Exemption of Compensatory Employee Stock Options From Registration Under Section 12(G) of the Securities Exchange Act of 1934, 69554-69567 [E7-23756]
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Federal Register / Vol. 72, No. 235 / Friday, December 7, 2007 / Rules and Regulations
SECURITIES AND EXCHANGE
COMMISSION
17 CFR Part 240
[Release No. 34–56887; International Series
Release No. 1305; File No. S7–14–07]
RIN 3235–AJ91
Exemption of Compensatory Employee
Stock Options From Registration
Under Section 12(G) of the Securities
Exchange Act of 1934
Securities and Exchange
Commission.
ACTION: Final rule.
AGENCY:
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SUMMARY: We are adopting two
exemptions from the registration
requirements of the Securities Exchange
Act of 1934 for compensatory employee
stock options. The first exemption will
be available to issuers that are not
required to file periodic reports under
the Exchange Act. The second
exemption will be available to issuers
that are required to file those reports
because they have registered under
Exchange Act Section 12 a class of
security or are required to file reports
pursuant to Exchange Act Section 15(d).
The exemptions will apply only to the
issuer’s compensatory employee stock
options and will not extend to the class
of securities underlying those options.
DATES: Effective Date: December 7, 2007.
FOR FURTHER INFORMATION CONTACT:
Amy M. Starr, Senior Special Counsel to
the Director, at (202) 551–3115, Division
of Corporation Finance, U.S. Securities
and Exchange Commission, 100 F
Street, NE., Washington, DC 20549.
SUPPLEMENTARY INFORMATION: We are
amending rule 12h–1 1 under the
Securities Exchange Act of 1934.2
Table of Contents
I. Introduction and Background
A. Proposing Release and Public Comment
Letters
B. Employee Stock Options and Exchange
Act Section 12(g)
II. Discussion of Exemptions
A. Exemption for Compensatory Employee
Stock Options of Issuers That Are Not
Exchange Act Reporting Issuers
1. Eligible Issuers
2. Eligible Compensatory Employee Stock
Options
3. Eligible Option Plan Participants
4. Option Terms
a. Compensatory Employee Stock Option
Transferability Restrictions
b. Permitted Exercisability of
Compensatory Employee Stock Options
5. Required Information
6. Issuer Obligation To Impose the
Conditions to the Exemption
1 17
2 15
CFR 240.12h–1.
U.S.C. 78a et seq.
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B. Exemption for Compensatory Employee
Stock Options of Exchange Act Reporting
Issuers
C. Registering When No Longer Eligible for
Exemption
III. Paperwork Reduction Act
A. Background
B. Summary of Collection of Information
C. Summary of Comments
D. Paperwork Reduction Act Burden
Estimates
IV. Cost-Benefit Analysis
A. Background
B. Summary of Amendments
1. Expected Benefits
2. Expected Costs
V. Consideration of Burden on Competition
and Promotion of Efficiency,
Competition and Capital Formation
Analysis
VI. Regulatory Flexibility Act Certification
VII. Administrative Procedure Act
VIII. Statutory Basis and Text of Rule
Amendments
I. Introduction and Background
A. Proposing Release and Public
Comment Letters
On July 5, 2007, we proposed
amendments to Exchange Act Rule 12h–
1 to provide two exemptions from
Exchange Act Section 12(g) 3 registration
for compensatory employee stock
options.4 The first proposed exemption
applied to compensatory employee
stock options of an issuer that did not
have a class of security registered under
Exchange Act Section 12 5 and was not
subject to the reporting requirements of
Exchange Act Section 15(d),6 provided
certain conditions were met. The
proposed exemption built on a line of
no-action letters issued by the staff of
the Division of Corporation Finance that
granted relief from Exchange Act
Section 12(g) registration to private,
non-reporting issuers for their
compensatory employee stock options.7
The second proposed exemption
applied to compensatory employee
stock options of issuers that were
required to file periodic reports under
the Exchange Act because they had
registered under Section 12 the class of
3 15
U.S.C. 78l(g).
of Compensatory Employee Stock
Options from Registration Under Section 12(g) of
the Securities Exchange Act of 1934, Release No.
34–56010 (Jul. 10, 2007) [72 FR 37608] (‘‘Proposing
Release’’).
5 15 U.S.C. 78l.
6 15 U.S.C. 78o(d).
7 See, e.g., no-action letters to Starbucks
Corporation (available Apr. 2, 1992); Kinko’s, Inc.
(available Nov. 30, 1999); Mitchell International
Holding, Inc. (available Dec. 27, 2000) (‘‘Mitchell
International’’); AMIS Holdings, Inc. (available Jul.
30, 2001) (‘‘AMIS Holdings’’); Headstrong
Corporation (available Feb. 28, 2003); and VG
Holding Corporation (available Oct. 31, 2006) (‘‘VG
Holding’’).
4 Exemption
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equity security underlying those
options.
In response to our request for
comment on the Proposing Release, we
received twelve comment letters from
various persons, all of whom expressed
support for the need for the proposed
exemptions.8 Commenters expressed
differing concerns about the scope of the
exemptions, and the transferability
restrictions and information conditions
of the proposed exemption for private,
non-reporting issuers. After considering
commenters’ views, we are adopting
amendments to Exchange Act Rule 12h1, substantially as proposed, with some
modifications including:
• Exemption for private, nonreporting issuers:
—Elimination of transferability and
ownership restrictions on holders of
shares issued on exercise of
compensatory employee stock
options; and
—Elimination of an issuer’s obligation
to provide certain required
information to holders of shares
received on exercise of compensatory
employee stock options.
• Exemption for public reporting
issuers:
—Expansion of the category of issuers
eligible to rely on the exemption to
include any issuer required to file
periodic reports under Exchange Act
Section 13 9 or Section 15(d).
B. Employee Stock Options and
Exchange Act Section 12(g)
In the 1980s, private, non-reporting
issuers began using compensatory
employee stock options 10 to
compensate a broader range of
employees, including executive, middle,
and lower-level employees, directors,
and consultants.11 Compensatory
8 See letters from American Bar Association,
Committee on Federal Regulation of Securities
(‘‘ABA’’); America’s Community Bankers (‘‘ACB’’);
Center for Audit Quality (‘‘CAQ’’); Deloitte &
Touche LLP (‘‘D &T’’); Drinker Biddle & Reath LLP
(‘‘Drinker’’); Ernst & Young LLP (‘‘E &Y’’); Freescale
Semiconductor (‘‘Freescale’’); KPMG LLP
(‘‘KPMG’’); Andrew Ross, Partner, Loeb & Loeb
(‘‘Ross’’); New York State Society of Certified Public
Accountants (‘‘NYSSCPA’’); Pink Sheets LLC (‘‘Pink
Sheets’’); and Simpson Thacher & Bartlett LLP
(‘‘Simpson’’).
9 15 U.S.C. 78m.
10 Throughout this release, for purposes of the
exemption for private, non-reporting issuers, we use
the term ‘‘compensatory employee stock options’’ to
refer to stock options issued to employees,
directors, consultants, and advisors (to the extent
permitted under Securities Act Rule 701 [17 CFR
230.701]). For reporting issuers, the phrase also
refers to those persons described in General
Instruction A.1(a) to Form S–8 [17 CFR 239.16b].
11 The National Center for Employee Ownership
surveyed 275 venture capital-backed private
businesses in the technology and
telecommunications businesses. Of these firms,
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employee stock options provide a
method to use non-cash compensation
to attract, retain, and motivate company
employees, directors, and consultants.12
Since the 1990s, a number of private,
non-reporting issuers have granted
compensatory employee stock options
to 500 or more employees, directors,
and consultants.13
Under Exchange Act Section 12(g), an
issuer with 500 or more holders of
record of a class of equity security and
assets in excess of $10 million at the
end of its most recently ended fiscal
year must register that class of equity
security, unless there is an available
exemption from registration.14 Stock
options, including stock options issued
to employees under stock option plans,
are a separate class of equity security for
purposes of the Exchange Act.15
Accordingly, an issuer with 500 or more
77% provided options to all employees while 23%
provided them only to select employees. ‘‘New Data
Show Venture-Backed Companies Still Issue
Options Broadly,’’ https://www.nceo.org/library/
option_venturebacked.html; see also J. Hand, 2005
‘‘Give Everyone a Prize? Employee Stock Options in
Private Venture-Backed Firms,’’ Working Paper,
Kenan-Flagler Business School, UNC Chapel Hill,
available at https://ssrn.com/abstracts=599904
(‘‘Hand Paper’’) (study investigating the impacts on
the equity values of private venture-backed firms of
the organizational depth to which they grant
employee stock options).
Securities Act Rule 701, which provides an
exemption from Securities Act registration for nonreporting issuers for offerings of securities to
employees, directors, consultants and advisors, and
specified others, pursuant to written compensatory
benefit plans or agreements, has given private
issuers great flexibility in granting compensatory
employee stock options to employees (and other
eligible persons) at all levels. See Rule 701(c) [17
CFR 230.701(c)]; and Rule 701 Exempt Offerings
Pursuant to Compensatory Arrangements, Release
No. 33–7645 (Mar. 8, 1999) [64 FR 11095] (‘‘Rule
701 Release’’). See also Compensatory Benefit Plans
and Contracts, Release No. 33–6768 (Apr. 14, 1988)
[53 FR 12918].
12 See Hand Paper, note 11 supra.
13 See no-action letters cited at note 7 supra.
14 The asset threshold was set originally at $1
million in Section 12(g). Pursuant to its authority
under Section 12(h) of the Exchange Act, the
Commission has increased the amount three times;
from $1 million to $3 million in 1982 (System of
Classification for Purposes of Exempting Smaller
Issuers From Certain Reporting and Other
Requirements, Release No. 34–18647 (Apr. 13,
1982)[47 FR 17046]), from $3 million to $5 million
in 1986 (Reporting by Small Issuers, Release No.
34–23406 (Jul. 8, 1986) [51 FR 253601]), and from
$5 million to $10 million in 1996 (Relief from
Reporting by Small Issuers, Release No. 34–37157
(May 1, 1996) [61 FR 21353]).
15 Exchange Act Section 3(a)(11) [15 U.S.C.
78c(a)(11)] defines equity security to include any
right to purchase a security (such as options) and
Exchange Act Rule 3a11–1 [17 CFR 240.3a11–1]
explicitly includes options in the definition of
equity security for purposes of Exchange Act
Sections 12(g) and 16 [15 U.S.C. 78l(g) and 78p].
Exchange Act Section 12(g)(5) [15 U.S.C. 78l(g)(5)]
defines class to include ‘‘all securities of an issuer
which are of substantially similar character and the
holders of which enjoy substantially similar rights
and privileges.’’
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optionholders and more than $10
million in assets is required to register
that class of options under the Exchange
Act, absent an available exemption.
While there is an exemption from
Exchange Act Section 12(g) registration
for interests and participations in
certain other types of employee
compensation plans involving
securities,16 currently there is no
exemption for compensatory employee
stock options.
