance of the M&A Brokers Letter, it also remains to be seen if those and other states will either amend their current requirements or enact new laws or regulations in response to the new Exemption. Companies using unregistered brokers in reliance on either the Exemption or the M&A Brokers letter need to continue to understand and carefully consider the limitations and scope of the relief provided.
¹ M&A Brokers, SEC No-Action Letter (Jan. 31, 2014).
² See H.R. 2774, 113th Cong. (2014); S. 1923, 113 Cong. (2014).