Wednesday, October 1, 2014

How do You Qualify for M & A Broker Exemption? (Article 8 in a series of 14 articles about Deal-Makers)

By Jim Verdonik
I'm an attorney with Ward and Smith PA. I also write a column about business and law for American Business Journals , have authored multiple books and teach an eLearning course for entrepreneurs. You can reach me at
Or you can check out my eLearning course at
or read my newspaper articles at
This article is one of 14 articles in a series of articles about Deal-Makers called:
LET'S MAKE A DEAL: REGULATING DEAL-MAKERS ON WALL STREET, MAIN STREET AND IN SILICON VALLEY IN THE CROWDFUNDING ERA                                                                                                                    
For many years, people who do deals have advised the SEC that there is no reason to apply strict broker-dealer rules to business brokers and finders who help people sell their businesses.

Business' sell assets all the time without dealing with securities laws.  In most situations, assets are not securities.  Why would selling all the assets in one transaction be covered by securities laws, but selling the same assets in several transactions not be covered by securities laws? 

But the neat divide between asset sales and securities sales often gets blurred after an owner decides to sell the business.  One reason is that whether a sale is structured as an asset sale or a stock sale or merger is influenced by tax, accounting, liability and other issues that have little to do with securities laws. 

For example, if a corporation that is taxed under Sub-Chapter C of the tax code sells its assets, the owner may be subject to double taxation – the corporation is taxed on the gain on sale if the assets and the owners taxed when they receive a liquidating dividend.  To avoid double taxation, the owners prefer to sell stock rather than assets. 

A business might have leases or other valuable contracts that cannot be sold.  Depending on how these contracts are worded, you might be able to avoid renegotiating favorable contracts by selling stock instead of transferring assets.

Stock sales usually involve fewer employee related issues, because the employees remain employed by the same company when the stock is sold.  In an asset sale, employees have to quit or be fired and then be re-employed by the buyer.

For many reasons, what might start out as a seller trying to sell the business' assets can turn into a stock sale after the business broker finds the buyer.  Likewise, stock sales can turn into asset sales when buyers seek to avoid taking on unknown liabilities or want to be able to depreciate assets.

Since all of these reasons for choosing deal structure have nothing to do with securities laws, it often makes little sense to apply broker-dealer registration rules to business sales – especially where there is a single buyer in a highly negotiated transaction.

Broker-Dealer Registration Requirements

For many years, people thought the sale of all the stock in a business to a single buyer was not a securities transaction.  Then, the courts reminded us that if you sell something that is called stock, it is covered by the definition of a security under both the Securities Act of 1933 ad the Securities and Exchange Act of 1934.

Business brokers usually charge success fees that are not payable unless the business is sold and is calculated based on the purchase price of the business.  As discussed in other articles in this series of articles, charging a success fee has been one of the hot button issues for the SEC in determining whether someone needs to register as a broker-dealer.

The broker registration provisions of the Exchange Act do not include a specific exemption for selling all the stock of a business a single buyer.

For this reason people have requested the SEC to create an exemption to permit business brokers to do deals without fear they will have liability for failing to register as a broker inder Section 15 (a) (1) of the Exchange Act.

M&A Broker No Action Exemption

The SEC's staff issued a no-action letter in January 2014 that indicates the staff would not take action against people who collect success fees for selling businesses under the circumstances described in the no action letter request.  The SEC indicated it took the following factors into account in issuing this no-action letter:

1.      The M&A Broker will not have the ability to bind a party to the M&A Transaction.  
2.      The M&A Broker will not directly, or indirectly through any of its affiliates, provide financing for the  M&A Transaction.  Any M&A Broker that assists purchasers to obtain financing from unaffiliated third parties must comply with all applicable legal requirements, including, as applicable, Regulation T (12 CFR 220 et seq.), and must disclose any compensation in writing to the client.
3.      The M&A Broker will not have custody, control, or possession of or otherwise handle funds or securities issued or exchanged in connection with the M&A Transaction or other securities transaction for the account of others.
4.      The M&A Transaction will not involve a public offering.  Any offering or sale of securities will be conducted in compliance with an applicable exemption from registration under the Securities Act.  No party to the M&A Transaction will be a shell company, other than a business combination related shell company.  The term "business combination related shell company" means a shell company (as defined in Securities Act Rule 405) that is: (1) formed by an entity that is not a shell company solely for the purpose of changing the corporate domicile of that entity solely within the United States; or (2) formed by an entity that is not a shell company solely for the purpose of completing a business combination transaction (as defined in Securities Act Rule 165(f)) among one or more entities other than the shell company, none of which is a shell company.  (SEC Rule 405 defines a shell company to include any company that has minimal business operations and only cash and cash equivalent assets.  Note that the shell company exclusion is not limited to shell companies the M & A Broker organizes.  Any shell company in the transaction brings the transaction outside the scope of this no action letter.  Of course, being outside the scope of the no action letter does not necessarily mean that the person that arranges the sale is required to be registered as a broker-dealer.  People organize shell companies every day for legitimate business reasons.  If a buyer organizes the shell and raises money for the shell without the assistance of the person who arranges the sale, it is difficult to see why the mere existence of the shell should require different treatment of the person who arranges the sale of the business.)
5.      To the extent an M&A Broker represents both buyers and sellers, it will provide clear written disclosure as to the parties it represents and obtain written consent from both parties to the joint representation.
6.      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.
7.      The buyer, or group of buyers, in any M&A Transaction will, upon completion of the M&A Transaction, control and actively operate the company or the business conducted with the assets of the business.  A buyer, or group of buyers collectively, would have the necessary control if it has the power, directly or indirectly, to direct the management or policies of a company, whether through ownership of securities, by contract, or otherwise.  The necessary control will be presumed to exist if, upon completion of the transaction, the buyer or group of buyers has the right to vote 25% or more of a class of voting securities; 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, has the right to receive upon dissolution or has contributed 25% or more of the capital.  In addition, the buyer, or group of buyers, must actively operate the company or the business conducted with the assets of the company.
8.      The M&A Transaction will not result in the transfer of interests to a passive buyer or group of passive buyers.
9.      Any securities received by the buyer or M&A Broker in an M&A Transaction will be restricted securities within the meaning of Rule 144(a)(3) under the Securities Act of 1933, because the securities would have been issued in a transaction not involving a public offering.
10.  The M&A Broker (and, if the M&A Broker is an entity, each officer, director or employee of the M&A Broker): (i) has not been barred from association with a broker-dealer by the Commission, any state or any self-regulatory organization; and (ii) is not suspended from association with a broker-dealer.  

This SEC's staff position is limited to the registration requirements of Section 15(a) of the Exchange Act.  Other provisions of the federal securities laws, including the anti-fraud provisions, continue to apply.  State laws regarding broker-dealer registration continue to apply even if you satisfy all the conditions stated in the SEC staff's no action letter.

If you would like to learn more, you can reach me at
Or you can check out my eLearning course at
or read my newspaper articles at




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