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The SEC and FINRA Sync-up on M&A Brokers

April 9, 2014

In a recent no-action letter, the SEC’s Division of Trading and Markets opened the door for M&A brokers to effect securities transactions in connection with the transfer of a company’s ownership or control without registering as a broker-dealer under the Securities Exchange Act of 1934 (Exchange Act). This no-action letter substantially changes prior SEC guidance in this area and will allow private company M&A brokers to receive transaction-based compensation under defined circumstances. In the past, the SEC has been reluctant to allow persons involved in securities transactions in any manner to receive transaction-based compensation without being a registered broker-dealer.

The Financial Industry Regulatory Authority, Inc. (FINRA) then followed with a regulatory notice soliciting comments on a proposed set of streamlined rules for registered broker-dealers that meet the definition of “limited corporate financing broker” (LCFB), but who do not otherwise operate as a traditional broker-dealer. According to FINRA, an LCFB is a member firm that engages in a limited range of brokerage activities, including advising companies and private equity funds on capital raising, mergers and acquisitions and corporate restructurings and soliciting potential institutional investors.

The SEC’s no-action letter came as Congress was considering revising the securities laws to exempt private company M&A brokers from broker-dealer registration on terms similar to those in the letter. FINRA then seized an opportunity to propose lightening the regulatory load on its member firms that operate as M&A brokers, or risk losing them as FINRA members in light of the SEC’s new no registration position on M&A brokers.

What Was the Problem?

Getting paid legally was the problem. The SEC’s historical position has been that, except in very narrow circumstances, when a person assists in the purchase or sale of a company’s securities and receives compensation based on the size of the transaction, that person is required to have been registered under Section 15(b) of the Exchange Act as a broker-dealer. On the other hand, a person engaged in identical activities with the same ultimate result, e.g., sale and transfer of a business, but structured rather as an asset purchase transaction was not required to register as a broker-dealer under the Exchange Act.

As a result, M&A brokers often registered with the SEC (and FINRA) as broker-dealers or affiliated themselves with a registered broker-dealer in order to receive transaction-based compensation. Typically, these M&A brokers did not engage in the types of activities generally associated with traditional broker-dealers, such as maintaining customer accounts, handling customer funds or securities, or accepting orders to purchase or sell securities. As such, the SEC exempted them from the definitions of broker and dealer (the “M&A Broker-Dealer Exemption”), and permitted them to conduct their M&A advisory business and receive transaction-based compensation outside of the SEC or FINRA’s broker-dealer regulatory reach. Despite the new federal exemption, individual states also regulate the activities of persons or entities involved in the sale of securities and have their own definitions and interpretations of the terms broker and dealer and may continue to require state registration by M&A brokers.

The No-Action Letter Request and Relief

The no-action letter was issued in response to a request by six attorneys who argued that it made little sense for a business broker to be required to register as a broker-dealer with the SEC (and FINRA) if the sale of a business involved a sale of securities, but not if the sale of a business involved only a sale of assets. In their request letter, the attorneys were seeking assurance that the SEC staff would not recommend enforcement if an M&A broker[1] were to effect securities transactions in connection with the transfer of ownership of a privately held company under the terms and conditions described in the letter. The request letter stipulated a number of conditions, such as M&A brokers would never take custody, control, possession or otherwise handle funds or securities or have the ability to bind a party to a transaction, that became the substance of the no-action letter relief.

The relief afforded by the no-action letter, however, comes with several conditions with which M&A brokers must comply. In general, the no-action letter permits an M&A broker to facilitate transactions such as mergers, acquisitions, business sales and business combinations between buyers and sellers of “privately-held companies” regardless of the size of the parties when, among other requirements, the buyer will both “control” and “actively operate” the target or the business conducted with the assets of the target upon closing.

The M&A Broker-Dealer Exemption allowed under the no-action letter only applies if the following 10 conditions are satisfied:

  • The broker cannot have the ability to bind a party to the transaction;
  • The broker cannot, directly or indirectly through affiliates, provide financing for the transaction;
  • The broker cannot have custody or control of, or otherwise handle funds or securities issued in connection with the transaction;
  • The transaction cannot involve a public offering or a “shell” company;
  • If representing both buyers and sellers, the broker must disclose who it represents and obtain consent to joint representations;
  • If the transaction involves a group of buyers, the group must have been formed without the involvement of the broker;
  • The buyer or group of buyers must control and actively operate the target company or the business conducted with the assets of the target. Control will be presumed if the buyer, or buyer group has the right to vote 25% or more of a class of voting securities, has the power to sell or direct the sale of 25% of more of a class of voting securities, or, in the case of a partnership or limited liability company, has the right to receive upon dissolution or has contributed 25% or more of the capital;
  • The transaction cannot involve transfers of interests to “passive” buyers;
  • Any securities issued in the transaction must be restricted securities under Rule 144(a)(3) of the Securities Act of 1933; and
  • The broker must not have been barred or suspended from associating with a broker-dealer.

