# 85 FR 80232: Modernization of Rules and Forms for Compensatory Securities Offerings and Sales

> Federal · Regulations · In force

URL: https://www.frixlaw.com/law-library/statutes/FR_PRORULE_2020-26390

## Section

- **Citation:** 85 FR 80232
- **Heading:** Modernization of Rules and Forms for Compensatory Securities Offerings and Sales
- **Jurisdiction:** Federal
- **Kind:** Regulations
- **Status:** In force
- **Text as of:** August 14, 2026
- **Source:** Compiled text
- **Location:** Federal Register / Vol. 85 / 85 FR 80232

## Text

SECURITIES AND EXCHANGE COMMISSION 17 CFR Parts 229, 230, and 239 [Release No. 33-10891; File No. S7-18-20] RIN 3235-AM38 Modernization of Rules and Forms for Compensatory Securities Offerings and Sales AGENCY:
Securities and Exchange Commission.

ACTION:
Proposed rule.

SUMMARY:
The Securities and Exchange Commission (“Commission”) is proposing for public comment amendments to Rule 701 under the Securities Act of 1933 (the “Securities Act”), which provides an exemption from registration for securities issued by non-reporting issuers pursuant to compensatory arrangements, and Form S-8, the Securities Act registration statement for compensatory offerings by reporting issuers. The amendments are designed to modernize the exemption and registration statement in light of the significant evolution in compensatory offerings since the Commission last substantively amended these regulations, consistent with investor protection.

DATES:
Comments should be received on or before February 9, 2021.

ADDRESSES:
Comments may be submitted by any of the following methods:
Electronic Comments
• Use the Commission's internet comment form ( https://www.sec.gov/rules/proposed.shtml ).
Paper Comments
• Send paper comments to Vanessa A. Countryman, Secretary, Securities and Exchange Commission, 100 F Street NE, Washington, DC 20549-1090.
All submissions should refer to File Number S7-18-20. To help us process and review your comments more efficiently, please use only one method. The Commission will post all comments on the Commission's website ( http://www.sec.gov/rules/proposed.shtml ). Comments are also available for website viewing and copying in the Commission's Public Reference Room, 100 F Street NE, Washington, DC 20549, on official business days between the hours of 10:00 a.m. and 3:00 p.m. All comments received will be posted without change. Persons submitting comments are cautioned that we do not redact or edit personal identifying information from comment submissions
). Comments are also available for website viewing and copying in the Commission's Public Reference Room, 100 F Street NE, Washington, DC 20549, on official business days between the hours of 10:00 a.m. and 3:00 p.m. All comments received will be posted without change. Persons submitting comments are cautioned that we do not redact or edit personal identifying information from comment submissions. You should submit only information that you wish to make available publicly.
We or the staff may add studies, memoranda, or other substantive items to the comment file during this rulemaking. A notification of the inclusion in the comment file of any such materials will be made available on our website. To ensure direct electronic receipt of such notifications, sign up through the “Stay Connected” option at www.sec.gov to receive notifications by email.
FOR FURTHER INFORMATION CONTACT:
Anne M. Krauskopf, Senior Special Counsel, or Lisa Krestynick, Special Counsel, Office of Chief Counsel, Division of Corporation Finance, at (202) 551-3500.

