How NASAA’s Proposed Model Rule Exempting M&A Brokers Stacks Up Against Other Efforts

The Broker-Dealer section of the North American Securities Administrators Association (“NASAA”) recently sent out a notice of request for comment on a proposed uniform state model rule (“Model Rule”) that would exempt merger and acquisition brokers (“M&A Brokers”) from state securities registration if certain requirements were met. While NASAA’s proposed Model Rule is similar to the recent SEC No-Action letter concerning M&A Brokers and the exemption for M&A Brokers provided by HR 37, there are some notable differences. Comments on the Model Rule must be submitted to NASAA by February 16, 2015.

First, this post will lay out the three current proposals by SEC staff, Congress, and NASAA to create an M&A Broker registration exemption. Second, a comparison between all three will be made in order to highlight how each body plans to regulate and define the scope of the exemption for M&A Brokers. Each comparison will be broken up into key aspects of each proposal’s efforts to create an exemption for M&A Brokers. Third, this post will emphasize the need to create an exemption, along with M&A Brokers, that will encompass other important unregistered actors: Private Placement Brokers.

I. The Three Efforts
The SEC No-Action letter issued in January, 2014, outlined certain circumstances under which the SEC would not pursue an enforcement action against a broker for failing to register with the SEC as a broker-dealer. On January 14, 2015, the House of Representatives passed H.R. 37, one section of which exempted M&A Brokers from registration. The most recent effort, NASAA’s Model Rule, also provides an exemption from registration for M&A Brokers. Subject to a few conditions, the M&A Broker, as defined by each respective effort, will be exempt from SEC registration.

II. Analysis of the Proposals
The SEC’s M&A Broker exception was proposed first, and laid the groundwork for the subsequent efforts put forth by Congress and NASAA. Next, H.R. 37, which was introduced in the House on January 6, 2015, mirrored most, but not all, of the conditions set out in the SEC No-Action letter. Last, NASAA’s proposed Model Rule more closely resembles H.R. 37 than the SEC No-Action letter, but it is not identical to either. Their similarities and differences are analyzed in more depth below.

(a) Defining “M&A Broker”
Many similarities of what a M&A Broker should be able to do run through H.R. 37 and the Model Rule. The Model Rule and H.R. 37 both define an M&A Broker as “any broker and any person associated with a broker engaged in the business of effecting securities transactions solely in connection with the transfer of ownership of an eligible privately-held company” as long as the broker reasonably believes that the acquiring party will control and be active in the management of the company and that anyone offered securities of the eligible privately-held company has reasonable access to the certain financial information regarding the company before the transaction is consummated.

The SEC No-Action’s definition of an M&A Broker is similar to H.R. 37 and the Model Rule, but differs in its conditions to the definition. The SEC requires absolutely that any person acquiring securities or assets will have control or be active in the management of the company, while H.R. 37 only requires that the M&A Broker have a reasonable belief of control or active management on behalf of the acquirer. Additionally, the SEC does not explicitly require the M&A broker to have a reasonable belief that any person offered assets or securities have reasonable access to certain financials before the transaction but of course, this No-Action letter provides no exemption from Rule 10b-5
(b) Prohibited Activities
Under all three proposals, an M&A Broker is prohibited from certain activities to maintain exemption from registration. The Model Rule prohibits M&A Brokers from (1) having custody or control of funds or securities subject to the transaction, (2) engaging in a public offering, and (3) engaging in a transaction involving a shell company. In contrast, H.R. 37 could allow M&A Brokers to engage in a broader scope of conduct compared to that outlined in NASAA’s Model Rule. The only conduct prohibited by H.R. 37 is having custody or control of funds or securities subject to the transaction and engaging in a public offering. No mention is made by H.R. 37 of prohibiting an M&A Broker from transactions involving a public shell company.

Compared to the other two proposals, the SEC No-Action letter, which is the only one that is currently effective, is most restrictive in the types of activities in which an M&A Broker can engage. In addition to the three activities prohibited by the Model Rule, the SEC lists four additional excluded activities. An M&A Broker cannot (1) have the ability to bind a party to a transaction; (2) provide financing, directly or indirectly, but if assisting in obtaining financing from unaffiliated third-parties, it must disclose any compensation in writing to the client; (3) represent both buyers and sellers unless clear written disclosure is given to the parties and written consent is obtained by both parties; or (4) facilitate a transaction with a group of buyers if the group was formed with the assistance of the M&A Broker.

(c) Defining “Privately Held Company”
Definitions for what constitutes a privately held company are identical in NASAA’s Model Rule and H.R 37. The company must not have any registered securities and must have revenue less than $250 million, earnings before interest, taxes, depreciation, and amortization of less than $25 million, or both. The SEC’s definition excludes the size limits placed on privately held companies by the Model Rule and H.R. 37.

(d) When Presumption of Control Arises
The SEC No-Action letter is also different from the Model Rule and H.R. 37 with respect to presumption of control. The presumption arises under the SEC’s No-Action letter if the person (1) is a director, general partner, member or manager of an LLC, or officer exercising executive responsibility; (2) has the right or to vote or power to sell 25% or more of class of voting securities; or (3) has the right to receive upon dissolution, or has contributed, 25% or more of the capital to the partnership or LLC. H.R. 37 and the Model Rule are identical, except that the percentages of voting shares and receipt of capital is reduced from 25% to 20%.

Based on a simple comparison of the proposals to exempt M&A Brokers from registration, NASAA’s Model Rule is strikingly similar to H.R. 37. Although the SEC No-Action letter is the least restrictive in the conditions that must be met for the exemption, it is the toughest on activities that M&A Brokers are prohibited from engaging in. Highlighting the comparisons of each effort to regulate M&A Brokers is important in maintaining uniformity in securities regulation and enforcement, however, a significant number of unregistered actors, mainly Private Placement Brokers, will be unaffected by these efforts.

III. Looking Ahead
Unfortunately, none of the three proposals address the bigger issue discussed in a previous post on this blog. What are we going to do about the huge gray market of Private Placement Brokers other than M&A Brokers? As pointed out in our previous post, this gray market was formally recognized and exhaustively analyzed by the American Bar Association in 2005. That analysis pointed out how critical and potentially dangerous this gray market is to early stage enterprises. Yet neither the SEC, NASAA nor Congress has seen fit to address this ongoing yet essential illegality.

Parker MacIntyre provides legal and compliance services to investment advisers, broker dealers, registered representatives, hedge funds, and issuers of securities, among others. Our regulatory practice group assists financial service providers with complex issues that arise in the course of their business, including complying with federal and state laws and rules. Please visit our website for more information.

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