The addition of Section 12(g) to the
Exchange Act in 1964 was intended ‘‘to
extend to investors in certain over-thecounter securities the same protection
now afforded to those in listed
securities by providing that the issuers
of certain securities now traded over the
counter shall be subject to the same
requirements that now apply to issuers
of securities listed on an exchange.’’ 17
Further, Exchange Act Section 12(g)
extended the disclosure and other
Exchange Act safeguards to unlisted
securities as a means to prevent fraud.18
A number of private, non-reporting
issuers faced with registration under
Exchange Act Section 12(g) due solely
to their compensatory employee stock
options being held by 500 or more
holders of record (as well as having
more than $10 million in assets) at the
end of their fiscal year have requested
registration relief from our Division of
Corporation Finance.19 Since 1992, the
Division has provided relief through noaction letters 20 to these private issuers
16 The exemption from registration under
Exchange Act Section 12(g) which is contained in
Exchange Act Rule 12h–1(a), was adopted in 1965,
for ‘‘[a]ny interest or participation in an employee
stock bonus, stock purchase, profit sharing,
pension, retirement, incentive, thrift, savings or
similar plan which is not transferable by the holder
except in the event of death or mental
incompetency, or any security issued solely to fund
such plans.’’ Rule 12h–1 is intended to exempt from
Section 12(g) registration the same types of
employee benefit plan interests as Section 3(a)(2)
[15 U.S.C. 77c(a)(2)] of the Securities Act of 1933
[15 U.S.C. 77a et seq.] exempts from Securities Act
registration and, thus, does not cover stock options.
See, e.g., L. Loss and J. Seligman, Securities
Regulations, 3d., at § 6–A–4.
17 House of Representatives Report No. 1418
(1964), 88th Cong., 2d Sess., HR 679, p.1. See also
Section 3(c) of the Securities Act Amendments of
1964, Pub. L. 88–467; 78 Stat. 565.
18 Senate Committee Report, No. 379 (1963), 88th
Cong., 1st Sess., p. 63.
19 The Division has delegated authority to grant
(but not deny) applications for exemption under
Exchange Act Section 12(h). See Rule 200.30–
1(e)(7) [17 CFR 200.30–1(e)(7)].
20 For the conditions necessary to receive relief
under these letters and orders see, e.g., the noaction letter to Mitchell International, note 7 supra
(for the pre-2001 relief) and the no-action letters to
AMIS Holdings, note 7 supra; ISE Labs, Inc.
(available Jun. 2, 2003); Jazz Semiconductor, Inc.
(available Nov. 21, 2005) (‘‘Jazz Semiconductor’’);
and VG Holding, note 7 supra (for the expanded
relief beginning in 2001).
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when specified conditions were present.
More recently, the Advisory Committee
on Smaller Public Companies, in its
Final Report, recommended that we
provide Exchange Act Section 12(g)
registration relief for compensatory
employee stock options.21
As we discussed further in the
Proposing Release, we believe that it is
appropriate at this time to adopt two
new exemptions from the registration
provisions of Exchange Act Section
12(g) for compensatory employee stock
options issued under employee stock
option plans that are limited to
employees, directors, consultants, and
advisors of the issuer, its parents, and
majority-owned subsidiaries of the
issuer or its parents.22
II. Discussion of Exemptions
We are adopting two amendments to
Exchange Act Rule 12h–1 as proposed,
with some modifications. These
amendments will:
• Provide an exemption for private,
non-reporting issuers from Exchange
Act Section 12(g) registration for
compensatory employee stock options
issued under employee stock option
plans; and
• Provide an exemption from
Exchange Act Section 12(g) registration
for compensatory employee stock
21 Final Report of the Advisory Committee on
Smaller Public Companies to the Securities and
Exchange Commission, Apr. 23, 2006 at 87 (‘‘Final
Report of the Advisory Committee’’).
22 The exemption for private, non-reporting
issuers allows compensatory employee stock
options to be held only by those persons described
in Securities Act Rule 701(c) [17 CFR 230.701(c)]
(including permitted transferees), while the
exemption for reporting issuers also allows options
to be held by those persons described in General
Instruction A.1(a) to Form S–8. Securities Act Rule
701(c) lists the categories of persons to whom offers
and sales of securities under written compensatory
benefit plans or contracts may be made in reliance
on Securities Act Rule 701 by an issuer, its parents,
and majority-owned subsidiaries of the issuer or its
parents. The categories of persons are: employees
(including specified insurance agents); directors;
general partners; trustees (where the issuer is a
business trust); officers; consultants and advisors
(under certain conditions); family members who
acquire their securities from such persons through
gifts or domestic relations orders; and former
employees, directors, general partners, trustees,
officers, consultants and advisors only if such
persons were employed by or providing services to
the issuer at the time the securities were offered.
The exemption also allows options to be transferred
to (and held by) family members (as described in
Securities Act Rule 701) through gifts or domestic
relations orders, or to an executor or guardian of the
optionholder upon the death or disability of the
optionholder. For ease of discussion, in this release
we use the phrase ‘‘employees, directors,
consultants and advisors of the issuer’’ to refer to
those persons described in Securities Act Rule
701(c) and transferees permitted by the exemption.
For reporting issuers, the exemption will cover
grants of options made prior to and after the issuer
becomes subject to the Exchange Act reporting
requirements.
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options of issuers that have registered
under Exchange Act Section 12 a class
of security or are required to file reports
pursuant to Exchange Act Section 15(d).
Given the differences between issuers
that are required to file periodic reports
under the Exchange Act and those
issuers that do not have such an
obligation, including the nature of the
trading markets and the amount of
publicly available information, we
believe that it is appropriate to adopt
separate exemptions for these different
types of issuers.
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A. Exemption for Compensatory
Employee Stock Options of Issuers That
Are Not Exchange Act Reporting Issuers
We believe it is appropriate to provide
an exemption from Exchange Act
registration, based on the factors
identified in Exchange Act Section
12(h),23 for compensatory employee
stock options of issuers that are not
required to file reports under the
Exchange Act.24 We believe that an
exemption from Exchange Act
registration of compensatory employee
stock options for private, non-reporting
issuers will provide useful certainty to
those issuers in their compensation
decisions and will help them avoid
becoming subject to the registration and
reporting requirements of the Exchange
Act prior to the time they have public
shareholders. The availability of this
exemption is subject to specified
limitations, including limitations
23 Exchange Act Section 12(h) provides for
exemptive authority with regard to certain
provisions of the Exchange Act. Included in
Exchange Act Section 12(h) is the authority to
create appropriate exemptions from the Exchange
Act registration requirements. Under Exchange Act
Section 12(h), the Commission may exempt a class
of securities by rules and regulations or by order if
it ‘‘finds, by reason of the number of public
investors, amount of trading interest in the
securities, the number and extent of the activities
of the issuer, income or assets of the issuer, or
otherwise, that such action is not inconsistent with
the public interest or the protection of investors.’’
Exchange Act Section 12(h) [15 U.S.C. 78l(h)].
24 We believe that the exemption is consistent
with the exemption provided for other employee
benefit plans in Exchange Act Rule 12h–1, which
is not available for stock option plans, the
compensatory employee stock options issued
pursuant to such plans, or the securities issued on
exercise of such compensatory employee stock
options. We believe that the characteristics of many
employee benefit plans, which are by their own
terms limited to employees, not available to the
general public, and subject to transfer restrictions,
obviate the need for applicability of all the rules
and regulations aimed at public trading markets. In
addition, because many of the conditions in the
exemption refer to certain Securities Act Rule 701
definitions and requirements, we believe that the
exemption from Exchange Act Section 12(g)
registration will allow non-reporting issuers to
continue to rely on Securities Act Rule 701 in
offering and selling compensatory employee stock
options and the shares issued on exercise of those
options.
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concerning permitted optionholders,
transferability, and provision of
information. We believe that the
conditions to the exemption and the
existing statutory provisions and rules
provide holders of compensatory
employee stock options in private, nonreporting issuers appropriate disclosure
and investor protections under the
federal securities laws, given the
compensatory circumstances of the
securities issuance and the restrictions
on transferability of the compensatory
employee stock options. As such, we
believe that the exemption is in the
public interest, in that it would clarify
and routinize the basis for an exemption
from Exchange Act Section 12(g)
registration for compensatory employee
stock options so private, non-reporting
issuers would be able to continue to use
compensatory employee stock options
and would provide appropriate investor
protections for optionholders.
1. Eligible Issuers
The amendment we are adopting
today will provide an exemption from
Exchange Act Section 12(g) registration
for compensatory employee stock
options of the following types of issuers:
• Issuers that do not have a class of
securities registered under Exchange
Act Section 12; and
• Issuers that are not subject to the
reporting requirements of Exchange Act
Section 15(d).25
The exemption will be available only
to those issuers that are not required to
report under the Exchange Act. As such,
the exemption will terminate once the
issuer becomes subject to the reporting
requirements of the Exchange Act. The
exemption also will terminate if the
issuer no longer satisfies the conditions
to the exemption.26
2. Eligible Compensatory Employee
Stock Options
The exemption for compensatory
employee stock options will:
• Apply only to compensatory
employee stock options that are issued
under a written compensatory stock
25 Under Exchange Act Section 15(d), an issuer’s
‘‘duty to file [reports under Section 15(d) is]
automatically suspended if and so long as any issue
of securities of such issuer is registered pursuant to
section 12 of this title.’’ [15 U.S.C. 78o(d)].
26 The exemption under Exchange Act Section 12
will allow issuers 120 calendar days to register the
class of options once an issuer no longer is able to
rely on the exemption. Currently, the no-action
letter relief terminates once an issuer becomes
subject to the Exchange Act reporting requirements.
See, e.g., no-action letter to VG Holding, note 7
supra. Moreover, the exemption will not be
available if the issuer was required, but failed, to
register another class of equity security under the
Exchange Act.
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option plan 27 that is limited to
employees, directors, consultants, and
advisors of the issuer, its parents, or
majority-owned subsidiaries of the
issuer or its parents; 28
• Apply to all compensatory
employee stock options issued under all
written compensatory stock option
plans on a combined basis where the
securities underlying the compensatory
employee stock options are of the same
class of securities of the issuer, with the
exemptive conditions applying to the
compensatory employee stock options
issued under each option plan; and
• Not extend to any class of securities
received or to be received on exercise of
the compensatory employee stock
options.
The exemption covers all
compensatory employee stock options
meeting the conditions of the
exemption, even if the compensatory
employee stock options are issued
under separate written option plans of
the issuer, its parents, or majorityowned subsidiaries of the issuer or its
parents.29 For the purpose of the
exemption, the compensatory employee
stock options will be considered to
belong to the same class of equity
security of the issuer if the same class
of securities of the issuer will be
issuable on exercise of the
compensatory employee stock
options.30 While one commenter
27 Securities Act Rule 701 is available only for
offers and sales of compensatory employee stock
options and the shares issuable upon exercise of
those options that are issued under written
compensatory employee benefit plans of an issuer,
its parents, or majority-owned subsidiaries of the
issuer or its parents. See Securities Act Rule 701(c)
[17 CFR 230.701(c)]. Thus, the requirement that the
options be issued under written compensatory stock
option plans will not impose a new obligation on
issuers relying on Securities Act Rule 701 in
offering and selling compensatory employee stock
options or the shares issued on exercise of those
options.
