Rule 701Exempt Offerings Pursuant to Compensatory Arrangements

SECURITIES AND EXCHANGE COMMISSION

17 CFR Part 230

[Release No. 33-7511; File No. S7-5-98]

RIN 3235-AG21

Rule 701--Exempt Offerings Pursuant to Compensatory Arrangements

AGENCY: Securities and Exchange Commission.

ACTION: Proposed rule.

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SUMMARY: The current dollar limitations on the amount of securities

that may be offered and sold under the Commission's Rule 701 under

Securities Act of 1933 which provides an exemption from registration

for such securities pursuant to compensatory benefit arrangements may

be too restrictive. Therefore, we propose to amend these limitations to

permit companies greater access to the exemption if certain disclosure

requirements are satisfied.

DATES: Public comments should be received on or before May 4, 1998.

ADDRESSES: Please send three copies of the comment letter to Jonathan

G. Katz, Secretary, Securities and Exchange Commission, 450 Fifth

Street, N.W., Washington, D.C. 20549. You can send comments

electronically to the following e-mail address: [email protected].

The comment letter should refer to File No. S7-5-98; if e-mail is used

please include the file number in the subject line. Anyone can inspect

and copy the comment letters at our Public Reference Room, 450 Fifth

Street, N.W., Washington, D.C. 20549. We will post comment letters

submitted electronically on our Internet site (http://www.sec.gov).

FOR FURTHER INFORMATION CONTACT: Richard K. Wulff (202-942-2950),

Office of Small Business, Division of Corporation Finance, Securities

and Exchange Commission, 450 Fifth Street, N.W., Washington, D.C.

20549.

[[Page 10786]]

SUPPLEMENTARY INFORMATION:

I. Executive Summary

Rule 701 1 under the Securities Act of 1933

(``Securities Act'') 2 was adopted in 1988 to allow private

companies to sell securities to their employees without the need to

file a registration statement in the same manner as a public company.

At that time we determined that it would be an unreasonable burden for

these private companies, many of which are small businesses, to incur

the expenses and disclosure obligations of public companies when their

only public sales were to employees. This is especially true because

these sales were for compensatory and incentive purposes, rather than

capital-raising. To accommodate these companies, we used the maximum

extent of our exemptive authority and exempted offers and sales of up

to $5 million per year.

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\1\ 17 CFR 230.701.

\2\ 15 U.S.C. 77a et seq.

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Over the years, the Commission staff monitored the use of the rule.

Until mid-1993, Form 701 was required to be filed with us whenever an

offering under the rule was made. On the basis of that data and

feedback from practitioners, the staff has concluded that the rule has

been popular for both small businesses and larger private companies

(such as mutual insurance companies, foreign issuers, and engineering

firms), but that the $5 million limit has been particularly restrictive

in light of: the popularity of equity ownership by employees;

inflation; and the growth of deferred compensation plans (which are

eligible for the rule). In addition, the staff has concluded that the

rule needs further simplification and clarification.

In October 1996, Congress enacted the National Securities Markets

Improvement Act of 1996 (``NSMIA'') 3 which, for the first

time, gave us the authority to provide exemptive relief beyond $5

million for transactions such as these. The legislative history of

NSMIA suggested specifically that the $5 million ceiling on Rule 701 be

lifted.4 As detailed below, we propose today to modify the

ceilings and to further simplify and streamline the rule. To ensure

continued investor protection along with the added flexibility, we

propose to mandate that a company must give any purchaser specific

types of disclosure.

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\3\ Pub. L. 104-290, 110 Stat. 3416 (October 11, 1996).

\4\ Both Committee Reports specifically highlighted the current

$5 million limit contained in Rule 701 and seek prompt Commission

action to raise that ceiling. H.R. Rep. No. 104-622 at 38; S. Rep.

No. 104-293 at 16.

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We seek to increase the flexibility and utility of Rule 701 by

issuing proposals that would:

(1) Remove the artificial $5 million ceiling and instead set the

maximum amount of securities that may be sold in a year at the greatest

of:

$1 million;

15% of the issuer's total assets; and

15% of the outstanding securities of that class

(2) Not count offers for purposes of calculating the ceiling;

(3) Require the issuer to disclose certain risk factors that may be

associated with investment in securities pursuant to the plan or

agreement, and deliver financial statements in accordance with Form 1-A

of Regulation A 5 to each person to whom securities are

sold;

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\5\ 17 CFR 230.251-263.

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(4) Amend Rule 701 to comport with current and more flexible

interpretations; and

(5) Simplify the Rule.

Together, these changes will add greater flexibility for companies

to sell securities to their employees and, at the same time, will

provide that essential information be delivered to employees in a

timely manner.

II. Background

Rule 701 was adopted under section 3(b) of the Securities Act to

provide an exemption from the registration requirements of that Act for

offers and sales of securities pursuant to certain compensatory benefit

plans or written agreements relating to compensation.6 The

exemptive scope covers securities offered or sold pursuant to a plan or

agreement established by a non-reporting (``private'') company, its

parents or majority-owned subsidiaries, to their employees, directors,

partners, trustees, consultants and advisors.

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\6\ Release No. 33-6768 (April 14, 1988) [53 FR 12918].

