securities regulation and the m&a broker rulemaking … resources/shane hansen... · michigan...

Shane B. HansenWarner Norcross & Judd LLP

111 Lyon Street, N.W.Grand Rapids, Michigan 49503

[email protected]

Michigan Business Brokers AssociationEast Lansing, Michigan

April 20, 2012

Securities Regulation and theM&A Broker Rulemaking Proposals

mailto:[email protected]

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Todays regulatory environment . . .

What is a security

Impacts of securities regulation

Practical responses AM&AA IBBA rulemaking proposals

M&A brokers and advisors

Small business sale transactions (CBI letter)

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Securities regulation . . .

Security" means . . . . . . any note, stock, treasury stock, security future,

bond, debenture, certificate of interest or participation in any profit-sharing agreement . . . preorganization certificate or subscription, transferable share, investment contract . . . any put, call, straddle, option . . . or in general, any instrument commonly known as a "security . . .

An LLC interest may be

A limited partnership interest may be

A general partnership interest is typically not

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A sellers note . . . A note is in the statutory definition

A note is presumed to be a security unless Family resemblance test Reves vs. Ernst & Young, U.S. Supreme Ct. (1990)

Cases are fact-specific and inconsistent - e.g., Short term/maturity Non-assignable

Tied to a price adjustment or holdback Collateralized by the assets sold

State regulators see all notes as a security

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Offers, sales, exchanges, and issuances Securities registration or an exemption No special exemption for M&A transactions

Creates antifraud liability . . . Material misstatements and omissions Written disclosure documents to evidence

Broker-dealer and agent registration Requires FINRA (f/k/a NASD) membership Firm-level and individual-level requirements Extensive, expensive, and complex requirements

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Broker-dealer regulation . . .

A broker is any person . . . Engaged in the business of Effecting transactions in securities For the account of others

A fact-specific analysis, but SEC and state regulators have a broad view Activities facilitating various steps in transaction Transaction-based compensation is a key factor

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SECs Broker-Dealer Guide says . . . Finders, business brokers, and individuals or

entities engaged in the following activities: Finding investors, making referrals, or splitting

commissions with registered broker-dealers; Finding investors for issuers (entities issuing

securities), even in a consultant capacity; Finding buyers and sellers of businesses (i.e.,

activities relating to mergers and acquisitions where securities are involved)

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SEC Hallmark Capital Corp Letter (2007) SEC said registration was required where the firm

Assists with mergers and acquisitions - Sell-side:

Prepares a confidential information summaries Identifies and qualifies prospective buyers Arranges meetings with prospective buyers

Buy-side: identifies acquisition targets

Conducts preliminary information gathering; Prepares target acquisition profile

Transaction-based compensated

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SEC Mike Bantuveris Letter (1975) This is not a new position for the SEC

Requested no-action response was denied . . . Identify and evaluate acquisition candidates Assist in formulating offers, negotiating agreements

and assembling documents

Compensation proportional to the transaction value SEC said the firm would do more than merely

bring together the parties in the role of a finder

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Who are finders" . . .

Merely making an introduction . . . Finder is not a statutory term

Activities not triggering broker status

Low value in merely making an introduction

Higher fees demand more services

Several states register and regulate finders (e.g., Texas, Minnesota, and South Dakota)

Michigans finder registration is in limbo

Several states register business brokers (e.g., Illinois and Nevada)

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Common misconceptions . . .

Sale of business doctrine rejected A court-created exception to security definition U.S. Supreme Court Landreth Timber case

Imposed civil antifraud liability on seller

One share or all of the shares made no difference If the instrument is stock, and

Has the characteristics associated with stock, Then it is a security under federal securities laws

Doctrine only applied to 100% stock sale

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Sale of business doctrine also rejected . . . Andrews v. Browne, 662 S.E.2d 58 (VA 2008)

Fong v. Oh, 173 P.3d 499 (Hawaii 2007) Cohen v. Goldberg & Co., 423 S.E.2d. 231 (GA 1992) Barnes v. Sunderman, 423 N.W.2d 793 (ND 1990) Banton v. Hackney, 557 So.2d 807 (AL 1989)

Kovatovich v. Barnett, 406 N.W.2d 516 (MN1987) Carver v. Blanford, 342 S.E. 406 (SC 1986)

