Status and Comparison of the SEC M&A Broker No-action Letter and

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1 Status and Comparison of the SEC M&A Broker No-action Letter and H.R S the Small Business Mergers, Acquisitions and Sales Brokerage Simplification Act Summary and Status Update By Shane B. Hansen, Partner Warner Norcross & Judd LLP December 19, 2014 H.R. 2274, the Small Business Mergers, Acquisitions, and Sales Brokerage Simplification Act of 2013, and its identical Senate companion bill, S (together, the Bill), would amend the Securities Exchange Act of 1934 (the Exchange Act), to create an exemption from federal broker-dealer registration for M&A brokers who facilitate mergers, acquisitions, sales, and similar transactions inoling priately held companies. While H.R unanimously passed the U.S. House of Representaties in 2014, the 113 th Congress adjourned without the U.S. Senate acting on the Bill. It is anticipated the Bill will be reintroduced in Two weeks after the Bill passed the U.S. House, the Securities and Exchange Commission (SEC) staff issued the M&A Broker no-action letter dated January 31, 2014, to six securities lawyers (the NAL). This NAL is generally aailable to any intermediary assisting with the transfer of a priately held company s ownership under its stated facts, circumstances, and conditions. Unlike most no-action letters, the application of this NAL is not limited to the persons requesting the guidance and relief. The SEC Diision of Trading and Markets staff s letter concludes it would not recommend enforcement action if, without registering with the SEC as a broker-dealer, an M&A broker engages in coered actiities if all of the NAL s conditions are satisfied. 1 While, in effect, the NAL has granted similar exemptie relief to what the Bill would add to the Exchange Act, the NAL does not bear the authority of a rule or order officially adopted by the SEC s fie commissioners, and so it is limited in its legal effect. 2 The NAL is effectie today for M&A brokers who satisfy its stated facts, circumstances, and conditions unless and until the SEC staff present or future chooses to change its stated position. The SEC staff s position is not legally binding on a court and does not apply to state securities regulation. 1 For additional information about the background and substance of the NAL and the Bill, please refer to the article, Simplifying Securities Regulation of M&A Brokers, first published in the Michigan Business Law Journal, aailable at: 2 See the SEC s explanation of its no-action letters on its website at:

2 SEC M&A Broker NAL s. H.R. 2274/S Page 2 of 4 The NAL and the Bill share fundamental public policy underpinnings, which is not coincidental because they share a common origin 3 and represent extensie discussions about M&A brokers that started in 2006 with the SEC staff and state securities regulators. Discussions with SEC staff about the terms of a possible no-action letter commenced on June 6, 2013, the same day as the Bill s introduction in the U.S. House. The NAL uses many terms and contains conditions that are the same or similar to those in the Bill. Notably, under both the NAL and the Bill, the target company must be priately held by the seller and, after the transaction s closing, the buyer must hae acquired control and be actiely inoled in operating the business. 4 The definition of an M&A broker, the types of coered M&A transactions, and, with the exception of its size, the definition of a priately held company are the same. Control concepts are the same but with slightly different presumption thresholds, as noted below. There are seeral notable differences. Most differences between the NAL and the Bill arise from the inherently factspecific nature of a no-action letter when compared to the general nature of a statutory amendment. A few substantie differences resulted from the timing of the Bill s introduction on June 6, 2013, and the NAL s release eight months later, as well as an amendment just prior to H.R s mark-up by the U.S. House Financial Serices Committee. The SEC requested that the Committee modify the Bill to create a self-executing exemption, rather than requiring a simplified form of notice-filing registration as was initially proposed. This amended ersion of H.R then unanimously passed the Committee (57-0) on Noember 14, 2013, and it unanimously passed the U.S. House (422-0) on January 14, Changes made to accommodate the SEC s request inadertently deleted certain disqualifications, as noted below. Comparison of the NAL and the Bill The NAL does not include any limitation on the size of a priately held company. Under the Bill the size of the target company was limited to being either: (i) less than $25 million in earnings before interest, taxes, depreciation, and amortization (commonly called EBITDA); and/or (ii) less than $250 million in gross reenues. The size was measured by the company s historical financial accounting records for the most recently completed fiscal year. The concept of a size limitation was included in the Bill in iew of an earlier suggestion of the SEC staff. The NAL uses a 25% threshold to create a presumption of a buyer s acquiring control of the target company. This threshold is commonly used by the SEC in a ariety of contexts such as reporting ownership in Form BD and when approal is required for a firm s change of control. The Bill uses a 20% threshold because the U.S. Small Business Administration uses this threshold to prescribe when a business owner must gie a personal financial guarantee to support an SBA loan to the company. 3 See the Report and Recommendations of the Priate Placement Broker-Dealer Task Force of the Business Law Section of the American Bar Association, 60 Business Lawyer (2005) aailable on the SEC s website at ). 4 These conditions are closely related to the public policy considerations articulated by the U.S. Supreme Court in SEC. Ralston Purina Co., 346 U.S. 119; 73 S. Ct. 981; 97 L. Ed (1953).