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Currently the rule provides that the amount of securities that may

be subject to outstanding offers in reliance on Rule 701 plus the

amount of securities offered or sold under the rule in the preceding 12

months may not exceed the greater of $500,000, or an amount determined

under one of two different formulas. One formula limits the amount to

15% of the issuer's total assets measured at the end of the issuer's

last fiscal year. The other formula restricts the amount to no more

than 15% of the outstanding securities of the class being offered.

Regardless of the measurement method elected, the Rule restricts the

aggregate offering price of securities subject to outstanding offers

and sold in the preceding 12 months to no more than $5 million.

A. Concerns With the Current Rule

In the decade since adoption of Rule 701, equity ownership by

employees has grown exponentially. Not only have employees benefited

generally as the value of their stock has appreciated, but companies'

managements have widely encouraged equity participation as a retention

and incentive device for employees. In addition, companies have sought

to provide tax benefits and possible investment opportunities by

offering many of their senior and middle management personnel

participation in deferred compensation plans. To the extent these plans

involve an offer of securities, they are eligible to use Rule 701. The

growth of these plans, coupled with the impact of inflation, has caused

the $5 million annual limit to be impractical for many companies.

In addition to concerns with the ceiling, a myriad of interpretive

questions have arisen under the current rule. While every new rule

needs routine interpretive gloss from the Commission staff, Rule 701

has been the subject of an abundance of highly technical requests for

clarification. Some of these issues include how to treat stock options,

former employees, subsidiaries, consultants, advisors, and successor

issuers, and when to integrate Rule 701 offerings with other exempt

offerings under the federal securities laws. In summary, the rule needs

to be both simplified and modernized.

B. National Securities Markets Improvement Act of 1996

In October 1996, NSMIA was signed into law. Title I of that statute

relating to ``Capital Markets'' adds section 28 to the Securities Act

providing us with general exemptive authority from any provision of the

Securities Act.7 During the legislative process, both the

House Committee on Commerce 8 and the Senate Committee on

Banking, Housing and Urban Affairs 9 noted, in

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considering this provision, that we should take steps to increase the

ceilings in our existing exemptions promulgated under section 3(b) of

the Securities Act. The legislative history of NSMIA reflects a

specific Congressional concern about the current $5 million aggregate

offering price ceiling in Rule 701 having a negative impact for many

issuers of securities in compensatory arrangements.

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\7\ The Commission, by rule or regulation, may conditionally or

unconditionally exempt any person, security, or transaction, or any

class or classes of persons, securities, or transactions, from any

provision or provisions of this title or of any rule or regulation

issued under this title, to the extent that such exemption is

necessary or appropriate in the public interest, and is consistent

with the protection of investors. 15 U.S.C. 77bb. New section 2(b)

of the Securities Act requires that when we engage in rulemaking and

are required to consider the public interest as well as the

protection of investors, we also must consider ``whether the action

will promote efficiency, competition, and capital formation.''15

U.S.C. 77b(b).

\8\ H.R. Rep. No. 104-622 (June 17, 1996) at 38.

\9\ S.Rep. No. 104-293 (June 26, 1996) at 15-16.

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III. Proposed Amendments to Rule 701

A. Exemptive Limits

The current rule limits the dollar amount of securities offered to

employees, regardless of how many securities are sold to employees.

Calculations based on offers for this purpose are problematic,

especially in determining how to treat options, warrants, rights and

other exercisable or convertible securities (which represent offers to

sell the underlying securities). In light of our new exemptive

authority, we propose eliminating the restriction in the dollar amount

of securities that may be offered pursuant to the rule since limiting

the amount of offers is not necessary to assure that these transactions

are not so large as to necessitate registration. Instead, a test that

focuses on the amount of sales in each 12-month period should serve

that purpose.

Changing the focus to sales means that issuers no longer will have

to calculate and regularly monitor the amount of options, warrants,

rights or other exercisable or convertible securities, but rather can

focus solely on the amount of securities sold. This change also reduces

the likelihood that companies will restrict eligibility or

participation in a compensatory benefit plan solely to meet an offering

limit. This proposal would make the exemption more usable to a greater

number of companies, including those that maintain deferred

compensation plans, but are not reporting companies under the Exchange

Act and therefore do not qualify to utilize Form S-8.10

Commenters are asked to address whether removing offers from the

calculation is appropriate or whether we should limit the amount of

securities being offered as well as, or instead of, a limit on the

amount of securities sold.

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\10\ 17 CFR 239.16b. Form S-8 is a simplified form for

registering securities for sale to employees but is limited to

public companies which file reports pursuant to the reporting

requirements of the Exchange Act.

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As part of eliminating the ceiling on the amount of offers of

securities that may be made pursuant to the rule, we propose

eliminating outstanding offers from the calculation under the two

formulas for determining the aggregate sales price or number of

securities that may be sold in a 12-month period. By only measuring the

amount of securities sold against the 15% of assets formula or the 15%

of outstanding securities formula, some issuers will be given more

flexibility and an increase in the limit on the amount of securities

that they may sell. The proposal also will greatly simplify a highly

technical calculation and the resulting need for incremental

interpretation. We believe no investor protection concerns are

presented by this added flexibility, but solicit comment as to whether

there might be unanticipated abuses.

