There has long been substantial uncertainty about whether the services provided by business brokers and similar M&A advisors may trigger broker-dealer registration requirements under the federal securities laws in transactions involving the use of securities as consideration. This is particularly true for intermediaries involved in smaller, privately-held company transactions -- to the extent that in 2013 federal legislation was introduced in the U.S. House of Representatives to create a new category of transaction intermediary to be known as a “Merger and Acquisition Broker,” with the objective of establishing a regulatory scheme that is appropriate to the limited scope of intermediary activity in that specific transactional context. The future of that legislation remains uncertain. However, on January 31, 2014, the staff of the U.S. Securities and Exchange Commission (SEC) provided new guidance regarding the scope of activity of an intermediary who only effects transactions in securities in connection with the transfer of ownership of a privately-held company. Granting “No-Action” advice on a request submitted by six lawyers who have represented clients in connection with mergers and acquisitions and similar business brokerage transactions, the SEC Staff embraced a definition of “M&A Broker” specifically for application in connection with the purchase or sale of privately-held companies, and recognized permissible activities that will not trigger federal broker-dealer registration requirements. In the Six Lawyers No-Action Letter, an “M&A Broker” is defined for purposes of the Staff’s guidance 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. A “privately-held company” for purposes of the No-Action Letter is one that does not have any class of securities registered, or required to be registered, with the SEC under the Securities Exchange Act of 1934, and as such is not a “reporting” company. The guidance applies without regard to the size of a privately-held company. The company must, however, be an operating company that is a going concern, and is not a “shell” company. An M&A Broker seeking to rely on the guidance must be free from certain “bad boy” regulatory criteria. Otherwise, the focus is on the particular services to be provided by the private company M&A Broker, and there is room for considerable flexibility in the assessment. As discussed in more detail below, the Six Lawyers No-Action Letter significantly expands the services that the SEC staff has historically permitted M&A Brokers to provide without registering as a broker-dealer. The Six Lawyers No-Action Letter adds to the staff’s pre-existing guidance by specifically identifying permissible activities, as well as restrictions on activities, that are realistically suited to the private company mergers and acquisitions, and enables companies and intermediaries alike to proceed with a far greater degree of regulatory certainty and confidence. This fresh guidance is best considered against the backdrop of pre-existing uncertainty faced by M&A brokers. The Securities Broker Conundrum for M&A Firms In 1985, the U.S. Supreme Court (in Landreth Timber Co. v. Landreth) rejected the so-called “sale of the business doctrine” and held that the federal securities laws apply to sales of all of the outstanding stock of a business, without regard to the fact that the transaction amounts to the sale of the entire business or the transfer of all control. The sale of the business doctrine, espoused by number of lower federal courts, posited that although such transactions were effectuated by the sale or exchange of “stock” -- expressly defined to be a security for purposes of the federal securities laws -- the context was such that stock used in this manner should not fall within the statutory definition of a security. Rejecting the doctrine, the Supreme Court opined that “stock” possessing all traditional characteristics is a security without regard to its role in the sale of an entire business. The Supreme Court thus extended application of the federal securities laws to mergers and acquisitions involving the sale or exchange of stock, with the immediate impact on M&A firms arising from securities broker-dealer registration requirements. As a matter of law, a securities “broker” is any person engaged in the business of effecting transactions in securities for the account of others. It is unlawful for any broker to effect any transactions in, or to induce or attempt to induce the purchase or sale of, any security unless the broker or dealer is registered with the SEC under the Securities Exchange Act of 1934. M&A firms acting as intermediaries in mergers or acquisitions involving stock or other securities have faced the prospect of federal regulation by reason of their activities. No distinction is made between the size or scope of any sale of a business transaction. Previous SEC guidance on the permissible scope of intermediary activities to avoid broker registration requirements came primarily in 1986 and 2006 SEC NoAction Letters (International Business Exchange Corp. and Country Business, Inc.), which imposed significant restrictions on the role of intermediaries. For example, the permissible role of an intermediary in negotiations between the seller and potential purchasers or their representatives under these no-action letters was strictly limited. Other limitations prohibited the intermediary from advising any party whether to issue securities, or otherwise how to effect the transfer of the business by means of securities, or to advise on or assess the value of any securities involved in the transaction. Furthermore, the staff’s relief from broker-dealer registration applied only to transactions in which the selling company met size standards for a “small business,” and only assets could be advertised or otherwise offered for sale by the intermediary. Although transaction-based compensation for an intermediary was permitted under the previous guidance, such compensation was subject to several conditions, such as the requirement that compensation be determined prior to any decision on how to effect the sale of the business. The substantial limitations on intermediary activities in smaller, privately-held company transactions prompted the call in Congress for “right-sizing” broker regulatory requirements under the federal securities laws. Now, with the Six Lawyers No-Action Letter, the SEC Staff has itself heeded the call for more relief from broker-dealer registration requirements in the private company transaction setting. Six Lawyers and the Scope of Permitted M&A Broker Activity No-Action advice is granted, or withheld, by the SEC staff on the basis of facts and representations presented by the party requesting it regarding