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. . . but might be recognized in: Doherty v. Kahn, 682 N.E. 163 (IL 1997) Anderson v. Heck, 554 So.2d 695 (LA 1989)

White v. Solomon, 732 P.2d 1389 (NM 1986)

but these are not states highest court decisions

States likely to follow the Landreth Timber case

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Federal securities laws apply except in Purely intrastate deals, but this is very limited

No Internet or interstate advertising No prospects, parties, or assets in another state

More than one states law may apply

Cannot waive securities laws by contract

Overlapping regulatory laws may also apply Franchise and business opportunity sales Real estate licensing

Business broker licensing

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Exempt securities and exempt transactions These exemption are from securities registration Not an exemption from broker-dealer registration

No broker-dealer registration size exemption Existing BD registration exemptions do not fit M&A

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Investment adviser definition . . . any person who,

for compensation engages in the business of advising others

as to the value of securities or as to the advisability of investing in, purchasing, or

selling securities, or as part of a regular business issues or promulgates

analyses or reports concerning securities

Exception for a broker-dealer if advisory services are solely incidental and no special compensation

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Consequences . . .

Federal and state securities violations . . . Render contracts void and unenforceable

Create civil remedies for injured persons Actions against the securities issuer Actions against the M&A broker/advisor Remedies could include rescission of the deal

Can result in administrative enforcement actions Fines, penalties, and disgorgement of compensation

Limitations or bars from future BD registration Permanent, public regulatory disclosures

Can carry criminal liabilities where there is fraud

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Consequences . . .

Recent adverse cases . . . Torsiello Capital Partners LLC v. Sunshine State

Holding Corp., 2008 N.Y. Misc. LEXIS 2879 (4-1-08) SEC v. Michael W. Crow, Duncan Capital LLC, et al,

07-Civ-3814 (CM)(S.D.N.Y.)(4-23-08)http://www.sec.gov/litigation/litreleases/2008/lr20535.htm

Murphy v. Stargate Def. Sys. Corp., 2007 U.S. App. LEXIS 18982 (6th Cir. Ohio, 2007)

But an older helpful case in Florida . . . Edelstein vs Flanagan 630 So.2d 1205 (Florida 1994)

(real estate)

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Practical responses . . .

Serving your clients interests . . . Seller engagements

Seller must have an offering exemption from securities registration

Prepare and document full disclosures to the buyer

Explain potential liabilities to seller

Buyer engagements If a buyer is issuing securities, similar

considerations apply Explain potential claims against a seller

http://www.sec.gov/litigation/litreleases/2008/lr20535.htm

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Four basic compliance strategies . . . Handle only asset sale transactions

Stick to Country Business letters pattern Individually register with a broker-dealer firm

Register your firm as a broker-dealer

Two other strategies . . . Federal and state M&AB rulemaking proposals A wing and a prayer

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Asset sale transactions . . . Asset sales generally not subject to securities laws

Cash consideration only . . . No stock sold, exchanged, or issued by either party Promissory notes could be securities

No retained equity interest or stock rights

No equity interest in the buyer/successor No involvement in the buyers capital raise

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Country Business letter . . .

What is a no-action letter? An ad hoc statement of facts with a conclusion

The same factual conditions must be met Not legally binding on any court or other regulator

See WN&J commentary letter in handouts

International Business Exchange Corp. (1986)

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If an asset deal becomes a stock deal, no enforcement only if ALL conditions are met Sale of the whole business

Does not cover buy-side transaction Does not cover sale of less than 100% ownership

Must be an SBA small business Advertise only the business or assets for sale Compensation paid in cash (installments are OK) Cannot advise about valuing or issuing securities Cannot advise about a stock transaction structure

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Once a stock deal, the brokers role is limited: Transmitting documents between the parties

Valuing business assets as a going concern Providing administrative support Assisting with financial statements Except for commercial loans, cannot assist in

raising capital or obtaining third-party financing UN-compensated referrals to commercial lenders

You need the lawyers to negotiate and close it

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Design your engagement agreement to . . . Describe the sale of the entire business

Limited scope to permitted services Describe limitations if it becomes stock deal Disclose unregistered status antifraud provisions

Paper the file to defend yourself Establish written policies and procedures (P&Ps) Train employees on the P&Ps

Keep transaction files and related correspondence

Response to SEC or state hello letter

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Individually register with a BD . . .