3 SEC M&A Broker NAL s. H.R. 2274/S Page 3 of 4 The NAL includes statutory bad actor and public shell disqualifications; substantially similar disqualifications were in H.R as first proposed and introduced, but were later inadertently deleted by Congressional legislatie counsel in accommodating the SEC s request for the Bill to create a self-executing registration exemption, rather than a notice-filing registration system. The NAL expressly permits a business combination related shell company, which in essence is an entity created specifically for tax and arious transaction-related business purposes. The SEC public shell disqualification pertains to so-called reerse mergers in which a priate company merges into an inactie public shell company and thereby becomes publicly traded. When reintroduced in 2015, the Bill is expected to include these disqualifications. The NAL expressly requires that the target company be an operating company that is a going concern. The Bill did not include these terms because, for example, small business owners sometimes hold business-related real estate assets in a separate legal entity that is neither an operating company nor a going concern. Sometimes a start-up business may not yet hae become operational. Sometimes a company s sale may be precipitated by financial troubles or it may be purchased out of a bankruptcy proceeding, and so might not be deemed a going concern. Whether or not a company is a going concern may not be readily eident or conclusiely determined, creating uncertainty oer the aailability of the exemptie relief, particularly for M&A brokers specializing in corporate work-outs, turn-arounds, and reorganizations. Both the NAL and the Bill require the buyer to be, directly or indirectly, actiely inoled in operating the business after closing. The NAL proides non-exclusie examples, including the power to elect executie officers and approe the annual budget, or by serice as an executie or other executie manager. The Bill is silent on these details. Both the NAL and the Bill prohibit an M&A broker from haing custody of client funds or securities. The NAL further proscribes that an M&A broker may not hae the ability to bind a party to an M&A transaction. The Bill is silent on this point. The NAL proscribes that an M&A broker or its affiliates may not proide financing for an M&A transaction. So, for example, a bank could not proide commercial financing to a transaction facilitated by a bank-affiliated M&A broker. Similarly, a priate equity or enture capital fund buyer could not use a fund-affiliated M&A broker for its own acquisition transactions. The NAL does permit an M&A broker to assist a party in obtaining financing; proided, that any related compensation is disclosed to the client and, in doing so, the M&A broker complies with all applicable laws including, as applicable, the Federal Resere Board s Regulation T. The Bill is silent on these points. The NAL acknowledges that an M&A broker may adertise the aailability of a priately held company for sale as such (in contrast to the sale of its securities), presumably to aoid the question of whether the adertising is general solicitation for a securities transaction. The Bill is silent on this point.

4 SEC M&A Broker NAL s. H.R. 2274/S Page 4 of 4 Under the NAL a qualifying M&A transaction may not inole a public offering of securities; that is, the transaction must qualify for a priate offering exemption from securities registration. Recognizing that priately owned businesses are sometimes acquired by publicly traded companies in stock-for-stock mergers or exchanges, the Bill is more finely tailored to preclude an M&A broker from engaging on behalf of an issuer in a public offering. The Bill would allow an M&A broker to assist the seller of a priately owned company that is being acquired by a publicly held buyer using its securities, rather than cash, to fund the transaction. The NAL expressly states that the securities acquired in the M&A transaction will be restricted securities within the meaning of Rule 144(a)(3). While the Bill is silent on this point, existing law results in the same characterization and legal treatment of the securities acquired by the buyer in the transaction. The NAL and the Bill both allow for acquisitions structured as stock-for-stock mergers or exchanges. In these transactions the seller will receie the buyer s securities. The Bill requires the buyer to proide basic financial and management information to the seller. The NAL does not include this inestor protection. Recognizing that, as an independent intermediary, an M&A broker cannot know or dictate a buyer s post-closing conduct, the Bill requires an M&A broker to reasonably beliee the buyer will acquire control and actiely manage the business after the transaction s closing. This belief could be established, for example, in and eidenced by the M&A broker s engagement letter. The NAL is silent on this nuance. Looking Ahead Both the NAL and the Bill only address the requirements of federal securities laws. Working through the North American Securities Administrators Association (NASAA), state regulators are deeloping a complementary model rule under state securities laws. If adopted by NASAA, the model rule would be aailable for use by each state to implement in accordance with its own administratie procedures. Some states already hae broker-dealer registration exemptions directly applicable to M&A brokers (e.g., California, Colorado, Ohio, and Texas). Some states hae transaction-based exemptions not specifically related to M&A transactions (e.g., transactions inoling institutional inestors as state-defined or construed). A model rule will help to bring a more uniform approach to state-leel securities regulation of M&A brokers. The NAL is presently effectie. The Bill, including technical corrections to add back those disqualifiers inadertently deleted during mark-up, is expected to be reintroduced in the 114 th Congress. Stay tuned for more federal and state deelopments affecting M&A brokers in #