SUPPLEMENTARY INFORMATION:
We are proposing to amend 17 CFR 230.405 (“Rule 405”), 17 CFR 230.413 (“Rule 413”), 17 CFR 230.416 (“Rule 416”), 17 CFR 230.456 (“Rule 456”), 17 CFR 230.457 (“Rule 457”), 17 CFR 230.701 (“Rule 701”), and 17 CFR 239.16b (“Form S-8”) under the Securities Act of 1933 1 (the “Securities Act”), and 17 CFR 229.601 (“Item 601”) of Regulation S-K.
1 15 U.S.C. 77a et seq.
Table of Contents
I. Overview II. Rule 701 A. Disclosure Requirements 1. The Disclosure Requirement for the Period Preceding the Threshold Amount Being Exceeded 2. Age of Financial Statements 3. Financial Statement Content Requirements for Foreign Private Issuers 4. Alternative Valuation Disclosure 5. Disclosure Requirements for Derivative Securities 6. Disclosure Requirements Following Business Combination Transactions B. Rule 701(d) C. Eligible Recipients 1. Consultants and Advisors 2. Former Employees 3. Employees of Subsidiaries III. Form S-8 A
ceeded 2. Age of Financial Statements 3. Financial Statement Content Requirements for Foreign Private Issuers 4. Alternative Valuation Disclosure 5. Disclosure Requirements for Derivative Securities 6. Disclosure Requirements Following Business Combination Transactions B. Rule 701(d) C. Eligible Recipients 1. Consultants and Advisors 2. Former Employees 3. Employees of Subsidiaries III. Form S-8 A. Addition of Plans and Securities or Classes of Securities to Form S-8 1. Addition of Plans to Form S-8 2. Securities Allocation Among Incentive Plans 3. Addition of Securities or Classes of Securities to Form S-8 B. Fee Calculation and Fee Payments on Form S-8 for Defined Contribution Plans 1. Calculation of the Registration Fee Using the Aggregate Offering Price 2. New Fee Payment Method for Sales Pursuant to Defined Contribution Plans 3. Additional Requests for Comment on Counting the Shares Registered on Form S-8 for Defined Contribution Plans C. Conforming Form S-8 to Rule 701 1. Scope of “Former Employee” 2. Consultants and Advisors D. Conforming Form S-8 Instructions With Current IRS Plan Review Practices E. Revisions to Item 1(f) of Form S-8; Tax Effects of Plan Participation F. Additional Requests for Comment About Form S-8 1. Plan Trustee Signatures on Form S-8 2. Bridging the IPO Gap for Employee Stock Purchase Plans IV. General Request for Comments V. Economic Analysis A. Economic Baseline 1. Rule 701 2. Form S-8 B. Benefits and Costs to Proposed Amendments to Rule 701 and Form S-8 1. Proposed Amendments to Rule 701(e) 2. Proposed Amendments to Rule 701(d) 3. Proposed Amendments to Rule 701(c) Eligible Participants 4. Benefits and Costs to Proposed Amendments to Form S-8 C. Anticipated Effects on Efficiency, Competition, and Capital Formation D. Reasonable Alternatives VI. Paperwork Reduction Act. A. Summary of the Collection of Information B. Summary of the Proposed Amendments' Effects on the Collections of Information C. Incremental and Aggregate Burden and Cost Estimates for the Proposed Amendments D
ants 4. Benefits and Costs to Proposed Amendments to Form S-8 C. Anticipated Effects on Efficiency, Competition, and Capital Formation D. Reasonable Alternatives VI. Paperwork Reduction Act. A. Summary of the Collection of Information B. Summary of the Proposed Amendments' Effects on the Collections of Information C. Incremental and Aggregate Burden and Cost Estimates for the Proposed Amendments D. Request for Comment VII. Initial Regulatory Flexibility Act Analysis A. Reasons for, and Objectives of, the Proposed Action B. Legal Basis C. Small Entities Subject to the Proposed Amendments D. Reporting, Recordkeeping and other Compliance Requirements E. Duplicative, Overlapping or Conflicting Federal Rules F. Significant Alternatives G. Request for Comments VIII. Small Business Regulatory Enforcement Fairness Act IX. Statutory Authority I. Overview
We are proposing amendments to Rule 701 and Form S-8 to modernize the two principal means by which issuers grant securities to employees in compensatory transactions. 2 Every offer 3 The Commission has long recognized that offers and sales of securities as compensation present different issues than offers and sales of securities by issuers that seek to raise capital. 4 Among other considerations, the Commission has recognized that the relationship between the issuer and recipient of securities is often different in a compensatory, rather than capital raising, transaction. The Commission has thus provided a limited exemption from registration—Rule 701—for certain compensatory securities transactions by non-reporting issuers 5 and a specialized form—Form S-8—for registering certain compensatory securities transactions by reporting issuers. The proposed amendments reflect changes in compensatory practices, including the types of securities offered, and are intended to modernize and simplify administrative requirements
n from registration—Rule 701—for certain compensatory securities transactions by non-reporting issuers 5 and a specialized form—Form S-8—for registering certain compensatory securities transactions by reporting issuers. The proposed amendments reflect changes in compensatory practices, including the types of securities offered, and are intended to modernize and simplify administrative requirements.
2 Rule 701 is available for compensatory transactions with employees, directors, general partners, trustees (where the issuer is a business trust), officers, or consultants and advisors, and their family members who acquire such securities from such persons through gifts or domestic relations orders. Offers and sales to former employees, directors, general partners, trustees, officers, consultants and advisors are exempted from registration by the rule subject to specified conditions. Form S-8 is available for compensatory transactions with “employees,” with the form defining “employee” as any employee, director, general partner, trustee (where the registrant is a business trust), or officer. “Employee” also includes consultants and advisors, former employees, See Rule 701(c) and General Instructions A.1(a)(1)-(3) to Form S-8.
3 15 U.S.C. 77e.
4 See, e.g., Notice of Proposed Form S-8, Release No. 33-3469-X (Apr. 12, 1953) [18 FR 2182 (Apr. 17, 1953)] and Adoption of Form S-8, Release No. 33-3480 (Jun. 16, 1953) [18 FR 3688 (Jun. 27, 1953)], each observing that the investment decision to be made by the employee is of a different character than when securities are offered for the purpose of raising capital.
5 Only issuers that are not subject to the reporting requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78m and 78o(d)) and are not investment companies registered or required to be registered under the Investment Company Act of 1940 (15 U.S.C. 80a-1 et seq. ) are eligible to use Rule 701. See Rule 701(b)
curities are offered for the purpose of raising capital.
5 Only issuers that are not subject to the reporting requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78m and 78o(d)) and are not investment companies registered or required to be registered under the Investment Company Act of 1940 (15 U.S.C. 80a-1 et seq. ) are eligible to use Rule 701. See Rule 701(b). As such, the use of the term “non-reporting issuer” in this release means issuers that are not subject to the reporting requirements of Section 13 or 15(d) of the Exchange Act, and includes issuers subject to Rule 257 of Regulation A [17 CFR 230.257].
In July 2018, in connection with amending Rule 701, 6 as mandated by the Economic Growth, Regulatory Relief, and Consumer Protection Act, 7 the Commission sought comment on ways to modernize the Rule 701 exemption from registration, the Form S-8 registration statement, and the relationship between these two regulations, consistent with investor protection. 8 In doing so, the Commission noted that significant evolution has taken place in both the types of compensatory offerings issuers make and the composition of the workforce since it last substantively amended these regulations and sought to determine whether and, if so, how the rules should be amended to address these developments. The Concept Release stated that the Commission's evaluation of any potential changes would focus on retaining the compensatory purpose of Rule 701 and Form S-8 and preventing them from being used for capital-raising purposes, consistent with the Commission's investor protection mandate. The Concept Release also solicited comment on how any possible rule or form amendments may affect an issuer's decision to become a reporting issuer. The Commission received many comment letters in response to the Concept Release. 9
6 Exempt Offerings Pursuant to Compensatory Arrangements, Release No. 33-10520 (Jul.18, 2018) [83 FR 34940] (“2018 Rule 701 Adopting Release”)
tor protection mandate. The Concept Release also solicited comment on how any possible rule or form amendments may affect an issuer's decision to become a reporting issuer. The Commission received many comment letters in response to the Concept Release. 9
6 Exempt Offerings Pursuant to Compensatory Arrangements, Release No. 33-10520 (Jul.18, 2018) [83 FR 34940] (“2018 Rule 701 Adopting Release”).
7 Public Law 115-174, 132 Stat. 1296 (2018). Section 507 of the Act mandated that the Commission amend Rule 701 to increase from $5 million to $10 million the aggregate sales price or amount of securities sold during any consecutive 12-month period in excess of which the issuer is required to deliver additional disclosures to investors.
8 Concept Release on Compensatory Securities Offerings and Sales, Release No. 33-10521 (Jul. 18, 2018) [83 FR 34958] (“Concept Release”). Unless otherwise noted, comments cited are to the Concept Release and may be found at the following link: https://www.sec.gov/comments/s7-18-18/s71818.htm.
9 See, e.g., letters from Airbnb, Inc. (“Airbnb”); American Bar Association, Business Law Section, Federal Regulation of Securities Committee (“ABA”); American Benefits Council (“Council”); Sen. Sherrod Brown, United States Senator (“Senator Brown”); Center for Capital Markets Competitiveness, U.S. Chamber of Commerce (“Chamber”); Davis Polk & Wardwell (“Davis Polk”); Ernest & Young LLP (“EY”); Indigo Ag, Inc. (“Indigo”); Rep. Patrick McHenry, United States Representative (“Representative McHenry”); National Association of Stock Plan Professionals (“NASPP”); National Employment Law Project (“NELP”); Marie P. Petion (“Petion”); Postmates (“Postmates”); Nick Reyes (“Reyes”); Brian Sament (“Sament”); Shearman & Sterling LLP (“Shearman”); John P. Stoelting (“Stoelting”); Sullivan & Cromwell LLP (“Sullivan”); Uber Technologies, Inc. (“Uber”); Rep. Maxine Waters, United States Representative (“Representative Waters”); Zachor Legal Institute (“Zachor”); and Zionist Advocacy Center (“Zionist”)
ELP”); Marie P. Petion (“Petion”); Postmates (“Postmates”); Nick Reyes (“Reyes”); Brian Sament (“Sament”); Shearman & Sterling LLP (“Shearman”); John P. Stoelting (“Stoelting”); Sullivan & Cromwell LLP (“Sullivan”); Uber Technologies, Inc. (“Uber”); Rep. Maxine Waters, United States Representative (“Representative Waters”); Zachor Legal Institute (“Zachor”); and Zionist Advocacy Center (“Zionist”).
Among the Rule 701 topics covered by the Concept Release were the Rule 701(d) exemptive conditions, including the 12-month sales caps, and the Rule 701(e) disclosure requirements, including the timing and manner of disclosure, and how those disclosure requirements apply to derivative securities. Form S-8 topics covered by the Concept Release included ways to reduce administrative burdens, such as by permitting multiple plans to be registered on a single Form S-8, permitting fee payment on a “pay-as-you-go” basis, and registering tax-qualified plans based on a dollar amount rather than the number of shares issued. The comments received on those topics and the Commission's related proposed rule amendments are discussed in this release.
Based, in part, on the consideration of feedback from commenters, with respect to Rule 701 we propose to: 10
10 The current version of Rule 701 was adopted pursuant to the Commission's general exemptive authority under Section 28 of the Securities Act. See Rule 701—Exempt Offerings Pursuant to Compensatory Arrangements, Release No. 33-7645 (Feb. 25, 1999) [64 FR 11095 (Mar. 8, 1999)] (“1999 Adopting Release”). We believe the proposed amendments to Rule 701 would modernize the exemption in light of the significant evolution in compensatory offerings since the Commission last substantively amended the rule, while maintaining important investor protections. For this reason and the reasons discussed below, we believe the proposed amendments to Rule 701, if adopted, would be necessary and appropriate in the public interest and consistent with investor protections
ernize the exemption in light of the significant evolution in compensatory offerings since the Commission last substantively amended the rule, while maintaining important investor protections. For this reason and the reasons discussed below, we believe the proposed amendments to Rule 701, if adopted, would be necessary and appropriate in the public interest and consistent with investor protections.
• Revise the additional disclosure requirements for Rule 701 exempt transactions exceeding $10 million, including how the disclosure threshold applies, the type of financial disclosure required, and the frequency with which it must be updated;
• Revise the time at which such disclosure is required to be delivered for derivative securities that do not involve a decision by the recipient to exercise or convert in specified circumstances where such derivative securities are granted to new hires;
• Raise two of the three alternative regulatory ceilings that cap the overall amount of securities that a non-reporting issuer may sell pursuant to the exemption during any consecutive 12-month period; and
• Make the exemption available for offers and sales of securities under a written compensatory benefit plan (or written compensation contract) established by the issuer's subsidiaries, whether or not majority-owned.
With respect to Form S-8, we propose to:
• Implement improvements and clarifications to simplify registration on the form, including:
○ Clarifying the ability to add multiple plans to a single Form S-8;
○ Clarifying the ability to allocate securities among multiple incentive plans on a single Form S-8;
○ Permitting the addition of securities or classes of securities by automatically effective post-effective amendment;
• Implement improvements to simplify share counting and fee payments on the form, including:
○ Requiring the registration of an aggregate offering amount of securities for defined contribution plans;
○ Implementing a new fee payment method for registration of offers and
○ Confo
rmitting the addition of securities or classes of securities by automatically effective post-effective amendment;
• Implement improvements to simplify share counting and fee payments on the form, including:
○ Requiring the registration of an aggregate offering amount of securities for defined contribution plans;
○ Implementing a new fee payment method for registration of offers and
○ Conforming Form S-8 instructions with current IRS plan review practices; and
• Revise Item 1(f) of Form S-8 to eliminate the requirement to describe the tax effects of plan participation on the issuer.
With respect to both the Rule 701 exemption and the Form S-8 registration statement, we propose to:
• Extend consultant and advisor eligibility to entities meeting specified ownership criteria designed to link the securities to the performance of services; and
• Expand eligibility for former employees to specified post-termination grants and former employees of acquired entities.
To comply with current Federal Register formatting requirements, we also propose a ministerial amendment to Rule 701 to remove the Preliminary Notes and move their provisions without change to Rule 701(a). This change does not affect the purpose or effect of these provisions.
The Concept Release also discussed the scope of eligible plan participants, including whether persons providing services in the so-called “gig economy” should be eligible to receive securities pursuant to Rule 701 and Form S-8. We are addressing these issues and the comments received on these topics in a separate companion release. 11
11 Temporary Rules to Include Certain “Platform Workers” in Compensatory Offerings Under Rule 701 and Form S-8, Release No. 33-10892 (Nov. 24, 2020).
We discuss the proposed amendments below. We welcome feedback and encourage interested parties to submit comments on any or all aspects of the proposed amendments. When commenting, it would be most helpful if you include the reasoning behind your position or recommendation.
II
ertain “Platform Workers” in Compensatory Offerings Under Rule 701 and Form S-8, Release No. 33-10892 (Nov. 24, 2020).
We discuss the proposed amendments below. We welcome feedback and encourage interested parties to submit comments on any or all aspects of the proposed amendments. When commenting, it would be most helpful if you include the reasoning behind your position or recommendation.
II. Rule 701
A. Disclosure Requirements
We are proposing to amend Rule 701(e) to revise the disclosure requirements for transactions exceeding $10 million, including the age of financial statements, and to allow issuers to provide alternative valuation information in lieu of financial statements. In addition, we are proposing to allow certain foreign private issuers 12 to provide financial statements using home country accounting standards if financial statements prepared in accordance with generally accepted accounting principles in the United States (“U.S. GAAP”) or International Financial Reporting Standards as issued by the International Accounting Standards Board (“IFRS”) are not otherwise available. Finally, we propose to modify the timing requirement for providing disclosure for certain derivative securities granted to new hires in specified circumstances.
12 A “foreign private issuer” is defined in Rule 405 and 17 CFR 240.3b-4(c) [Exchange Act Rule 3b-4(c)] as a foreign issuer other than a foreign government, except an issuer meeting the following conditions as of the last business day of its most recently completed second fiscal quarter: (i) More than 50 percent of the outstanding voting securities of which are directly or indirectly owned of record by residents of the United States; and (ii) any of the following: (A) the majority of the executive officers or directors are United States citizens or residents; (B) more than 50 percent of the assets of the issuer are located in the United States; or (C) the business of the issuer is administered principally in the United States
ting securities of which are directly or indirectly owned of record by residents of the United States; and (ii) any of the following: (A) the majority of the executive officers or directors are United States citizens or residents; (B) more than 50 percent of the assets of the issuer are located in the United States; or (C) the business of the issuer is administered principally in the United States.
