Are Independent Sponsors Unlicensed Securities Brokers?

I was recently at a conference for independent sponsors.  What’s an independent sponsor?  It’s a person, or small team, that identifies and acquires a company with a combination of its own cash, some bank debt, and third party investor cash and/or debt.  A discussion came up at the conference about whether it was worth the risk to take an acquisition fee, which is a fee the independent sponsor receives at the closing of the acquisition.

What is the Risk?

Some of the conference participants expressed concern that charging an acquisition fee could be deemed to be compensation for selling securities.  If that were true, then the independent sponsor could be considered an unregistered securities broker.

Let’s break this down.  The general rule is that a person or entity cannot “sell securities for the account of others” unless that person or entity is properly licensed.  In other words, you can’t be compensated for brokering the sale of securities between a buyer and seller.  If you receive compensation for that service, you are a securities broker.  If you are not licensed, then you are an unlicensed broker. Unlicensed brokers can find themselves in a world of trouble.


Selling for Others?

There is also a threshold issue: is the individual selling securities for others?  An entity that is issuing securities is not a broker because it is selling securities for its own account, not for the account of others.  This “issuer exemption” does not automatically apply to all the employees of the issuer.  The SEC states that “[t]he employees and other related persons of an issuer who assist in selling its securities may be “brokers,” especially if they are paid for selling these securities and have few other duties.”

Some independent sponsors are focusing on the first clause in that statement: they are concerned that the “acquisition fee” is payment for the sale of securities.  That is a narrow reading of that part of the statement.  It is also a narrow interpretation of why an independent sponsor receives an acquisition fee.  Is the fee earned only if the independent sponsor secures an equity investment? Of course not.  A lot more needs to happen in order for the independent sponsor to receive an acquisition fee, including the sine qua non of the deal: the acquisition of the target company.

Then, of course, there is also the second part of the SEC’s statement – that the employee has few other duties.  A typical independent sponsor wears many hats: identifying acquisition targets, negotiating the transaction terms, undertaking due diligence and, yes, negotiating with investors.  Even if an independent sponsor is a group of individuals, it is extremely unlikely that the division of labor results in one member of the team having “few other duties” than soliciting investments.

Safe Harbor for Independent Sponsors

In the event, however, that an independent sponsor is concerned that it may be violating the broker-dealer laws, the SEC has created a safe harbor, Rule 3a4-1.  It is important to note that the rule provides a “non-exclusive” safe harbor.  In other words, the rule does not provide the sole method for avoiding being classified as a broker.  The rule states that, so long as the employee complies with the parameters below, he or she will not be deemed to be a broker dealer. Under the safe harbor test, an employee will not be deemed a broker if, among other things, the person:

  • Is not compensated by payment of commissions or other remuneration based on securities transactions;
  • Is not associated with a brokerdealer; and
  • Limits sales activities either (1) to one offering per 12 month period and performs other substantial duties, (2) to soliciting only certain financial institutions or (3) to passive or clerical duties not involving solicitation of investors.

Will an independent sponsor be considered an unregistered broker-dealer because it takes an acquisition fee?  The facts play a large role in the answer to the question.  Based on the typical manner in which independent sponsors operate, however, it would be difficult to make the argument that taking an acquisition fee violates the securities laws.


This article should not be relied upon as legal advice and is provided for informational purposes only. Information contained in this article may also become outdated with the passage of time and as laws change.  Readers should not act or refrain from acting on the basis of any content in this article.  For legal advice and up-to-date-information, please contact the author.

Transactional Group

Transactional Group