proposed activity, as to which the party requests assurances that the staff would not recommend enforcement action if the proposed activity were undertaken. Accordingly, in the Six Lawyers No-Action Letter, the staff of the SEC Division of Trading and Markets, based on the specific facts and representations made in the request, advised that it would not recommend enforcement action if a M&A Broker (as specifically described earlier for purposes of the request) 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 request letter without registering as a broker-dealer under the Securities Exchange Act of 1934. The representations on which the staff granted No-Action advice consist of the following: The M&A Broker will not have the ability to bind a party to an M&A transaction; The M&A Broker will not, directly or indirectly, provide financing for an M&A transaction; The M&A Broker may not under any circumstances have custody, control, or otherwise possession of, or otherwise handle, funds or securities issued or exchanged in connection with the M&A transaction or any other securities transaction for the account of others; The M&A transaction will not involve a “public offering” of securities, that is to say, any offering or sale of securities will be conducted in compliance with an applicable exemption from registration under the federal Securities Act of 1933; No party to any M&A transaction may be a “shell company,” other than a business combination related shell company as that term is defined in rules under the Securities Act; The M&A Broker may represent both buyers and sellers, provided it provides clear written disclosure as to the parties it represents, and obtains written consent from both parties to the joint representation; An M&A Broker will facilitate an M&A transaction with a group of buyers only if the group is formed without the assistance of the M&A Broker; The buyer, or group of buyers, in any M&A transaction will, upon completion of the M&A transaction, control and actively operate the business conducted with assets of the business; The M&A transaction may not result in the transfer of interests to a passive buyer or group of buyers; Any securities received by the buyer or the M&A Broker in an M&A transaction will be “restricted securities” within the meaning of Rule 144 under the Securities Act of 1933, and resales will be governed by the conditions prescribed in Rule 144; and The M&A Broker (and, if the M&A Broker is an entity, each officer, director, or employee of the M&A Broker): (1) has not been barred from association with a broker-dealer by the SEC, any state or any self-regulatory organization; and (2) is not suspended from association with a broker-dealer. Importantly, in the Six Lawyers No-Action Letter, the SEC staff accepted the proposition that an M&A Broker would advertise a privately-held company for sale with information such as the description of the business, general location and price range. Also, the staff accepted the representation that a buyer or buyer group would be presumed to have post-transaction control of a company if, upon completion of the transaction: (1) the buyer or buyer group has the right to vote 25 percent or more of a class of voting securities; or (2) 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. In addition, as noted above, the buyer, or group of buyers, must actively operate the company or the business conducted with the assets of the company. The staff also noted that a buyer could actively operate the company through the power to elect executive officers and approve the annual budget, or by service as an executive or other executive manager, among other things. Practical Considerations Going Forward The Six Lawyers No-Action Letter recognizes the particular characteristics of M&A transactions involving privately-owned companies such as the typically active role of buyers and sellers (and their advisors) that distinguishes these transactions from the purchase or sale of securities by investors for passive investment purposes. M&A Brokers may now be much more involved with buyers and sellers in negotiating the terms of a transaction and advising in regard to the securities and the value of securities in structuring a transaction. Under previous guidance, if a decision was made to effect a transaction by the sale of securities, the M&A Broker’s role was strictly limited to, among other things, only valuing the assets of the business as a going concern. The M&A Broker could not engage in negotiations on behalf of a client, advise the client whether to issue securities or assess the value of securities to be sold. Moreover, alternative transaction-based fee arrangements were left uncertain. As with any No-Action Letter, the relief extended in the Six Lawyers letter is limited solely to the activity represented in the request. Different facts and circumstances could produce a different conclusion. However, it is also true that the representations presented to the staff are broadly stated, and consistent with the notion that particular services to be provided by an intermediary will vary depending on the facts and circumstances of a particular transaction. Previous guidance was clearly restrictive, limited the number of intermediaries who would provide important services, and limited their utility based upon how parties determined to structure transactions. Guidance under the Six Lawyers No-Action Letter opens the door to much more realistic assessments of activity in terms of what could, or should, be impacted by securities broker registration requirements in circumstances in which there is no need for their application, and recognizes what those requesting the Six Lawyers No-Action Letter urged: Intermediaries in M&A Transactions can perform a valuable function in preserving and creating jobs, and maximizing shareholder value. They can assist buyers by, among other things, bringing potential acquisitions to their attention. They can benefit sellers as well by exposing their businesses to a wider range of potential purchasers than the seller itself might be able to identify. Such exposure can result in competing bids, thus assisting the seller to maximize the sale price and perhaps shortening the time to conclude a sale. It is important to note that while the SEC staff’s interpretive position is an important step forward at the federal level, it does not address other licensing or registration requirements to which M&A advisors may be subject under various state laws or regulations. Nevertheless, the Six Lawyers No-Action Letter provides welcome relief to privately held companies and their advisors in M&A transactions, and the flexibility and practicality of the SEC’s approach may prove influential to state regulators as well.