Rule 701 has become increasingly of limited utility to larger

companies due to the $5 million limitation. We believe that this would

be the case even if we re-focus the limitation on sales. Moreover, the

more appropriate focus is not the absolute dollar amount sold, but

rather how the amount compares to the size of the company and its

capital base. Therefore, we propose to eliminate the $5 million

aggregate offering price ceiling and rely on the three-part calculation

of the amount of securities that may be sold in a 12-month period to

set a more appropriate dollar limit. In addition, we propose to amend

Rule 701 so that the issuer's most recent balance sheet date would be

used for purposes of that calculation. This would make the measurement

consistent and avoid confusion as to the date to be used when

performing the calculation.11 Comment is solicited as to

whether a specific aggregate offering price ceiling, such as $10

million, $15 million or $20 million, is preferable to no ceiling, and

whether we should change the measurement periods as we propose. We also

solicit comment as to whether non-reporting foreign issuers should be

subject to an annual limit, such as $10 million, because the

application of the calculation to large foreign private companies could

result in the sale of a large amount of securities to a large number of

employees without such companies ever being required to register under

either the Securities Act or the Exchange Act.12

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\11\ Under the current rule, assets are calculated as of the end

of its last fiscal year. The rule is silent as to when outstanding

securities are calculated.

\12\ Domestic issuers that acquire more than 500 shareholders

and have assets exceeding $10 million must register under Section

12(g) of the Exchange Act. Foreign private issuers crossing those

thresholds may instead rely on the exemption from Section 12(g)

provided by Rule 12g3-2(b). 17 CFR 240.12g3-2(b). The rule exempts

from Exchange Act registration securities of a foreign private

issuer if the issuer furnishes to us annual and other reports and

other materials that are publicly available in its home market.

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Comment is solicited as to whether Rule 12g3-2(b) should be amended

so that foreign private issuers that either sell securities under Rule

701 or sell more than some annual threshold amount under the rule, such

as $10 million, would be ineligible for the Rule 12g3-2(b) exemption

since that exemptive relief from reporting under Section 12(g) is

predicated on the foreign issuer not taking any steps to enter the U.S.

market voluntarily.

It is not only the $5 million ceiling that has an obvious limiting

effect; the $500,000 level used in the calculation also has such an

effect. We are particularly concerned that many small businesses are

unnecessarily constrained by this limit. We therefore propose setting

this level of the amount of securities sold in reliance on the rule

during a 12-month period at $1 million. The proposed $1 million limit

should ensure issuers adequate flexibility. Thus, regardless of total

assets or outstanding securities, a private company could always sell

up to $1 million in securities to its employees in a 12-month period.

We note that this level would be consistent with the $1 million

offering exemption in Rule 504 of Regulation D.13 (Unlike

Rule 504, however, securities sold under Rule 701 are ``restricted''

securities and cannot be freely resold.) We request comment on whether

the alternative level allowed under Rule 701 should be limited to $1

million, as proposed, or alternatively whether the amount should be

retained at $500,000 or raised to $750,000, $1.5 million or $2 million.

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\13\ 17 CFR 230.504.

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We propose that the changes in the Rule 701 ceilings would apply to

plans and agreements currently covered by the rule, including those

with consultants and advisors. We do not propose to change the status

of securities sold under the rule, so that the securities would

continue to be ``restricted'' and subject to resale restrictions. We do

not anticipate that the same types of abuses that are associated with

Form S-8, with issuers selling securities to consultants and advisors,

who are in effect underwriters in reselling the securities to the

public, would arise because the securities would be restricted.

However, we solicit comment as to whether Rule 701 should retain

consultants and advisors as eligible participants pursuant to the rule,

whether the current offer and sale ceilings should be retained for

consultants and advisors, and whether the definition of consultant

[[Page 10788]]

and advisor should be narrowed to the definition used with Form S-8.

B. Disclosure to Persons Covered by Rule 701

Similar to some private placements, there is no requirement in Rule

701 to deliver a specific disclosure document to buyers other than a

copy of the relevant compensation plan or agreement. However, because

these transactions are subject to the antifraud provisions of the

federal securities laws,14 we understand that many companies

prepare an offering document to provide information to employee

investors.15 While we are not aware of any widespread

abuses, we are concerned that the increased flexibility added by

today's proposals could lead to a series of larger transactions and

consequently a broader impact on U.S. investors. While it may be

burdensome to impose specific disclosure requirements on small

transactions by small businesses, the cost-benefit balance may shift

because the amended rule would facilitate larger transactions to

potentially unsophisticated employees.

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\14\ See 15 U.S.C. 77q(a) and 15 U.S.C. 78j(b).

\15\ Issuers are reminded of the preliminary note to Rule 701

which reaffirms the obligations of issuers and persons acting on

their behalf to provide disclosure to employees or other persons

within the scope of the rule adequate to satisfy the antifraud

provisions of the federal securities laws.

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We propose that sales of securities under Rule 701 would require

that the employees and other persons covered by the rule be supplied

with recent financial and other information a reasonable period of time

prior to the sale of such securities. We propose that this disclosure

include the risk factors associated with investment in the securities

pursuant to the plan or agreement and the financial statements required

in an offering statement pursuant to Form 1-A of Regulation A under the

Securities Act.16 Regulation A allows for simpler unaudited

financial statements. We also propose that the financial statements be

as of a date no more than 180 days prior to the sale of such

securities.17

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\16\ Form 1-A [17 CFR 239.90] under Regulation A sets forth the

financial and non-financial information required in an offering

statement.