Rule 701(e) currently provides that an issuer must deliver to investors a copy of the compensatory benefit plan or contract, as applicable. In addition, if the aggregate sales price or amount of securities sold during any consecutive 12-month period exceeds $10 million, the issuer must deliver the following additional disclosure to investors a reasonable period of time before the date of sale: 13
13 Rule 701(e).
• A copy of the summary plan description required by ERISA 14 or a summary of the plan's material terms if it is not subject to ERISA;
14 The Employee Retirement Income Security Act of 1974 (29 U.S.C. 1001 et seq. ).
• Information about the risks associated with investment in the securities sold pursuant to the compensatory plan or compensation contract; and
• Financial statements required to be furnished by Part F/S of Form 1-A 15 under 17 CFR 230.251 through 230.263 (“Regulation A”). These financial statements must be as of a date no more than 180 days before the sale of securities relying on Rule 701. 16
15 Form 1-A [17 CFR 239.90].
16 Rule 701(e)(4).
• Foreign private issuers must provide a reconciliation to U.S. GAAP if their financial statements are not prepared in accordance with U.S. GAAP or IFRS.
This disclosure must be provided to investors a reasonable period of time before the date of sale. For options and other derivative securities, this requires the issuer to deliver disclosure a reasonable period of time before the date of exercise or conversion
e issuers must provide a reconciliation to U.S. GAAP if their financial statements are not prepared in accordance with U.S. GAAP or IFRS.
This disclosure must be provided to investors a reasonable period of time before the date of sale. For options and other derivative securities, this requires the issuer to deliver disclosure a reasonable period of time before the date of exercise or conversion. 17 In adopting Rule 701(e), the Commission made clear that if the required disclosure has not been provided to all investors on a timely basis, the issuer will lose the exemption for the entire offering. 18
17 Rule 701(e)(6). As described in Section II.A.5, infra, for options and other derivative securities, the issuer's obligation to deliver Rule 701(e) disclosure is determined based on whether the option or other derivative security was granted during a 12-month period in which the disclosure threshold is exceeded. If the grant occurred during such a period, the issuer must deliver the Rule 701(e) disclosure a reasonable period of time before the date of exercise or conversion.
18 In the 1999 Adopting Release at Section II.B, the Commission, referencing the $5 million threshold that applied at the time, stated: “Where the formula permits sales in excess of $5 million during a 12-month period, and the issuer chooses to take advantage of this increased amount, the new disclosure should be provided to all investors before sale. This requirement will obligate issuers to provide disclosure to all investors if the issuer believes that sales will exceed the $5 million threshold in the coming 12-month period. If disclosure has not been provided to all investors before sale, the issuer will lose the exemption for the entire offering when sales exceed the $5 million threshold.”
1
ould be provided to all investors before sale. This requirement will obligate issuers to provide disclosure to all investors if the issuer believes that sales will exceed the $5 million threshold in the coming 12-month period. If disclosure has not been provided to all investors before sale, the issuer will lose the exemption for the entire offering when sales exceed the $5 million threshold.”
1. The Disclosure Requirement for the Period Preceding the Threshold Amount Being Exceeded
We are proposing to revise Rule 701(e) to provide that, if the aggregate sales price or amount of securities sold during any consecutive 12-month period exceeds $10 million, the issuer must deliver to investors the additional disclosure required by the rule only with respect to those sales that exceed the rule's $10 million threshold. One commenter who addressed the current rule characterized the requirement that the disclosure be provided for all sales, including those occurring before the threshold is exceeded, as “largely unworkable” and “a trap for the unwary.” 19 The same commenter recommended that there be a thirty-day “grace period” following the date when the threshold is exceeded, so that the issuer would be required to provide disclosure only for future offers or sales after the “grace period.” Another commenter suggested that crossing the threshold should impact the exemption's availability only for: (1) The securities issued that caused the threshold to be breached and for which disclosure was not provided; and (2) any subsequent offerings in the same 12-month period for which sufficient disclosure was not provided. 20 This commenter further expressed the view that treating sales over $10 million separately from earlier sales would be consistent with the current operation of Rule 504 of Regulation D. 21
19 See letter from ABA.
20 See letter from Sullivan
and for which disclosure was not provided; and (2) any subsequent offerings in the same 12-month period for which sufficient disclosure was not provided. 20 This commenter further expressed the view that treating sales over $10 million separately from earlier sales would be consistent with the current operation of Rule 504 of Regulation D. 21
19 See letter from ABA.
20 See letter from Sullivan.
21 See Instruction to paragraph (b)(2) of Rule 504 (“If a transaction under § 230.504 fails to meet the
Currently, for issuers to be able to rely on Rule 701, they must anticipate whether their compensatory sales could exceed $10 million at the outset of a 12-month period. If an issuer does not anticipate exceeding the $10 million threshold and, as a result, does not provide disclosures to all investors, then that issuer cannot exceed the $10 million threshold without losing the exemption for all of the sales in that 12-month period. We understand that the “lookback” aspect of the requirement may make it unduly difficult for issuers to plan their compensatory programs or respond efficiently to unforeseen situations, such as where an issuer wants to offer equity compensation in connection with an unanticipated opportunity to hire new employees.
We are proposing to amend the rule to provide that the disclosure required by Rule 701(e) be delivered to investors only with respect to sales after the $10 million threshold is exceeded and not to require after-the-fact disclosure for sales made in reliance on the rule during the 12-month period before the threshold was exceeded. 22 The exemption would remain available for all sales that exceed the $10 million threshold during the 12-month period if the issuer provides the required disclosure for those sales
s only with respect to sales after the $10 million threshold is exceeded and not to require after-the-fact disclosure for sales made in reliance on the rule during the 12-month period before the threshold was exceeded. 22 The exemption would remain available for all sales that exceed the $10 million threshold during the 12-month period if the issuer provides the required disclosure for those sales. We are not proposing to include a “grace period” between the point at which the $10 million threshold is exceeded and the requirement to deliver the Rule 701(e) disclosure, given that other amendments to Rule 701(e) proposed in this release should make it easier for issuers to comply with the disclosure delivery requirement. 23
22 Proposed Rule 701(e).
23 See Sections II.A.2-6, infra.
Request for Comment:
1. Should the rule be amended, as proposed, to require additional disclosure only for those sales during the 12-month period that exceed the $10 million threshold? Are there circumstances in which issuers may have trouble providing the information upon exceeding the threshold? If so, how could those difficulties be addressed?
2. Should there be a “grace period” between crossing the $10 million threshold and the requirement to provide additional disclosure with respect to the sales exceeding the $10 million threshold? If so, how long a period is appropriate? Would the other amendments proposed in this release that make it easier for issuers to comply with Rule 701's disclosure delivery requirement mitigate the need for a grace period?
3
a “grace period” between crossing the $10 million threshold and the requirement to provide additional disclosure with respect to the sales exceeding the $10 million threshold? If so, how long a period is appropriate? Would the other amendments proposed in this release that make it easier for issuers to comply with Rule 701's disclosure delivery requirement mitigate the need for a grace period?
3. Alternatively, upon crossing the $10 million threshold, should the issuer be required to provide the additional Rule 701(e) disclosure on a retrospective basis to all investors who had previously been granted or purchased securities during the 12-month period? Would such after-the fact disclosure mitigate informational asymmetry between investors who purchase before and investors who purchase after crossing the $10 million threshold? If we impose such a requirement, should the issuer lose the exemption for those earlier transactions if it fails to retrospectively provide the disclosure? Should there be a “grace period” between crossing the $10 million threshold and the requirement to retrospectively provide the disclosure? If so, how long a period is appropriate?
2. Age of Financial Statements
We propose to conform the age of financial statement requirement set forth in Rule 701(e) to the corresponding requirement in Part F/S of Form 1-A. Rule 701(e) requires delivery of financial statements required to be furnished by Part F/S of Form 1-A, which prescribes the financial statements required for Regulation A Tier 1 and Tier 2 offerings. In Regulation A offerings, issuers generally must include two years of consolidated balance sheets, statements of comprehensive income, cash flows, and changes in stockholders' equity. 24 Issuers relying on Rule 701 may choose to provide financial statements that comply with the requirements of either tier. 25
24 Tier 2 offerings require audited financial statements. See Part F/S of Form 1-A [17 CFR 239.90]
n A offerings, issuers generally must include two years of consolidated balance sheets, statements of comprehensive income, cash flows, and changes in stockholders' equity. 24 Issuers relying on Rule 701 may choose to provide financial statements that comply with the requirements of either tier. 25
24 Tier 2 offerings require audited financial statements. See Part F/S of Form 1-A [17 CFR 239.90].
25 Specifically, an issuer may elect to provide financial statements that follow the requirements of either Tier 1 or Tier 2 Regulation A offerings without regard to whether the amount of sales that occurred pursuant to Rule 701 during the time period contemplated in Rule 701(e) would have required the issuer to follow the Tier 2 financial statement requirements in a Regulation A offering of the same amount. Rule 701 does not, and the proposals would not, require an issuer utilizing Rule 701 that would be subject to Tier 2 financial statement requirements to file with the Commission the current and periodic reports required by Rule 257(b) [17 CFR 230.257(b)].
Currently, the age of the financial statements must be as of a date no more than 180 days before the date of sale of securities relying on the Rule 701 exemption. 26 This requirement, in effect, necessitates financial statements to be prepared on a quarterly basis, and to be completed within three months after the end of each quarter, in order to keep current information available for delivery a reasonable time before the date of sale so that sales may occur on an uninterrupted basis. One commenter 27 recommended requiring the financial statement disclosure to be updated and provided only once per fiscal year, unless a material event results in a material change to the issuer's enterprise value or the value of the securities. 28
26 See Rule 701(e)(4).
27 See letter from ABA.
28 This is generally the same timing that applies to updating valuation disclosures under the IRS Section 409A regulations. See Treas. Reg. § l.409A-l(b)(5)(iv)(B) (2017)
e to be updated and provided only once per fiscal year, unless a material event results in a material change to the issuer's enterprise value or the value of the securities. 28
26 See Rule 701(e)(4).
27 See letter from ABA.
28 This is generally the same timing that applies to updating valuation disclosures under the IRS Section 409A regulations. See Treas. Reg. § l.409A-l(b)(5)(iv)(B) (2017).
Moreover, under existing Rule 701, foreign private issuers are required to provide financial information on the same schedule as domestic issuers. 29 Foreign private issuers, like domestic issuers, may issue securities in reliance on Rule 701 throughout the year, which could require them to update their financial statements more frequently than required for registered offerings under Form 20-F. 30 Commenters expressed the view that non-reporting foreign private issuers should not be obligated to prepare quarterly financial statements solely to rely on Rule 701, but instead should be able to satisfy the requirements of Rule 701 by providing investors financial statements conforming to the requirements for annual financial statements in reports on Form 20-F and interim financial statements within the timeframe required by home country rules. 31
29 See Rule 701(e). See also 1999 Adopting Release at Section II.C.
30 17 CFR 249.220f. See Item 8.A.5 of Form 20-F.
31 See letters from ABA, Davis Polk, and Shearman. In particular, one commenter noted that foreign private issuers subject to Exchange Act reporting requirements can use Form S-8 for compensatory offerings without providing financial statements more frequently than required by their home jurisdiction, which puts U.S. employees of non-registered foreign private issuers at a disadvantage compared to U.S. employees of registered foreign private issuers. See letter from Davis Polk.
We propose to amend Rule 701(e) to apply the age of financial statement requirements of Form 1-A, Part F/S, paragraphs (b)(3) and (4) at the time of sale
ements more frequently than required by their home jurisdiction, which puts U.S. employees of non-registered foreign private issuers at a disadvantage compared to U.S. employees of registered foreign private issuers. See letter from Davis Polk.
We propose to amend Rule 701(e) to apply the age of financial statement requirements of Form 1-A, Part F/S, paragraphs (b)(3) and (4) at the time of sale. 32 This proposal, which would apply to both domestic and foreign issuers, would conform the Rule 701(e) financial statement age requirements with those of Regulation A. 33 Under the proposal, financial statements must be available on at least a semi-annual basis
32 Proposed Rule 701(e)(4)(i).
33 See Part F/S of Form 1-A.
Rule 12h-1(f) 34 under the Securities Exchange Act of 1934 35 (“Exchange Act”), which exempts from Exchange Act Section 12(g)'s registration requirements stock options issued under written compensatory stock option plans by non-reporting issuers, includes, as a condition to the exemption, the delivery of Rule 701(e) information every six months with the financial statements that are not more than 180 days old. For ease of plan administration, we considered proposing to amend the age of financial statements requirements of this rule to remain consistent with those of Rule 701(e). However, it is unclear to what extent non-reporting companies continue to rely on Rule 12h-1(f) after the adoption of Exchange Act Rule 12g5-1(a)(8), 36 which excludes from the definition of “held of record” for purposes of Section 12(g) certain securities held by persons who received them pursuant to employee compensation plans. Accordingly, we request comment below on whether we should rescind or adopt a conforming amendment to Rule 12h-1(f).
34 17 CFR 240.12h-1(f).
35 15 U.S.C 78a et seq.
36 17 CFR 240.12g5-1(a)(8). See discussion in Section II.C.1, infra.
Request for Comment:
4
f record” for purposes of Section 12(g) certain securities held by persons who received them pursuant to employee compensation plans. Accordingly, we request comment below on whether we should rescind or adopt a conforming amendment to Rule 12h-1(f).
34 17 CFR 240.12h-1(f).
35 15 U.S.C 78a et seq.
36 17 CFR 240.12g5-1(a)(8). See discussion in Section II.C.1, infra.
Request for Comment:
4. Would the proposed amendment to the age of financial statement requirements ease the burden of compliance with Rule 701(e) in a manner consistent with investor protection, both for domestic issuers and foreign private issuers? Would a different age of financial statement requirement better promote this objective? For example, should issuers be required to update financial statements only once per fiscal year, unless there is a material change to the issuer's enterprise value or the value of the securities? Should issuers be permitted to rely on either Tier 1 or Tier 2 financial statement requirements regardless of the size of the offering, as proposed?
5. Subsequent to the adoption of Exchange Act Rule 12g5-1(a)(8), to what extent do non-reporting issuers rely on the Rule 12h-1(f) exemption? If we amend Rule 701(e), should we also make conforming amendments to the age of financial statement requirement under Rule 12h-1(f), assuming non-reporting issuers continue to rely on the rule? If non-reporting issuers no longer rely on the exemption it provides, should we rescind Rule 12h-1(f)?
3. Financial Statement Content Requirements for Foreign Private Issuers
We propose to allow foreign private issuers that are eligible for the exemption from Exchange Act registration provided by Exchange Act Rule 12g3-2(b) 37 to provide financial statements prepared in accordance with home country accounting standards for purposes of Rule 701(e) disclosure without reconciliation to U.S. GAAP in certain circumstances. Currently, all foreign private issuers relying on the Rule 701 exemption must provide a reconciliation to U.S
ble for the exemption from Exchange Act registration provided by Exchange Act Rule 12g3-2(b) 37 to provide financial statements prepared in accordance with home country accounting standards for purposes of Rule 701(e) disclosure without reconciliation to U.S. GAAP in certain circumstances. Currently, all foreign private issuers relying on the Rule 701 exemption must provide a reconciliation to U.S. GAAP if their financial statements are not prepared in accordance with U.S. GAAP or IFRS to satisfy their financial statement disclosure requirements under Rule 701(e). 38
37 17 CFR 230.12g3-2(b).
38 See Rule 701(e)(4).
The Concept Release requested comment on whether we should amend any aspect of the Rule 701 financial statement requirements that apply to foreign private issuers other than the timing requirements. 39 A few commenters addressed this topic. One commenter 40 stated that the financial statement reconciliation and the need to keep it current for an ongoing plan is unduly costly and burdensome. Another commenter 41 stated that Rule 701 should allow foreign private issuers to provide financial statements audited under the International Standards on Auditing (“ISAs”).
39 See Concept Release at Section II.C.1.