An M&A broker is now able to receive transaction-based compensation in connection with (i) advertising a private company for sale using information about the company’s business, operations and management that the broker prepared, (ii) being an active participant in the discussions and negotiations of any M&A transaction, and (iii) recommending a transactional structure involving securities or assessing the value of any securities being sold. Firms and individuals providing M&A advice that fall within the confines of the no-action letter no longer will have to register as broker-dealers in order to receive transaction-based compensation or a success fee in connection with their services.

Nevertheless, it is a limited form of relief associated only with the acquisition and operation of a business. In this regard, the requested relief will not be helpful to persons or entities who help place equity or venture capital investments for less than 25% of the target company or where the buyer will not actively operate the business upon closing. A placement of those investments would continue to be viewed as a purchase and sale of securities (requiring broker-dealer registration to accept transaction-based compensation), and not as the acquisition of a business.

FINRA Follows Suit

Taking its cue from the SEC no-action letter, FINRA has proposed establishing a “streamlined set” of regulatory rules called the Limited Corporate Financing Broker Rules (“LCFB Rules”), that are tailored to address and apply exclusively to the LCFB’s limited business activities. The proposed LCFB Rules define an LCFB as any broker that solely engages in any one or more of the following activities:

  • advising an issuer, including a private fund, concerning its securities offerings or other capital raising activities;
  • advising a company regarding its purchase or sale of a business or assets or regarding its corporate restructuring, including a going-private transaction, divestiture or merger;
  • advising a company regarding its selection of an investment banker;
  • assisting in the preparation of offering materials on behalf of an issuer;
  • providing fairness opinions; and
  • qualifying, identifying, or soliciting potential institutional investors.[2]

As proposed by FINRA, an LCFB does not include any broker or dealer that carries or maintains customer accounts, holds or handles customers’ funds or securities, accepts orders from customers to purchase or sell securities either as principal or as agent for the customer, possesses investment discretion on behalf of any customer, or engages in proprietary trading of securities or market-making activities.

Proposed Rule Set. The proposed LCFB Rules are deceptively short and succinct because most of the proposed rules merely incorporate by reference the corresponding FINRA rule applicable to registered full service broker-dealers. For example, LCFBs would generally be subject to the same membership procedures and approval standards as other registered broker-dealers, as well as FINRA’s rules relating to investigations and sanctions, codes of procedure and arbitration and mediation. LCFB principals and representatives would also be subject to the same registration and qualification examination requirements as principals and representatives of other FINRA members; although they would have a more streamlined continuing education requirement.

On the other hand, the LCFB Rules would impose a more streamlined know-your-customer and suitability obligations than are imposed under current FINRA rules, as well as an abbreviated version of FINRA’s rule that prohibits false and misleading statements in a firm’s public communications. The streamlined set of LCFB conduct rules would include the present FINRA conduct rules and interpretative guidance related to the standards of commercial honor and principles of trade, use of manipulative, deceptive or other fraudulent devices and transactions involving FINRA employees. Moreover, LCFBs would still be subject to all of the SEC rules and regulations applicable to broker-dealers.

The FINRA comment period expires on April 28, 2014.

For more information about the M&A Broker-Dealer Exemption or the proposed LCFB Rules, please contact the author of this alert, Robert B. Murphy (202-906-8721) or D. Richard McDonald, who leads Dykema’s public company practice group (248-203-0859), or any of the attorneys listed to the left.



[1] The term “M&A broker” was defined in the no-action letter request 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.”

[2] Unfortunately, the proposed rules limit such solicitations by an LCFB to only (i) banks, savings and loan associations, insurance companies or registered investment companies; (ii) a governmental entity or subdivision thereof; (iii) certain types of employee benefit plans with at least 100 participants; (iv) other persons (whether a natural person, corporation, partnership, trust, family office or otherwise) with total assets of at least $50 million; and (v) any person acting solely on behalf of any such institutional investor. As such, an LCFB will not be able to solicit investment by any persons (other than banks, S&Ls, insurance companies, governmental entities and certain employee benefit plans) with less than $50 million of assets.

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