\17\ Proposed Rule 701(g) would provide that the disclosure

delivery obligation would apply a reasonable period of time prior to

the date of sale, but not necessarily at the time offers are first

made. For example, for stock options, disclosure would be required a

reasonable period of time prior to the date of exercise, rather than

at the time of grant or when the option becomes exercisable, and

deferred compensation plans would have a disclosure delivery

obligation a reasonable period of time prior to the date the

employee makes the irrevocable election to defer.

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We do not believe that this limited disclosure would be unduly

burdensome to private companies. In proposing such requirements, we

note that issuers with deferred compensation plans would be required to

disclose the material risks that may be associated with such plans,

such as the risks arising from the unsecured nature of the companies'

obligations.

Commenters are asked to address whether any specific disclosure

requirements should be adopted. In this regard, commenters may want to

address any differences between a disclosure regime for compensatory

purposes and one for capital-raising purposes. Comment also solicited

comment as to whether additional disclosure, such as the other

requirements of Form 1-A, should be required. Commenters should address

whether these disclosure requirements should apply to all Rule 701

sales, or only to those sales that exceed a specified minimum amount

per 12-month period, such as $1 million. That approach would harmonize

Rule 701 with Rule 504.

C. Other Disclosure Approaches

We considered information requirements other than Regulation A,

such as those reflected in Rule 502 of Regulation D.\18\ We decided

however, not to use the Rule 502 requirements because, among other

things, they require audited financial statements and more non-

financial information. They would therefore be more burdensome on these

companies, many of which are small businesses. At the same time, it

does not appear that this level of information should be necessary for

all persons participating in compensatory benefit plans. We also

considered requiring the information requirements of Form SB-1, \19\

which allows small business issuers to offer and sell up to $10 million

worth of securities in any 12-month period under a Regulation-A-type

format, and Form SB-2 \20\ which uses the simplified Regulation S-B

\21\ rules. However, both of those forms also require audited financial

statements as well as more non-financial information than what we

propose. We request comment as to whether other informational

requirements should be utilized rather than the proposed risk factor

and financial, such as those in Rule 502, Form SB-1 or Form SB-2.

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\18\ 17 CFR 230.502.

\19\ 17 CFR 239.9.

\20\ 17 CFR 239.10.

\21\ 17 CFR 228.10 et seq.

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As an alternative, should the level of disclosure to employees

depend on their level of sophistication? For example, executive

officers (as defined by Rule 3b-7 under the Exchange Act), directors

and general partners are very knowledgeable about the company/

partnership and may not benefit significantly from a mandated

disclosure document. ``Officers'' as defined by Rule 3b-2 can be

presumed to be somewhat knowledgeable about the company but may have

less access to company information than executive officers. For this

group, the proposed financial statements and risk factor disclosure may

be appropriate. For more junior employees, former employees,

consultants, advisors, disclosure substantially similar to Form 1-A may

be appropriate.\22\ Would this approach be practical and better protect

those employees who may not have the requisite knowledge about the

company?

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\22\ If this regime were adopted, the private nature of these

companies may justify less disclosure about executive compensation

than you would expect from a public company.

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D. Plain-English Technical and Clarifying Revisions

We also propose to recast Rule 701 by making various non-

substantive technical and clarifying revisions in plain English to make

it more concise, readable and understandable. In this regard, we

propose changes to make it clear that an issuer may combine several

different exemptions under the Securities Act (such as Rule 701 and

Rule 506 \23\), and that Rule 701 is available to plans and agreements

encompassing consultants and advisors that are natural persons without

regard to exclusivity of representation of the issuer, as long as they

render bona fide services that are not in connection with capital-

raising. Comment is solicited on to whether there should be other

changes to make the rule more understandable. Comment also is solicited

as to whether the proposed modifications would be helpful.

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\23\ 17 CFR 230.506.

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E. Other Interpretive Revisions

We would amend the rule in several ways to address a variety of

questions that have arisen since its adoption.\24\ This section

describes each of these proposed changes.

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\24\ Not all staff interpretations need specific changes in Rule

701. For example, although the ability to make offerings to

employees through a trust is not specifically stated in the rule,

the staff has interpreted the rule to allow for such offerings.

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1. Treatment of Affiliates

In the past few years, it has become increasingly commonplace to

sell stock of a private subsidiary to employees of

[[Page 10789]]

a parent or affiliate subsidiary. Given that these transactions appear

to retain the envisioned compensatory aspect, the proposed amendments

would expand coverage to sales to employees of majority-owned

subsidiaries of the issuer's parent (i.e., brother-sister

subsidiaries).

We also understand that some subsidiaries, particularly those

intending to use the rule for deferred compensation arrangements, may

not be able to utilize to great effect the two formulas in the

calculation of the maximum sales per 12-month period. They may not have

sufficient assets or independent business operations to make the ``15%

of assets'' formula meaningful or enough securities to make the ``15%

of outstanding securities'' formula meaningful. Therefore, we propose

to provide that if a parent (whether or not a reporting company) of a

wholly-owned subsidiary fully and unconditionally guarantees the

obligations of the subsidiary, and if such guarantee does not exceed

15% of the parent's assets, the subsidiary can use the 15% of assets

formula with respect to its parent. In that situation, the parent would

deliver its financial statements to satisfy the disclosure

obligations.\25\ Comment is requested as to whether employees of

related companies would be sufficiently informed about their affiliates

such that the information provided would suffice to protect them?

