In Short

The Situation: Congress recently amended the
Securities Exchange Act of 1934 (the “Exchange Act”) to
exempt certain “M&A brokers” from registration as
broker-dealers with the U.S. Securities and Exchange Commission
(“SEC”).

The Issue: While the new
exemption essentially codifies previously granted no-action relief
from the SEC’s Division of Trading & Markets, its terms are
narrower than the prior relief, applying only to M&A
transactions for small entity issuers. The new legislation also
does not preempt state law registration requirements for M&A
brokers.

Looking Ahead: Following the granting of the
previous SEC no-action relief, some states took action to provide
similar relief on the state level. It remains to be seen if those
and other states will either amend their current requirements or
enact new laws or regulations exempting M&A brokers from state
registration requirements to match the new statutory federal
exemption.

Included in the Consolidated Appropriations Act, 2023 (H.R.
2617) at page 1080 (the “Act”), signed into law by
President Biden on December 29, 2022, is a provision exempting
brokers that facilitate small business M&A from registration
with the SEC. Section 501 of Title V of Division AA of the Act
amends Section 15(b) of the Exchange Act by adding a new subsection
15(b)(13), which provides an exemption (the “New
Exemption”) from SEC registration for so-called “M&A
brokers” that meet the conditions of the exemption. A person
meeting the conditions of the New Exemption may receive commissions
for its brokerage services—a hallmark of broker-dealer status
that typically requires SEC registration—without having to
register with the SEC as a broker-dealer. The New Exemption is
intended to facilitate small business change-of-control
transactions and create cost-saving opportunities for small
businesses.

Terms of the New Statutory Exemption

For purposes of the New Exemption, an “M&A broker”
is essentially defined as a broker (and its associated persons)
that is engaged in the business of effecting securities
transactions solely in connection with the transfer of ownership of
an “eligible privately held company” through the
disposition of securities or assets of the eligible privately held
company, if the broker reasonably believes that:

• Upon consummation of the transaction, the buyer will
  “control” (e.g., have the right to vote or direct the
  sale of 25% of the shares of) the eligible privately held company
  or the business conducted with its acquired assets, and will be
  active in the management of the business (by, for example, electing
  executive officers, approving the annual budget, or serving as an
  executive or other executive manager); and




• Any buyer, before becoming legally bound to consummate the
  transaction, has received or has reasonable access to various
  disclosure documents, including, among others, the company’s
  most recent fiscal year-end financial statements, as well as
  information pertaining to the management, business, results of
  operations, and material loss contingencies of the issuer.

To be an “eligible privately held company,” the
acquired company must (i) not have any class of securities
registered with the SEC pursuant to Exchange Act Section 12 or
subject to Section 15(d)’s filing obligations; and (ii) in the
fiscal year prior to the engagement of the M&A broker, have (a)
earnings of less than $25 million before interest, taxes,
depreciation, and amortization and/or (b) gross revenues of less
than $250 million.

The New Exemption contains a list of activities that, if
conducted by the M&A broker, would preclude it from taking
advantage of the exemption. These activities include, among
others:

• Directly or indirectly, receiving, holding, transmitting, or
  having custody of funds or securities of the parties in connection
  with the transaction;




• Engaging 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,
  providing financing to a party to the transaction;




• Assisting 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;




• Representing both the buyer and the seller in the same
  transaction without providing written disclosure as to the parties
  represented and obtaining written consent from both parties to the
  joint representation;




• Assisting to form a group of buyers to acquire the eligible
  privately held company;




• Engaging in a transaction involving the transfer of ownership
  of an eligible privately held company to a passive buyer or group
  of passive buyers; and




• Binding a party to a transfer of ownership of an eligible
  privately held company.

Furthermore, to qualify for the New Exemption, neither the
M&A broker nor its associated persons can have been barred from
association with a broker or dealer by the SEC, any state, or any
self-regulatory organization (i.e., an exchange or FINRA) or
suspended from association with a broker or dealer.

Previous SEC No-Action Relief in the Area is Still in
Force

The New Exemption is similar to relief previously provided by
the staff of the SEC’s Division of Trading and Markets in its
“M&A Brokers” 2014 No-Action Letter (the “SEC No-Action Letter”), but there
are some notable differences. For instance, while the SEC No-Action
Letter applies to transactions involving privately held companies
of any size, the New Exemption is limited to transactions involving
a change of control over small business entities. However, the New
Exemption explicitly provides that it does not limit the authority
of the SEC to exempt any person from any provision of the Exchange
Act, so M&A brokers should still be able to rely on the SEC
No-Action Letter if they engage in M&A transactions involving
larger private issuers and meet the conditions for that relief.

In addition, the SEC No-Action Letter conditions relief, in
part, on the fact that “[a]ny 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 new Section 15(b)(13) does not
explicitly address the status (i.e., restricted or otherwise) of
any securities transferred in a transaction facilitated by an
M&A broker pursuant to the New Exemption, the acquiror will
nevertheless need to determine, as part of its compliance with the
Securities Act, whether any securities it receives in such a
transaction are restricted securities. Also, while the New
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, the SEC
No-Action Letter requires that the buyer must actually
control and actively operate the privately held company.

Congress Did Not Preempt State Securities Laws

Importantly, the New Exemption does not appear to preempt state
law broker registration or other requirements. In the wake of the
2014 No-Action Letter, the North American Securities Administrators
Association (“NASAA”), an association representing state
and local securities regulators in the United States, Canada, and
Mexico, developed a model rule (the “Model Rule”) that,
if adopted by a state, would exempt certain M&A brokers from
state broker registration. As of November 2020, at least 19 states had adopted
some form of exemptive relief, based on the Model Rule, the SEC
No-Action Letter, or a combination of both.

The terms of the Model Rule, the SEC No-Action Letter, and the
New Exemption differ from each other. For instance, the Model Rule
does not incorporate many of the restrictions on the activities of
an M&A broker found in those other exemptions. Likewise,
similar to the New Exemption, the Model Rule only requires that the
M&A broker have a “reasonable belief” that the buyer
will control and be actively involved in the management of the
eligible privately held company and does not require actual control
and management as required by the SEC No-Action Letter. The Model
Rule also differs from the others in that it defines
“control” of a privately held company as at least a 20%
voting interest in the company, instead of at least a 25% voting
interest to establish “control” for Exchange Act
registration purposes. Finally, unlike the SEC No-Action Letter but
similar to the New Exemption, the Model Rule imposes limitations on
the size of the acquired privately held company (either $25 million
in earnings or $250 million in gross revenues). It remains to be
seen whether any of the various states will adopt new exemptions or
amend their current M&A broker exemptions to match the terms of
the New Exemption.

Consequently, even where an M&A broker is exempt from
federal registration as a broker-dealer under either the New
Exemption or the SEC No-Action Letter, the M&A broker should
assure itself that it is not required to register with any
particular state as a result of its M&A broker activity in or
with residents of that state.

The New Exemption is effective 90 days after enactment (i.e., on
March 29, 2023).

Three Key Takeaways

1. Congress has enacted a new conditional statutory exemption from
   federal broker-dealer registration for M&A brokers that
   facilitate change-of-control transactions involving certain small
   privately held companies.




2. M&A brokers facilitating change-of-control transactions
   involving larger private issuers may still rely on the SEC
   staff’s 2014 M&A Broker No-Action Letter to avoid having to
   register with the SEC as a broker-dealer.




3. Because the new exemption does not preempt state laws, persons
   relying on the new statutory exemption to avoid SEC registration
   nevertheless will need to determine whether they are subject to
   broker-dealer registration under applicable state laws.

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.