Client Alert

U.S. SEC Proposes Amendments for Compensatory Securities Offerings

16 Dec 2020

On November 24, 2020, the U.S. Securities and Exchange Commission (SEC) proposed amendments to Rule 701 and Form S-8.[1] In a companion release, the SEC also proposed amendments to Rule 701 and Form S-8 to permit, on a temporary basis and subject to certain conditions, a company to provide equity compensation to certain “platform workers” who provide services available through a company’s technology-based marketplace platform.[2] The proposed rules follow a concept release regarding Rule 701 and Form S-8 that was issued in 2018. In the concept release, the SEC solicited comment on possible ways to update the requirements of Rule 701 and Form S-8.[3]

Rule 701

Rule 701 under the Securities Act of 1933 (Securities Act) provides an exemption from registration for the offer and sale of securities in compensatory transactions by non-reporting companies.

Timing of Disclosure

The SEC proposes 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 company must provide to recipients the additional disclosure required by the rule only with respect to those sales that exceed the $10 million threshold. Under these proposed amendments, the exemption would remain available for all sales that exceed the $10 million threshold during the 12-month period if the company provides the required disclosure for those sales.

Financial Statement Requirements

The SEC proposes to amend Rule 701(e) to apply the age of financial statements requirement in  Part F/S (paragraphs (b)(3) and (b)(4)) of Form 1-A, at the time of sale, conforming the Rule 701(e) age of financial statements requirement with Regulation A.

The SEC also proposes to allow foreign private issuers that are eligible for the exemption from registration provided by Rule 12g3-2(b) under the Securities Exchange Act of 1934 (Exchange Act) to provide financial statements prepared in accordance with home country accounting standards without reconciliation to U.S. GAAP, if financial statements prepared in accordance with U.S. GAAP or IFRS are not otherwise available.

Alternative Valuation Information

The SEC proposes to allow companies to provide alternative valuation information instead of financial statements. This information could be an independent valuation report of the subject securities’ fair market value, as determined by an independent appraisal consistent with the rules and regulations under Internal Revenue Code Section 409A. This alternative would not apply to foreign private issuers eligible for the Rule 12g3-2(b) exemption. 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 Rule 701.

Derivative Securities

The SEC proposes to revise Rule 701(e)(6) to address the distinction between derivative securities that involve a decision to exercise or convert, and those that do not. Under these proposals:

  • If the sale involves a stock option or other derivative security that involves a decision to exercise or convert, the company would continue to be required to deliver disclosure to recipients a reasonable period of time before the date of exercise or conversion; or
  • If the sale involves an RSU or other derivative security that does not involve a decision to exercise or convert, the company generally would continue to be required to deliver disclosure to recipients a reasonable period of time before the date the RSU or similar derivative security is granted.

If a new employee receives RSUs or similar derivative securities in connection with being hired, 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.

The SEC proposes to amend Rule 701(e) to provide that, as long as an entity acquired in a business combination transaction 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 acquirer would be exempt from registration, subject to the acquirer’s compliance, where applicable, with Rule 701(e).

With respect to derivative securities that are assumed by an acquirer and for which the acquired entity was required to provide disclosure pursuant to Rule 701(e), when the derivative securities are exercised or converted after completion of the business combination transaction, the acquirer 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).

The SEC also proposes that, following completion of a business combination transaction, in determining whether the amount of securities the acquirer sold during any consecutive 12-month period exceeds $10 million, the acquirer 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 701 during the same 12-month period.

Limits on the Amount of Securities Sold

Rule 701(d) specifies that the amount of securities that may be sold in reliance on the Rule 701 exemption during any consecutive 12-month period is limited to the greatest of:

  • $1 million;
  • 15% of the total assets of the company, measured at the company’s most recent balance sheet date; or
  • 15% of the outstanding amount of the class of securities being offered and sold in reliance on the rule, measured at the company’s most recent balance sheet date.

The SEC proposes to:

  • Raise the $1 million cap to $2 million; and
  • Raise the total assets cap from 15% to 25% of the total assets of the company (or of the company’s parent if the company is a wholly-owned subsidiary and the securities represent obligations that the parent fully and unconditionally guarantees), measured at the company’s most recent balance sheet date (if no older than its last fiscal year end).