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\25\ Rule 701 would provide that, in limited situations, the

guarantee also would be exempt from the registration requirements of

the Securities Act even though the guarantee may be issued by a

reporting company.

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2. Treatment of Former Employees, Advisors and Consultants

The proposed amendments also would clarify an interpretive question

relating to former employees by specifying that sales may be made to

former employees under the rule. A condition to this treatment would be

that at the time the offer of those securities was originally made the

employee must have been a current employee. Comment is solicited as to

whether companies similarly should be allowed to use the rule to sell

securities to former directors, consultants and advisors.

Historically, the staff has interpreted broadly the definition of

``employee'' and ``consultant'' for purposes of Rule 701.\26\ This

interpretation does not appear to have resulted in any significant

abuses. However, comment is solicited as to whether consultants and

advisors should be restricted from using Rule 701 if they are directly

or indirectly promoting the company's securities. Comment also is

solicited as to whether sales to consultants and advisors who sell the

company's products or services should be limited to those who derive a

certain minimum percentage of their income from sales on behalf of the

issuer, such as 20 percent.

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\26\ See Exceptional Producers Holding Company (August 17,

1989), agents who serve as independent sales representatives for an

affiliate of an insurance company are considered ``consultants and

advisors'' under Rule 701; Golfpro, Inc. (October 3, 1989), golf

pros who serve as independent agents for the distribution of golf

products through their pro shops considered consultants and

advisors; Herff Jones, Inc. (November 13, 1990), Microship

Technology, Inc. (November 4, 1992) and Optika Imaging Systems, Inc.

(October 1, 1996), independent sales representatives for the

distribution of the issuer's products considered consultants and

advisors within the meaning of Rule 701; US Web Corporation

(November 7, 1996), non-employee franchisees considered consultants

and advisors within the meaning of Rule 701; and The Morgan Health

Group, Inc. (December 18, 1995), Princeton Medical Management

Resources, Inc. (September 12, 1997), PHM Management, Inc.

(September 12, 1997) and Talbert Medical Corporation (September 12,

1997), participating physicians who contract to provide medical

services pursuant to various managed care arrangements considered

consultants and advisors within the meaning of Rule 701.

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3. Valuation of Services

The proposed amendments also would simplify the determination of

value of consultant services for purposes of calculating aggregate

sales limit. Rather than retaining different rules for employees and

consultants, such as currently not counting employee services while

counting consultants' and advisors' services, proposed Rule 701 would

treat employee services the same as consultant/advisor services so that

in both cases they would count for determining aggregate sales.

4. Transfers to Family Members

As senior and mid-management personnel receive an increasing

proportion of their compensation in the form of securities, these

investments assume greater significance in the context of estate

planning transactions and other intra-family transfers, such as

property settlements in connection with divorce. Given the common

economic interest of family members evidenced by estate planning

transactions and the non-capital raising nature of these transactions,

we believe that Rule 701 should be available for sales to family donees

of such securities and transferees who receive these securities in

divorce proceedings. Therefore, we propose to amend Rule 701 so that it

is available for immediate family members who have acquired such

securities through a gift or a domestic relations order. For this

purpose ``immediate family'' would be defined as in Form S-8 to include

any child, stepchild, grandchild, parent, stepparent, grandparent,

spouse, siblings, aunt, uncle, mother-in-law, father-in-law, son-in-

law, daughter-in-law, brother-in-law or sister-in-law, including

adoptive relationships, trusts for the exclusive benefit of these

persons, and other entities owned solely by these persons. This

proposal would be consistent with the treatment of transferable

securities pursuant to the pending proposals for Form S-8.\27\

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\27\ See Release No. 33-7506.

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5. Form 701

Should Form 701, a notice filing required to be filed when Rule 701

was first adopted, be reinstituted completely or substantially? How

would this type of information be useful to investors? Should the form,

if reinstituted, be required to be filed electronically on EDGAR?

Should we require that copies of any consultant or advisor agreements

be filed along with or described in Form 701? Would public disclosure

help ensure that only bona fide consultants and advisors purchase

securities from the company under the Rule?

IV. General Request for Comment

Any interested person wishing to submit written comments on the

proposed rule amendments or suggest additional changes or comments on

other matters that might have an impact on the proposals set forth in

this release are invited to do so by submitting them in triplicate to

Jonathan G. Katz, Secretary, Securities and Exchange Commission, 450

Fifth Street, N.W., Washington, D.C. 20549. We request comment as to

the impact of the proposals from the point of view of the public, as

well as the entities required to make available information to persons

covered by Rule 701. We will consider comments on this inquiry in

complying with our responsibilities under section 19(a) of the

Securities Act.\28\ We further request comment on any competitive

burdens that may result from adoption of the proposals. We will

consider comments on this inquiry in complying with our

responsibilities under section 23(a) of the Exchange Act.\29\ Comment

letters should refer to File No. S7-5-98. All comments received will be

available for public inspection and copying in the Commission's Public

Reference Room, 450 Fifth Street, N.W., Washington, D.C. 20549.

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\28\ 15 U.S.C. 77s(a).

\29\ 15 U.S.C. 78w(a).

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[[Page 10790]]

V. Summary of Initial Regulatory Flexibility Analysis

In accordance with 5 U.S.C. 603 we have prepared an initial

Regulatory Flexibility Analysis (``IRFA'') regarding the proposed

amendments.