28 The exemption for the compensatory employee
stock options will not extend to other rights issued
in connection with the compensatory employee
stock options, such as stock appreciation rights.
Any such other rights will be evaluated separately
for purposes of Exchange Act Section 12(g)
registration. Some commenters had requested that
the exemption apply to all compensation
arrangements involving securities, including
restricted stock units, stock appreciation rights, and
other rights or securities. See letters from ABA and
Freescale. Consistent with the scope of the staff noaction letters granting Section 12(g) registration
relief for compensatory employee stock options, at
this time we believe the exemption should address
only compensatory employee stock options. We,
therefore, are not expanding the scope of the
exemption beyond compensatory employee stock
options.
29 In response to comment (see letter from ABA),
we have clarified that the options may be granted
under plans of the issuer, its parents, and majorityowned subsidiaries of the issuer or its parents.
30 See Exchange Act Section 12(g)(5) [15 U.S.C.
78l(g)(5)].
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requested that we allow companies to
determine whether a particular group of
compensatory employee stock options
was the same class as other
compensatory employee stock options
for purposes of determining whether it
had met the 500 holder threshold,31 we
are adopting the exemption as proposed
in this regard.32 We believe that, solely
for purposes of determining whether the
Rule 12h–1 exemption is available, it is
important to establish uniformity in
evaluating whether there are 500 or
more holders of compensatory employee
stock options and so that issuers
appropriately analyze when Exchange
Act Section 12(g) applies to their
compensatory employee stock
options.33
The exemption, as adopted, applies to
the compensatory employee stock
options only and not to the securities
issued (or to be issued) on exercise of
the compensatory employee stock
options. Thus, the issuer will have to
apply the registration requirements of
Exchange Act Section 12 to the class of
equity security underlying the
compensatory employee stock options
without regard to the exemption.34
3. Eligible Option Plan Participants
The exemption is available only
where the class of persons eligible to
receive compensatory employee stock
options under the stock option plans is
limited to those persons described in
the exemption. These eligible
optionholders are the same as those
participants permitted under Securities
Act Rule 701 and include: 35
• Employees of the issuer, its parents,
or majority-owned, direct or indirect,
subsidiaries of the issuer or its parents;
• Directors of the issuer, its parents,
or majority-owned, direct or indirect,
31 See
letter from ABA.
commenter suggested that the class of
options should only include those options issued
after the effective date of the exemption that
satisfied the conditions of the exemption. See letter
from Drinker. We are not adopting such a provision.
Under the Exchange Act, the class of equity security
is not determined based on when the securities are
issued. The exemption provides that the class of
compensatory employee stock options for purposes
of the exemption includes all compensatory
employee stock options on the same class of the
issuer’s securities regardless of whether the plan is
a plan of the issuer, its parents, or majority-owned
subsidiaries of the issuer or its parents. No
distinction is made in the exemption as to when
those options are issued.
33 This provision will not affect the separate class
analysis under Exchange Act Section 12(g)(5) for
other purposes.
34 For example, if an issuer had more than $10
million in assets and 500 or more holders of a class
of equity security underlying the compensatory
employee stock options as of the end of its fiscal
year, it would have to register under Exchange Act
Section 12 that class of equity security.
35 See the discussion at note 22 supra.
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subsidiaries of the issuer or its parents;
and
• Consultants and advisors of the
issuer, its parents, or majority-owned,
direct or indirect, subsidiaries of the
issuer or its parents.
As adopted, the exemption is limited
to those situations where compensatory
employee stock options may be held
only by those persons who are
permitted to hold or be granted
compensatory employee stock options
under Securities Act Rule 701 and their
permitted transferees.36 We believe that
the experience of issuers and their
counsels with Securities Act Rule 701
will ease compliance with and limit
uncertainty regarding the exemption.37
Just as Securities Act Rule 701 was
designed specifically not to be available
for capital-raising transactions, the
exemption will apply only to employee
stock options issued for compensatory
purposes. The restrictions on the
eligible participants in the stock option
plans are intended to assure that the
exemption is limited to employee stock
options issued solely for compensatory
purposes.38
4. Option Terms
a. Compensatory Employee Stock
Option Transferability Restrictions
The exemption is available only
where there are certain restrictions on
the transferability by an optionholder of
those options and, prior to the exercise
of the options, the shares issuable on
exercise of those options.39 Specifically,
the exemption is available only if:
• The compensatory employee stock
options and, prior to exercise, the shares
to be received on exercise of those
36 In this regard, we note that this category of
eligible optionholders is broader than the category
of persons to whom employee benefit securities,
including compensatory employee stock options,
may be offered and sold by reporting issuers using
a Form S–8 registration statement. See General
Instruction A.1(a) to Form S–8. As we note below,
the exemption for reporting issuers will allow
eligible optionholders to satisfy the definitions
contained in either Securities Act Rule 701 or Form
S–8 because an issuer may grant options both prior
to and after it becomes subject to the periodic
reporting requirements of the Exchange Act.
37 Some commenters were concerned that the
terms of outstanding options may not contain all
the restrictive provisions of the exemption. (See
letters from Drinker and Ross). We believe that our
elimination of the restrictions on holders of shares
received on exercise of an option and the
modification of the transferability conditions
affecting optionholders should address these
concerns.
38 All option grants and exercises must, of course,
comply with the requirements of the Securities Act.
39 The exemption does not impose any limitations
on the ability of current or former employees,
directors, consultants, or advisors of an issuer to
retain or exercise their compensatory employee
stock options.
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69557
options cannot be transferred except, as
permitted by the exemption: 40
—To family members (as defined in
Securities Act Rule 701) by gift or
pursuant to domestic relations orders;
and
—On death or disability of the
optionholder; 41
• There can be no other permitted
pledges, gifts, hypothecations, or other
transfers of the compensatory employee
stock options, or shares issuable on
exercise of those options, prior to
exercise, until the issuer becomes
subject to the reporting requirements of
the Exchange Act or is no longer relying
on the exemption; provided that there
may be:
—Transfers back to the issuer; or
—Transfers in connection with a change
of control or other acquisition
transactions involving the issuer if,
following such transaction, the
options no longer will be outstanding
and the issuer no longer will be
relying on the exemption; 42 and
• The compensatory employee stock
options or the securities issuable upon
exercise of those options cannot be the
subject of a short position, a ‘‘put
equivalent position’’ 43 or a ‘‘call
equivalent position’’ 44 by the
optionholder, prior to exercise, until the
issuer becomes subject to the reporting
requirements of the Exchange Act or is
no longer relying on the exemption;
provided that the options may be
subject to repurchase rights of the issuer
or the optionholder may participate in
a change of control or other acquisition
transaction involving the issuer.
As adopted, the conditions provide
that, except with regard to the limited
40 The transferability restrictions are not intended
to supersede other transferability restrictions
imposed for other reasons, including under the
Internal Revenue Code of 1986, as amended [26
U.S.C. 422(b)(5)].
41 These permitted transferees are intended to be
the same as those permitted under Securities Act
Rule 701(c) as well as executors or guardians of an
optionholder on the death or disability of the
optionholder. See note 22 supra.
42 After an issuer becomes subject to the reporting
requirements of the Exchange Act, the issuer will
be able to rely on the exemption for Exchange Act
reporting issuers only if it becomes subject to
Exchange Act reporting as a result of its Exchange
Act Section 12 registration of a class of security or
pursuant to Exchange Act Section 15(d).
43 17 CFR 240.16a–1(h). Rule 16a–1(h) defines a
‘‘put equivalent position’’ as a derivative security
position that increases in value as the value of the
underlying equity decreases, including, but not
limited to, a long put option and a short call option
position.
44 17 CFR 240.16a–1(b). Rule 16a–1(b) defines a
‘‘call equivalent position’’ as a derivative security
position that increases in value as the value of the
underlying equity increases, including, but not
limited to, a long convertible security, a long call
option, and a short put option position.
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permitted transfers specified in the
conditions, an optionholder cannot be
permitted, prior to exercise, to pledge,
hypothecate, or otherwise transfer the
compensatory employee stock options
or the shares underlying those options,
including through a short position, a
‘‘put equivalent position,’’ or a ‘‘call
equivalent position,’’ until the issuer
becomes subject to the reporting
requirements of the Exchange Act or is
no longer relying on the exemption.45
For the exemption to be available, these
transfer restrictions will have to apply
to options outstanding at the time that
the issuer is relying on the exemption.
The restrictions on transfer of the
compensatory employee stock options
and the shares underlying those options,
prior to exercise, are intended to limit
the possibility for a trading market to
develop for the compensatory employee
stock options while the issuer is relying
on the exemption. These restrictions
also are intended to assure that an
optionholder is not able to profit from
the compensatory employee stock
options or the securities to be received
on exercise of those options (except
from permitted payments or transfers as
described in the exemption), until the
issuer becomes subject to the reporting
requirements of the Exchange Act or is
no longer relying on the exemption.
In response to comments, we have
modified the transferability condition to
permit optionholders to receive
compensation for their options from the
issuer or arising from a change of
control or other acquisition transaction
after which the options no longer will
be outstanding and the issuer no longer
will be relying on the exemption.46
Commenters also were concerned that
a requirement for an issuer to
repurchase the shares or options due to
state law limitations on transfer
restrictions could have adverse
accounting consequences to
companies.47 As a result, we have
modified the transferability conditions
to eliminate a requirement for an issuer
to repurchase options if an express
prohibition on transfer of options is not
45 The current no-action letters contain similar
conditions on transferability of the options,
although the rule as adopted clarifies the
limitations on the ability of optionholders to engage
in certain derivative transactions prior to exercise,
such as restrictions on an optionholder from
entering into a ‘‘put equivalent position’’ or ‘‘call
equivalent position’’ until the issuer becomes
subject to the reporting requirements of the
Exchange Act, or is no longer relying on the
exemption. See, e.g., no-action letter to VG Holding,
note 7 supra. In addition, the amendment as
adopted does not restrict holders of shares
following exercise of compensatory employee stock
options.
46 See letters from ABA, Ross, and Simpson.
47 See letters from CAQ, D&T, E&Y, and KPMG.
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permitted under applicable state law.
Instead, the condition permits the issuer
to provide that it may repurchase the
options in the event of an impermissible
transfer. Issuers also may provide that
the options terminate in such an event.
We note that compensatory employee
stock option plans or written stock
option agreements generally restrict the
persons who may exercise the options,
so providing for a termination of an
option in the event of an impermissible
transfer would, in many cases, already
be contemplated by the terms of the
written stock option agreement or plan.