5 SHANE B. HANSEN BIOGRAPHICAL SUMMARY SHANE B. HANSEN is a partner and co-chairs the Funds and Inestment Serices Practice in the law firm of Warner Norcross & Judd LLP. His law practice concentrates in the area of financial serices regulation, primarily inoling federal and state securities and banking laws and related rules. He adises banks, broker-dealers, M&A adisors and business brokers, inestment adisers, inestment managers, priate fund adisers, family offices, financial planners, and registered representaties about a wide range of business, corporate, contract, compliance, and regulatory topics, and frequently speaks on compliance topics. He has substantial experience inoling formations, mergers, acquisitions, and sales of financial serices firms and practices. He was recognized in The Best Lawyers in America, Corporate Law and Securities Regulation, 2007 through 2014 editions and named a super lawyer in the 2006, 2007, and 2009 through 2013 editions of Michigan Super Lawyers. Mr. Hansen sered as the lead counsel and primary draftsman of H.R. 2274, the Small Business Mergers, Acquisitions, and Sales Brokerage Simplification Act of This bill would amend the Securities Exchange Act of 1934 to clarify and simplify federal broker-dealer regulation of M&A adisers and business brokers. Mr. Hansen presented oral and written testimony before the Committee on Financial Serices of the U.S. House of Representaties. The bill unanimously passed the U.S. House of Representaties on January 14, 2014, and is pending before the U.S. Senate. Mr. Hansen is a member of the Business Law Section Council, State Bar of Michigan (2014-present) and is a long-time actie member of both the Section s Securities and Financial Institutions Committees. He is the immediate past chair the Committee on State Regulation of Securities in the Business Law Section of the American Bar Association ( ). This ABA committee is comprised of more than 600 lawyers, paralegals, state regulators, and law professors from around the country. He co-chairs its Subcommittee of Liaisons to Securities Administrators in the U.S. and Canada (2007- present), producing an annual report on state securities law deelopments. He is also an actie member of the ABA s Committee on Federal Securities Regulation. Other professional memberships and associate memberships include the Compliance and Legal Society of the Securities Industry and Financial Markets Association (SIFMA), the Financial Serices Institute (FSI), the Inestment Adiser Association (IAA), the Financial Planning Association (FPA), and the National Society of Compliance Professionals (NSCP). Mr. Hansen graduated with honors from the Uniersity of Michigan Law School in He graduated with high honors from Albion College in Warner Norcross & Judd LLP is a full serice law firm with oer 220 attorneys practicing from eight offices located in Grand Rapids, Southfield, Holland, Kalamazoo, Muskegon, Lansing, Midland, and Macomb County, Michigan. The firm s Funds and Inestment Serices Practice is an interdisciplinary group of attorneys and securities compliance consultants with substantial experience in the matters important to financial and inestment serices proiders and others who may be subject to federal and state securities laws, rules and regulations, as well as FINRA rules, regulation, and enforcement. Client matters include corporate, contracts, formation and registration, compliance, mergers and acquisitions, as well as preparing for and responding to examinations, enforcement, customer arbitration, and litigation. Other common client matters include human resources, labor, and benefits, trusts and estates, and tax issues. The firm represents a wide range of clients from large to small, with arious business models, and located in arious parts of the country. More information about Shane and Warner Norcross & Judd LLP can be found on the Internet at: He can be reached at or [email protected] /20/2014