40 See letter from Shearman.
41 See letter from EY.
After consideration of the comments received, we propose to permit foreign private issuers that are eligible for the exemption from registration under Section 12(g) 42 of the Exchange Act provided by Exchange Act Rule 12g3-2(b) to provide financial statements prepared in accordance with home country accounting standards to satisfy the financial statement disclosure requirements of Rule 701(e) if financial statements prepared in accordance with U.S. GAAP or IFRS are not otherwise available. 43 Consistent with the current requirements, all other foreign private issuers would continue to be required to provide a reconciliation to U.S. GAAP if their financial statements are not prepared in accordance with U.S. GAAP or IFRS.
42 15 U.S.C
ial statement disclosure requirements of Rule 701(e) if financial statements prepared in accordance with U.S. GAAP or IFRS are not otherwise available. 43 Consistent with the current requirements, all other foreign private issuers would continue to be required to provide a reconciliation to U.S. GAAP if their financial statements are not prepared in accordance with U.S. GAAP or IFRS.
42 15 U.S.C. 78 l (g).
43 Proposed Rule 701(e)(4)(i).
We believe it is appropriate to extend this relief to foreign private issuers that are eligible for the exemption from registration under Section 12(g) because, in other contexts, those issuers are currently not required to provide a reconciliation to U.S. GAAP if financial statements prepared in accordance with U.S. GAAP or IFRS are not otherwise available. Specifically, to be eligible for the exemption from registration under Rule 12g3-2(b), a foreign private issuer that is not otherwise subject to Exchange Act reporting must maintain a securities listing on one or more exchanges in a foreign jurisdiction that constitutes the primary trading market for its securities and must publish in English, on its website or through an electronic information delivery system generally available to the public in its primary trading market, information that satisfies specified public dissemination and shareholder distribution requirements. 44 The Rule 12g3-2(b) exemption allows a foreign private issuer to exceed the registration thresholds of Section 12(g) and effectively have its equity securities traded on a limited basis in the over-the-counter market in the United States. The Commission determined that such Section 12(g) exemptive relief was appropriate for a foreign private issuer that has not sought a public market in the United States and that makes available its non-U.S. disclosure documents
xceed the registration thresholds of Section 12(g) and effectively have its equity securities traded on a limited basis in the over-the-counter market in the United States. The Commission determined that such Section 12(g) exemptive relief was appropriate for a foreign private issuer that has not sought a public market in the United States and that makes available its non-U.S. disclosure documents. 45 As a foreign private issuer eligible for the exemption under Rule 12g3-2(b) would not be seeking to create a public market for its securities in the United States through its reliance on Rule 701, we believe that the same level of disclosure would be appropriate.
44 See the specific requirements of Exchange Act Rule 12g3-2(b).
45 See Exemption from Registration Under Section 12(g) of the Securities Exchange Act of 1934 for Foreign Private Issuers, Release No. 34-57350 (Feb. 19, 2008), citing Adoption of Rules Relating to Foreign Securities, Release No. 34-8066 (Apr. 28, 1967).
The proposal would not modify the disclosure requirements of Rule 701(e) to permit foreign private issuers to provide financial statements audited under ISAs, as suggested by one
Request for Comment:
6. Should we permit foreign private issuers that are eligible for the exemption from Exchange Act registration provided by Exchange Act Rule 12g3-2(b) to provide financial statements prepared in accordance with home country accounting standards without reconciliation to U.S. GAAP, as proposed? Would such an accommodation provide financial information that is consistent with investor protection?
7
. Should we permit foreign private issuers that are eligible for the exemption from Exchange Act registration provided by Exchange Act Rule 12g3-2(b) to provide financial statements prepared in accordance with home country accounting standards without reconciliation to U.S. GAAP, as proposed? Would such an accommodation provide financial information that is consistent with investor protection?
7. Should the proposal be expanded to apply to any foreign private issuer with securities that are listed and traded in its home country, without regard to Exchange Act Rule 12g3-2(b) eligibility? Alternatively, if we do not expand the proposal to all foreign private issuers with securities listed and traded in its home country, should we amend Rule 701(e)(4) to allow issuers to present their financial statements in accordance with other international financial reporting standards, such as International Financial Reporting Standards as adopted by the European Union, without requiring such issuers to provide a reconciliation to U.S. GAAP?
4. Alternative Valuation Disclosure
We propose to allow issuers to provide alternative valuation information, specifically an independent valuation report of the securities' fair market value as determined by an independent appraisal consistent with the rules and regulations under Internal Revenue Code Section 409A 46 (a “Section 409A independent valuation report”), in lieu of financial statements, for purposes of Rule 701(e) disclosure. The Concept Release solicited comment on whether we should allow valuation information regarding the securities in lieu of, or in addition to, financial statements. In particular, the Concept Release asked what valuation method should be used for this purpose, and whether ASC Topic 718 47 grant date fair value information or IRC Section 409A valuation information would be informative.
46 26 U.S.C. 409A (“IRC Section 409A”).
47 FASB ASC Topic 718
letter from ABA.
50 See letter from Sullivan.
We propose amending Rule 701(e)(4) to permit, as an alternative to financial statement disclosure, the use of a Section 409A independent valuation report prepared in accordance with the rules and regulations applicable to determining the fair market value of service recipient stock for stock not readily tradable on an established securities market. 51 The proposed alternative would apply to all issuers other than foreign private issuers eligible for the Rule 12g3-2(b) exemption. We believe that permitting this alternative is appropriate because the disclosure would be particularly helpful to employee investors in non-reporting issuers, which typically do not have a significant trading market from which to readily derive valuation information. To provide employee investors with meaningful information that they can use to assess the manner in which fair market value was derived, the amendments would require the issuer to provide employees the entire Section 409A independent valuation report provided to the issuer. 52 As noted above, 53 the applicable rules and regulations under IRC Section 409A specify numerous factors to be taken into account in determining the fair market value of securities not readily tradeable on an established securities market, including but not limited to recent arm's length transactions involving the sale or transfer of such securities, and specifically provide that use of a valuation method is not reasonable if such valuation method does not take into consideration all available information material to the value of the company. These rules are widely-used and have independent legal significance under Federal tax law. We believe that a Section 409A independent valuation report containing a rigorous analysis of the factors considered in such a valuation would provide employee investors with appropriate financial disclosure.
51 Proposed Rule 701(e)(4)(ii). As provided in Treasury Reg
material to the value of the company. These rules are widely-used and have independent legal significance under Federal tax law. We believe that a Section 409A independent valuation report containing a rigorous analysis of the factors considered in such a valuation would provide employee investors with appropriate financial disclosure.
51 Proposed Rule 701(e)(4)(ii). As provided in Treasury Reg. 1.409A-1(b)(5)(iv)(B)( 1 ), in the case of service recipient stock that is not readily tradable on an established securities market, the fair market value of the stock as of a valuation date means a value determined by the reasonable application of a reasonable valuation method. For this purpose, a valuation is presumed to be a reasonable valuation if the valuation is determined by an independent appraisal that meets certain requirements. See Treasury Reg. 1.409A-1(b)(5)(iv)(B)( 2 )(i). The determination whether a valuation method is reasonable, or whether an application of a valuation method is reasonable, is made based on the facts and circumstances as of the valuation date. Factors to be considered under a reasonable valuation method include, as applicable, the value of tangible and intangible assets of the corporation, the present value of anticipated future cash-flows of the corporation, the market value of stock or equity interests in similar corporations and other entities engaged in trades or businesses substantially similar to those engaged in by the corporation the stock of which is to be valued, the value of which can be readily determined through nondiscretionary, objective means (such as through trading prices on an established securities market or an amount paid in an arm's length private transaction), recent arm's length transactions involving the sale or transfer of such stock or equity interests, and other relevant factors such as control premiums or discounts for lack of marketability and whether the valuation method is used for other purposes that have a material economic effect on the service recipi
an established securities market or an amount paid in an arm's length private transaction), recent arm's length transactions involving the sale or transfer of such stock or equity interests, and other relevant factors such as control premiums or discounts for lack of marketability and whether the valuation method is used for other purposes that have a material economic effect on the service recipient, its stockholders, or its creditors. The use of a valuation method is not reasonable if such valuation method does not take into consideration in applying its methodology all available information material to the value of the corporation. Under the Treasury Regulation, the use of a value previously calculated under a valuation method is not reasonable as of a later date if such calculation fails to reflect information available after the date of the calculation that may materially affect the value of the corporation (for example, the resolution of material litigation or the issuance of a patent).
52 Proposed Rule 701(e)(4)(ii)(B).
53 See n. 51, supra.
To ensure appropriate investor protections, we are proposing certain conditions on the use of a Section 409A independent valuation report. First, the proposed amendments require an independent appraisal that is consistent with the rules and regulations under Section 409A applicable to determination of the fair market value of service recipient stock for stock not 54 Further, in order to keep valuation information current, similar to Rule 701(e) financial statement disclosure, the proposed amendments would require the Section 409A independent valuation report to be as of a date that is no more than six months before the sale of securities in reliance on this exemption. 55 This updating schedule would be comparable to the proposed age of financial statement requirements for Rule 701(e).
54 To meet the requirements of Treasury Reg
701(e) financial statement disclosure, the proposed amendments would require the Section 409A independent valuation report to be as of a date that is no more than six months before the sale of securities in reliance on this exemption. 55 This updating schedule would be comparable to the proposed age of financial statement requirements for Rule 701(e).
54 To meet the requirements of Treasury Reg. 1.409A-1(b)(5)(iv)(B)(2)(i), the valuation must be determined by an independent appraisal that meets the requirements of IRC Section 401(a)(28)(C) and the Treasury Regulations thereunder. For purposes of IRC Section 401(a)(28)(C), the term “independent appraiser” means any appraiser meeting requirements similar to the requirements of the Treasury Regulations prescribed under IRC Section 170(a)(1). IRC Section 170(f)(11)(E) and Treasury Reg. 1.170A-17 define the terms “qualified appraisal” and “qualified appraiser.” In order to be a “qualified appraisal,” a valuation of property must be made by a “qualified appraiser.” See IRS Publication 561, which generally describes a “qualified appraiser” as a disinterested person who has earned an appraisal designation from a generally recognized professional appraiser organization or met specified minimum educational requirements, and regularly prepare appraisals for which he or she is paid.
55 In contrast, the applicable Treasury Regulations provide that use of a previously calculated valuation is not reasonable if the value was calculated more than 12 months earlier than the date for which the valuation is being used, or if the valuation fails to reflect information available after the date of the calculation that may materially affect the value of the corporation. Treasury Reg. 1.409A-1(b)(5)(iv)(B).
We anticipate that providing the proposed valuation disclosure may be less costly, particularly because it is likely the issuer is already preparing such reports for purposes of complying with IRC Section 409A
, or if the valuation fails to reflect information available after the date of the calculation that may materially affect the value of the corporation. Treasury Reg. 1.409A-1(b)(5)(iv)(B).
We anticipate that providing the proposed valuation disclosure may be less costly, particularly because it is likely the issuer is already preparing such reports for purposes of complying with IRC Section 409A. At the same time, as commenters suggested, valuation disclosure may be as useful to an investor, if not more so, than financial statements in the particular context of evaluating the value of an equity award granted pursuant to Rule 701.
Although most non-reporting issuers relying on Rule 701 are unlikely to have a trading market of the necessary depth and liquidity to justify using the IRC Section 409A valuation standard for stock readily traded on an established securities market, foreign private issuers eligible for the Rule 12g3-2(b) exemption may meet this criterion. In particular, such an issuer must maintain a listing of a class of securities on one or more exchanges in a foreign jurisdiction that, either singly or together with the trading of the same class of the issuer's securities in another foreign jurisdiction, constitutes the primary trading market for those securities. 56 For this reason, the proposed amendments would allow Rule 12g3-2(b) eligible foreign private issuers to provide alternative valuation disclosure prepared consistent with the IRC Section 409A rules and regulations applicable to determining the fair market value of stock readily tradeable on an established securities market. 57 To comply with this alternative disclosure requirement, the eligible issuer would simply disclose the fair market value of the stock on the most recent trading day preceding the date of sale. 58
56 Exchange Act Rule 12g3-2(b)(1)(ii).
57 Proposed Rule 701(e)(4)(ii)(A)
d regulations applicable to determining the fair market value of stock readily tradeable on an established securities market. 57 To comply with this alternative disclosure requirement, the eligible issuer would simply disclose the fair market value of the stock on the most recent trading day preceding the date of sale. 58
56 Exchange Act Rule 12g3-2(b)(1)(ii).
57 Proposed Rule 701(e)(4)(ii)(A).
58 For stock readily tradable on an established securities market, the fair market value of the stock must be determined “based upon the last sale before or the first sale after the grant, the closing price on the trading day before or the trading day of the grant, the arithmetic mean of the high and low prices on the trading day before or the trading day of the grant, or any other reasonable method using actual transactions in such stock as reported by such market.” See Treasury Reg. 1.409A-1(b)(5)(iv)(A). For this purpose, stock is treated as “readily tradable” if it is regularly quoted by brokers or dealers making a market in such stock, and the term “established securities market” means an established securities market within the meaning of Treasury Reg. 1.897-1(m). See Treasury Reg. 1.409A-1(b)(5)(vi)(G) and 1.409A-1(k). Treasury Reg. 1.897-1(m) provides that the term “established securities market” means “(1) A national securities exchange which is registered under section 6 of the Securities Exchange Act of 1934 (15 U.S.C. 78f), (2) A foreign national securities exchange which is officially recognized, sanctioned, or supervised by governmental authority, and (3) Any over-the-counter market. An over-the-counter market is any market reflected by the existence of an interdealer quotation system
eans “(1) A national securities exchange which is registered under section 6 of the Securities Exchange Act of 1934 (15 U.S.C. 78f), (2) A foreign national securities exchange which is officially recognized, sanctioned, or supervised by governmental authority, and (3) Any over-the-counter market. An over-the-counter market is any market reflected by the existence of an interdealer quotation system. An interdealer quotation system is any system of general circulation to brokers and dealers which regularly disseminates quotations of stocks and securities by identified brokers or dealers, other than by quotation sheets which are prepared and distributed by a broker or dealer in the regular course of business and which contain only quotations of such broker or dealer.”
Request for Comment:
8. Should we permit a Section 409A independent valuation report to be provided in lieu of financial statement disclosures, as proposed? Would the IRC Section 409A regulations for determining the fair market value of stock not readily tradable on an established securities market generate valuation information that is easy to understand and appropriate to the financial disclosure needs of investors receiving securities under Rule 701? Would such disclosure be an acceptable alternative to financial statements prepared in accordance with U.S. GAAP or IFRS, as applicable? Would this proposal provide meaningful information to securities recipients while avoiding competitive risks from unauthorized financial statement disclosure?
9
and appropriate to the financial disclosure needs of investors receiving securities under Rule 701? Would such disclosure be an acceptable alternative to financial statements prepared in accordance with U.S. GAAP or IFRS, as applicable? Would this proposal provide meaningful information to securities recipients while avoiding competitive risks from unauthorized financial statement disclosure?