We proposed that the transferability
restrictions apply to holders of shares
issued on exercise of the options. In
response to comments,48 we have not
adopted this condition of the
exemption. We understand from
commenters that private, non-reporting
issuers normally already have
shareholder agreements and other
mechanisms to restrict the transfer of
shares received on exercise of options
prior to the time the issuer becomes
subject to the reporting requirements of
the Exchange Act or is involved in a
change of control or other acquisition
transaction involving the issuer.49 We
also understand that private, nonreporting issuers do not anticipate that
optionholders will exercise their
options prior to a liquidity event, such
as an initial public offering or sale of the
company, or prior to termination of the
options.50
We are not adopting as a condition to
the exemption separate transferability
restrictions on holders of the shares
received on exercise of the
compensatory employee stock options.
While we acknowledged in the
Proposing Release the existence of
company-imposed and securities law
transferability restrictions, we are
48 See letters from ABA, Drinker, Ross, and
Simpson.
49 See letters from ABA, Freescale, Ross, and
Simpson.
50 In expressing their views that the proposed
transferability restrictions should not be expected to
affect a private company’s ability to value the
compensatory employee stock options under
Financial Accounting Standards Board Statement of
Financial Accounting Standards No. 123R (revised
2004) Share-Based Payment (FAS 123R), some
commenters noted that in valuing employee stock
options for purposes of FAS 123R, private, nonreporting issuers use an expected term assumption
that does not anticipate early exercise of the
options. See letters from CAQ, E&Y, and KPMG.
These commenters noted that employees of nonpublic companies normally do not have an
incentive to exercise a vested option early due to
the lack of a market for the underlying shares.
These commenters observed that non-public
company employees typically hold their options
until they have incentive to exercise such as at the
end of their terms, termination of employment, or
until a liquidity event, such as an initial public
offering or sale of the company occurs.
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persuaded to modify the exemption in
light of the additional concerns that
commenters believed the proposed
transferability restrictions would raise.
In modifying the exemption, we have
considered the treatment of
compensatory employee stock options
under Securities Act Rule 701 as
restricted securities as defined in
Securities Act Rule 144,51 the fact that
optionholders typically do not exercise
their options prior to their termination
or a liquidity event and the fact that, if
exercised, most private companies take
steps to restrict transferability of shares
received on exercise of compensatory
employee stock options, so that there is
a limited possibility of a market
developing in the securities issued on
exercise of immediately exercisable
compensatory employee stock options.
In addition, we have considered a
commenter’s view that imposing
separate transferability restrictions on
the holders of shares received on
exercise of compensatory employee
stock options may affect a company’s
decision to use stock options for
compensatory purposes.52 We also note
that the exemptions we are adopting
today do not impact the continued
potential applicability of Exchange Act
Section 12(g) to the securities issued on
exercise of the options.
We also are not adopting the proposed
restriction on other shares of the same
class of equity security as those
underlying the options. We believe that
this restriction is no longer necessary
because we have not adopted
transferability restrictions on holders of
securities received on exercise of
compensatory employee stock options.
In addition, we have taken into account
one commenter’s concern that the
transferability restrictions on the
optionholder with respect to shares of
the same class as those issuable on
exercise of the options would affect an
optionholder’s ability to dispose of
other securities of the issuer that the
optionholder owned.53
As proposed, the exemption would
have provided that there could be no
market, process, or methodology that
would permit optionholders, prior to
exercise, to receive compensation or
consideration for their options, the
shares issuable on exercise of the
options, or shares of the same class of
equity security as those underlying
those options. Commenters noted that
generally there is no market for the
securities underlying the options while
51 17 CFR 230.144. See, e.g., Securities Act Rule
701(g).
52 See letter from ABA. See also, letter from Ross.
53 See letter from Ross.
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the issuer is a private, non-reporting
entity.54 Commenters were concerned
that optionholders should not be
disadvantaged from receiving payments
from an issuer or in connection with a
change of control or other corporate
transaction involving an issuer, either
with respect to their options or shares
of the issuer they already own.55 In light
of these comments, we do not believe
the exemption should impair an
optionholder’s ability to participate in
transactions involving the issuer’s
securities they already own and we do
not believe the exemption should
restrict an issuer or other shareholders
from engaging in particular transactions
due to the issuer’s reliance on the
exemption.
b. Permitted Exercisability of
Compensatory Employee Stock Options
The exemption will not require that
there be any restriction on the timing of
the exercise of the compensatory
employee stock options:
• By the optionholder (regardless of
whether the optionholder continues to
be an employee, director, consultant or
advisor of the issuer);
• In the event of the death or
disability of the optionholder, by the
estate or guardian of the optionholder;
or
• By a family member (as defined in
Securities Act Rule 701) who acquired
the options through a gift or domestic
relations order.
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5. Required Information
We are adopting the proposed
requirement that the issuer provide
information to optionholders with
certain modifications. In response to
comment, we are not adopting a
requirement for issuers to provide
information to holders of shares
received on exercise of compensatory
employee stock options after exercise or
for issuers to provide optionholders
access to their books and records.56
As adopted, the information condition
will require the issuer, for purposes of
the exemption, to periodically provide
the following information to
optionholders: 57
• The same risk and financial
information that would be required to
54 See letters from ABA, Freescale, Ross, and
Simpson.
55 See letters from ABA, Freescale, Ross, and
Simpson.
56 See letter from ABA.
57 In response to comment (see letters from ABA
and Ross), we are clarifying that the information
conditions may commence once a company has 500
or more optionholders and may terminate once the
company becomes subject to the reporting
requirements of the Exchange Act or is no longer
relying on the exemption.
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be provided under Securities Act Rule
701 if securities sold in reliance on
Securities Act Rule 701 in a 12-month
period exceeded $5 million (as such
provision may be modified 58), with the
optionholders being provided every six
months required information, including
financial statements that are not more
than 180 days old.59
The issuer will be permitted to
provide the required information to the
optionholders either by:
• Physical or electronic 60 delivery of
the information; or
• Notice to the optionholders of:
—The availability of the information on
an Internet site that may be passwordprotected; 61 and
—Any password needed to access the
information.
In Securities Act Rule 701, we
established the type of information that
employees holding compensatory
employee stock options must be
provided before the exercise of those
options.62 The Securities Act Rule 701
58 One commenter suggested that the exemption
take into account changes in the dollar threshold in
Securities Act Rule 701. See letter from ABA. The
rule text, as proposed and adopted, refers only to
the relevant paragraph of Securities Act Rule 701
and does not include a separate dollar threshold.
Therefore, any change in the dollar threshold in
Securities Act Rule 701 would apply to the
exemption.
59 See Securities Act Rule 701(e) [17 CFR
230.701(e)] for a description of the risk factor and
financial statement requirements. The required
information will have to be provided under the
terms of the exemption, once an issuer is relying on
the exemption regardless of whether the issuer
would be required to provide the information under
Securities Act Rule 701 (for example, because the
issuer did not sell $5 million in securities in a 12month period in reliance on Securities Act Rule
701). The financial statement requirements under
Securities Act Rule 701 refers to financial
statements of Part F/S of Form 1–A [17 CFR 239.90].
Part F/S of Form 1–A does not require audited
financial statements unless an issuer has prepared
them for other purposes. Otherwise, Part F/S of
Form 1–A permits an issuer to provide two years
of unaudited financial statements.
60 Electronic delivery of such information will
have to be made in compliance with the
Commission’s interpretations regarding the
electronic delivery of information. See, e.g., ‘‘Use of
Electronic Media,’’ Release No. 34–42728 (Apr. 28,
2000) [65 FR 25843].
61 A password-protected closed-system intranet
site accessible to employees also would be a
permitted method to provide the required
information to those persons having access to such
site.
62 See Rule 701 Release, note 11 supra. ‘‘The type
and amount of disclosure needed in a compensatory
securities transaction differs from that needed in a
capital-raising transaction. In a bona fide
compensatory arrangement, the issuer is concerned
primarily with compensating the employee-investor
rather than maximizing its proceeds from the sale.
Because the compensated individual has some
business relationship, perhaps extending over a
long period of time, with the securities issuer, that
person will have acquired some, and in many cases,
a substantial amount of knowledge about the
enterprise. The amount and type of disclosure
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69559
information provisions provide
optionholders and other persons who
purchase securities without registration
under Securities Act Rule 701 with
important information. While one
commenter objected to the provision of
information condition,63 we believe that
the ongoing provision of the same
information is necessary and
appropriate for purposes of the
exemption from Exchange Act
registration.64 While requiring private,
non-reporting issuers to provide
information, as adopted, the exemption
will allow flexibility in the means of
providing the information by permitting
physical, electronic, or Internet-based
delivery.
Securities Act Rule 701 provides that
the required information must be
provided to an optionholder a
reasonable period of time before the
date of exercise of the compensatory
employee stock options. Securities Act
Rule 701 also requires that the required
financial statements be as of a date no
more than 180 days before the sale of
the securities (which in the case of
compensatory employee stock options is
the date of exercise of the options). We
believe that the exemption from
Exchange Act registration presents the
need for ongoing information to be
provided to optionholders. As such, the
exemption requires that, once an issuer
has 500 or more optionholders, the
optionholders must be provided every
six months the required information,
including financial statements that are
not more than 180 days old.
We believe that our experience with
Securities Act Rule 701 and the
combined conditions of the exemption,
including the eligibility and
transferability provisions, make it
appropriate to require the same risk and
financial information as required under
Securities Act Rule 701, as noted above,
rather than essentially the same
required for this person is not the same as for the
typical investor with no particular connection with
the issuer.’’ Id.
63 See letter from ABA.
64 As the Commission reminded issuers when it
adopted the amendments to Securities Act Rule 701
in 1999, issuers should be aware that compliance
with the minimum disclosure standards for
Securities Act Rule 701 may not necessarily satisfy
the antifraud standards of the securities laws. See
Rule 701 Release, note 11 supra. (Preliminary Note
1 to Rule 701 states that issuers and other persons
acting on their behalf have an obligation to provide
investors with disclosure adequate to satisfy the
antifraud provisions of the federal securities laws.)
We recognize that the Advisory Committee has
recommended modifications to Securities Act Rule
701 that would affect the thresholds that would
trigger the disclosure provisions of that rule. Our
amendments do not address the Advisory
Committee’s recommendations regarding Securities
Act Rule 701. See Final Report of the Advisory
Committee, note 21 supra, at p. 92–93.
