On July 18, 2018, the US Securities and Exchange Commission (SEC) issued a concept release1 soliciting public comment on potential ways to modernize compensatory offerings and sales of securities, consistent with investor protection. Specifically, the concept release requests comment on aspects of Rule 701 under the Securities Act of 1933 (Securities Act), an exemption from registration for securities issued by non-reporting companies pursuant to compensatory arrangements, and on Form S-8, a registration statement used by SEC-reporting companies for compensatory offerings. This Legal Update highlights key questions raised by the concept release. The comment period is scheduled to remain open through September 24, 2018.
Request for Comment on Rule 701
Rule 701 provides an exemption from the registration requirements of the Securities Act for securities issued in compensatory circumstances to specified persons (for example, officers, directors, employees, consultants and advisors) by companies that are not subject to the reporting requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934. The SEC recognizes that since the time it last adopted substantive amendments to Rule 701, there has been a "significant evolution" in the types of compensatory offerings that companies make and in the composition of the work force. Accordingly, the concept release raises 41 topics for comment relating to Rule 701 under the Securities Act, including those described below.
Gig Economy. The concept release asks a series of questions geared to the development of the "gig economy," which involves more short-term, part-time or freelance arrangements. Individuals participating in the gig economy may use a company's Internet platform to perform services or sell goods to end users on an independent contractor basis in areas such as ride-sharing, food delivery, lodging and car rentals. These individuals may have similar arrangements with multiple companies in which they may engage in the same or different business activities. Recognizing that workers participating in such arrangements may not be "employees" in a traditional sense, and also may not qualify as consultants or advisors, the concept release seeks comment on whether the definition of employee under regulatory regimes other than the securities laws should apply for Rule 701 purposes. It also asks what services, if any, should an individual working in the gig economy be providing to the issuer in order to be eligible to participate in a Rule 701 offering and whether Rule 701 eligibility should require that the issuer exercise some level of control over, or vetting of, the individual providing the services.
Some of the requests for comment in the gig economy area focus on whether the eligibility test should take into account the individual's level of dependence on the issuer or the issuer's degree of dependence on such individual. Other requests for comment relate to the potential impact of increased volume of Rule 701 issuances if the rule were to be revised to accommodate issuers involved in the gig economy and whether having a separate ceiling, or additional disclosures, would be appropriate for issuers in the gig economy. The SEC is also seeking information about gig economy issuers' use of securities to compensate individuals generally and the impact on competition of potential Rule 701 offerings by gig economy issuers.
Disclosure. At the same time that the SEC issued the concept release, it amended Rule 701(e) by increasing to $10 million the aggregate sales price or amount of securities sold during any consecutive 12-month period.2 In the event that issuances are made by an issuer in excess of that amount, the company is required to deliver additional disclosures to investors (including a summary of the plan's material terms, a description of the risks associated with an investment in the securities and specified financial statements) before the sale or, with respect to options or other derivative securities, within a reasonable period of time before the date of exercise or conversion. The concept release raises a number of questions relating to the timing of such disclosures, such as whether the additional disclosure should continue to be required for the period that precedes the threshold amount being exceeded and whether the consequence for failing to provide the disclosure should be loss of exemption only for transactions that occur after the threshold is crossed and for which no disclosure was provided.
The concept release solicits comment on whether the type of information provided should depend on the recipient of the securities and whether such disclosure should be updated less frequently than currently required. The concept release asks which methods of disclosure delivery best satisfy the purpose of disclosure without undermining the confidentiality of financial information of private companies and whether there is a need for the rule to specify that confidentiality safeguards should not be so burdensome that they interfere with effective access by the intended recipients.
RSUs. Because restricted stock units (RSUs) may settle without the recipient taking action, the SEC noted that the investment decision, if any, likely takes place on the date of grant. Observing that the requirement to deliver disclosures at a reasonable time before the date of grant could compel disclosure of financial information at a time when potential new hires are negotiating the terms of employment before joining a company, the concept release requests comment on when disclosure should be required for RSUs and what the appropriate valuation for RSUs is for the purpose of Rule 701. The concept release also asks whether any other types of derivative compensatory securities should be specifically addressed by Rule 701.
Annual Ceiling. Rule 701(d) generally provides a 12-month sales limit on the amount of securities that may be sold under the exemption on an aggregate basis under all plans equal to the greatest of (i) 15 percent of the total assets of the issuer, measured as of the most recent balance sheet date; (ii) 15 percent of the total outstanding amount of the class of securities being offered and sold in reliance on the rule, measured as of the most recent balance sheet date; and (iii) $1 million. The concept release asks whether there is a continuing need for any annual regulatory ceiling for Rule 701 transactions and, if so, whether the ceiling should be increased.
Request for Comment on Form S-8
The concept release also seeks comment on 15 topics relating to Form S-8, a simplified form of registration statement used by reporting companies for the registration of offerings of securities pursuant to employee benefit plans to specified persons (for example, officers, directors, employees, consultants and advisors). For instance, the concept release asks whether changes to Form S-8 are appropriate to address the gig economy, including whether consistent changes should be made to both Rule 701 and Form S-8. In addition, the release solicits comment on ways to reduce various perceived burdens associated with registration on Form S-8 and whether such revisions would encourage more companies to become reporting companies. There are questions relating to the possible use of a single Form S-8 for all employee benefit plans that a company sponsors and whether there should be a "pay-as-you-go" system for filing fees, similar to what is permitted for well-known seasoned issuers. The concept release solicits comment on Form S-8 generally, including on whether the current operation of Form S-8 presents significant challenges to the use of benefit plans. It also asks what the advantages, disadvantages and impact would be of eliminating Form S-8 and instead extending the Rule 701 exemption to reporting companies.
Private companies that offer securities as part of their compensation programs in reliance on the Rule 701 exemption—or that are considering doing so—should consider submitting comments to the SEC, whether in response to specific questions raised in the concept release or to any other concerns that they may have based on the current operation of that rule.
Because Rule 701 is available for foreign private issuers as well as private domestic companies, foreign private issuers that are not SEC-reporting companies should focus on the issues raised by the concept release. The SEC has encouraged comment on the concept release from all interested parties. Accordingly, foreign private issuers are welcome to submit comments on the concept release, and it could be in their interest to do so, particularly with respect to topics impacting specifically them.
Public companies that offer, or are considering offering, securities as part of their compensation programs should determine whether there are any issues relating to Form S-8 for which they would like to submit comments and whether reliance on Rule 701 would be a viable alternative if made available to public companies.
The concept release reflects a desire by the SEC to encourage public offerings. Therefore, private companies that may be considering going public in the future may want to submit comments to the SEC regarding any changes in compensatory securities offerings and sales regulations that would impact their decisions to engage in an initial public offering.
1Available at https://www.sec.gov/rules/concept/2018/33-10521.pdf.
2See our Legal Update, "SEC Amends Rule 701(e) Threshold for Compensatory Offerings ," dated July 19, 2018, available at https://www.mayerbrown.com/sec-amends-rule-701e-threshold-for-compensatory-offerings-07-19-2018/.
This Legal Update was subsequently published by the Harvard Law School Forum on Corporate Governance and Financial Regulation.