9. Should we require, as proposed, that Section 409A independent valuation reports be prepared pursuant to an independent appraisal for Rule 701(e) disclosure purposes? Taken together, would the related Treasury Regulations defining the terms “independent appraiser,” “qualified appraiser,” and “qualified appraisal” provide adequate guidance for purposes of satisfying this proposed requirement? If not, should we provide further guidance? Would the proposed independence requirement add significantly to preparation costs? How would those costs compare to the costs of preparing the financial statements required by the proposed amendments?
10. As proposed, the Section 409A independent valuation reports would need to be updated at six-month intervals. Would a different interval be more appropriate to ensure that such valuation disclosures provide appropriate information? If so, what interval should we prescribe? Would the proposed updating schedule impose significant costs? Would a less frequent updating schedule raise investor protection concerns?
11. More specifically, would the Section 409A updating schedule imposed for tax purposes, calling for an independent valuation report to be updated if it fails to reflect information that may materially affect the value of the issuer and otherwise only once per fiscal year, result in more frequently updated information than if the issuer provides financial statement disclosure only on a semi-annual basis as proposed? Would using the tax updating schedule for Rule 701(e) purposes provide adequate investor protection?
12
report to be updated if it fails to reflect information that may materially affect the value of the issuer and otherwise only once per fiscal year, result in more frequently updated information than if the issuer provides financial statement disclosure only on a semi-annual basis as proposed? Would using the tax updating schedule for Rule 701(e) purposes provide adequate investor protection?
12. Should we require disclosure of the entire Section 409A independent valuation report, as proposed? Would requiring disclosure of the entire Section 409A independent valuation report result in disclosure of competitively sensitive information? If so, how could we modify the proposal to avoid this result while still providing investors with appropriate disclosure? Are there particular contents of the report that would be competitively sensitive and not meaningful to investors?
13. Is the proposed alternative valuation information based on IRC Section 409A valuation standards for stock readily tradable on an established securities market appropriate for Rule 12g3-2(b) eligible foreign private issuers? From an investor protection standpoint, would disclosure of the securities' fair market value alone be a sufficient alternative to financial statement disclosure? Would disclosure of the securities' fair market value provide any benefit considering the securities are traded in an established trading market?
14. Are there any other circumstances in which an issuer should be able to provide the alternative valuation information based on market price in accordance with the IRC Section 409A valuation standards for stock readily tradable on an established securities market?
15. Are there any other aspects of the Section 409A valuation regulations that would be useful for purposes of Rule 701(e) disclosure?
16
there any other circumstances in which an issuer should be able to provide the alternative valuation information based on market price in accordance with the IRC Section 409A valuation standards for stock readily tradable on an established securities market?
15. Are there any other aspects of the Section 409A valuation regulations that would be useful for purposes of Rule 701(e) disclosure?
16. Other than the independent valuation prescribed with respect to IRC Section 409A, are there any other securities valuation methods that would be appropriate to import into the Rule 701(e) disclosure requirements?
5. Disclosure Requirements for Derivative Securities
We propose to amend the date by which Rule 701(e) disclosure must be provided for certain derivative securities. Specifically, for derivative securities that do not involve a decision by the recipient to exercise or convert, we propose to modify the date by which Rule 701(e) disclosure must be delivered for grants to new hires in specified circumstances.
Rule 701(e)(6) currently provides that if a sale involves a stock option or another derivative security, the issuer must deliver disclosure a reasonable period of time before the date of exercise or conversion. Adopted in 1999, this rule contemplates derivative securities where the sale of the underlying shares involves an investment decision at the time of exercise or conversion. 59
59 See 1999 Release, which predates issuers' utilization of restricted stock units and similar instruments for compensatory awards.
Since Rule 701(e) was initially adopted, compensatory programs have developed that use derivative securities—such as restricted stock units (“RSUs”) and performance stock units (“PSUs”)—that do not require a decision to exercise or convert. Instead, when held to maturity, these instruments settle automatically in the underlying shares without need for any investment decision by the holder
wards.
Since Rule 701(e) was initially adopted, compensatory programs have developed that use derivative securities—such as restricted stock units (“RSUs”) and performance stock units (“PSUs”)—that do not require a decision to exercise or convert. Instead, when held to maturity, these instruments settle automatically in the underlying shares without need for any investment decision by the holder. In the Concept Release, the Commission observed that, because such instruments settle by their terms without action by the holder, the relevant investment decision, if there is one, likely takes place at the date of grant. Consequently, the issuer's obligation to provide Rule 701(e) disclosure would apply a reasonable period of time before the date the RSU or PSU award is granted. 60
60 See Concept Release at Section II.C.3.
Commenters did not raise any concerns regarding the application of the existing rule to options, stock appreciation rights, or convertible securities. While commenters did not dispute the logic of the Commission's date of sale analysis for RSUs and PSUs, 61 they questioned its practicability in the context of grants to new hires. 62 In particular, one commenter stated that providing financial information to an individual who is considering whether to join the issuer would result in an obligation to provide sensitive financial and operational risk information before the individual starts employment. 63
61 See letters from Chamber and Davis Polk.
62 See letters from ABA and Chamber.
63 See letter from ABA.
To address these practical challenges, commenters suggested several alternative approaches. One commenter suggested permitting issuers to provide the required disclosure within 30 days after employment commences. 64 Another commenter recommended treating RSU settlement as a conversion within the meaning of Rule 701(e)(6) on the date of settlement, so that disclosure delivery would be required a reasonable period of time before settlement. 65
64 See letter from Chamber
ative approaches. One commenter suggested permitting issuers to provide the required disclosure within 30 days after employment commences. 64 Another commenter recommended treating RSU settlement as a conversion within the meaning of Rule 701(e)(6) on the date of settlement, so that disclosure delivery would be required a reasonable period of time before settlement. 65
64 See letter from Chamber.
65 See letter from ABA.
We propose revising Rule 701(e)(6) to clarify the distinction between derivative securities that involve a decision to exercise or convert, and those that do not. 66 If the sale involves a stock option or other derivative security that involves a decision to exercise or convert, the issuer would continue to be required to deliver disclosure a reasonable period of time before the date of exercise or conversion. If the sale involves an RSU or other derivative security that does not involve a decision to exercise or convert, the issuer generally would continue to be required to deliver disclosure a reasonable period of time before the date the RSU or similar derivative security is granted.
66 Proposed Rule 701(e)(6)(i).
We also propose to amend the rule's application to the grant of an RSU or similar derivative security made in connection with the hire of new employees. In such circumstances, the disclosure would be considered delivered a reasonable period of time before the date of sale if it is provided no later than 14 calendar days after the date the person begins employment. In our view, providing an accommodation for delivery 14 calendar days after commencing employment would provide the issuer an opportunity to address confidentiality concerns while providing the employee disclosure within an appropriate time period. In any other circumstances, the issuer would be required to deliver the disclosure a reasonable period of time before the date the RSU or similar derivative security is granted
accommodation for delivery 14 calendar days after commencing employment would provide the issuer an opportunity to address confidentiality concerns while providing the employee disclosure within an appropriate time period. In any other circumstances, the issuer would be required to deliver the disclosure a reasonable period of time before the date the RSU or similar derivative security is granted. In any case, however, the disclosure may be provided subject to appropriate confidentiality conditions. We do not propose to treat RSU settlement the same as a conversion because, unlike conversion, RSU settlement does not involve an investment decision, and, as discussed above, the requirements of Rule 701 contemplate disclosure delivery as part of an investment decision.
Request for Comment:
17. Does the proposal sufficiently clarify the distinction between derivative securities that involve a decision to exercise or convert and those that do not with respect to the timing of the obligation to deliver Rule 701(e) disclosure?
18. Is there any basis for treating settlement of an RSU or PSU as a conversion under the current rule, given that the holder does not make any investment decision at the time of settlement? For example, should the decision whether to settle tax obligations arising at settlement by withholding shares be viewed as an investment decision?
19. For new hires, is it appropriate to require delivery of Rule 701(e) disclosures within 14 calendar days after a recipient's commencement of employment, as proposed? Would a shorter period, such as seven calendar days, or longer period, such as 30 calendar days, be more appropriate?
20. Does the proposal adequately address issuer confidentiality concerns in the context of new hires, in a manner consistent with investor protection?
21. Are there any circumstances in which the proposed new hire accommodation should not apply, such
22
ployment, as proposed? Would a shorter period, such as seven calendar days, or longer period, such as 30 calendar days, be more appropriate?
20. Does the proposal adequately address issuer confidentiality concerns in the context of new hires, in a manner consistent with investor protection?
21. Are there any circumstances in which the proposed new hire accommodation should not apply, such
22. Should the proposed accommodation for new hires be available only if the financial disclosure that will be provided consists of financial statements, rather than the alternative proposed Section 409A valuation disclosure? Does a Section 409A independent valuation report raise the same concerns about disclosure of sensitive financial and operational risk information?
23. Are there any other categories of Rule 701 eligible participants for whom the proposed accommodations should apply?
24. Would it be helpful to amend Rule 701(e) to specify that disclosure may be made either by physical or electronic delivery or by written notice of the availability of the information on a website that may be password-protected and of any password needed to access the information? Would it be helpful for the rule to specifically permit use of dedicated physical disclosure rooms that house the medium used to convey the information required to be disclosed?
6. Disclosure Requirements Following Business Combination Transactions
To clarify the application of Rule 701 to merged entities, we propose to amend Rule 701(e) to address the application of the exemption and its disclosure delivery obligations to acquired entity derivative securities that the acquiring issuer assumes in a business combination transaction. 67
67 Proposed Rule 701(e)(7).
In some business combination transactions, outstanding derivative securities issued by the acquired entity in compensatory transactions will not be accelerated, but will instead be assumed by the acquiring issuer
nd its disclosure delivery obligations to acquired entity derivative securities that the acquiring issuer assumes in a business combination transaction. 67
67 Proposed Rule 701(e)(7).
In some business combination transactions, outstanding derivative securities issued by the acquired entity in compensatory transactions will not be accelerated, but will instead be assumed by the acquiring issuer. In these circumstances, shares of the acquiring issuer will be issued upon the exercise or conversion of the derivative securities, instead of those of the acquired entity. Under the proposal, as long as the acquired entity complied with Rule 701 at the time it originally granted the derivative securities, the exercise or conversion of those derivative securities that are assumed by the acquiring issuer would be exempt from registration, subject to the acquiring issuer's compliance, where applicable, with Rule 701(e). For assumed derivative securities for which the acquired entity was required to provide disclosure pursuant to Rule 701(e) and where the derivative securities are exercised or converted after completion of the business combination transaction, the acquiring issuer would satisfy that disclosure obligation by providing information meeting the requirements of Rule 701(e) consistent with the timing requirements of Rule 701(e)(6). 68 In other words, if the acquired entity would have been required to provide Rule 701(e) disclosure upon exercise or conversion of its derivative securities, the acquiring issuer that assumes those derivative securities would assume the obligation to provide Rule 701(e) disclosure upon their exercise or conversion.
68 Proposed Rule 701(e)(7)(ii)
t with the timing requirements of Rule 701(e)(6). 68 In other words, if the acquired entity would have been required to provide Rule 701(e) disclosure upon exercise or conversion of its derivative securities, the acquiring issuer that assumes those derivative securities would assume the obligation to provide Rule 701(e) disclosure upon their exercise or conversion.
68 Proposed Rule 701(e)(7)(ii).
Following completion of a business combination transaction, in determining whether the amount of securities the acquiring issuer sold during any consecutive 12-month period exceeds $10 million, the acquiring issuer would consider only the securities that it sold in reliance on Rule 701 during that period and would not be required to include any securities sold by the acquired entity pursuant to the rule during the same 12-month period. 69 Because the acquiring issuer presumably did not consider the acquired entity's Rule 701 sales preceding the business combination transaction in planning its own Rule 701 transactions, taking them into account after the business combination transaction could in some cases result in retroactive loss of the exemption if the combined Rule 701 transactions exceed the $10 million threshold. We believe that this result would be unduly restrictive and could create hurdles to potentially value-enhancing business combinations.
69 Proposed Rule 701(e)(7)(i).
Request for Comment:
25. Would the proposal addressing acquired entity derivative securities assumed by an acquiring issuer sufficiently clarify the exempt status of and disclosure obligations applicable to exercises and conversions of those securities after completion of the business combination transaction? Are any additional clarifications needed? For example, is guidance needed to clarify who is the acquiring issuer in a business combination transaction where the acquirer is not the same entity for legal and accounting purposes?
26
y the exempt status of and disclosure obligations applicable to exercises and conversions of those securities after completion of the business combination transaction? Are any additional clarifications needed? For example, is guidance needed to clarify who is the acquiring issuer in a business combination transaction where the acquirer is not the same entity for legal and accounting purposes?
26. Following completion of a business combination transaction, in determining whether the amount of securities the acquiring issuer sold pursuant to Rule 701 during any consecutive 12-month period exceeds $10 million, should the acquiring entity be permitted to disregard the securities that the acquired entity sold pursuant to the rule during the same 12-month period, as proposed? Are there any circumstances in which the acquiring entity should be required to take those acquired entity securities into account for purposes of the $10 million disclosure threshold, and how do these circumstances relate to investor protection?
B. Rule 701(d)
We propose to raise two of the three alternative regulatory ceilings that cap the overall amount of securities that a non-reporting issuer may sell pursuant to Rule 701 during any consecutive 12-month period. Since 1999, 70 the rule has provided that the amount of securities that may be sold in reliance on the exemption during any consecutive 12-month period is limited to the greatest of: 71
70 See 1999 Adopting Release.
71 Rule 701(d).
• $1 million;
• 15% of the total assets of the issuer, 72 measured at the issuer's most recent balance sheet date; or
72 The relevant limit applies to the total assets of the issuer's parent if the issuer is a wholly-owned subsidiary and the securities represent obligations that the parent fully and unconditionally guarantees.
• 15% of the outstanding amount of the class of securities being offered and sold in reliance on the rule, measured at the issuer's most recent balance sheet date
balance sheet date; or
72 The relevant limit applies to the total assets of the issuer's parent if the issuer is a wholly-owned subsidiary and the securities represent obligations that the parent fully and unconditionally guarantees.
• 15% of the outstanding amount of the class of securities being offered and sold in reliance on the rule, measured at the issuer's most recent balance sheet date.
