Prior to 1985, the SEC did not consider a sale of a deal structured as a stock sale to be a sale of securities under the securities laws. This became known as the Business Selling Doctrine. As a result, the penalties and rules that apply to sales of securities do not apply to the sale of a business, and business brokers and M&A brokers could receive commissions in connection with those sales without being registered as brokers. of bag. This changed in 1985 when the United States Supreme Court took the position that the sale of a business structured as a stock sale was in fact the sale of securities. As a result, commercial brokers and M&A brokers were prohibited from earning commissions in connection with those sales unless they were registered as stockbrokers. This has substantial implications for trade brokers and M&A brokers, especially when a transaction started out structured as an asset sale and then, during the course of negotiations, the transaction was restructured to become a share sale. In that case, commercial brokers and M&A brokers who were not registered as stockbrokers were theoretically prohibited from earning a commission, simply because the structure of the transaction had changed. This result was often seen as unfair in the industry.
The ABA’s task force on privately placed stockbrokers noted in its 2000 final report that the stockbroker registration process involved significant costs, as well as a regulatory model that is inadequately sized to accommodate the role role played by commercial brokers in connection with the sale of a business. The requirement to register as a stockbroker is a lengthy process and there are substantial costs and fees, along with first-year and start-up expenses, including legal, accounting, and operating costs that can amount to several hundred thousand dollars. People who make one or several transactions a year simply cannot bear this financial burden. These companies do not hold client funds or securities and typically simply introduce the parties to each other and transmit documents between the parties. They do not participate in the structuring or negotiation of these transactions nor do they advise the parties. Both buyers and sellers in this type of transaction are typically represented by legal counsel who can assist with due diligence, draft transaction documents, and advise their clients on structure, tax considerations, and contractual provisions and there are resources, both contractual and by operation of law. , which are available to the parties in this type of operation.
On January 31, 2014, the SEC changed its mind on these matters and issued a long-awaited no-action letter that allows certain M&A brokers to receive commissions in connection with the sale of a business, even when the sale is structured. Like a stock sale.
Under the new interpretation, M&A brokers can facilitate acquisitions, mergers, business sales, and business combinations on behalf of buyers and sellers of private companies and receive commissions in connection with the transaction. Additionally, the letter does not limit the amount or type of compensation an M&A broker can receive, and it does not limit the size of the private company. The letter also allows M&A brokers to advertise the sale of a private company and to include in such announcements a description, general location, and price range of the business.
For the purposes of this letter resolution, a private equity firm is one that does not have any class of securities registered or required to be registered with the SEC under Section 12 of the Exchange Act or for which it is required to file periodic reports under Section 15(d) of the Exchange Law. Also, the company must be a going concern and not a shell company.
As is often the case in these matters, there is a catch. In this case, the problem is that the relief available under this no action letter is only available if the transaction meets ten (10) very specific conditions.
Those conditions are the following:
1. The “M&A intermediary” must not have the ability to bind a party to an M&A transaction. A “mergers and acquisitions broker” for purposes of the letter is a person who is engaged in the business of effecting the transaction of securities solely in connection with the transfer of ownership and control of a private company through the purchase, sale, exchange, issue, repurchase, redemption, or business combination involving company securities or assets, to a buyer who will actively operate the company or business with the assets of the acquired company.
2. The M&A broker must not, directly or indirectly through any of its affiliates, provide financing for the M&A transaction. The M&A broker may assist the buyer in obtaining financing from an unaffiliated third party, but must comply with all applicable legal requirements and disclose to its client, in writing, receipt of any compensation in connection with the financing.
3. The M&A broker is prohibited from having custody, control, possession or otherwise handling any funds or securities issued or exchanged in connection with the M&A transaction or other securities transactions on behalf of third parties. The merger and acquisition operation cannot imply a public offer. Any offering of securities must be made pursuant to an applicable exemption from registration.
4. Neither party to a merger and acquisition transaction may be a shell company, other than a company related to a business combination.
5. If an M&A broker represents both a buyer and a seller in a transaction, they must clearly disclose the potential conflict in writing to the parties they represent and must obtain the written consent of both parties for joint representation.
6. An M&A broker may only facilitate an M&A transaction with a group of buyers if the group is formed without the assistance of the M&A broker.
7. The buyers or a group of buyers in a merger and acquisition transaction must actively control and operate the acquired business with the assets of that business. In this sense, control will be deemed to have been achieved if the buyers have the power directly or indirectly to manage the company or company policies through ownership of securities by contract or otherwise. Under the SEC’s opinion, an acquirer could be considered to actively operate an acquired company simply by possessing the power to elect executive officers and approve annual budgets or by serving as an executive or other executive officer, among other things. The necessary control will be presumed if at the end of the operation the buyer or group of buyers has the right to vote 25% or more of the class of securities with voting rights; has the power to sell or direct the sale of 25% or more of a class of voting securities; or in the case of a partnership or limited liability company is entitled to receive, at the time of dissolution, 25% or more of the proceeds of the dissolution, or has contributed 5% or more of the capital of the transaction. In addition, the buyer or a group of buyers must actively operate the acquired company or business with the company’s assets.
8. No merger and acquisition transaction may result in the transfer of interests to a passive buyer or to a group of passive buyers.
9. All securities received by the buyer in the merger and acquisition transaction will be restricted securities within the meaning of Rule 144(a)(3) of the Securities Act.
10. The M&A broker must meet the following conditions:
(a) The SEC or any state or self-regulatory organization has not prohibited the broker from associating with a stockbroker.
(b) The broker must not be suspended from association with a stockbroker.
These rules make it very clear who will be entitled to the exemption provided in the no action letter. As a result of these changes, business brokers and M&A brokers will no longer have to worry about whether or not they will be able to receive their commission if a transaction ultimately turns into a stock purchase. The SEC’s actions in this case are based on an understanding of the realities of the typical business sale transaction. The truth is that these transactions are structured on the basis of accounting or tax considerations, and not on the application of federal securities laws. The sale of a business between sellers and buyers of privately held companies is qualitatively different in virtually every respect from traditional retail or institutional brokerage transactions.
We are encouraged that the SEC has recognized these distinctions. This decision will clarify a sensitive area of the law and provide appropriate relief to commercial brokers and M&A brokers working in this area.