The analysis notes that we are proposing the amendments to Rule 701

as a result of:

(i) Concerns expressed to us by practitioners;

(ii) Feedback that the current dollar limitations unduly constrain

the ability of many eligible issuers to utilize Rule 701; and

(iii) The specific Congressional mandate expressed in the

legislative history of NSMIA. The purpose of the revisions is to remove

unnecessary constraints. We have determined that the proposed

amendments will not impair investor protection.

As the IRFA describes, we are aware of approximately 1100 Exchange

Act reporting companies that currently satisfy the definition of

``small business'' under Rule 157 of the Securities Act.\30\ The

proposals do not impose any new recordkeeping requirements or require

reporting of additional information. Thus, we believe that the

proposals will not increase reporting, recordkeeping or compliance

burdens, and may reduce those burdens for smaller businesses.

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\30\ 17 CFR 230.157.

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As discussed more fully in the IRFA, several possible significant

alternatives to the proposals were considered. These included

establishing different compliance or reporting requirements for small

entities, exempting them from all or part of the proposed requirements,

or requiring them to provide more disclosure, such as more Form 1-A

items, more information pursuant to Rule 502 of Regulation D or the

full disclosure requirements of Form SB-1 or SB-2. The IRFA also

indicates that no current federal rules duplicate, overlap, or conflict

with the proposed rule amendments.

We encourage written comments on any aspect of the IRFA. In

particular, we seek comment on:

(i) The number of small entities that would be affected by the

proposed rule amendments; and

(ii) The determination that the proposed rule amendments would not

increase (and in some cases may reduce) reporting, recordkeeping and

other compliance requirements for small entities. If you believe the

proposals will significantly impact a substantial number of small

entities, please describe the nature of the impact and estimate the

extent of the impact. For purposes of making determinations required by

the Small Business Regulatory Enforcement Fairness Act of 1996

(``SBREFA''),\31\ we are also requesting data regarding the potential

impact of the proposed amendments on the economy on an annual basis.

Your comments will be considered in the preparation of the Final

Regulatory Flexibility Analysis if the proposed amendments are adopted.

A copy of the Initial Regulatory Flexibility Act Analysis may be

obtained from Twanna M. Young, Office of Small Business, Division of

Corporation Finance, Securities and Exchange Commission, 450 Fifth

Street, N.W., Washington, D.C. 20549.

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\31\ Pub. L. No. 104-121, 110 Stat. 857 (1996)(codified in

scattered sections of 5 U.S.C., 15 U.S.C., and as a note to 5 U.S.C.

601).

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VI. Cost-Benefit Analysis

As an aid in the evaluation of the costs and benefits of these

proposals, we request the views and other supporting information of the

public. We believe that the proposed rule amendments, if adopted, would

result in significant cost savings for issuers without compromising

investor protection. We believe that the expanded use of Rule 701 may

provide significant savings to small issuers and considerable benefits

to compensated persons who in the past may have been deprived of the

opportunity to receive securities as an incentive or in payment for

their services. We note that during the period from mid-1988 through

mid-1993, when persons relying upon the exemption were required to file

a report with us concerning reliance on the exemption, that 1,294

filings were made covering approximately $2.28 billion worth of

securities.

We request your comment on whether the proposed rule amendments

would be a ``major rule'' for purposes of the SBREFA. We have concluded

preliminarily that the proposed rule amendments would not result in a

major increase in costs or prices for consumers or individual

industries, or significant adverse effects on competition, employment,

investment, productivity, innovation or small business. We believe that

those persons who will rely on the rule will not have significantly

increased costs for providing the proposed information since many of

these persons either provide to or have such information readily

available for their employees and other persons covered by the rule

now. We request comments on whether the proposed rule amendments are

likely to have an annual effect on the economy of $100 million or more.

Your comments should provide empirical data to support your views.

VII. Paperwork Reduction Act

Our staff has consulted with the Office of Management and Budget

(``OMB'') and has submitted the proposals for review in accordance with

the Paperwork Reduction Act of 1995 (``the Act'').\32\ The title to the

affected information collection is: ``Rule 701.'' The specific

information that must be included is explained in the rule itself, and

relates to the issuer and the risk factors that may be associated with

investment in securities under the plan or agreement. The information

is needed by prospective purchasers to make informed investment

decisions.

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\32\ 44 U.S.C. 3501 et seq.

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The proposed amendments, if adopted, would increase the flexibility

and utility of Rule 701 for private companies using securities to

compensate their employees.

The collection of information in Rule 701 will be required in order

for companies to use the rule for sales of their securities to their

employees and other persons covered by the rule. The likely respondents

to the rule are those companies that have heretofore utilized the rule,

but were being constrained by its limits and those private companies

who could not utilize the two formulas. While we cannot estimate the

number of respondents that may use expanded Rule 701, there were 1,294

Form 701 filings during the period from mid-1988 through mid-1993, when

persons relying upon the exemption were required to file a report with

us concerning reliance on the exemption. We expect that approximately

300 companies each year will be relying on the exemption. If expanded

Rule 701 is adopted, the estimated burden for responding to the

collection of information in Rule 701 would not increase for most

companies due to the current disclosure requirements in Rule 701, but

may increase slightly for other companies who may not be currently

providing risk factor information and financial statements to employee

purchasers. We estimate that the burden hours per respondent each year

will be two. Therefore, we estimate an aggregate of 600 burden hours

per year.

