Regulatory and Licensing Developments for Merger and Acquisition Advisors
September 1,2009 – Dallas, TX. - In response to the economic crisis and Wall Street scandals, federal and state government agencies have proposed or adopted new rules and legislation designed to enhance investor protection. Most industries, and particularly the financial services sector, are experiencing additional government oversight. One segment, merger and acquisition services, has had relatively little past direct governmental oversight but that is changing. This article summaries recent regulatory and licensing developments and explains how they may affect merger and acquisition advisors and business brokers.
Real Estate Broker Licenses
There is no nationally recognized license specifically for merger and acquisition (“M&A”) or business broker services. Accordingly, most practitioners have relied upon state real estate broker licenses for their transaction activities. Most states require a realty license to sell a business property, and some states stipulate that a broker must hold a realty license to sell a business. Therefore, over time, the real estate broker license became the defacto license for this niche service.
Reliance upon a real estate license, alone, has been problematic for some dealmakers for certain transactions. For instance, there are cases where a business broker sells a business that has locations or stores in multiple states where the broker may not be licensed. In those instances, they would either co-broker or forgo the fee for those properties. Additional confusion arose when a buyer was located from a different state from which the seller and broker were located. Issues like these were handled on a case-by-case basis between the principals involved and their attorneys, and in some cases the courts.
SEC No Action Letters
Another area of concern arose when the buyer purchased the stock of the small business versus the assets. Was this a sale of securities or not? Section 15(a)(1) of the Securities Exchange Act of 1934 makes it unlawful for any person or entity to “effect any transactions in, or to induce or attempt to induce the purchase or sale of, any security” unless such person or entity is registered as a broker or dealer with the Securities and Exchange Commission (“SEC”). Section 3(a)(4)(A) defines a broker as any person engaged in the business of effecting transactions in securities for the account of others. State securities boards have adopted similar rules.
The SEC has issued several no-action letters regarding the registration requirements for people or entities that act as business brokers or finders. It is beyond the scope of this article to delve into each of these letters; however, this patchwork of no-action letters has formed the guidance for determining whether a small business stock sale qualifies as a security, thereby requiring registration for the professional and firm involved.
Proposals
Given the murky requirements for licensure, the brokerage community has made efforts to codify the SEC no-action letters into a uniform set of rules. Most notably, the Alliance of Merger and Acquisition Advisors (“AM&AA”) seems to be leading the way. The AM&AA licensure initiative is currently advocating for three separate, but related proposals surrounding regulatory rules for M&A advisors and intermediaries: The Private Placement Broker proposal, first proposed by the American Bar Association, the M&A Broker proposal, first proposed by AM&AA, and The Small Business Sale Transaction Exemption, first proposed by the International Business Broker’s Association (“IBBA”). These three actions seek to appropriately scale federal and state securities regulation for the benefit of smaller business owners and buyers, while preserving important investor protections under these laws. This information can be located at www.amaaonline.org.
New Securities License – Series 79
The Financial Industry Regulatory Authority (“FINRA”) proposed FINRA Rule 1032(i) creating a new Limited Representative – Investment Banking Registration Category and Series 79 Investment Banking Exam. The new rule which was adopted by the SEC becomes effective November 2, 2009.
FINRA Rule 1032(i) “requires an associated person to register with FINRA as a Limited Representative – Investment Banking Representative and pass a corresponding qualification examination if such person’s activities include:
(1) advising on or facilitating debt or equity securities offerings through a private placement or a public offering, including but not limited to origination, underwriting, marketing, structuring, syndication, and pricing of such securities and managing the allocation and stabilization activities of such offerings, or
(2) advising on or facilitating mergers and acquisitions, tender offers, financial restructurings, asset sales, divestitures or other corporate reorganizations or business combination transactions, including but not limited to rendering a fairness, solvency or similar opinion.”
According to FINRA Regulatory Notice to Members 09-41, “Investment bankers who hold the Series 7 registration may opt-in to the Investment Banking Representative registration, provided that, as of the date they opt-in, such individuals are engaged in investment banking activities covered by Rule 1032(i). Those individuals who choose to opt-in will retain their Series 7 registered representative registration in addition to the investment banking registration. After May 3, 2010, any person who wishes to
engage in the specified investment banking activities will be required to pass the
Series 79 Exam or obtain a waiver.”
