Nearly a decade ago, the SEC Staff issued a no-action letter that enabled investment bankers who limit their services to M&A transactions involving private companies to avoid broker-dealer registration with the SEC. The M&A Brokers No-Action Letter (the “No-Action Letter”)[1] provided long-overdue relief. The regulatory scheme developed for traditional broker-dealers has little relevance for brokers engaged solely in advising buyers and sellers of private companies. The relief provided in the No-Action Letter included various conditions intended to ensure that the relief was limited to private company transactions involving a change in control and not involving any public distribution of securities. There was no limit on the size of private companies that might be advised by brokers relying on the No-Action Letter.
While the No-Action Letter was a welcome development, it did not fully resolve the issue. Many commentators fretted that reliance on a no-action letter was risky, as the SEC could overrule or withdraw the No-Action Letter at any time. Moreover, broker-dealers are subject to registration at both the federal and state levels, and the No-Action Letter provided no protection against state registration requirements. Some state regulators supported a model rule that largely paralleled the No-Action Letter;[2] but other states, including California, did not join this effort. As a result, many lobbied for federal legislation to address this issue, with some also asking Congress to preempt any inconsistent state laws.
The federal legislation finally arrived when Congress passed the Consolidated Appropriations Act of 2023 at the end of 2022 (the “Act”).[3] The Act creates a statutory exemption from the broker-dealer registration requirements of the Securities Exchange Act of 1934 for persons who limit their services to private company M&A transactions.[4] While the Act is substantially similar to the No-Action Letter in most respects, it differs on a key issue: it provides that the exemption is only available for transactions involving an “eligible privately held company,” which is defined as a private company with:
- EBITDA in their last fiscal year of less than $25 million; and/or
- Gross revenues in their last fiscal year of less than $250 million.[5]
Following adoption of the Act, while the No-Action Letter remained outstanding, private company M&A brokers could continue to rely on it for transactions involving larger private companies that did not fit within the limits set forth above. However, the SEC withdrew the No‑Action Letter on March 30, 2023, specifically citing the fact that the Act imposed size limitations not found in the No-Action Letter.
For many private company M&A advisers, the limitation on the size of eligible private companies will pose a major obstacle. We are in an era when more and more successful private companies decline to go public or postpone that decision to a later stage of their growth.[6] According to The New York Times, the number of public companies in the United States dropped by approximately 52% from the late 1990s to 2016.[7] As a result, the number of private companies that are larger than the caps permitted under the Act is likely to grow. M&A brokers servicing these companies now must register with the SEC as broker-dealers, even if they never engage in any other form of brokerage activity.
By contrast, M&A brokers who limit their involvement to the smaller “eligible” private companies will be entirely free of federal broker-dealer regulation. This stark difference may result in two different tiers of M&A boutiques, with some operating with limited or no regulatory oversight,[8] while those serving larger private companies will be subject to the extensive requirements of federal broker-dealer regulation. Some Congressional supporters of the Act argued that it was important to reduce the regulatory burden on brokers handling smaller deals in local communities. While that may be a worthwhile goal, it is not clear why brokers who, on occasion or on a regular basis, may advise larger private companies in M&A transactions and provide no other brokerage services should be subject to federal broker-dealer regulations that are equally ill-fitted to their business.
[1] SEC M&A Brokers No-Action Letter, available January 31, 2014, amended on February 4, 2014, and withdrawn on March 30, 2023.
[2] See the Model Rule adopted by the North American Securities Administrators Association (“NASAA”) on September 29, 2015 (the “Model Rule”).
[3] A New Federal Exemption for M&A Brokers.
[4] Section 15(b)(13) of the Securities Exchange Act of 1934.
[5] The SEC has authority to increase these limits over time. However, firms currently providing private company M&A services will need to make their decisions based on the current limits.
[6] See The Shrinking Public Market: A Continuing Trend, Pantheon (2021).
[7] More Small Companies Avoid I.P.O.s, Sapping U.S. Economy’s Vitality.
[8] The issue of state regulation remains unresolved, as Congress did not preempt state law on this question, and it remains uncertain how the various states will respond. Some commentators expect that NASAA will revise its Model Rule to conform with the federal statutory exemption and that more states will adopt the revised Model Rule.
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