Some registered BDs specialize in M&A

Design engagement to assign your rights to BD

The BD firm must supervise the transaction M&A client becomes a client of the BD firm BD firm must review/retain transaction documents

Success fee must flow through the BD firm BDs will take a share of the success fee BDs often charges on-going fees

BD becomes legally responsible for the deal

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Required FINRA examinations: FINRA Series 7 General Securities Representative

FINRA Series 79 Investment Banking FINRA Series 24 General Securities Principal

State Series 63 (or 66) uniform agent exam BD and individual registration with each state

Registration through FINRAs WebCRD System Finger printing and FBI background check Registration on Form U-4 (filed by the firm)

Annual BD and agent registration fees

Continuing education requirements

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Individual will be an associated person of the BD subject to FINRA jurisdiction and regulation

must follow the BD firms policies and procedures all securities transactions must go through BD must report all outside business activities

Individuals office and records subject to . . . BDs periodic inspections (typically every 3 years) Examination by SEC, FINRA, and state examiners

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Individual will be an independent contractor Representative agreement will cover . . .

Representations about business background Permitted and prohibited activities Supervision of securities-related activities BD firms share of the deal compensation

Representatives responsibility for: His/her own operating expenses and taxes Annual FINRA and state registration fees Fidelity bonding and E&O insurance

Indemnification of the BD firm

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Restrictions on securities compensation sharing Individual cannot assign or endorse securities

compensation unregistered firm or individuals

May pay M&A firm for bona fide operating expenses E.g., office space, equipment and utilities,

secretarial and administrative support SEC rejected scenarios in 1st Global letter

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Register firm as a broker-dealer . . .

FINRA membership Extensive preparation before filing the application

Detailed FINRA business plan Detailed 12-month pro forma financials Comprehensive compliance P&Ps

Membership application process

Process is highly paper intensive Approximately 6 to 9 months from filing Nonrefundable application and registration fees

All principals and representatives must be qualified

Two Series 24 principals and a Series 28 FinOp Initial cost $50,000 to $75,000+

On-going cost of $50,000+ per year

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FINRA and securities regulation is complex Competent compliance staffing is essential

Regulatory requirements are oriented for retail brokerage

Comparison of existing and proposed regulation (handouts)

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Annually audited GAAP financial statements

Quarterly and annual financial reporting Minimum net capital requirement (continuous compliance)

Limitation on aggregate indebtedness Regulation of advertising

Anti-money laundering procedures and testing FINRA approval for

Change of 25% ownership Material change of size, scope, or activities

2 to 3 year cycle examinations by FINRA and SEC Sometimes state examinations

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Rulemaking proposals . . .

Private Placement Broker (PPB) proposal Capital-raising for small businesses Proposed by an ABA Task Force in 2005

M&A Broker (M&AB) proposed rules M&A activities (but not selling publicly traded companies) Most types of transaction structures other than IPOs

Small Business Sale Transaction Exemption Codify and clarify the SEC Country Business letter Main Street business brokerage transactions

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M&A Broker Proposal . . .

Concept outline developed with AM&AA Timeline

Presented at the 2006 SEC Small Biz Forum Subsequently at 2007 2011 forums

Draft SEC and model state rules presented in 2007 Regulatory summit held on 7/11/07 in Chicago Small Business Sale Transaction exemption in 2008 Rulemaking proposals on the AM&AA website:

http://www.amaaonline.com/advocacy

http://www.amaaonline.com/advocacy

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Create a federal exemption from BD registration No FINRA membership

Create a simplified system of state-level regulation Annual firm registration covering individuals too Home state registration/notice filing others Disclosure document to prospective clients Written engagement Specific business records Compliance manual addressing securities laws A complaint file for regulatory inspection Prohibits specific abusive M&A practices

Regulators retain examination authority

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An M&A Broker could . . . Broker and advise in M&A transactions

Transferring all or part of the business Buyer must be actively involved in the business Could advise about all deal structures

Regardless of the legal structure No deal size limitation proposed

Advise about the value of the business and assets Negotiate price and terms Receive cash or restricted stock compensation Receive fully-disclosed M&A referral fees Market as a Registered M&A Broker in [States]

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An M&A Broker could not: Advertise the sale of stock (e.g., a 50% interest) Participate in capital-raising Organize groups of investors Advise about public offerings or public stock Deal with a public shell company Handle funds or securities Close a transaction on discretionary basis

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Small Business Sale Exemption . . .