Enforcement Actions
At the AM&AA Summer Conference in Chicago which I attended, Ms. Tanya Solov, the Illinois Securities Commissioner, spoke on the latest details and emerging issues of the new regulations, with particular regard to how it will affect small to medium sized businesses and transactions. In her remarks, she commented on recent enforcement actions taken against unregistered persons performing securities transactions.
In one such case, on June 19, 2009, the SEC instituted a settled administrative order with RAM Capital Resources, LLC and its principals pursuant to Sections 15(b) and 21C of the Securities and Exchange Act of 1934. The commission found that the firm’s two principals, neither of whom was registered as a broker/dealer or associated with a registered broker/dealer, operated and controlled RAM as an unregistered broker/dealer while serving as its principals. RAM’s business focused on identifying investment opportunities for private investments in public entities (“PIPEs”) and soliciting investors. The principals involved agreed to pay disgorgement and civil penalties as part of their settlement agreement. The administrative proceeding document, File No. 3-13524, is a matter of public record.
This is but one such case, but it highlights the SEC’s focus on this matter.
Regulatory Debate
The AM&AA, IBBA and their counter-parts have invested significant resources into their proposals which would provide much needed clarity to a murky area of merger and acquisition regulation and licensing requirements. It appears that these proposals have reached the upper ends of governmental, financial and political review and are being given serious consideration. As this article is being written, the SEC, FED, Treasury, and Capitol Hill are conducting heated debates on a major overhaul of financial and banking oversight and regulations. As part of this overhaul, I would expect this matter to be dealt with in some shape or form.
It is my opinion, however, given the current economic and political climate, it is unlikely that FINRA or the SEC will grant any exemptions or create a new limited broker/dealer category, often referred to as “broker/dealer light”. In a time such as this, one would expect more regulation and oversight, not less, particularly in the financial services sector. I believe that the new Investment Banking License is a response to proposals such as these, to codify the SEC no-action letters on this subject, and to force most M&A practitioners into the existing broker/dealer model.
Conclusion
One question that I have received is “how will brokers know that they have to have a securities license?” I believe that the governmental agencies are doing their best to forecast this requirement, and our trade associations are assisting greatly, but do not expect a singular moment or announcement. Rather unfortunately, unsuspecting agents may learn the hard way at a closing table when a client’s attorney asks to see their securities license and the sale commission would be at risk. Even worse yet, a disgruntled client, buyer or past employee may notify FINRA or a state securities board about potential unregistered persons conducting securities activities. Despite the grey areas surrounding licensing requirements for M&A, particularly for very small transactions, that would create a rude awakening for the unlearned broker, but ignorance of the law is no defense.
In planning for these events, our firm obtained a broker/dealer license and became a member of FINRA/SIPC. It did not come without cost or difficulty, but we recognized which way the regulatory winds are blowing in Washington and wanted to be prepared. For those M&A advisors and business brokers that are not registered, I suggest becoming licensed. While an exemption could be granted, I would not bet my career or next closing commission on it. As time passes, I think that there will be a parting of the seas in our industry between professionals that go through the licensing examinations and background checks required to be associated with a broker/dealer, and ones that do not. These developments have been 20 years in the making and it is gratifying to see our industry take another step upward in terms of professional transparency and accountability. The sale of a privately held business is usually the most important transaction a client will ever have, and that person or family deserves the utmost professionalism. In my view, the broker/dealer license has become the gold standard and a requirement for our industry.
The article was written by Brenen Hofstadter, MBA, CM&AA, President of Generational Capital Markets, Inc. (“GCM”), member FINRA/SIPC, Dallas, TX. GCM is a merger and acquisition advisory firm selling privately held companies. This article expresses Mr. Hofstadter’s own opinions based on his knowledge at the time of this writing. Neither GCM nor the author give legal advice, and nothing in this article should be considered legal advice. Should you require advice pertaining to your circumstances, you should seek an attorney and compliance advisor experienced in the securities industry. Mr. Hofstadter can be contacted at 972-448-1000 or through GCM’s website located at www.gencm.com.
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