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California Commissioner of Corporations to Amend Compensatory Benefit Plan Regulations - Temporary Waiver of Current Requirements Available for Permit Applications

11/18/2006
Client Alert

California Commissioner of Corporations to Amend Compensatory Benefit Plan Regulations

On November 3, 2006, the California Commissioner of Corporations proposed to amend the compensation benefit plan regulations under the California Corporate Securities Law of 1968 (“California Securities Law”) to provide greater flexibility to companies in drafting compensatory plans.  The proposed rules were issued to help alleviate the burden imposed on businesses seeking to create jobs and expand operations in California who are currently subject to compensatory benefit plan rules that are inconsistent with those in other states or federal securities laws.  The Commissioner has provided for a public comment period for the proposed rules, which will end on December 18, 2006.  It is expected that the proposed rules will become effective in the first quarter of 2007.

Background

Companies that issue securities in California pursuant to a compensatory benefit plan, such as a stock option plan or stock purchase plan, must either seek qualification of the plan by the Commissioner of Corporations under Section 25110 et seq. of the California Corporations Code, or be exempt from qualification under 25102(o).  To be qualified under Section 25110 et seq., the plan must satisfy the regulatory guidelines enumerated in Sections 260.140.8, 260.140.41, 260.140.42, 260.140.45, and 260.140.46 of the California Securities Law; and to qualify for the exemption under Section 25102(o), (i) the plan must satisfy all of the requirements of Rule 701 of the Securities Act of 1933, as amended (the “Securities Act”), (ii) the issuer must file a notice with the Department of Corporations, and (iii) the plan must satisfy the requirements of Sections 260.140.41 or 260.140.42 (depending on whether it is an option plan or purchase plan), 260.140.45, and 260.140.46 of the California Securities Law. 

Proposed Amendments

Eligible Persons
Sections 260.140.41 and 260.140.42 currently provide that under an option plan or purchase plan, securities must be issued only to employees, directors, managers, or consultants pursuant to specified conditions.  The proposed amendments expand the list of eligible persons who may participate under an option plan or purchase plan to include the same eligible persons who are exempt under Rule 701 of the Securities Act (such as officers, advisors, and insurance agents who are employees).

Elimination of Minimum Exercise or Purchase Prices
Sections 260.140.41(b) and 260.140.42(b) currently provide that the exercise price of an option under an option plan or the purchase price of a share under a purchase plan must have a minimum exercise or purchase price of 85% of the fair value at the time of grant or issuance.  The proposed amendments would eliminate the restrictions on minimum exercise prices of options and minimum purchase prices of securities under compensatory benefit plans. 

Elimination of Minimum Vesting Period
Section 260.140.41(f) currently provides that options granted under a plan to non-management employees must vest a minimum of 20% per year over 5 years from the date the option is granted.  The proposed amendments would eliminate this requirement, allowing companies to determine an exercise schedule that meets its needs, including the use of targeted incentives and performance-based vesting for non-management employees.

Amendment of 12-Month Security Holder Requirement
Currently, Sections 260.140.41(i) and 260.140.42(f) provide that a plan must be approved by the security holders within 12 months of adoption.  This is somewhat problematic for out-of-state issuers seeking to issue securities to individuals in California but who have adopted their plans more than a year prior to making such grants.  The proposed amendments would require security holder consent by the later of within 12 months of adopting the plan or prior to granting any options in California.  In addition, the proposed amendments would allow foreign private issuers to issue options or stock under plans to recipients in California without consent from their security holders so long as the number of recipients does not exceed 35.

Elimination of Restrictions on Repurchase Rights for Exempted Plans
The current requirements under Sections 260.140.41(k) and 260.140.42(h) place certain restrictions on repurchase rights for plans (i.e., minimum repurchase price, minimum repurchase period, right of repurchase to lapse as to at least 20% of the shares per year). The proposed amendments eliminate Sections 260.140.41(k) and 260.140.42(h), but add similar language to Section 260.140.8. The effect of this change is to remove the restrictions on repurchase rights for plans that intend to utilize the exemption under Section 25102(o), but retain the restrictions for purposes of plans that are seeking qualification under Section 25110 et. seq. It should be noted, however, that in determining any repurchase price, companies are still subject to Section 25401 of the California Corporations Code requiring the disclosure of all material information to the grantee during the course of negotiating the repurchase price. 

Elimination of Equal Voting Right Requirement for Exempted Plans
Sections 260.140.41(l) and 260.140.42(i) currently provide that the shares of common stock issuable under the plans must carry equal voting rights on all matters where such vote is permitted by applicable law.  The proposed amendments would eliminate this requirement for plans intending to meet the exemption under Section 25102(o).

Elimination of Limitation of Total Number of Shares if Rule 701 is Met
Section 260.140.45 limits the total number of securities issuable under a plan to no more than 30% of the then outstanding securities of the company, unless a higher percentage is approved by two-thirds of the outstanding securities entitled to vote.  The proposed amendments would eliminate this requirement for plans that meet the conditions of Rule 701 of the Securities Act.  Rule 701(d) limits the aggregate sales price or amount of securities sold in reliance on such rule within any 12-month period to the greater of $1 million, 15% of the total assets of the company, or 15% of the outstanding number of shares of the class of securities being offered.

Elimination of Financial Disclosure Requirement if Rule 701 is Met
Currently, under Section 260.140.46, companies are required to provide the security holders participating in plans or agreements with financial statements at least annually.  The proposed amendments would eliminate this requirement for plans that meet the conditions of Rule 701.

Waiver of Requirements in the Interim

Since the proposed rules are not expected to become effective until the first quarter of 2007, on November 14, 2006, the California Commissioner of Corporations issued a release stating that, until February 28, 2007, the Commissioner will consider a waiver of the requirements of the current regulations solely to the extent they conflict with the proposed amendments on a case-by-case basis by companies seeking to qualify a plan under Section 25110 et seq. of the California Corporations Code. The waiver will be available to companies who have not violated any statute or accompanying regulation of the California Securities Law, and who represent that the granting of any options pursuant to the plan will conform with all applicable charter documents, and that the dates such options are issued are accurately reflected in the company’s books, records, and financial statements.

The release can be found at:

 http://www.corp.ca.gov/commiss/rel118c.htm.

A full explanation of the amendments can be found at:

http://www.corp.ca.gov/pol/rm/2706c.pdf

The language of the amended regulations can be found at:

http://www.corp.ca.gov/pol/rm/2706b.pdf.