New Law Exempts M&A Brokers from SEC Registration

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. 
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