The information collection requirements imposed by Rule 701 are

mandatory to the extent that a company elects to utilize the Rule 701

exemption. The information will be disclosed to third parties or the

public. We may not require a response to the collection of

[[Page 10791]]

information if the rule does not display a current valid OMB control

number.

In accordance with the Act,\33\ we solicit comment on the

following: whether the proposed changes in the collection of

information is necessary; on the accuracy of our estimate of the burden

of the proposed changes to the collection of information; on the

quality, utility and clarity of the information to be collected; and

whether the burden of collection of information on those who are to

respond; including through the use of automated collection techniques

or other forms of information technology, may be minimized.

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\33\ 44 U.S.C. 3506(c)(2)(B).

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Persons desiring to submit comments on the collection of

information requirement should direct them to: Office of Management and

Budget, Attention: Desk Officer for the Securities and Exchange

Commission, Office of Information and Regulatory Affairs, Washington,

D.C. 20503, and should also send a copy of their comments to Jonathan

G. Katz, Secretary, Securities and Exchange Commission, 450 Fifth

Street, N.W., Washington, D.C. 20549, with reference to File No. S7-5 -

98. OMB is required to make a decision concerning the collection of

information between 30 and 60 days after publication, so a comment to

OMB is best assured of having its full effect if OMB receives it within

30 days of publication.

VIII. Statutory Basis, Text of Proposals and Authority

The amendments to our rules and forms are being proposed pursuant

to sections 2, 3(b), 6, 7, 8, 10, 19(a) and 28 of the Securities Act.

List of Subjects in 17 CFR Part 230

Reporting and recordkeeping requirements, Securities.

For the reasons set out in the preamble, title 17, chapter II of

the Code of Federal Regulations is proposed to be amended as follows:

PART 230--GENERAL RULES AND REGULATIONS, SECURITIES ACT OF 1933

1. The general authority citation for part 230 is revised to read

in part as follows:

Authority: 15 U.S.C. 77b, 77f, 77g, 77h, 77j, 77r, 77s, 7sss,

78c, 78d, 78l, 78m, 78n, 78o, 78w, 78ll(d), 79t, 80a-8, 80a-24, 80a-

29, 80a-30, and 80a-37, unless otherwise noted.

* * * * *

2. Section 230.701 is revised to read as follows:

Sec. 230.701 Exemption for offers and sales of securities pursuant to

certain compensatory benefit plans and contracts relating to

compensation.

Preliminary Notes

1. This section relates to transactions exempted from the

registration requirements of section 5 of the Act (15 U.S.C. 77e).

These transactions are not exempt from the antifraud, civil liability,

or other provisions of the federal securities laws. Issuers have an

obligation to provide investors with any additional material

information as may be necessary to make the information required under

this regulation, in light of the circumstances under which it is

furnished, not misleading.

2. In addition to complying with this section, the issuer also must

comply with any applicable state law relating to the offer and sale of

securities.

3. An issuer that attempts to comply with this section, but fails

to do so, may claim any other exemption that is available.

4. This section is available only to the issuer of the securities.

Affiliates of the issuer may not use this section to offer or sell

securities. This section also does not cover resales of securities by

any person. This section provides an exemption only for the

transactions in which the securities are offered or sold by the issuer,

not for the securities themselves.

5. The purpose of this section is to provide an exemption from the

registration requirements of the Act for securities issued in

compensatory circumstances. This section is not available for plans or

schemes to circumvent this purpose, such as to raise capital. This

section also is not available to exempt any transaction that is in

technical compliance with this section but is part of a plan or scheme

to evade the registration provisions of the Act. In any of these cases,

registration under the Act is required unless any other exemption is

available.

(a) Exemption. Offers and sales made in compliance with all of the

conditions of this section are exempt from section 5 of the Act (15

U.S.C. 77e).

(b) Issuers eligible to use the rule--(1) General. This section is

available to any issuer that is not subject to the reporting

requirements of section 13 or 15(d) of the Securities Exchange Act of

1934 (the ``Exchange Act'') (15 U.S.C. 78m or 78o(d)) and is not an

investment company registered or required to be registered under the

Investment Company Act of 1940 (15 U.S.C. 80a-1 et seq.).

(2) Issuers that become subject to reporting. If an issuer becomes

subject to the reporting requirements of section 13 or 15(d) of the

Exchange Act (15 U.S.C. 78m or 78o(d)) after it has made offers

complying with this section, it may nevertheless rely on this section

to sell the securities previously offered to the persons to whom those

offers were made.

(3) Guarantees by reporting companies. An issuer subject to the

reporting requirements of section 13 or 15(d) of the Exchange Act (15

U.S.C. 78m, 78o(d)) may rely on this section if it is merely

guaranteeing the repayment of a subsidiary's securities that are sold

under this rule.

(c) Transactions exempted by the rule. This section exempts offers

and sales of securities (including plan interests and guarantees

pursuant to Sec. 230.701(d)(1)(ii)) under a written compensatory

benefit plan (or written compensation contract) established by the

issuer, its parents, its majority-owned subsidiaries or majority-owned

subsidiaries of the issuer's parent, for the participation of their

employees, former employees, directors, general partners, trustees

(where the issuer is a business trust), or consultants and advisors,

and their immediate family who acquire such securities from such

persons through gifts or domestic relations orders. In the case of a

former employee, this section exempts offers and sales only if the

former employee was employed by the issuer at the time the securities

were offered to the employee.