The SEC proposes an amendment to provide that, after completion of a business combination transaction, to calculate compliance with Rule 701(d)(2), the acquirer 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. Further, in determining the amount of securities that it may offer pursuant to Rule 701 following a business combination transaction, the acquirer would not be required to include the aggregate sales price and amount of securities for which the acquired entity claimed the Rule 701 exemption during the same 12-month period.

Eligibility

The SEC proposes to expand eligible consultants and advisors to include entities, 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 company 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.

The SEC proposes to expand the eligibility of former employees under Rule 701 to include offers and sales to:

  • Persons who were employed by or providing services to the company, its parents, its subsidiaries, or subsidiaries of the company’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 company if the securities are issued in substitution or exchange for 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.

The SEC also proposes to define the term “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.

The SEC proposes to harmonize Rule 701 and Form S-8 by substituting the term “subsidiaries” for “majority-owned subsidiaries,” making Rule 701 available for the issuance of securities to employees of all subsidiaries of a company, without regard to whether those subsidiaries are majority-owned.

Form S-8

Form S-8 is the short-form Securities Act registration statement for compensatory offerings by reporting companies.

Post-Effective Amendment Approach

The SEC proposes to permit companies to file an automatically effective post-effective amendment to a previously filed Form S-8 to add employee benefit plans where the new plan does not require the authorization and registration of additional securities for offer and sale. This post-effective amendment would:

  • Disclose any material change in the plan of distribution, including that a new plan is being added to an existing Form S-8.
  • Describe how shares that will not be issued under the previous plans may become authorized for issuance under the current plans.
  • Identify all covered plans on the cover page; and
  • Describe how shares that were registered for previous offerings on the Form S-8 pursuant to other plans have instead become authorized for issuance under the newly added plan.
Allocation of Securities

The SEC proposes to clarify that companies are not required to allocate registered securities among incentive plans and may use a single Form S-8 for multiple incentive plans. For companies utilizing this proposed approach, the initial registration statement would need to list the types of securities covered by the registration statement and identify the plan or plans pursuant to which the company intended to issue securities as of that date. The SEC notes in the proposing release that, under this proposal, “the form may be used to create a pool of registered shares that may be issued under the company’s various incentive plans as necessary.”

Proposed Changes to Rules 413 and 457

The SEC proposes to amend Rule 413 to permit companies to register the offer and sale of additional securities or classes of securities on Form S-8 by post-effective amendment.

Under the proposed amendments, a company that has an effective registration statement for a  plan would no longer be required to file a new Form S-8 to register the offering of additional shares under an existing or new incentive plan; instead, that company could file an automatically effective post-effective amendment to the existing Form S-8 to register the offer and sale of the additional securities. If a company adopts a new employee benefit plan which makes available a new class of security on a compensatory basis, the company would only be required to file an automatically effective post-effective amendment to its existing Form S-8 to add the new plan and the new class of security to the registration fee table, as well as any additional disclosure that would be required to inform investors about the new class of securities.

The SEC proposes to amend Rule 457 to require registration based on the aggregate offering price of all the securities registered. The SEC also proposes a new fee payment method that would require companies to pay the fee for all sales made pursuant to defined contribution plan offerings during a given fiscal year no later than 90 days after end of the company’s fiscal year.

Other Changes

Item 8(b) of Form S-8 currently specifies that, in lieu of providing an opinion of counsel regarding compliance with the requirements of ERISA or an Internal Revenue Service determination letter (as required by Item 601(b)(5)(ii) and (iii) of Regulation S-K), the company may undertake to submit the plan and any amendments to the plan to the IRS in a timely manner and to make all changes required by the IRS in order to qualify the plan. The SEC notes in the proposing release that the IRS is only issuing determination letters for amendments to previously qualified plans under very limited circumstances.

