Registration as a Broker-Dealer with the SEC. Who Needs it?
John D. Mirkin Feb. 9, 2023
It can be challenging to understand when and whether a person or entity needs to register as a broker-dealer. For example, a company or fund that is trying to raise capital will often consult with a third party to help find the right investors. If the third party receives compensation based on successfully finding a suitable investor, then they may be acting as a broker without realizing it, subjecting themselves to unintended liability. Unregistered broker-dealers can attract harsh sanctions from the U.S. Securities and Exchange Commission (“SEC”), lose the ability to enforce contracts, and may even face criminal prosecution under state and federal law. It is particularly important for individuals and companies engaged in transaction-based compensation to understand the complex rules regarding broker-dealer registration with the SEC.
The Securities Exchange Act of 1934 (“the ’34 Act") governs the way the nation's securities markets and its brokers and dealers operate. Section 3(a)(4)(A) of the ’34 Act defines a "broker" broadly as “any person engaged in the business of effecting transactions in securities for the account of others.” The SEC lists certain situations where whether a business is acting as a broker is “less clear.” One situation where broker status is less clear to the SEC is where businesses or individuals are engaged in finding buyers and sellers of businesses, such as activities relating to mergers and acquisitions where securities are involved. Individuals and companies involved in these business activities may need to register, depending on several factors. In a series of No-Action Letters ranging from May of 2001 to May of 2010, the SEC fixated on transaction-based compensation as a primary indicator of acting as broker. The SEC’s attempts at enforcement on these grounds often led to unsuccessful efforts in court, with courts typically applying a more balanced and plain reading of the statutory elements of Section 3(a)(4)(A) of the ’34 Act. Additional factors that courts will consider include participating in negotiations, analyzing the issuer's financial needs, discussing the details of the transaction, and recommending an investment.
In January 2014, the SEC issued a staff No-Action Letter exempting certain intermediaries from registering as brokers when facilitating or assisting in the sale of private companies. This Letter was a significant step forward by the SEC in providing clarity in this area, though the Letter’s official legal effect is that it is a statement of the SEC staff’s position with respect to enforcement of registration for mergers and acquisitions (“M&A”) brokers, and as such, it is not legally binding on the SEC. Nonetheless, if the Letter’s provisions are complied with, it is unlikely that the SEC would attempt to enforce registration. The 2014 Letter has prompted legislative changes in various states including Florida. M&A brokers are defined in the Letter as individuals or entities “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.”
The Letter also contains specific limitations on the registration exemption which must be observed, including that M&A brokers may not bind a party to an M&A transaction and may not provide the actual financing for the transaction. Assisting purchasers in obtaining financing from unaffiliated third parties is permissible. The intermediary cannot handle or control any funds or securities issued or exchanged in connection with an M&A transaction for the account of others. The transactions cannot involve public offerings and no party to the transaction can be a shell company. If representing both buyers and sellers, the broker must obtain written consent from both parties. An M&A broker can only facilitate an M&A transaction with a group of buyers if the group was formed without the assistance of the broker. The group of buyers must control and actively operate the business after the transaction, and the transaction must not result in the transfer of interests to one or a group of passive buyers. Compliance with these restrictions will make it unlikely that SEC would attempt to enforce registration.
Shortly after the SEC furnished this guidance, Florida enacted Florida Statute Section 517.061(22) which largely mirrors the provisions in the No-Action Letter set forth above. This statute functions as a state law exemption from registration for M&A brokers. The Florida statute is more restrictive than the SEC with respect to defining privately held companies, requiring that in the fiscal year immediately preceding the fiscal year during which the M&A broker begins to provide services for the securities transaction, the company (to be considered private) must have EBITDA of less than $25 million or gross revenue of less than $250 million with a provision for future adjustments for inflation. Additionally, both the Florida and federal exemptions only require that the seller be a private company, not the buyer. The SEC specifically states: “in connection with the transfer of ownership and control of a privately-held company.” Likewise, the Florida statute states: “in connection with the transfer of ownership of an eligible privately held company.” Neither the federal nor Florida exemption places such a restriction on the buyer of the privately held company.
In summary, individuals and companies concerned with whether they are required to register with the SEC should seek to understand the nuanced exemptions carved out by the SEC and under Florida State law and avoid inadvertently triggering restrictions from exemptions. It is important to note that even if it is determined that a person or business does not need to register with the SEC or Florida as an M&A broker-dealer, there may be other applicable registration requirements under Florida law. Certain business activities may necessitate another form of registration and fall under the purview of other Florida statutes that are outside the scope of this article.
If you have any questions or would like to discuss your situation, you can contact a member of our team directly or contact us through our website.