(1) Special requirements for consultants and advisors. This section

is only available if bona fide services are provided by the consultants

or advisors that are natural persons and the services are not provided

in connection with the offer and sale of securities in a capital-

raising transaction.

(2) Definition of ``Compensatory benefit plan''. For purposes of

this section, a compensatory benefit plan is any purchase, savings,

option, bonus, stock appreciation, profit sharing, thrift, incentive,

deferred compensation, pension or similar plan.

(d) Amounts that may be sold--(1) Offers. Any amount may be offered

in reliance on this section.

(2) Sales. The aggregate sales price or amount of securities sold

in reliance on this section in any consecutive 12-month period, shall

not exceed the greatest of the following:

(i) $1,000,000;

(ii) 15% of the total assets of the issuer (or of the issuer's

parent if the issuer is a wholly-owned subsidiary and the securities

represent obligations that the parent fully and unconditionally

[[Page 10792]]

guarantees), measured at the issuer's most recent balance sheet date;

or

(iii) 15% of the outstanding amount of the class of securities

being offered and sold in reliance on this section, measured at the

issuer's most recent balance sheet date.

(3) Rules for calculating prices and amounts--(i) Aggregate sales

price. The term aggregate sales price means the sum of all cash,

property, notes, cancellation of debt or other consideration received

or to be received by the issuer for the sale of the securities. Non-

cash consideration must be valued by reference to bona fide sales of

that consideration made within a reasonable time or, in the absence of

such sales, on the fair value as determined by an accepted standard.

The value of services exchanged for securities issued to employees, as

well as to consultants and advisors, should be included in the

aggregate sales price.

(ii) Derivative securities. In calculating outstanding securities

for purposes of paragraph (d)(2)(iii) of this section, treat the

securities underlying all currently exercisable or convertible options,

warrants, rights or other securities, other than those issued under

this section, as outstanding. In calculating the amount of securities

sold for purposes of paragraph (d)(1) of this section, count the amount

of securities that would be acquired upon exercise or conversion in

connection with sales of options, warrants, rights or other exercisable

or convertible securities.

(iii) Other exemptions. Amounts of securities sold in reliance on

this section do not affect amounts that may be sold in reliance on

other exemptions, and amounts of securities sold in reliance on other

exemptions do not affect amounts that may be sold in reliance on this

section.

(e) Disclosure that must be provided--The issuer must deliver the

following disclosure to investors a reasonable period of time prior to

the date of sale:

(1) A copy of the compensatory benefit plan or the contract, as

applicable;

(2) If the plan is subject to the Employee Retirement

Income Security Act of 1974 (``ERISA'') (29 U.S.C. 1104-1107), a

copy of the summary plan description required by ERISA;

(3) If the plan is not subject to ERISA, a summary of the material

terms of the plan;

(4) Information about the risks associated with investment in the

securities sold pursuant to the compensatory benefit plan or

compensation contract; and

(5) Financial statements required to be furnished by Part F/S of

Form 1-A (Regulation A Offering Statement) (Sec. 239.90 of this

chapter). Such financial statements must be as of a date no more than

180 days prior to the sale of securities in reliance on this section.

If the issuer is relying on Sec. 230.701(d)(2)(ii) to use its parent's

total assets to determine the amount of securities that may be sold,

the parent's financial statements must be delivered. If the parent is

subject to the reporting requirements of section 13 or 15(d) of the

Exchange Act (15 U.S.C. 78m or 78o(d)), the financial statements of the

parent required by Rule 10-01 of Regulation S-X (Sec. 210.10-01 of this

chapter) and Item 310 of Regulation S-B (Sec. 228.310 of this chapter),

as applicable, must be delivered.

(6) If the sale involves a stock option or other exercisable or

convertible security, the issuer must deliver disclosure a reasonable

period of time prior to the date of exercise or conversion. For

deferred compensation or similar plans, the issuer must deliver

disclosure to investors a reasonable period of time prior to the date

the irrevocable election to defer is made.

(f) No integration with other offerings. Offers and sales exempt

under this section are deemed to be a part of a single, discrete

offering and are not subject to integration with any other offers or

sales, whether registered under the Act or otherwise exempt from the

registration requirements of the Act.

(g) Resale limitations--(1) Securities issued pursuant to this

section are deemed to be ``restricted securities'' as defined in

Sec. 230.144.

(2) Resales of securities issued pursuant to this section must be

in compliance with the registration requirements of the Act or an

exemption therefrom.

(3) Ninety days after the issuer becomes subject to the reporting

requirements of section 13 or 15(d) of the Exchange Act (15 U.S.C. 78m

or 78o(d)), securities issued pursuant to this section may be resold by

persons who are not affiliates (as defined in Sec. 230.144) in reliance

on Sec. 230.144 without compliance with paragraphs (c), (d), (e) and

(h) of Sec. 230.144, and by affiliates without compliance with

paragraph (d) of Sec. 230.144.

By the Commission.

Dated: February 27, 1998.

Margaret H. McFarland,

Deputy Secretary.

[FR Doc. 98-5728 Filed 3-4-98; 8:45 am]

BILLING CODE 8010-01-P