These measures apply on an aggregate basis, not plan-by-plan. For securities underlying options, the aggregate sales price is determined when the option grant is made, using the exercise price of the option, without regard to when it becomes exercisable. 73 For deferred compensation plans, the calculation is made at the time of the participant's irrevocable election to defer. 74 There is no separate limitation on the amount of securities that may be offered. 73 See Rule 701(d)(3)(i)-(ii).
74 See Rule 701(d)(3)(ii).
In proposing the current rule, the Commission explained that the purpose of a 12-month cap is to “assur[e] that the exemption does not provide a threshold that small issuers could use to raise substantial capital from employees.” 75 The alternatives based on 15% of total assets or 15% of the outstanding amount 76 The $1 million alternative provides an amount that any issuer can use, regardless of size.
75 See Employee Benefit and Compensation Contracts, Release No. 33-6726 (July 30, 1987) [52 FR 29033 (Aug. 5, 1987)] (“Rule 701 Reproposing Release”). As originally adopted, the rule permitted the amounts of securities offered and sold annually to be the greatest of $500,000, 15% of total assets of the issuer, or 15% of the outstanding securities of the class, subject to an absolute limit of $5,000,000 derived from Securities Act Section 3(b). See Compensatory Benefit Plans and Contracts, Release No. 33-6768 (Apr. 14, 1988) [53 FR 12918 (Apr. 20, 1988)] (“Rule 701 Adopting Release”).
76 See Rule 701 Adopting Release at Section I.A.(2)
to be the greatest of $500,000, 15% of total assets of the issuer, or 15% of the outstanding securities of the class, subject to an absolute limit of $5,000,000 derived from Securities Act Section 3(b). See Compensatory Benefit Plans and Contracts, Release No. 33-6768 (Apr. 14, 1988) [53 FR 12918 (Apr. 20, 1988)] (“Rule 701 Adopting Release”).
76 See Rule 701 Adopting Release at Section I.A.(2).
The Concept Release solicited comment on whether there is a continuing need for any annual regulatory ceiling for Rule 701 transactions, and whether investors would be harmed if the Commission eliminated or raised the ceiling. One commenter stated that compliance with Rule 701(d) imposes costly ongoing analysis and monitoring on issuers without any clear benefit to them or their employees. 77 A different commenter recommended raising the $1 million limit to $2 million, to retain its utility for start-up issuers that have few assets and may want to issue a large percentage of current equity to first round employees. 78 This commenter also recommended raising the 15% asset cap to 25%, as modern issuers rely increasingly on human capital and are less asset-intensive. Another commenter recommended providing relief in business combination transactions where the acquirer assumes the target's employee benefit plans, resulting in the combined enterprise exceeding the aggregate offering limitations in Rule 701(d)(2), particularly in the first year following closing of the transaction. 79
77 See letter from ABA.
78 See letter from Sullivan.
79 See letter from Chamber.
We continue to believe that the Rule 701(d) caps are useful in curbing non-compensatory sales in reliance on the rule. Accordingly, the proposal retains the general structure of Rule 701(d)(2), providing that the aggregate sales price or amount of securities sold in reliance on Rule 701 during any consecutive 12-month period must not exceed the greatest of the three alternative ceilings
Chamber.
We continue to believe that the Rule 701(d) caps are useful in curbing non-compensatory sales in reliance on the rule. Accordingly, the proposal retains the general structure of Rule 701(d)(2), providing that the aggregate sales price or amount of securities sold in reliance on Rule 701 during any consecutive 12-month period must not exceed the greatest of the three alternative ceilings. In light of the less asset-intensive nature of contemporary businesses and the effects of inflation since the adoption of these alternatives in 1999, we believe that it could be beneficial to issuers and securities recipients to raise two of the ceilings. As proposed, the asset cap would be raised from 15% to 25% 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 guarantees) measured at the issuer's most recent balance sheet date (if no older than its last fiscal year end). 80 The alternative $1 million cap available to any issuer would be raised to $2 million. 81 The third alternative cap—15% of the outstanding amount of the class of securities being offered and sold—would be retained with no changes. The considerations that motivate us to propose raising the alternative percentage of assets cap and the $1 million cap do not apply to the percentage of outstanding securities cap, and we continue to believe this cap is appropriate to prevent misuse of the exemption for capital-raising purposes.
80 Proposed Rule 701(d)(2)(ii).
81 Proposed Rule 701(d)(2)(i)
ld—would be retained with no changes. The considerations that motivate us to propose raising the alternative percentage of assets cap and the $1 million cap do not apply to the percentage of outstanding securities cap, and we continue to believe this cap is appropriate to prevent misuse of the exemption for capital-raising purposes.
80 Proposed Rule 701(d)(2)(ii).
81 Proposed Rule 701(d)(2)(i).
To facilitate the operation of compensatory plans following a merger or acquisition, we propose an amendment to provide that after completion of a business combination transaction, to calculate compliance with paragraph (d)(2) of this section, the acquiring issuer may use a pro forma balance sheet that reflects the transaction or a balance sheet for a date after the completion of the transaction that reflects the total assets and outstanding securities of the combined entity. 82 Furthermore, in determining the amount of securities that it may offer pursuant to Rule 701 following a business combination transaction, as proposed, the acquiring issuer would not be required to include the aggregate sales price and amount of securities for which the acquired entity claimed the exemption during the same 12-month period. We believe that these changes would remove hurdles to potentially value-enhancing business combination transactions, consistent with investor protection.
82 Proposed Rule 701(d)(3)(v).
Request for Comment:
27. Do the two proposed sales cap increases appropriately adjust the ceilings in a manner that benefits both issuers and securities recipients, consistent with investor protection? Should either cap be raised by a higher or lower amount? If so, what amount would be more appropriate? Should either cap remain unchanged?
28
estor protection.
82 Proposed Rule 701(d)(3)(v).
Request for Comment:
27. Do the two proposed sales cap increases appropriately adjust the ceilings in a manner that benefits both issuers and securities recipients, consistent with investor protection? Should either cap be raised by a higher or lower amount? If so, what amount would be more appropriate? Should either cap remain unchanged?
28. Should we retain the current structure of Rule 701(d) with three alternative sales caps? If not, how should the structure be changed? In particular, do the caps further the goal of facilitating only compensatory transactions in reliance on Rule 701? Are there alternative provisions that would serve this purpose?
29. Does the cap based on 15% of the outstanding amount of the class of securities being offered and sold continue to play a useful and effective role in Rule 701? Does it prevent issuers from improperly relying on the rule to raise capital from employees? Have there been changes in the marketplace, as discussed above for the two other alternative caps, which suggest that this cap may inhibit beneficial compensatory transactions? Should this cap be raised? If so, what would be a more appropriate percentage?
30. Does the proposal to permit use of a pro forma balance sheet, or a balance sheet for a date after the completion of the business combination transaction that reflects the total assets and outstanding securities of the combined entity, meaningfully facilitate the operation of compensatory plans following a business combination transaction? Are any other changes necessary to achieve this objective?
31. Should we amend Rule 701(d), as proposed, to provide that following a business combination transaction, in determining the amount of securities that it may offer pursuant to Rule 701, the acquiring issuer need not include the aggregate sales price and amount of securities for which the acquired entity claimed the exemption during the same 12-month period?
C. Eligible Recipients
1
ective?
31. Should we amend Rule 701(d), as proposed, to provide that following a business combination transaction, in determining the amount of securities that it may offer pursuant to Rule 701, the acquiring issuer need not include the aggregate sales price and amount of securities for which the acquired entity claimed the exemption during the same 12-month period?
C. Eligible Recipients
1. Consultants and Advisors
We propose to extend Rule 701 consultant and advisor eligibility to entities meeting specified ownership criteria designed to assure that the securities compensate the performance of services. Currently, consultants and advisors may participate in Rule 701 offerings only if:
• They are natural persons;
• They provide bona fide services to the issuer, its parents, its majority-owned subsidiaries or majority-owned subsidiaries of the issuer's parent; and
• The services are not in connection with the offer or sale of securities in a capital-raising transaction, and do not directly or indirectly promote or maintain a market for the issuer's securities. 83
83 Rule 701(c)(1). Where the consultant or advisor performs services for the issuer through a wholly-owned corporate alter ego, the issuer may contract with, and issue securities as compensation to, that corporate entity. Cf., Registration of Securities on Form S-8, Release No. 33-7646 (Feb. 25, 1999) [64 FR 11103 (Mar. 8, 1999)] at n. 20, (“1999 Form S-8 Adopting Release”) addressing such a corporate alter ego in the Form S-8 context.
Some commenters on the Concept Release addressed whether participation should be limited to natural persons and corporate alter egos, as currently permitted, or expanded to include entities
stration of Securities on Form S-8, Release No. 33-7646 (Feb. 25, 1999) [64 FR 11103 (Mar. 8, 1999)] at n. 20, (“1999 Form S-8 Adopting Release”) addressing such a corporate alter ego in the Form S-8 context.
Some commenters on the Concept Release addressed whether participation should be limited to natural persons and corporate alter egos, as currently permitted, or expanded to include entities. One commenter noted that staff has not objected to treating personal services businesses as corporate alter egos of natural persons with respect to the ability to participate in Form S-8 84 The commenter suggested that we expand eligible corporate alter egos to include entities wholly-owned by multiple natural person service providers or the management of the entities. Other commenters noted that service providers may be organized as entities in order to provide legal benefits such as tax and estate planning and stated that these providers should not have to choose between such benefits and receiving equity compensation. 85
84 See letter from Davis Polk.
85 See letters from Chamber and Indigo.
While we acknowledge these points, we are concerned that opening up Rule 701 eligibility to entities that are more broadly held than the corporate alter ego of an individual consultant could undermine the compensatory nature of the exemption by permitting securities to be issued to passive investment vehicles rather than individuals who perform services for the issuer. This concern is amplified by the fact that a person who receives securities pursuant to the plan and participant conditions of Rule 701(c) is not considered a holder of record for purposes of Exchange Act Section 12(g) registration
e compensatory nature of the exemption by permitting securities to be issued to passive investment vehicles rather than individuals who perform services for the issuer. This concern is amplified by the fact that a person who receives securities pursuant to the plan and participant conditions of Rule 701(c) is not considered a holder of record for purposes of Exchange Act Section 12(g) registration. Specifically, Section 502 of the Jumpstart Our Business Startups Act 86 (“JOBS Act”) amended Exchange Act Section 12(g)(5) 87 to exclude from the definition of “held of record,” for purposes of determining whether an issuer is required to register a class of equity securities, securities that are held by persons who received them pursuant to an “employee compensation plan” in transactions exempted from the registration requirements of Section 5 of the Securities Act. 88 To implement this statutory amendment, the Commission amended the definition of “held of record” in Exchange Act Rule 12g5-1 89 to exclude certain securities held by persons who received them pursuant to employee compensation plans in a transaction exempt from, or not subject to, the registration requirements of Section 5. 90 This amendment also established a non-exclusive safe harbor for determining whether securities are “held of record” for purposes of registration under Exchange Act Section 12(g), providing that an issuer may deem a person to have received securities pursuant to an employee compensation plan if the plan and the person who received the securities pursuant to it met the plan and participant conditions of Rule 701(c). It is therefore important in expanding eligible participants under Rule 701(c) not to include passive investment vehicles that properly should be record holders for purposes of triggering Section 12(g) registration and the protections of Exchange Act reporting.
86 Sec. 502, 126 Stat. at 326. Section 501 of the JOBS Act [Sec. 601, 126 Stat
t met the plan and participant conditions of Rule 701(c). It is therefore important in expanding eligible participants under Rule 701(c) not to include passive investment vehicles that properly should be record holders for purposes of triggering Section 12(g) registration and the protections of Exchange Act reporting.
86 Sec. 502, 126 Stat. at 326. Section 501 of the JOBS Act [Sec. 601, 126 Stat. at 325] amended Section 12(g)(1) of the Exchange Act to require an issuer to register a class of equity securities (other than exempted securities) within 120 days after its fiscal year-end if, on the last day of its fiscal year, the issuer has total assets of more than $10 million and the class of equity securities is “held of record” by either (i) 2,000 persons, or (ii) 500 persons who are not accredited investors. Section 601 of the JOBS Act [Sec. 601, 126 Stat. at 326] further amended Exchange Act Section 12(g)(1) to require an issuer that is a bank or bank holding company, as defined in Section 2 of the Bank Holding Company Act of 1956 [12 U.S.C. 1841], to register a class of equity securities (other than exempted securities) within 120 days after the last day of its first fiscal year ended after the effective date of the JOBS Act, on which the issuer has total assets of more than $10 million and the class of equity securities is “held of record” by 2,000 or more persons.
87 15 U.S.C. 78 l (g)(5).
88 This statutory exclusion applies solely for purposes of determining whether an issuer is required to register a class of equity securities under the Exchange Act and does not apply to a determination of whether such registration may be terminated or suspended.
89 17 CFR 240.12g5-1.
90 See Changes to Exchange Act Registration Requirements to Implement Title V and Title VI of the JOBS Act, Release No. 33-10075 (May 3, 2016) [81 FR 28689 (May 10, 2016)] (“JOBS Act Release”), adopting Exchange Act Rule 12g5-1(a)(8)
equity securities under the Exchange Act and does not apply to a determination of whether such registration may be terminated or suspended.
89 17 CFR 240.12g5-1.
90 See Changes to Exchange Act Registration Requirements to Implement Title V and Title VI of the JOBS Act, Release No. 33-10075 (May 3, 2016) [81 FR 28689 (May 10, 2016)] (“JOBS Act Release”), adopting Exchange Act Rule 12g5-1(a)(8).
The proposed amendments seek to strike a balance between, on the one hand, allowing service providers flexibility to obtain the legal benefits of organizing as entities and, on the other hand, preventing Rule 701 securities from being issued to passive investment vehicles that would not be record holders, by expanding consultant or advisor eligibility to an entity, subject to the following conditions:
• Substantially all of the activities of the entity involve the performance of services; and
• Substantially all of the ownership interests in the entity are held directly by:
○ No more than 25 natural persons, of whom at least 50 percent perform such services for the issuer through the entity;
○ The estate of a natural person specified above; and
○ Any natural person who acquired ownership interests in the entity by reason of the death of a natural person specified above. 91
91 Proposed Rule 701(c)(1)(iii). These conditions are loosely modeled on, but have a different focus than, the Internal Revenue Code definition of a “qualified personal service corporation. See 26 U.S.C. 448(d)(2).
The proposal seeks to expand eligibility for consultant entities while helping to ensure that compensatory securities are issued only to entities through which services are provided that are owned by those service providers. We believe that the proposed conditions are appropriate to help achieve this objective
Code definition of a “qualified personal service corporation. See 26 U.S.C. 448(d)(2).
The proposal seeks to expand eligibility for consultant entities while helping to ensure that compensatory securities are issued only to entities through which services are provided that are owned by those service providers. We believe that the proposed conditions are appropriate to help achieve this objective. In particular, substantially all of the ownership interests would need to be held directly by no more than 25 natural persons, at least 50 percent of whom provide services to the issuer, and by the estates and heirs of those natural persons. An entity that satisfies these conditions would also—like a natural person—need to satisfy the existing requirements for consultant and advisory eligibility by providing bona fide services that are not in connection with the offer or sale of securities in a capital-raising transaction and do not directly or indirectly promote or maintain a market for the issuer's securities. 92
92 Rule 701(c)(1)(ii) and (iii), proposed to be re-designated as Rule 701(c)(1)(i) and (ii), respectively.
Request for Comment:
32. Should we extend consultant and advisor eligibility to entities meeting specified ownership criteria designed to link the securities to the performance of services for the issuer, as proposed?
33. Does the proposed standard for consultant and advisor entity eligibility appropriately balance a consultant's needs to obtain the legal benefits of entity organization with the rule's purpose to exempt from Securities Act registration offerings of securities issued in compensatory circumstances? 93