The SEC proposes to amend Item 8(b) to eliminate the requirement that companies undertake to submit any amendment to the plan to the Internal Revenue Service. The SEC also proposes to amend Item 601(b)(5)(iii) of Regulation S-K to remove the requirement to file a copy of the IRS determination letter that the amended plan is qualified under Section 401 of the Internal Revenue Code. The SEC’s proposed amendments would revise Item 8(b) to permit an undertaking that companies will maintain the plan’s compliance with ERISA and will make all changes required to maintain such compliance in a timely manner. If the company does not provide the undertaking, the requirements of Item 601(b)(5)(iii) of Regulation S-K would continue to apply with regard to plan amendments, and therefore the company would need to file a legal opinion confirming compliance of the amended provisions of the plan with the requirements of ERISA in the event of an amendment.

The SEC proposes revisions to the disclosure requirements in Form S-8 to eliminate the description of the tax effects, if any, on the company.

Proposed Amendments for Compensatory Offerings to Platform Workers

In a separate release, the SEC proposed amendments to Rule 701 and Form S-8 that, on a temporary basis and subject to certain conditions, would permit a company to provide equity compensation to certain “platform workers” who provide services available through a company’s technology-based platform or system. For this purpose, platform workers could include individuals providing services to end users, such as ride-sharing, food delivery, household repairs, dog-sitting, or tech support, or using the platform to sell goods or lease property to third parties.

Under the proposal, Rule 701 would be amended by adding a temporary rule provision that, for five years, would enable companies to use Rule 701 to compensate certain platform workers, subject to specified conditions. Under these proposed amendments, a company would be able to use the Rule 701 exemption to offer and sell its securities on a compensatory basis to platform workers who, pursuant to a written contract or agreement, provide bona fide services by means of an internet-based platform or other widespread, technology-based marketplace platform or system provided by the company if:

  • The company operates and controls the platform, as demonstrated by its ability to provide access to the platform, to establish the principal terms of service for using the platform and terms and conditions by which the platform worker receives payment for the services provided through the platform, and by its ability to accept and remove platform workers participating in the platform;
  • The issuance of securities to participating platform workers is pursuant to a compensatory arrangement, as evidenced by a written compensation plan, contract, or agreement, and is not for services that are in connection with the offer or sale of securities in a capital-raising transaction, or services that directly or indirectly promote or maintain a market for the company’s securities;
  • No more than 15% of the value of compensation received by a participating worker from the company for services provided by means of the platform during a 12-month period, and no more than $75,000 of such compensation received from the company during a 36-month period, shall consist of securities, with such value determined at the time the securities are granted;
  • The amount and terms of any securities issued to a platform worker may not be subject to individual bargaining or the worker’s ability to elect between payment in securities or cash; and
  • The company must take reasonable steps to prohibit the transfer of the securities issued to a platform worker pursuant to this exemption, other than a transfer to the company or by operation of law.

The amendments would permit a company eligible to use Form S-8 to make registered securities offerings to its platform workers using Form S-8, under the same conditions, except for the proposed transferability restriction. The proposed amendments would require a company that sells securities to platform workers under the proposed amendments to furnish certain information to the SEC at six-month intervals.

The SEC indicates that it was proposing these amendments on a temporary basis to allow it to assess whether issuances of securities to platform workers under Rule 701 or Form S-8 are being made for legitimate compensatory purposes (and not for capital-raising purposes), whether such issuances would have the expected beneficial effects for companies in the “gig economy” and their investors, and whether such issuances would result in any unintended consequences.

Next Steps

The SEC has provided a 60-day comment period for these proposed amendments to Rule 701 and Form S-8.


[1] Release No. 33-10891, Modernization of Rules and Forms for Compensatory Securities Offerings and Sales (Nov. 24, 2020), available at: https://www.sec.gov/rules/proposed/2020/33-10891.pdf.

[2] Release No. 33-10892, Temporary Rules to Include Certain "Platform Workers" in Compensatory Offerings under Rule 701 and Form S-8 (Nov. 24, 2020), available at: https://www.sec.gov/rules/proposed/2020/33-10892.pdf.

[3] Release No. 33-10521, Concept Release on Compensatory Securities Offerings and Sales (Jul. 18, 2018), available at: https://www.sec.gov/rules/concept/2018/33-10521.pdf.

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