I have written in the past about the challenges of people looking to facilitate deals without a broker-dealer license. Short answer: You probably can’t get paid.
However, there is an entire industry of business brokers and M&A advisors that seem to get close to the line. In January 2014, the SEC outlined when an M&A advisor could assist in the sale of a privately held company without registering as a broker-dealer. Its been hanging out there for a while, but I figured this was a good enough time to write about it.
First, it defined “M&A Broker” as “a person engaged in the business of effecting securities transactions solely in connection with the transfer of ownership and control of a privately-held company (as defined below) 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.”
In addition, a “privately-held company” is not an SEC filing company
The SEC provided a list of several conditions:
The M&A Broker will not have the ability to bind a party to an M&A Transaction.
An M&A Broker will not directly, or indirectly through any of its affiliates, provide financing for an M&A Transaction.
The M&A Broker may not have custody, control, or possession of or otherwise handle funds or securities issued or exchanged in connection with an M&A Transaction or other securities transaction for the account of others.
No M&A Transaction will involve a public offering.
Any offering or sale of securities will be conducted in compliance with an applicable exemption from registration under the Securities Act of 1933.
No party to any M&A Transaction may be a shell company, other than a business combination related shell company.
To the extent an M&A Broker represents both buyers and sellers, it will provide clear written disclosure as to the parties it represents and obtain written consent from both parties to the joint representation.
An M&A Broker will facilitate an M&A Transaction with a group of buyers only if the group is formed without the assistance ofthe M&A Broker.
The buyer, or group of buyers, in any M&A Transaction will, upon completion of the M&A Transaction, control and actively operate the company or the business conducted with the assets of the business.
Any securities received by the buyer or M&A Broker in an M&A Transaction will be restricted securities within the meaning of Rule 144(a)(3) under the Securities Act.
There are more details in the SEC’s letter, which we may cover in another post. It will be interesting over time to see if the SEC focuses on one or more elements of the interpretation.
Nasdaq debutes market for private companies, taking aim at SecondMarket and others.
Most people are familiar with Nasdaq as a stock exchange for many well known public companies. Most people would like to forget Nasdaq for its handling of the Facebook IPO, but that’s another story.
For private companies, even those with shares held by many people, it is difficult for their shareholders to find a buyer for their shares. Buyers often have a difficult time finding a way to invest in those companies if the Company is not offering directly to them on a private basis.
funding of $30 million within the last 2 years and an enterprise value of $50 million, based on the most recent financing round
Total assets of $50 million and annual revenue of $50 million in the latest fiscal year or 2 of the last 3 fiscal years
shareholders’ equity of $5 million and a two-year operating history
backing by a recognized financial investor with a track record of successful venture investments
The qualifying company will be subject to governance and reporting requirements.
Nasdaq is taking aim at SecondMarket and the burgeoning market for secondary transactions and the coming deluge of crowdfunding and other platforms for private company finance that people have been predicting since the passage of the JOBS Act. For their sake, I hope it goes better than the PORTAL market did way back when.
The SEC has been reviewing due diligence processes for investment advisers for alternative investments and is getting concerned. After all, assets under management, or “AUM” in industry talk, reached $6.5 trillion for alternative investments. The SEC issued an alert reminding advisers to perform due dilience to determine whether the investment:
Meets the clients’ investment needs; and
Is consistent with disclosed investment strategies.
According to the SEC, “alternative investments” include hedge funds, private equity, venture capital, real estate and funds of private funds.
The SEC conducted examinations of registered advisers and noted the following trends in alternative investment due diligence to identify risk indicators:
Advisers are seekeing more information directly from alternative investment managers
Advisers are using third parties to supplement their analyses and verify data
Advisers are performing additional quantitative analysis of performance returns and risk measures
Advisers are expanding their due diligence processes and focus areas
The SEC then used the alert to remind advisers about their obligations to adopt and review their compliance programs and codes of ethics.
SEC Office of Compliance Inspections and Examinations issues risk alert for due diligence processes by investment advisers
On Thursday, November 7, 2013, the Financial Industry Regulatory Authority, Inc. (“FINRA”) halted trading in all OTC Equity Securities pursuant to FINRA Rule 6440(a)(3). FINRA determined to impose a temporary halt because of a lack of current quotation information. Therefore, FINRA has determined that halting quoting and trading in all OTC Equity Securities is appropriate to protect investors and ensure a fair and orderly marketplace. The trading and quotation halt began on Thursday, November 7, 2013, at 11:25:00 a.m. E.T. FINRA will notify the market when trading may resume.
In the book, there was a discussion of Wing Chau, who helped create and, in theory, manage some disastrous CDOs. He was not portrayed like the brilliant hedge fund managers who cashed in on the crash of real estate-backed securities. He was portrayed like a fool. For this, he sued Lewis for defamation.