Codifies Country Business letter into a rule Creates an exemption from all BD registration For asset sales that become stock sales . . .

Adds buy-side and independent engagements Sale of all the stock of the business, which must be:

A going concern and not a shell organization A small business under the SBA standard Sold to a single buyer or group of buyers

Assemble documents and describe business Advertise the business or its assets

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Business brokers cash compensation . . . Formula does not vary by transaction structure

Fixed, hourly, commission, or combination Percentage of the sale price

May be contingent or deferred If transaction becomes a stock sale . . .

The broker must limit any further services to - Transmitting documents between the parties Valuing the business as a going concern Providing administrative support Preparing/analyzing financials statements

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Business broker could not . . . Advise whether to buy, sell or issue securities Advise about a stock structure Value any securities Advertise sale of stock or other securities Assist in raising capital to fund the transaction Bind any party in the transaction Handle funds or securities

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Rulemaking processes . . .

SEC level (in general) . . . SEC staff develops recommendations Commission approves proposal for public comment Period of public comment 60 to 90 days

Opportunity for members to comment SEC staff analyzes all of the comments

Proposal may be adapted Staff makes further/final recommendations Staff prepares adopting release Includes cost/benefit analysis

Commission acts on the final rule Where we are at today

See Chairman Schapiros January 2012 letter

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Rulemaking processes . . .

State level (in general) . . . North American Securities Administrators Assn.

NASAA coordinates state securities matters NASAA M&A/Finders Board Committee Draft model rules submitted in 2007-2008 NASAAs Board governs model rulemaking Proposals often published for public comment

An opportunity for member input States vote to adopt model rules

States must follow their own rulemaking procedures States adapt model rules to fit their law States may seek public comments

Where we are at today

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Legislative proposal . . .

Objectives of the legislative proposal SEC staff unofficially suggested we talk to Congress Congressional priorities drive the SEC Create a national M&A broker registration system

Drive uniformity at the 50-state level Expedite the systems creation

Where we are at today with US House and Senate

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More information . . .

SEC registration and regulation Guide to Broker-Dealer Registration

http://www.sec.gov/divisions/marketreg/bdguide.htm

FINRA membership and regulation FINRA How to Become a Member Guide

http://www.finra.org/RegistrationQualifications/MemberFirms/index.htm

State registration/licensinghttp://www.nasaa.org/industry___regulatory_resources/broker_dealers/520.cfm

Alliance of Merger & Acquisition Advisorshttp://www.amaaonline.com/advocacy

WN&J websitehttps://files.wnj.com/Merger-Acquisition Broker Briefing Book

http://www.sec.gov/divisions/marketreg/bdguide.htmhttp://www.finra.org/RegistrationQualifications/MemberFirms/index.htmhttp://www.nasaa.org/industry___regulatory_resources/broker_dealers/520.cfmhttp://www.amaaonline.com/advocacyhttps://files.wnj.com/Merger-Acquisition

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Handouts

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Questions?

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Shane is a partner and co-chairs the Broker-Dealer and Investment Adviser Practice Group in the law firm of Warner Norcross & Judd LLP. His law practice concentrates in the area of financial services regulation, including federal and state securities and banking laws. He wasrecognized in The Best Lawyers in America, Corporate Law and Securities Regulation, 2007 through 2012 editions and named a super lawyer in the 2006, 2007, and 2009 through 2011 editions of Michigan Super Lawyers. More information is available at www.wnj.com

Securities and M&A Experience Chair, American Bar Association Committee on State Securities Regulation Co-chair, ABA Subcommittee of Liaisons to Securities Administrators Formation, registration, and regulation of broker-dealers and investment advisers Broker-dealer, investment adviser, and private fund compliance issues Contracts, regulatory inspections, examinations, and enforcement matters 20 years of M&A experience involving banks, broker-dealers, and investment advisersProfessional Memberships Securities Industry and Financial Markets Association Financial Planning Association National Society of Compliance Professionals (NSCP)

111 Lyon Street, N.W.Grand Rapids, Michigan 49503

616.752.2145 or [email protected]

Shane B. Hansen

http://www.wnj.commailto:[email protected]

securities regulation and the m&a broker rulemaking … resources/shane hansen... · michigan...

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