The broker-dealer registration requirements of federal and state law were not designed with persons in mind who engage as intermediaries for business sales between sophisticated parties. Yet by virtue of the definition of "security" as interpreted by the U.S. Supreme Court, even the transfer of 100 percent of the stock of a business to persons intending to own and operate the business can be construed as the sale of securities and subject a participating intermediary to possible registration as a broker-dealer. This is so even though the intermediary may play a limited role in the transaction and never takes possession of any funds or securities. Because contracts entered in violation of the securities laws are void, the use of an unlicensed intermediary has potentially significant consequences for both the intermediary and its client. Prior SEC guidance narrowly construed the type of activities which might be permissible without registration, generally limiting them to assistance with asset deals or acting as a finder or in a similarly restricted capacity.

A recent no-action letter relating to M&A Brokers (January 31, 2014) issued by the SEC's Division of Trading and Markets now offers some much needed clarity and opportunity for unregistered persons engaged as intermediaries in the sale of businesses. In this letter, the SEC indicated it would not recommend enforcement action if an "M&A Broker" were to, without a federal broker-dealer registration, engage in the sale of a business by means of its securities if certain terms and conditions were met.

An "M&A Broker" is 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
  • To a buyer that will actively operate the company

A "privately held company" is defined by the letter as a company that does not have a class of securities registered under the Securities Exchange Act of 1934 or otherwise obligated to file periodic reports under that Act. The letter suggests a buyer could "actively operate" a company through, "among other things," the power to elect executive officers and approve annual budgets or by service as an executive.

Importantly, the SEC letter does not place the kind of significant restrictions on the scope of activity that it had previously or that is customarily thought to be necessary in order for an intermediary to be construed as a "finder" and not a broker-dealer. For example, there are no limitations placed on:

  • Transaction-based compensation
  • Transaction structure or structuring advice
  • Negotiation activity
  • Making a recommendation
  • Valuation advice
  • The size of the parties
  • Conveyance of 100 percent of the seller's equity interests
  • Whether stock or assets are advertised for sale

The restrictions the SEC does impose upon M&A Brokers are in large part designed to distinguish efforts to effect a minority, passive investment, including requirements that:

  • The intermediary will have no custody, control or possession of funds or securities.
  • The intermediary will have no role in forming a group to effect the purchase.
  • The buyer, or group of buyers, will upon completion of the transaction control and actively operate the acquired business. "Control" includes the power, directly or indirectly, to direct the management or policies of a company and will be presumed to exist if the buyer or group of buyers has the right to vote 25 percent or more of a class of voting securities; has the power to sell or direct the sale of 25 percent or 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 percent or more of the capital.
  • The transaction will not result in the transfer of interests to a passive buyer or group of passive buyers.
  • The intermediary will not provide financing for the transaction directly or indirectly.
  • No transaction will involve a public offering and no party to a transaction will be a shell company, as that term is used in the federal securities laws, other than a business combination shell.
  • The M&A Broker may not have authority to bind any party to the transaction.
  • The transactions will be "M&A Transactions," which the SEC staff defines as "mergers, acquisitions, business sales and business combinations" (although the definition of M&A Broker also includes transactions through "exchange, issuance, repurchase or redemption of … securities").
  • The M&A Broker and, if an entity, its management and employees, cannot have been barred from association with a broker-dealer by the SEC, any state or self-regulatory organization and may not be suspended from association with a broker-dealer.
  • If securities are sold, they will be treated as restricted within the meaning of the Securities Act of 1933.

While this SEC no-action letter is an encouraging development at the federal level, it remains to be seen what comfort it will bring to interpretation of applicable state securities laws. States regulate the registration of both entities and individuals engaged in the sale of securities, and definitions of broker and dealer have many similarities to the language of corresponding federal law. So it is possible that an interpretation similar to the federal interpretation reflected in the no-action letter could be applied by the states. 

The laws of those few states that recognize a form of "finder" exemption to applicable registration requirements, such as Minnesota, may not afford the unlicensed intermediary the latitude desired under state law to take full advantage of the SEC no-action position. In Minnesota, for example, the exemption from "agent" licensing requirements is limited only to individuals representing issuers. Further, it restricts persons to introducing prospective investors and issuers and to services to the issuer that do not involve dealings with prospective investors if compensation is contingent on investment by a prospective investor.

The American Bar Association has been pressing for change in this area of broker-dealer regulation for years. This relatively informal change to the regulatory landscape is a welcome development, but a bit surprising given historical SEC resistance to unlicensed broker-dealer activity. Its potential to facilitate fuller representation of sellers by unlicensed brokers in M&A transactions must now await corresponding state law developments.