93 See Proposed Rule 701(a)(5), formerly Preliminary Note 5 to Rule 701.
34
, as proposed?
33. Does the proposed standard for consultant and advisor entity eligibility appropriately balance a consultant's needs to obtain the legal benefits of entity organization with the rule's purpose to exempt from Securities Act registration offerings of securities issued in compensatory circumstances? 93
93 See Proposed Rule 701(a)(5), formerly Preliminary Note 5 to Rule 701.
34. The proposed standard would require that substantially all of the ownership interests of the entity be held by no more than 25 natural persons, of whom at least 50 percent perform services for the issuer through the entity, their estates, and natural persons who acquired ownership interests due to their death. Are the proposed conditions appropriate? Are there different or additional conditions we should consider? Should the rule specify criteria defining what “substantially all” would mean for this purpose? For example, should 95 percent ownership be required to establish “substantially all”? 94
94 Regulation Reg. Sec. 1.448-1T(e)(5)(i)(D) defines “substantially all” as 95% or more for purposes of a “personal service corporation” as defined in IRC Section 448(d)(2).
35. To ensure that securities are issued to compensate persons who provide services to the issuer and not to 95 Should the entity's eligibility to receive securities be conditioned on at least 50 percent of those natural person owners performing services for the issuer, as proposed? Should that percentage be larger or smaller?
95 In this regard, we note that to qualify for S corporation status, a corporation may have no more than 100 shareholders. See generally IRC Sections 1361(a)(2) and 1361(b).
36. To assure that a compensatory purpose is maintained, would it be necessary to further restrict ownership by persons who acquire the securities by reason of the death of a current or former service provider to a two-year period beginning on the date of death, as in the Internal Revenue Code definition of a qualified personal service corporation?
37
rally IRC Sections 1361(a)(2) and 1361(b).
36. To assure that a compensatory purpose is maintained, would it be necessary to further restrict ownership by persons who acquire the securities by reason of the death of a current or former service provider to a two-year period beginning on the date of death, as in the Internal Revenue Code definition of a qualified personal service corporation?
37. As noted above, a person who receives securities pursuant to the plan and participant conditions of Rule 701(c) is not considered a holder of record for purposes of Exchange Act Section 12(g) registration. How should this provision influence the limitations we place on those persons eligible to receive Rule 701 securities? Are any other restrictions or conditions needed to ensure that Rule 12g5-1(a)(8) excludes from the definition of held of record securities received as compensation for services that the recipients provided to the issuer?
2. Former Employees
We are proposing to expand Rule 701 eligibility for former employees to specified post-termination grants and to former employees of acquired entities. Rule 701 currently exempts offers and sales to former employees, directors, general partners, trustees, officers, or consultants and advisors only if such persons were employed by or providing services to the issuer at the time the securities were offered.
In response to the Concept Release, one commenter stated that Form S-8 should be available to register new grants to former employees that are made as compensation for prior service during the 12-month period after retirement or termination. 96 Another commenter suggested expanding eligible participants to include former employees of an acquired issuer that were granted equity awards in an acquisition in exchange for securities issued as compensation while such former employees were still employed by the acquired issuer. 97
96 See letter from Sullivan.
97 See letter from Davis Polk
12-month period after retirement or termination. 96 Another commenter suggested expanding eligible participants to include former employees of an acquired issuer that were granted equity awards in an acquisition in exchange for securities issued as compensation while such former employees were still employed by the acquired issuer. 97
96 See letter from Sullivan.
97 See letter from Davis Polk.
We believe that expanding Form S-8 eligibility to encompass former employees as suggested by commenters could benefit both issuers and securities recipients by facilitating compensatory transactions consistent with the purposes of the form. 98 We believe that this rationale applies equally to Rule 701 and Form S-8. Accordingly, we propose to expand the eligibility of former employees under Rule 701 to include offers and sales to:
98 See Section III.C.1, infra.
• Persons who were employed by or providing services to the issuer, its parents, its subsidiaries, or subsidiaries of the issuer's parent and who are issued securities after resignation, retirement, or other termination as compensation for services rendered during a performance period that ended within 12 months preceding such termination; and
• former employees of an entity that was acquired by the issuer if the securities are issued in substitution or exchange for 99 securities that were issued to the former employees of the acquired entity on a compensatory basis while such persons were employed by or providing services to the acquired entity.
99 Consistent with Exchange Act Rule 12g5-1(a)(8)(i)(B), we are using the language “in substitution or exchange for” to cover the various methods by which issuer securities may be received in place of acquired entity securities that were issued in compensatory transactions, such as upon exercise or conversion of those securities. See JOBS Act Release at Section III.B.3
es to the acquired entity.
99 Consistent with Exchange Act Rule 12g5-1(a)(8)(i)(B), we are using the language “in substitution or exchange for” to cover the various methods by which issuer securities may be received in place of acquired entity securities that were issued in compensatory transactions, such as upon exercise or conversion of those securities. See JOBS Act Release at Section III.B.3.
The proposal also would define “employee” for purposes of Rule 701 to include executors, administrators, and beneficiaries of the estates of deceased employees, guardians or members of a committee for incompetent former employees, or similar persons duly authorized by law to administer the estate or assets of former employees. This amendment would conform to the corresponding provision relating to former employee eligibility in Form S-8. 100
100 General Instruction A.1(a)(3) to Form S-8, which as discussed in Section III.C.1, infra, would similarly be amended to expand eligibility for former employees and former employees of an entity acquired by the issuer.
Request for Comment:
38. Should we make Rule 701 available for new offers and sales to former employees as compensation for their service while employed by the issuer in the preceding 12 months, as proposed? Would expanding the exemption in this way facilitate compensatory transactions consistent with the purpose of the rule? To what extent do issuers grant awards on such a retrospective basis? Does “following resignation, retirement, or other termination” clearly describe the relationship of the award to former employment? Should the rule specifically address any other scenarios, such as expiration of the term of employment?
39
in this way facilitate compensatory transactions consistent with the purpose of the rule? To what extent do issuers grant awards on such a retrospective basis? Does “following resignation, retirement, or other termination” clearly describe the relationship of the award to former employment? Should the rule specifically address any other scenarios, such as expiration of the term of employment?
39. Should Rule 701 be available to a former employee of an acquired entity for securities substituted or exchanged for acquired entity securities issued as compensation for the former employee's work for the acquired entity, as proposed? Would this be consistent with the underlying rationale that the Rule 701 exemption is available based on the compensatory relationship with the issuer?
40. Would amending the rule, as proposed, to extend eligibility to executors, administrators, and beneficiaries of employees' estates and others duly authorized by law to administer the estates or assets of former employees facilitate the administration of compensatory plans relying on the exemption? If not, how should this proposal be modified to facilitate that objective?
3. Employees of Subsidiaries
In an effort to harmonize Rule 701 and Form S-8, we also propose to amend Rule 701(c) by substituting the term “subsidiaries” 101 for “majority-owned subsidiaries.” The proposed amendment would make the exemption available for offers and sales of securities under a written compensatory benefit plan (or written compensation contract) established by the issuer, its parents, its subsidiaries, or subsidiaries of the issuer's parent. 102 Like Form S-8, Rule 701 would be available for the issuance of issuer securities to employees of its subsidiaries, without regard to whether those subsidiaries are majority-owned. 103 We are not aware of
101 Rule 405 defines “subsidiary” for purposes of the Securities Act as an affiliate controlled by such person directly, or indirectly through one or more intermediaries
the issuer's parent. 102 Like Form S-8, Rule 701 would be available for the issuance of issuer securities to employees of its subsidiaries, without regard to whether those subsidiaries are majority-owned. 103 We are not aware of
101 Rule 405 defines “subsidiary” for purposes of the Securities Act as an affiliate controlled by such person directly, or indirectly through one or more intermediaries. Rule 405 defines “control” as the possession, direct or indirect, of the power to direct or cause the direction of the management and policies of a person, whether through the ownership of voting securities, by contract, or otherwise.
102 Under the proposal, “subsidiary” would replace “majority-owned subsidiary” in each place in Rule 701(c) where “majority-owned subsidiary” currently appears.
103 The term “majority-owned subsidiary” is defined as a subsidiary more than 50 percent of whose outstanding securities representing the right, other than as affected by events of default, to vote for the election of directors, is owned by the subsidiary's parent and/or one or more of the See Rule 405.
By broadening the exemption to include all subsidiaries, as defined, rather than only those that are majority-owned, the proposal would, among other things, expand eligibility to subsidiaries consolidated by the issuer as variable interest entities, such as physicians employed by medical practices controlled by the issuer. 104
104 In the 1999 Adopting Release at Section at Section II.D, n. 41, the Commission rejected a view expressed by the staff in certain no-action letters that such physicians were eligible as consultants or advisors in light of the narrower definition of consultant or advisor adopted in that release. Under Financial Accounting Standards Board Accounting Standards Codification Subtopic 810-10, Consolidation—Overall, a medical practice is often a variable interest entity. An issuer that has a controlling financial interest in such a medical practice generally would consolidate it
ible as consultants or advisors in light of the narrower definition of consultant or advisor adopted in that release. Under Financial Accounting Standards Board Accounting Standards Codification Subtopic 810-10, Consolidation—Overall, a medical practice is often a variable interest entity. An issuer that has a controlling financial interest in such a medical practice generally would consolidate it. As a result, physicians employed by the medical practice would become eligible as employees of the issuer's subsidiary.
Request for Comment:
41. Should we harmonize the Rule 701 and Form S-8 eligibility requirements by broadening the Rule 701 exemption to include all subsidiaries, as proposed? Would the proposal facilitate a non-reporting issuer's transition to reporting issuer status and its subsequent registration of compensatory offerings on Form S-8?
42. Unlike Form S-8, the Rule 701 exemption currently is available to majority-owned subsidiaries of the issuer's parent rather than only subsidiaries of the issuer itself. 105 Should we amend Form S-8 to further harmonize the scope of Rule 701 and Form S-8 by making Form S-8 available to employees of all subsidiaries of the issuer's parent? Are there any other harmonizing amendments we should consider?
105 See Form S-8, General Instruction A.1.(a).
43. Are there any reasons not to extend Rule 701 eligibility to persons employed by subsidiaries that are consolidated by the issuer as variable interest entities? For example, are there any reasons not to extend Rule 701 eligibility to physicians employed by medical practices controlled by the issuer, based on their employment by a subsidiary of the issuer?
III. Form S-8
Form S-8 was originally adopted in 1953, as a simplified form for the Securities Act registration of securities to be issued pursuant to employee stock purchase plans
interest entities? For example, are there any reasons not to extend Rule 701 eligibility to physicians employed by medical practices controlled by the issuer, based on their employment by a subsidiary of the issuer?
III. Form S-8
Form S-8 was originally adopted in 1953, as a simplified form for the Securities Act registration of securities to be issued pursuant to employee stock purchase plans. 106 Form S-8 is available for the registration of securities to be offered under any employee benefit plan to an issuer's employees or employees of its subsidiaries or parents. 107 Registration on Form S-8 is used for many different types of employee benefit plans, including Internal Revenue Code Section 401(k) plans and similar defined contribution retirement savings plans, employee stock purchase plans, nonqualified deferred compensation plans, and incentive plans that provide for issuance of options, restricted stock, or RSUs. The form may be used by any issuer that is subject, at the time of filing, to the reporting requirements of Section 13 or 15(d) of the Exchange Act and has filed all reports required during the preceding 12 months or such shorter period that it was subject to those requirements. 108 Form S-8 is not available for shell companies. 109
106 See generally Registration of Securities Offered Pursuant to Employees Stock Purchase Plans, Release No. 33-3480 (June 16, 1953) [18 FR 3688 (June 27, 1953)].
107 “Employee benefit plan” is defined in Securities Act Rule 405.
108 See Form S-8, General Instruction A.1.
109 “Shell company” is defined in Securities Act Rule 405. When a company ceases to be a shell company, by combining with a formerly private operating business, General Instruction A.1 to Form S-8 provides that it then becomes eligible to use Form S-8 60 days following the filing of Form 10-equivalent information with the Commission
ties Act Rule 405.
108 See Form S-8, General Instruction A.1.
109 “Shell company” is defined in Securities Act Rule 405. When a company ceases to be a shell company, by combining with a formerly private operating business, General Instruction A.1 to Form S-8 provides that it then becomes eligible to use Form S-8 60 days following the filing of Form 10-equivalent information with the Commission.
Over time, the Commission has made revisions to the Form S-8 requirements to simplify the use of the form and streamline the form's requirements where such simplification is consistent with investor protection. 110 In the Concept Release, the Commission asked whether Form S-8 registration is still necessary, and if so, how the Commission could further streamline Form S-8 registration. Among other things, the Concept Release solicited comment on the potential elimination of Form S-8 in favor of allowing Exchange Act reporting issuers to use the Rule 701 exemption and whether Form S-8 incentivized issuers to remain current in their Exchange Act reporting obligations. Commenters who addressed this issue generally supported eliminating the form, while expressing some reservations. 111 One commenter stated that the principal advantage of such an approach would be the elimination of compliance costs associated with filing and maintaining an effective Form S-8. 112 A few other commenters indicated that keeping Form S-8 is not necessary to provide an incentive for reporting issuers to remain current in their Exchange Act reporting obligations
while expressing some reservations. 111 One commenter stated that the principal advantage of such an approach would be the elimination of compliance costs associated with filing and maintaining an effective Form S-8. 112 A few other commenters indicated that keeping Form S-8 is not necessary to provide an incentive for reporting issuers to remain current in their Exchange Act reporting obligations. 113
110 See, e.g., 17 CFR 230.462(a) (allowing Form S-8 to go effective automatically without review by the staff or other action by the Commission); Item 3 and General Instruction G of Form S-8 (allowing the incorporation by reference of certain past and future reports required to be filed by the issuer under Section 13 or 15(d) under the Exchange Act); 17 CFR 230.428(a)(1) (providing an abbreviated disclosure format that eliminated the need to file a separate prospectus and permitting the delivery of regularly prepared materials to advise employees about benefit plans to satisfy prospectus delivery requirements); Rule 416(c) and Rule 457(h)(2) (providing for registration of an indeterminate amount of plan interests and providing that there is no separate fee calculation for registration of plan interests, respectively); and General Instruction E to Form S-8 (providing a procedure for the filing of a simplified registration statement covering additional securities of the same class to be issued pursuant to the same employee benefit plan).
111 See letters from ABA, Davis Polk, and NASPP.
112 See letter from ABA.
113 See letters from NASPP and ABA.
At the same time, commenters noted a number of potential disadvantages with eliminating Form S-8. One commenter stated that reporting issuers would find it a significant disadvantage if failure to register on Form S-8 would subject an issuance of employee benefit plan shares to registration under state blue sky laws
olk, and NASPP.
112 See letter from ABA.
113 See letters from NASPP and ABA.
At the same time, commenters noted a number of potential disadvantages with eliminating Form S-8. One commenter stated that reporting issuers would find it a significant disadvantage if failure to register on Form S-8 would subject an issuance of employee benefit plan shares to registration under state blue sky laws. 114 A different commenter stated that reporting issuers would not migrate to Rule 701 if securities issued under the exemption would be restricted securities, as defined in Rule 144, and observed that, unlike Rule 701 offerings, secur

