Who Qualifies Under the New Exemption for M&A Brokers?

The Consolidated Appropriations Act amended Section 15 of the Securities Exchange Act of 1934 to add a statutory exemption for qualifying M&A brokers effective March 29. A question had long existed as to whether brokers and other financial advisors facilitating business combinations of privately held companies were subject to the registration requirements for broker-dealers under Section 15 of the Exchange Act. Since 2014, M&A brokers had relied on a letter ruling by the Securities and Exchange Commission (SEC) that it would not recommend enforcement action if M&A brokers effected transactions in accordance with the 2014 no-action letter.

Who Is Covered by the Exemption?

The exemption defines a qualifying M&A broker as a broker, or any person associated with the broker, that assists in effecting a transfer of ownership of an eligible privately held company if the M&A broker reasonably believes that upon consummation of the transaction the buyer will, directly or indirectly, direct the management or policies of the company through ownership, contract, or otherwise, and be active in the management of the company. Included examples of being active in management are electing executive officers, approving annual budgets and serving as an executive officer or other executive management. Control is presumed if the buyer has the right to vote or sell (or direct the sale of) 25% or more of a class of voting securities, or in the case of an LLC or partnership, has contributed or has the right to receive on dissolution 25% or more of its capital.

An eligible private company is defined as a privately held company that meets both of these factors:

• • It does not have any securities registered or required to be registered under Section 12 of the Exchange Act or subject to reporting requirements.
  • In the fiscal year ending immediately before the fiscal year in which the M&A broker is engaged, has less than $25 million of EBITDA or less than $250 million of gross revenue, subject to adjustments every five years for inflation.

To qualify for the exemption, any person offered securities in the transaction must receive or have access to the most recent year-end financials of the issuer customarily prepared by management in the normal course of business. If the issuer’s financials are audited, reviewed or compiled by an independent accountant, the person must also receive or have access to any related statement by the accountant, a balance sheet dated not more than 120 days before the offer date, and information on the management, business and results of operations for the period covered by the financials and any material loss contingencies of the issuer.

Who Is Not Covered by the Exemption?

A broker or financial advisor otherwise qualifying as an M&A broker, however, cannot rely on the exemption if the M&A broker:

A. Directly or indirectly receives, holds, transmits or has custody of the funds or securities to be exchanged in the transaction.

B. Engages in a public offering of securities that are either:

1. Registered or required to be registered under Section 12.

2. With respect to which the issuer is required to file periodic information, documents and reports under Section 15(d).

C. Engages on behalf of any party in a transaction involving a shell company, other than a business-related shell company. A shell company is defined as a company that at the time of the transaction has minimal operations and no or minimal assets, assets consisting solely of cash or cash equivalents, or assets consisting of cash or cash equivalents and nominal other assets. A business-related shell company is formed by a company that is not a shell company solely to change the corporate domicile of that company within the U.S. or solely to complete a business combination among one or more entities other than the company itself, none of which is a shell company.

D. Directly or indirectly provides financing related to the transfer of the ownership of an eligible privately held company.

E. Assists any party in obtaining financing from an unaffiliated party without complying with all other applicable laws in connection with such assistance and disclosing in writing any compensation.

F. Represents both the buyer and seller in the same transaction without providing clear written disclosure to the parties and obtaining written consent from both to the joint representation.

G. Facilitates a transaction with a group of buyers formed with the assistance of the M&A broker to acquire an eligible privately held company.

H. Engages in a transaction involving the transfer of ownership of an eligible privately held company to a passive buyer or group of passive buyers.

I. Binds a party to a transfer of ownership of an eligible privately held company.

The M&A broker is not exempt from registration if the broker or any officer, director, member, manager, partner or employee of the broker has been barred from association with a broker or dealer by the SEC, any state or any self-regulatory organization, or is suspended from association with a broker or dealer.

While the new exemption codifies many elements of the 2014 no-action letter, it also narrows the exemption in ways that will make it available for fewer transactions. The 2014 no-action letter has not been retracted by the SEC, and the new exemption explicitly states that it does not limit the authority of the SEC to exempt any person from any provision of the Exchange Act. Thus, M&A brokers should still be able to rely on the 2014 no-action letter if they engage in M&A transactions that do not meet the conditions for the new exemption.

Finally, it is important to note that the exemption does not apply to state “blue-sky” laws and that the anti-fraud provisions of the federal securities acts still apply.

Please contact Hal West, Carolyn Duncan, or any member of Phelps’ Corporate and Securities or Mergers and Acquisitions teams if you have questions or need advice or guidance.