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Exchange Act information and reports
as if it was subject to the Exchange Act
reporting requirements in the context of
an ongoing reporting exemption relating
to compensatory employee stock
options.65 As such, we believe that the
scope of information that the
optionholders will be provided under
the exemption is not inconsistent with
investor protection and the public
interest.66
One commenter objected to the
proposed condition that the issuer make
its books and records available for
inspection by the optionholder and
holders of shares received on exercise of
compensatory employee stock options
to the same extent that they are
available to other shareholders of the
issuer.67 This commenter stated that
such a requirement may go beyond or be
inconsistent with state law
requirements. We are not adopting the
books and records element of the
information condition. We believe that
holders of such shares can exercise their
state law rights to inspect corporate
books and records. Moreover, because
optionholders, as such, are not
shareholders, we agree with the
commenter that it is not necessary to
65 As the Commission also recognized when it
adopted the Securities Act Rule 701 amendments in
1999, and because many issuers that have 500 or
more optionholders and more than $10 million in
assets are likely to have received venture capital
financing (see for example the data in the Hand
Paper, note 11 supra), we believe that many of these
issuers already have prepared the type of disclosure
required in their normal course of business, either
for using other exemptions, such as Regulation D,
or for other purposes. As a result, the disclosure
requirement generally will be less burdensome for
them. In adopting the amendments to Securities Act
Rule 701, we stated that a minimum level of
disclosure was essential to meet even the reduced
level of information needed to inform
compensatory-type investors such as employees
and consultants. See Rule 701 Release, note 11
supra.
66 For a private, non-reporting issuer with a
significant number of optionholders (and with more
than $10 million in assets at the end of its fiscal
year), we believe it is likely that such issuer either
already is obligated to provide the same information
to optionholders due to sales of securities in
reliance on Securities Act Rule 701 or already
prepares and, as such, provides such information to
its shareholders. One commenter also stated that
many private, non-reporting issuers prepare
financial statements, including audited financial
statements, for other purposes. See letter from E&Y.
Moreover, because of the transferability restrictions
on the compensatory employee stock options and,
prior to exercise, the shares to be received on
exercise of those options, optionholders will have
limited investment decisions to make, until the
issuer becomes subject to the reporting
requirements of the Exchange Act or is engaged in
an acquisition transaction affecting the options.
Consequently, we believe that the disclosure
required under the exemption is the appropriate
level of disclosure to be provided optionholders
until the issuer becomes subject to the reporting
requirements of the Exchange Act or is no longer
relying on the exemption.
67 See letter from ABA.
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extend the books and records inspection
right to them if it is not already
provided for under applicable state law.
To permit issuers to safeguard
proprietary or confidential information
that may be contained in the
information to be provided, the
exemption will permit provision of the
disclosure to be conditioned on the
optionholder agreeing to maintain the
confidentiality of the information.68 In
response to a commenter,69 we are not
adopting the proposed provision that
would have required an issuer to allow
inspection of the documents at one of
the described issuer offices if an
optionholder chooses not to enter into
such a confidentiality agreement. Under
the exemption, as adopted, the issuer is
not required to provide the information
to a particular optionholder if the holder
does not agree to keep the information
to be provided pursuant to the
exemption confidential.70 Therefore, the
exemption, as adopted, permits an
issuer to take steps to protect the
confidentiality of its information.
The proposal also would have
required that the issuer provide the
required information to holders of
shares received on exercise of options.
We have revised the information
condition to apply only to
optionholders in light of concern
regarding the potential misuse of
information by non-employees or former
employees of a company.71 The
amendments, as adopted, do not
condition the exemption on
transferability restrictions on the
underlying shares similar to those
applicable to the compensatory
employee stock options. One
commenter expressed concern that the
information delivery conditions would
treat these company shareholders
differently than other company
shareholders.72 Since the exemption
applies only to the compensatory
employee stock options and not to the
shares received on exercise of the
compensatory employee stock options,
we believe our revisions should address
concerns in this regard and provide
companies flexibility in addressing
confidentiality and share transferability
issues.
68 This provision is consistent with the related
information provision under Securities Act Rule
701.
69 See letter from ABA.
70 This provision does not affect an issuer’s
information delivery obligation under Securities
Act Rule 701.
71 See letter from ABA.
72 See letter from ABA.
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6. Issuer Obligation To Impose the
Conditions to the Exemption
We are adopting essentially as
proposed the requirement that, for the
exemption to be available, a private,
non-reporting issuer must include the
necessary limitations and conditions in
the written stock option plans, within
the terms of the individual written
option agreements, or in another
enforceable written agreement. Some
commenters were concerned about the
need to include the conditions and
obligations in option plans or option
agreements and one commenter
suggested that the conditions and
restrictions should only have to be
satisfied in practice.73 We believe that
the nature of the exemption necessitates
the inclusion of the conditions to the
exemption in an enforceable written
agreement or agreements between the
issuer and the optionholders, or in the
issuer’s by-laws or certificate of
incorporation. By allowing the
conditions and obligations to be
included in any enforceable written
agreement or in the issuer’s certificate of
incorporation or by-laws, we also
believe that the modified condition will
provide issuers necessary flexibility in
where to include the conditions in their
agreements with optionholders.
B. Exemption for Compensatory
Employee Stock Options of Exchange
Act Reporting Issuers
To provide certainty regarding the
obligations of issuers that already have
registered securities under the Exchange
Act or are required to file reports under
the Exchange Act pursuant to Exchange
Act Section 15(d), we are adopting an
exemption from Exchange Act
registration for compensatory employee
stock options of these reporting
issuers.74 While the proposed
exemption would have been available
only for an issuer that had registered
under Exchange Act Section 12 the class
of equity security underlying the
compensatory employee stock options,
in response to comment,75 we are
expanding the eligibility for this
exemption to all issuers required to file
periodic reports pursuant to Exchange
73 See, e.g., letters from ABA, Drinker, and Ross.
While one commenter suggested eliminating any
requirement for the conditions to be embodied in
an agreement (see letter from ABA), we believe that
the condition must be enforceable by the
optionholder. Further, we believe the issuer must
have written evidence that it satisfies this
condition.
74 We believe the exemption will provide
important guidance regarding, and an appropriate
exemption to, eligible issuers from the Exchange
Act registration requirement for compensatory
employee stock options.
75 See letter from ABA.
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Act Section 13 or Exchange Act Section
15(d). The filing of Exchange Act reports
pursuant to Exchange Act Sections 13 or
15(d) will provide the appropriate
information to optionholders.
As with the exemption for private,
non-reporting issuers, the exemption for
issuers subject to the reporting
requirements of the Exchange Act will
be available only where the options are
issued pursuant to a written
compensatory stock option plan. We
have revised the exemption, in response
to comment,76 to provide that the class
of persons eligible to receive or hold
compensatory employee stock options
under the stock option plans includes
those participants permitted to be
granted options under an issuer’s Form
S–8, as well as to those participants
permitted under Securities Act Rule
701.77 We have made this change to take
into account the fact that, for a reporting
issuer, compensatory employee stock
options may have been granted before,
and may be granted after, the issuer
becomes subject to the Exchange Act
reporting requirements.
We also have modified the
optionholder eligibility condition to
address the concerns of some
commenters that the exemption still
should be available to reporting issuers
even where a small number of
optionholders may not necessarily fall
within the permitted categories of
optionholders.78 We are adopting a
provision that will permit the
exemption to continue to be available
even if there is an insignificant
deviation from satisfying the eligibility
conditions of the exemption.79 This
76 See
letter from ABA.
expansion will make the categories of
eligible optionholders consistent under both
exemptions. See the discussion under ‘‘Eligible
Option Plan Participants,’’ above, for a description
of the eligible optionholders.
78 See letters from ABA, Drinker, and Ross.
Commenters noted that options could be held by
persons that previously had been granted options
by the issuer, or by another entity acquired by the
issuer. One commenter also was concerned about
options held by former employees of an acquired
entity who would not be considered eligible
optionholders under Form S–8.
79 While we are allowing the exemption to be
available to reporting issuers that have insignificant
deviations from the eligibility conditions, we are
not adopting a similar provision for private, nonreporting issuers. We believe this distinction is
appropriate because reporting issuers are subject to
all of the disclosure requirements under the
periodic reporting rules of the Exchange Act and
also are subject to staff review. The concept of
allowing an insignificant deviation from required
conditions also is included in Regulation D and
Regulation A under the Securities Act [17 CFR
230.260 and 17 CFR 230.508]. We believe that
issuers are familiar with the concept under the
Securities Act and applying a similar concept to the
exemption under the Exchange Act will assist
issuers in avoiding unintentional failures to satisfy
the exemption conditions.
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77 This
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provision will allow reporting issuers to
rely on the exemption if the number of
optionholders that do not meet the
eligibility condition are insignificant
both as to the aggregate number of
optionholders and number of
outstanding options. Further, following
the effective date of the exemption, to be
able to rely on the exemption, including
the insignificant deviation provision,
the issuer must have made a good faith
and reasonable attempt to comply with
the conditions of the exemption.
The exemption from Section 12(g)
registration for compensatory employee
stock options of Exchange Act reporting
issuers does not include any
information conditions, other than those
arising from the registration of a class of
security under the Exchange Act or
arising under Exchange Act Section
15(d).
We are not conditioning the
availability of the exemption on the
issuer being current in its Exchange Act
reporting. As we noted in the proposing
release, we believe it would seem
inappropriate for the issuer to lose the
exemption, and be required to register a
class of compensatory employee stock
options under Exchange Act Section
12(g), because it was late in filing a
required Exchange Act report and, for
the days before that report was filed,
was not ‘‘current’’ in its Exchange Act
reporting. One commenter agreed with
this approach.80
While we had proposed that the
exemption apply only where the issuers
had registered the class of equity
security underlying the compensatory
employee stock options, which would
provide optionholders the protections of
Exchange Act Sections 13(e) 81 and
14(e),82 we agree with one commenter
that the exemption should be available
to all issuers required to file periodic
reports under the Exchange Act.83 For
those issuers required to file periodic
reports pursuant to Exchange Act
Section 15(d), the exemption will no
longer be available once their obligation
to file reports under Exchange Act
Section 15(d) is suspended. In that case,
to maintain the exemption, the issuer
would have to register a class of security
under Exchange Act Section 12.
We believe that once an issuer has
500 or more optionholders it is more
likely that it will have 500 or more
holders of the shares underlying the
80 See
letter from ABA.
U.S.C. 78m(e).
82 15 U.S.C. 78n(e).
83 See letter from ABA. Exchange Act Section
14(e) would, of course, continue to apply regardless
of whether the issuer had registered the class of
equity security underlying the compensatory
employee stock options.
81 15
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69561
options and therefore will be required to
register that class under Exchange Act
Section 12 if it also has more than $10
million in assets. In addition, if the
issuer becomes a private, non-reporting
issuer due to the suspension or
termination of its reporting obligation, it
may rely on the exemption for the
compensatory employee stock options
of private, non-reporting issuers if the
conditions to that exemption are
satisfied.
C. Registering When No Longer Eligible
for Exemption
If a private, non-reporting issuer
becomes ineligible to rely on the
exemption, the issuer will be permitted
up to 120 calendar days from the date
it became ineligible to rely on the
exemption to file a registration
statement to register under Exchange
Act Section 12(g) the class of
compensatory employee stock options.