[Text truncated at 120,000 characters. The full text is on the page linked above.]

## Nearby sections

- [85 FR 265 Federal Government Participation in the Automated Clearing House](https://www.frixlaw.com/law-library/statutes/FR_PRORULE_2019-27261.md)
- [85 FR 647 District Financial Reporting](https://www.frixlaw.com/law-library/statutes/FR_PRORULE_2019-27573.md)
- [85 FR 852 Modifications to Pressure-Temperature Limits](https://www.frixlaw.com/law-library/statutes/FR_PRORULE_2019-28061.md)
- [85 FR 1131 Air Plan Approval; California; San Joaquin Valley Unified Air Pollution Control District](https://www.frixlaw.com/law-library/statutes/FR_PRORULE_2019-28442.md)
- [85 FR 1134 Telecommunications Relay Service Modernization](https://www.frixlaw.com/law-library/statutes/FR_PRORULE_2019-28444.md)
- [85 FR 1290 Airworthiness Directives; The Boeing Company Airplanes](https://www.frixlaw.com/law-library/statutes/FR_PRORULE_2019-28469.md)
- [85 FR 1297 Idaho: Final Approval of State Underground Storage Tank Program Revisions, Codification, and Incorporation by Reference](https://www.frixlaw.com/law-library/statutes/FR_PRORULE_2019-28391.md)
- [85 FR 1771 Undue and Unreasonable Preferences and Advantages Under the Packers and Stockyards Act](https://www.frixlaw.com/law-library/statutes/FR_PRORULE_2020-00152.md)
- [85 FR 1794 Air Plan Approval; Missouri; Open Burning](https://www.frixlaw.com/law-library/statutes/FR_PRORULE_2020-00266.md)
- [85 FR 1796 Air Plan Approval; Georgia; Revisions to Aerospace VOC Rule](https://www.frixlaw.com/law-library/statutes/FR_PRORULE_2020-00327.md)
- [85 FR 1798 Consumer and Governmental Affairs Bureau Seeks Comment To Refresh the Record on Truth-in-Billing Rules To Ensure Protections for All Consumers of Voice Services](https://www.frixlaw.com/law-library/statutes/FR_PRORULE_2020-00260.md)
- [85 FR 2061 Revised Applicability Dates for Regulations Under Section 382(h) Related to Built-in Gain and Loss](https://www.frixlaw.com/law-library/statutes/FR_PRORULE_2020-00469.md)
- [85 FR 2354 Fair Housing Act Design and Construction Requirements; Adoption of Additional Safe Harbors](https://www.frixlaw.com/law-library/statutes/FR_PRORULE_2020-00233.md)
- [85 FR 2676 Significant New Use Rules on Certain Chemical Substances (20-1.B)](https://www.frixlaw.com/law-library/statutes/FR_PRORULE_2019-26292.md)

---

Source: Frix Law Library, https://www.frixlaw.com/law-library/statutes/FR_PRORULE_2020-26390. Check the current official text before relying on it. Not legal advice.