I’m not sure if that case is ongoing or not, but the SEC has weighed in. Verdict: fraud charges against Chau for misleading investors in a CDO and for breach of fiduciary duties.
The SEC’s claims that Chau and his firm, Harding Advisory LLC, compromised their independent judgment as collateral manager to a CDO in favor of a hedge fund firm. The hedge fund, the awesomely named Magnetar Capital LLC, had invested in the equity of the CDO. Merrill Lynch structured and marketed the CDO. Harding was collateral manager for the CDO.
Specifically, the SEC claims that Harding agreed to let the hedge fund help select the subprime mortgage-backed assets underlying the CDO. This was not disclosed to investors.
The SEC claims that the influence of the hedge fund led Harding to select assets that its own credit analysts disfavored. In the tradition of criminal geniuses everywhere, in accepting the bonds, Chau wrote in an e-mail to the head of CDO syndication at Merrill Lynch:
“I never forget my true friends.”
The SEC claims that Chau understood that Magnetar was interested in investing as the equity buyer in CDO transactions, and that Magnetar’s strategy included “hedging” its equity positions in CDOs by betting against the debt issued by the CDOs. Because Magnetar stood to profit if the CDOs failed to perform, Magnetar’s interests were not necessarily aligned with investors in the CDO debt, which depended solely on the CDO performing well.
The SEC is taking notice of private oil and gas offerings and has increased its scrutiny of these deals. They have noted the recent increase in fraud cases for these deals at the federal and state levels. Thus, the SEC has released an Investor Alert for Private Oil and Gas Offerings. And the first thing they recommend to investors approached to invest?
“Is the person recommending the investment registered? Most people offering you securities must be registered as a broker with the SEC and must be a member of the Financial Industry Regulatory Authority, or FINRA.”
The SEC cautions that being registered is not a seal of approval and that there may be conflicts of interest between the broker-dealer and the issuer.
In a general alert regarding the oil and gas industry, it is not surprising to find the SEC focused on the broker-dealer issue. Many advisors (including this writer) have been approached to sign off on an offering sales arrangement without a licensed broker-dealer with the explanation that:
“I do this all the time and it has never been a problem.”
“I am not acting as a broker-dealer, just a consultant who gets paid when the investment closes.”
Unfortunately for the would-be commission-eers, the SEC and state securities authorities do not share that analysis.
As the SEC said in the alert:
“If someone who is not registered solicits your investment, that person may be violating the law. One exception from broker registration is available to employees of the company offering the securities and who engage in strictly limited sales activities. If you aren’t consulting a registered broker or adviser, you should consider doing so. A registered broker or adviser that is familiar with the oil and gas industry and not connected to the offering can help you analyze the investment. Most importantly, working with a registered broker or investment adviser affords you certain legal protections.”
The SEC then illustrated benefits of using a licensed professional to assist in the investment decision:
Keep in mind that if the investment opportunity is an outright fraud, the written materials may look legitimate and every question you have about the opportunity may be answered to your satisfaction, but that doesn’t make any of it true. It is important to conduct your own independent research. One good way to do that may be to engage an investment professional specializing in oil and gas.”
It should be instructive to practitioners that in the course of a general industry investor alert, the SEC chose to highlight the risks of dealing with unlicensed broker-dealers. They are still clearly focused on this issue. Although some bad actors promote these deals, hoping to stay under the radar is a bad strategy for the promoter, issuer and investor.
I frequently get questions along these lines: “If we pay someone a commission to make introductions to investors, that’s okay, right? I mean, people do it all the time.”
Then we get into discussions about broker-dealer vs. finder and the requirements for a finder under the Texas statutes. However, if someone is getting paid a commission for introductions to investors, you can bet he or she is acting as broker and better have a license.
Another unregistered broker-dealer case came down from the SEC last month. In this case, an investment fund retained Stephens as a “consultant” to find potential investors. Stephens had not been registered with the SEC in any capacity since he was barred from association with investment advisers since 2002. However, due to connections with the fund and a long history in the industry, he still had contacts with potential investors.
Stephens’ consulting arrangement entitled him to a percentage of all capital commitments from investors he introduced, which was revised for other introductions. He earned about $3.8 million on commitments of $569 million, which is not too shabby. He was also involved significantly in the investor solicitation process and provided services way beyond the “finder” function.
Fines, industry suspensions and cease-and-desist orders were delivered to the fund and the principals of the fund, proving that someone else’s improper conduct can hurt the issuer and the individuals involved (another thing I hear: “If it is a problem, it isn’t my problem, right?” Wrong.). Although the facts of the case seem egregious, most situations seem to be closer calls. However, the results are usually the same, and calling someone a “consultant” (a frequent suggestion) does not change the analysis.
For $3.8 million (or even a lot less), just get licensed or hire someone who is.