For a reporting issuer that becomes
ineligible to rely on the exemption, the
issuer will be permitted up to 60
calendar days from the date it became
ineligible to rely on the exemption to
file a registration statement to register
under Exchange Act Section 12(g) the
class of compensatory employee stock
options or a class of security. We have
revised the transition provision for
private, non-reporting issuers in
response to a commenter’s concern that
60 days would not be sufficient for
private, non-reporting issuers to prepare
a Form 10 registration statement
including audited financial
statements.84 We have retained the 60
day time period for reporting issuers
because they already would have been
required to prepare and file periodic
reports under the Exchange Act,
including audited financial statements.
III. Paperwork Reduction Act
A. Background
Certain provisions of the amendments
to Exchange Act Rule 12h–1 85 contain
‘‘collection of information’’
requirements within the meaning of the
Paperwork Reduction Act of 1995
(‘‘PRA’’).86 We published a notice
requesting comment on the collection of
information requirements in the
Proposing Release and submitted these
to the Office of Management and Budget
(‘‘OMB’’) for review and approval in
accordance with the PRA.87 OMB
approved the collection and the control
number is 3235–0632. An agency may
not conduct or sponsor, and a person is
84 See
letter from ABA.
CFR 240.12h–1.
86 44 U.S.C. 3501 et seq.
87 44 U.S.C. 3507(d) and 5 CFR 1320.11.
85 17
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not required to respond to, a collection
of information unless it displays a
currently valid OMB control number.
The title for this information is:
• Exchange Act Rule 12h–1.
The hours and costs associated with
preparation of notices, maintaining
Internet sites, and preparation of
information to be disclosed to
optionholders for private, non-reporting
issuers relying on the exemption from
Exchange Act Section 12(g) 88
registration constitute cost burdens
imposed by the collection of
information. The exemption available to
reporting issuers will not constitute new
collections of information. The
amendments will not affect existing
collections of information.
The exemptions from Exchange Act
Section 12(g) registration are being
adopted pursuant to the Exchange Act.
The information collection requirements
related to the exemption for private,
non-reporting issuers are a condition to
reliance on the exemption. There is no
mandatory retention period for the
information disclosed and the
information disclosed is not required to
be filed with the Commission.
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B. Summary of Collection of
Information
Our amendments to Exchange Act
Rule 12h–1 will provide an exemption
for private, non-reporting issuers from
Exchange Act Section 12(g) registration
for compensatory employee stock
options issued under employee stock
option plans. The amendments also will
provide an exemption from Exchange
Act Section 12(g) registration for
compensatory employee stock options
of issuers that are subject to the periodic
reporting requirements of the Exchange
Act pursuant to Exchange Act Section
13 or Section 15(d).
The requirements regarding notice of
information availability, Internet
availability of information, and, for
certain issuers, the preparation of
information related to the exemption
from Exchange Act Section 12(g) for
compensatory employee stock options
of private, non-reporting issuers
constitute a new collection of
information under the Exchange Act.
The information provision in the
exemption for private, non-reporting
issuers is not a new collection of
information for those private, nonreporting issuers that also are required
to provide such information to
optionholders pursuant to Securities
Act Rule 701 89 or that already prepare
88 15
89 17
U.S.C. 78l(g).
CFR 230.701.
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and provide such information to their
shareholders.
The collection of information is
required for those private, non-reporting
issuers that rely on the exemption
because they had 500 or more
optionholders and more than $10
million in assets at the end of their
fiscal year. The issuers likely to use the
exemption are those private, nonreporting issuers that had more than $10
million in assets and had used stock
options to compensate employees,
directors, consultants, and advisors on a
broad basis. The exemption from
Section 12(g) registration for
compensatory employee stock options
of reporting issuers that are subject to
the periodic reporting requirements of
the Exchange Act pursuant to Exchange
Act Section 13 or Section 15(d) does not
impose any new collection of
information on these reporting issuers.
C. Summary of Comments
None of the commenters addressed
our request for comment on the PRA
analysis and, accordingly, we have not
revised our PRA estimates.
D. Paperwork Reduction Act Burden
Estimates
For purposes of the PRA, we estimate
that the annual burden for responding to
the collection of information in the
exemption will not increase
significantly for most private, nonreporting issuers, due to the current
disclosure provisions of Securities Act
Rule 701 and the probability that such
issuers already prepare such
information for other purposes. The
costs may increase for those private,
non-reporting issuers who are not
relying on Securities Act Rule 701 when
they grant compensatory employee
stock options or who do not prepare the
information for other purposes. The cost
of providing such information may
increase because of the requirement in
the exemption for private, non-reporting
issuers to provide the required
information.
Our estimates represent the burden
for private, non-reporting issuers
eligible to rely on the exemption.
Because the registration provisions of
Exchange Act Section 12(g) apply only
to an issuer with 500 or more holders
of record of a class of equity security
and assets in excess of $10 million at
the end of its most recently ended fiscal
year, only those private, non-reporting
issuers satisfying those thresholds will
be subject to the collection of
information. The Division of
Corporation Finance has granted noaction relief from registration of
compensatory employee stock options
PO 00000
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to 30 private, non-reporting issuers
during the period 1992 through 2006. If
we assume that approximately 3 new
private, non-reporting issuers will be
relying on the exemption each year and
that a certain number of private, nonreporting issuers will no longer be
relying on the exemption because they
have become reporting issuers, have
been acquired, or have terminated
business, we estimate that
approximately 40 private, non-reporting
issuers each year may be relying on the
exemption. The exemption for private,
non-reporting issuers would terminate
once such issuer became subject to the
reporting requirements of the Exchange
Act or was no longer relying on the
exemption. Thus, the number of private,
non-reporting issuers that may rely on
the exemption may vary from year to
year.
For purposes of the PRA, we estimate
the annual paperwork burden for
private, non-reporting issuers desiring
to rely on the exemption and to comply
with our collection of information
requirements to be approximately 20
hours of in-house issuer personnel time
and to be approximately $24,000 for the
services of outside professionals.90
These estimates include the time and
the cost of preparing and reviewing the
information and making the information
available to optionholders. We assume
that the same number of private, nonreporting issuers will rely on the
exemption each year.
We estimate that 25% of the burden
of preparation and provision of the
information required by the exemption
is carried by the issuer internally and
that 75% of the burden is carried by
outside professionals retained by the
issuer at an average cost of $400 per
hour.91 The portion of the burden
carried by outside professionals is
reflected as a cost, while the portion of
the burden carried by the issuer
internally is reflected in hours.
IV. Cost-Benefit Analysis
A. Background
Compensatory stock options provide a
method to use non-cash compensation
to attract, retain, and motivate issuer
employees, directors and consultants.
Since the 1990s, a number of private,
non-reporting issuers have granted
90 For administrative convenience, the
presentation of the totals related to the paperwork
burden hours have been rounded to the nearest
whole number and the cost totals have been
rounded to the nearest hundred.
91 In connection with other recent rulemakings,
we have had discussions with several private law
firms to estimate an hourly rate of $400 as the
average cost of outside professionals that assist
issuers in preparing disclosures for offerings.
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compensatory employee stock options
to 500 or more employees, directors,
and consultants. Compensatory
employee stock options also are used
routinely by issuers required to report
under the Exchange Act.
Stock options, including stock options
issued to employees under stock option
plans, are a separate class of equity
security for purposes of the Exchange
Act. Under Exchange Act Section 12(g),
an issuer with 500 or more holders of
record of a class of equity security and
assets in excess of $10 million at the
end of its most recently ended fiscal
year must register that class of equity
security, unless there is an available
exemption from registration. While
there is an exemption from Exchange
Act Section 12(g) registration for
interests and participations in certain
other types of employee compensation
plans involving securities, currently
there is no exemption for compensatory
employee stock options.
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B. Summary of Amendments
We are adopting two exemptions from
the registration provisions of Exchange
Act Section 12(g) for compensatory
employee stock options issued under
employee stock option plans that are
limited to employees, directors,
consultants, and advisors of the issuer.
One amendment to Exchange Act
Rule 12h–1 will provide an exemption
from Exchange Act Section 12(g)
registration for compensatory employee
stock options of an issuer that does not
have a class of securities registered
under Exchange Act Section 12 and is
not subject to the reporting
requirements of Exchange Act Section
15(d), where the following conditions
are present:
• Eligible optionholders are limited to
employees, directors, consultants, and
advisors of the issuer, its parents, or
majority-owned subsidiaries of the
issuer or its parents and permitted
transferees;
• Transferability by optionholders of
compensatory employee stock options
and, prior to exercise, the shares to be
received on exercise of those options is
restricted; and
• Risk and financial information is
provided to optionholders that is of the
type that would be required under
Securities Act Rule 701 if securities sold
in reliance on Securities Act Rule 701
exceeded $5 million in a 12-month
period.
The second amendment to Exchange
Act Rule 12h–1 will provide an
exemption for compensatory employee
stock options of issuers that are required
to file reports under the Exchange Act
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pursuant to Exchange Act Section 13 or
Exchange Act Section 15(d).
1. Expected Benefits
Benefits of the exemption for private,
non-reporting issuers are likely to
include the following: (1) Lower costs
to, and reduced uncertainty for, private,
non-reporting issuers desiring relief
from registration under Section 12(g) for
compensatory employee stock options
issued to employees, directors,
consultants, and advisors for
compensatory purposes; (2) benefits to
private, non-reporting issuers in
designing and implementing employee
stock option plans without regard to
concerns arising from Exchange Section
12(g) registration of the compensatory
employee stock options; (3) benefits to
private, non-reporting issuers arising
from the use of electronic or Internetbased methods of providing the
information necessary to satisfy the
information requirement of the
exemption; and (4) benefits to
optionholders of private, non-reporting
issuers arising from the required
provision of information under the
exemption.
Private, non-reporting issuers would
benefit from cost savings as a result of
the exemption from Section 12(g)
registration of their compensatory
employee stock options. A number of
private, non-reporting issuers that have
500 or more optionholders and assets in
excess of $10 million have hired
attorneys and requested no-action relief
from the Division of Corporation
Finance with regard to the registration
of the options. The conditions to noaction relief from the Division include
information provision conditions that
are more extensive than in the
exemption. The exemption, which is
available if the provisions of the
exemption are satisfied, will reduce the
legal and other costs to a private, nonreporting issuer arising from the noaction request and relief. Such cost
savings include reduced legal and
accounting fees arising from both the
request for no-action relief and for
preparation of reports equivalent to
Exchange Act reports of a reporting
issuer on an ongoing basis. Because we
expect that a number of the issuers that
may take advantage of the exemption
may be smaller issuers, these cost
savings could be significant relative to
revenues.
The amendments require the same
information that the issuer otherwise
would be required to provide if
securities sold in reliance on Securities
Act Rule 701 exceeded $5 million
during any consecutive 12-month
period. Thus, for private, non-reporting
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69563
issuers with a significant number of
optionholders (and with more than $10
million in assets at the end of its fiscal
year), it is likely that such issuer either
already is obligated to provide the same
information to optionholders due to
sales of securities in reliance on
Securities Act Rule 701, or already
prepares and, as such, provides such
information to its shareholders.92
Further, any private, non-reporting
issuer that has received no-action relief
regarding registration of its
compensatory employee stock options
will face reduced disclosure costs under
the exemption.
The amendment also will benefit
private, non-reporting issuers by
providing the less expensive alternative
of electronic or Internet-based methods
of providing the information necessary
to satisfy the information requirement of
the exemption.
Private, non-reporting issuers also
will benefit from the certainty that the
exemption will provide in designing
and implementing compensation
programs and employee stock option
plans. The amendments identify the
eligibility provisions and transfer
restrictions that need to be contained in
compensatory stock option plans or
other written agreements, thereby
lessening the need for issuers, at the
time that Section 12(g) registration relief
is needed for the compensatory
employee stock options, to amend their
stock option plans and outstanding
options to include provisions that
would be necessary to obtain no-action
relief. The exemption will help private,
non-reporting issuers avoid becoming
subject to the registration and reporting
requirements of the Exchange Act prior
to the time they have public
shareholders.
Optionholders also will benefit from
the exemption. The exemption assures
the provision of the information every
six months, including financial
information that is not more than 180
days old, to optionholders. Employees,
directors, consultants, and advisors
would benefit from the exemption
because private, non-reporting issuers
will be able to use options for
compensatory purposes without
concern that the option grants will
subject the issuer to Exchange Act
registration.
The exemption for reporting issuers
also will benefit optionholders and
holders of shares received on exercise of
92 One commenter noted that ‘‘they expect that
most non-public companies with the number of
compensatory optionholders necessary to benefit
from the proposed exemption are likely to already
be obtaining audited financial statements for other
business and financial purposes.’’ Letter from E&Y.
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options. Optionholders and holders of
shares received on exercise of options
will have access to the issuer’s publicly
filed Exchange Act reports. Further, if
the issuer has registered under
Exchange Act Section 12 the class of
equity security underlying the
compensatory employee stock options,
certain provisions of Exchange Act
Sections 13 and 14 would apply to the
options and the securities issuable on
exercise of the options. Holders of
shares issued on exercise of those
options would have the same rights as
other shareholders of the issuer. Thus,
the exemption eliminates a possible
disincentive for issuers to use certain
compensatory employee stock options.
This may be a benefit if this type of
compensation is useful in attracting and
retaining qualified employees that
increase the issuer’s competitiveness.
2. Expected Costs
Issuers will be required to satisfy the
provisions of the amendments to avoid
registering under Exchange Act Section
12(g) their compensatory employee
stock options if the registration
thresholds are met at the end of the
issuer’s fiscal year. Private, nonreporting issuers may incur certain costs
to rely on the exemption including (1)
costs to amend their existing employee
stock option plans if the plans and
option grants do not contain the
restrictive and information provisions of
the exemption; (2) costs arising from
preparing and providing the information
required by the exemption to the extent
that the issuer does not already prepare
or provide such information for other
purposes; and (3) costs of maintaining
an Internet site on which the
information may be available if the
issuer chooses to use that method to
provide the required information to
optionholders.
We believe that the provisions of the
exemption are consistent in many
respects with the restrictive provisions
of other laws and rules governing option
grants and, thus, the costs to private,
non-reporting issuers should not be
increased. The exemption provisions
also are consistent with or are more
flexible than the existing conditions for
obtaining no-action relief from the
Division of Corporation Finance.
Therefore, the costs to private, nonreporting issuers to prepare the
information required by the exemption
may be the same or less than the current
costs to the issuer relying on registration
relief provided in a no-action letter
issued by the Division of Corporation
Finance.
Those private, non-reporting issuers
who do not already prepare the required
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information will face costs if they desire
to avail themselves of the exemption. In
addition to the costs discussed in the
Paperwork Reduction Act analysis,93 as
described below, issuers may face costs
in maintaining the confidentiality of the
information required to be provided,
including preparation and enforcement
of confidentiality agreements entered
into with optionholders. It should be
noted, however, that these increased
costs will be borne voluntarily, as it is
within the issuer’s control as to the
number of optionholders it may have.
Issuers are able to perform their own
cost-benefit analysis to determine
whether to comply with the conditions
to the exemption or avoid issuing
options to 500 or more optionholders.
Private, non-reporting issuers may
incur costs in providing the information
required under the exemption. These
costs may include printing and sending
the information or making the
information available on an Internet
site.
The Division of Corporation Finance
has granted no-action relief from
registration of compensatory employee
stock options to 30 private, nonreporting issuers during the period 1992
through 2006. If we assume that
approximately 3 new private, nonreporting issuers will be relying on the
exemption each year and that a certain
number of private, non-reporting issuers
will no longer be relying on the
exemption because they have become
reporting issuers, have been acquired, or
have terminated business, we estimate
that approximately 40 private, nonreporting issuers each year may be
relying on the exemption. The
exemption for private, non-reporting
issuers will terminate once such issuer
becomes subject to the reporting
requirements of the Exchange Act or is
no longer relying on the exemption.
Thus, the number of private, nonreporting issuers that may rely on the
exemption may vary from year to year.
For purposes of the Paperwork
Reduction Act, we have estimated that
the annual paperwork burden for
private, non-reporting issuers desiring
to rely on the exemption and to comply
with our collection of information
requirements to be approximately 20
hours of in-house issuer personnel time,
which is equivalent to $3,500, and to be
approximately $24,000 for the services
of outside professionals, for a total
paperwork burden cost of $27,500.94
93 See discussion under ‘‘PAPERWORK
REDUCTION ACT,’’ above.
94 For administrative convenience, the
presentation of the totals related to the paperwork
burden hours have been rounded to the nearest
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These estimates include the time and
the cost of preparing and reviewing the
information and making the information
available to optionholders. We have
assumed that the same number of
private, non-reporting issuers would
rely on the exemption each year. We
have estimated that 25% of the burden
of preparation and provision of the
information required by the exemption
would be carried by the private, nonreporting issuer internally and that 75%
of the burden would be carried by
outside professionals retained by the
private, non-reporting issuer at an
average cost of $400 per hour.95
Although a private, non-reporting
issuer relying on the exemption will
benefit from cost savings associated
with not having to register the
compensatory employee stock options
as a separate class of equity security
under the Exchange Act, or obtaining
no-action relief, by not doing so, an
optionholder will not have the benefit of
the disclosures contained in Exchange
Act reports that the issuer otherwise
would be obligated to file with us,
including audited financial statements,
or the disclosures required to be
provided under the terms of the noaction relief.
Optionholders also will not be able to
freely sell their options while the
private, non-reporting issuer is relying
on the exemption. Optionholders will
not be able realize value from the
options or, prior to exercise of the
options, the shares to be issued on
exercise of the options until after the
private, non-reporting issuer becomes
subject to the reporting requirements of
the Exchange Act or is not relying on
the exemption, other than as a result of
certain permitted transfers. Many
private, non-reporting issuers that grant
options, however, currently restrict the
transfer of securities held by holders of
shares received on exercise of options,
in most cases until after the issuer
becomes subject to the reporting
requirements of the Exchange Act or
unless the issuer is acquired by another
entity. In some cases, private, nonreporting issuers retain the right to
repurchase options or shares received
on exercise of an option. Any exercise
of such repurchase right by the issuer
would be a cost to such issuer.
whole number and the cost totals have been
rounded to the nearest hundred.
95 In connection with other recent rulemakings,
we have had discussions with several private law
firms to estimate an hourly rate of $400 as the
average cost of outside professionals that assist
issuers in preparing disclosures and conducting
registered offerings. Consistent with recent
rulemaking releases, we estimate the value of work
performed by the company internally at a cost of
$175 per hour.
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V. Consideration of Burden on
Competition and Promotion of
Efficiency, Competition and Capital
Formation Analysis
Section 23(a)(2) 96 of the Exchange
Act requires us, when adopting rules
under the Exchange Act, to consider the
impact that any new rule would have on
competition. In addition, Section
23(a)(2) prohibits us from adopting any
rule that would impose a burden on
competition not necessary or
appropriate in furtherance of the
purposes of the Exchange Act. We are
adopting an exemption for private, nonreporting issuers from Exchange Act
Section 12(g) registration for
compensatory employee stock options
issued under employee stock option
plans. We also are adopting an
exemption from Exchange Act Section
12(g) registration for compensatory
employee stock options of issuers that
are subject to the reporting requirements
of the Exchange Act pursuant to
Exchange Act Section 13 or Exchange
Act Section 15(d).
We expect that the exemption for
private, non-reporting issuers from
Exchange Act registration of
compensatory employee stock options
will provide necessary certainty to those
issuers in their compensation decisions
and will help them avoid becoming
subject to the registration and reporting
requirements of the Exchange Act prior
to the time they have public
shareholders. We anticipate that the
exemption would save such private,
non-reporting issuers costs and will not
require that companies make their
confidential issuer information public
prior to the issuer voluntarily
determining to become a public
reporting issuer or being required to
register a class of equity security under
the Exchange Act. Further, we
anticipate that the exemption will
continue to provide private, nonreporting issuers freedom to determine
appropriate methods of compensating
their employees, directors, consultants,
and advisors without concern that they
will be required to register their
compensatory employee stock options
as a class of equity security under
Exchange Act Section 12. Thus, the
exemption eliminates a possible
disincentive for issuers to use certain
compensatory employee stock options.
This may be a benefit if this type of
compensation is useful in attracting and
retaining qualified employees that
increase the private, non-reporting
issuer’s competitiveness.
96 15
U.S.C. 78w(a)(2).
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21:15 Dec 06, 2007
The exemption for reporting issuers
will provide certainty regarding the
obligations of issuers that already are
subject to the reporting requirements of
the Exchange Act pursuant to Exchange
Act Section 13 or Exchange Act Section
15(d) to register their compensatory
employee stock options under the
Exchange Act. In addition, in the case
of these reporting issuers, the
optionholders would have access to the
issuer’s publicly filed Exchange Act
reports and, if the issuer has registered
under Exchange Act Section 12 the class
of equity security underlying the
options, the appropriate provisions of
Sections 13 and 14 would apply to the
compensatory employee stock options
and the equity securities issuable on
exercise of those options.
Section 3(f) 97 of the Exchange Act
requires us, when engaging in
rulemaking that requires us to consider
or determine whether an action is
necessary or appropriate in the public
interest, to consider, in addition to the
protection of investors, whether the
action will promote efficiency,
competition, and capital formation.
We believe that the exemption from
Exchange Act registration for the
compensatory stock options may
beneficially affect the issuer’s ability to
compete for employees because it will
allow such issuers to continue to use
employee stock options in their
compensation programs, thus enabling
them to compete for such employees
with both private, non-reporting issuers
and public reporting issuers. The
exemption also will provide an eligible
issuer a more efficient, available
exemption from Exchange Act Section
12(g) registration of compensatory
employee stock options, instead of such
issuer having to seek no-action relief or
an exemptive order under Exchange Act
Section 12(h).
The exemptions do not relate to or
affect capital formation, as the
compensatory employee stock options
covered by the exemptions are issued
for compensatory and not capital raising
purposes.
The exemptions will allow eligible
issuers to continue to have freedom to
determine appropriate methods of
compensating their employees,
directors, consultants, and advisors. For
private, non-reporting issuers, these
compensation decisions could be made
without concern that the issuer will
become subject to the Exchange Act
reporting requirements before they have
public shareholders.
97 15
Jkt 214001
PO 00000
U.S.C. 78c(f).
Frm 00013
Fmt 4701
Sfmt 4700
69565
VI. Regulatory Flexibility Act
Certification
The Commission hereby certifies
pursuant to 5 U.S.C. 605(b) that the two
exemptions from the registration
provisions of Exchange Act Section
12(g) for compensatory employee stock
options issued under employee stock
option plans that are limited to
employees, directors, consultants, and
advisors of the issuer, its parents, and
the majority-owned subsidiaries of the
issuer or its parents will not have a
significant economic impact on a
substantial number of small entities. We
prepared an Initial Regulatory
Flexibility Act Analysis in which we
stated that the proposed exemption
would not affect issuers that are small
entities because small entities do not
satisfy the asset threshold of Section
12(g) and therefore the exemptions
would not be needed by such entities
until their asset size increased to more
than $10 million at the end of a fiscal
year. We stated, therefore, that there
may not be a large number of small
entities that may be impacted. Because
we received no comment disagreeing
with that conclusion we are certifying
that the two exemptions will not have
a significant economic impact on a
substantial number of small entities.
VII. Administrative Procedure Act
Section 553(d) of the Administrative
Procedure Act generally provides that,
unless an exception applies, a
substantive rule may not be made
effective less than 30 days after notice
of the rule has been published in the
Federal Register. One exception to the
30-day requirement is if such rule grants
or recognizes an exemption or relieves
a restriction. We are adopting two
exemptions designed to relieve issuers
from the registration requirements of
Section 12(g) for compensatory
employee stock options. The rules only
affect issuers that issue stock options as
compensation to their employees,
directors, consultants, and advisors.
Even after the rules are effective, issuers
may still register the compensatory
employee stock options under Exchange
Act Section 12(g) as before; however,
the new amendments to Exchange Act
Rule 12h–1 grant exemptions to the
requirement, relieving eligible issuers of
the Exchange Act registration
obligations, subject to certain
conditions. Immediate effectiveness will
provide certainty to issuers that provide
compensatory employee stock options
to their current or future employees,
directors, consultants, and advisors as a
form of compensation. Eligible issuers
that satisfy the conditions to the
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exemptions can make compensation
decisions without having to register
under Exchange Act Section 12(g) the
compensatory employee stock options
or seek a no-action letter from the staff
of the Commission or an exemption
under Section 12(h) from the
Commission for such registration relief.
VIII. Statutory Basis and Text of Rule
Amendments
We are amending Exchange Act Rule
12h–1 under the authority in Sections
12, 23, and 36 of the Exchange Act, as
amended.
List of Subjects in 17 CFR Part 240
Reporting and recordkeeping
requirements, Securities.
Text of Rule
For the reasons set out in the
preamble, we are amending Title 17,
Chapter II of the Code of Federal
Regulations as follows:
I
PART 240—GENERAL RULES AND
REGULATIONS, SECURITIES
EXCHANGE ACT OF 1934
1. The authority citation for part 240
continues to read in part as follows:
I
Authority: 15 U.S.C. 77c, 77d, 77g, 77j,
77s, 77z–2, 77z–3, 77eee, 77ggg, 77nnn,
77sss, 77ttt, 78c, 78d, 78e, 78f, 78g, 78i, 78j,
78j–1, 78k, 78k–1, 78l, 78m, 78n, 78o, 78p,
78q, 78s, 78u–5, 78w, 78x, 78ll, 78mm, 80a–
20, 80a–23, 80a–29, 80a–37, 80b–3, 80b–4,
80b–11, and 7201 et seq.; and 18 U.S.C. 1350,
unless otherwise noted.
*
*
*
*
*
2. Amend § 240.12h-1 to remove
‘‘and’’ at the end of paragraph (d), and
add paragraphs (f) and (g) to read as
follows:
I
§ 240.12h–1 Exemptions from registration
under section 12(g) of the Act.
jlentini on PROD1PC65 with RULES3
*
*
*
*
*
(f)(1) Stock options issued under
written compensatory stock option
plans under the following conditions:
(i) The issuer of the equity security
underlying the stock options does not
have a class of security registered under
section 12 of the Act and is not required
to file reports pursuant to section 15(d)
of the Act;
(ii) The stock options have been
issued pursuant to one or more written
compensatory stock option plans
established by the issuer, its parents, its
majority-owned subsidiaries or
majority-owned subsidiaries of the
issuer’s parents;
Note to paragraph (f)(1)(ii): All stock
options issued under all written
compensatory stock option plans on the same
class of equity security of the issuer will be
considered part of the same class of equity
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21:15 Dec 06, 2007
Jkt 214001
security for purposes of the provisions of
paragraph (f) of this section.
(iii) The stock options are held only
by those persons described in Rule
701(c) under the Securities Act (17 CFR
230.701(c)) or their permitted
transferees as provided in paragraph
(f)(1)(iv) of this section;
(iv) The stock options and, prior to
exercise, the shares to be issued on
exercise of the stock options are
restricted as to transfer by the
optionholder other than to persons who
are family members (as defined in Rule
701(c)(3) under the Securities Act (17
CFR 230.701(c)(3)) through gifts or
domestic relations orders, or to an
executor or guardian of the optionholder
upon the death or disability of the
optionholder until the issuer becomes
subject to the reporting requirements of
section 13 or 15(d) of the Act or is no
longer relying on the exemption
pursuant to this section; provided that
the optionholder may transfer the stock
options to the issuer, or in connection
with a change of control or other
acquisition transaction involving the
issuer, if after such transaction the stock
options no longer will be outstanding
and the issuer no longer will be relying
on the exemption pursuant to this
section;
Note to paragraph (f)(1)(iv): For purposes
of this section, optionholders may include
any permitted transferee under paragraph
(f)(1)(iv) of this section; provided that such
permitted transferees may not further transfer
the stock options..
(v) The stock options and the shares
issuable upon exercise of such stock
options are restricted as to any pledge,
hypothecation, or other transfer,
including any short position, any ‘‘put
equivalent position’’ (as defined in
§ 240.16a–1(h) of this chapter), or any
‘‘call equivalent position’’ (as defined in
§ 240.16a–1(b) of this chapter) by the
optionholder prior to exercise of an
option, except in the circumstances
permitted in paragraph (f)(1)(iv) of this
section, until the issuer becomes subject
to the reporting requirements of section
13 or 15(d) of the Act or is no longer
relying on the exemption pursuant
paragraph (f)(1) of this section; and
Note to paragraphs (f)(1)(iv) and (f)(1)(v):
The transferability restrictions in paragraphs
(f)(1)(iv) and (f)(1)(v) of this section must be
contained in a written compensatory stock
option plan, individual written
compensatory stock option agreement, other
stock purchase or stockholder agreement to
which the issuer and the optionholder are a
signatory or party, other enforceable
agreement by or against the issuer and the
optionholder, or in the issuer’s by-laws or
certificate or articles of incorporation.
PO 00000
Frm 00014
Fmt 4701
Sfmt 4700
(vi) The issuer has agreed in the
written compensatory stock option plan,
the individual written compensatory
stock option agreement, or another
agreement enforceable against the issuer
to provide the following information to
optionholders once the issuer is relying
on the exemption pursuant to paragraph
(f)(1) of this section until the issuer
becomes subject to the reporting
requirements of section 13 or 15(d) of
the Act or is no longer relying on the
exemption pursuant paragraph (f)(1) of
this section:
The information described in Rules
701(e)(3), (4), and (5) under the
Securities Act (17 CFR 230.701(e)(3),
(4), and (5)), every six months with the
financial statements being not more
than 180 days old and with such
information provided either by physical
or electronic delivery to the
optionholders or by written notice to the
optionholders of the availability of the
information on an Internet site that may
be password-protected and of any
password needed to access the
information.
Note to paragraph (f)(1)(vi): The issuer
may request that the optionholder agree to
keep the information to be provided pursuant
to this section confidential. If an
optionholder does not agree to keep the
information to be provided pursuant to this
section confidential, then the issuer is not
required to provide the information.
(2) If the exemption provided by
paragraph (f)(1) of this section ceases to
be available, the issuer of the stock
options that is relying on the exemption
provided by this section must file a
registration statement to register the
class of stock options under section 12
of the Act within 120 calendar days
after the exemption provided by
paragraph (f)(1) of this section ceases to
be available; and
(g)(1) Stock options issued under
written compensatory stock option
plans under the following conditions:
(i) The issuer of the equity security
underlying the stock options has
registered a class of security under
section 12 of the Act or is required to
file periodic reports pursuant to section
15(d) of the Act;
(ii) The stock options have been
issued pursuant to one or more written
compensatory stock option plans
established by the issuer, its parents, its
majority-owned subsidiaries or
majority-owned subsidiaries of the
issuer’s parents;
Note to paragraph (g)(1)(ii): All stock
options issued under all of the written
compensatory stock option plans on the same
class of equity security of the issuer will be
considered part of the same class of equity
E:\FR\FM\07DER3.SGM
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security of the issuer for purposes of the
provisions of paragraph (g) of this section.
jlentini on PROD1PC65 with RULES3
(iii) The stock options are held only
by those persons described in Rule
701(c) under the Securities Act (17 CFR
230.701(c)) or those persons specified in
General Instruction A.1(a) of Form S–8
(17 CFR 239.16b); provided that an
issuer can still rely on this exemption if
there is an insignificant deviation from
satisfaction of the condition in this
paragraph (g)(1)(iii) and after December
7, 2007 the issuer has made a good faith
VerDate Aug<31>2005
21:15 Dec 06, 2007
Jkt 214001
and reasonable attempt to comply with
the conditions of this paragraph
(g)(1)(iii). For purposes of this paragraph
(g)(1)(iii), an insignificant deviation
exists if the number of optionholders
that do not meet the condition in this
paragraph (g)(1)(iii) are insignificant
both as to the aggregate number of
optionholders and number of
outstanding stock options.
(2) If the exemption provided by
paragraph (g)(1) of this section ceases to
be available, the issuer of the stock
options that is relying on the exemption
PO 00000
Frm 00015
Fmt 4701
Sfmt 4700
69567
provided by this section must file a
registration statement to register the
class of stock options or a class of
security under section 12 of the Act
within 60 calendar days after the
exemption provided in paragraph (g)(1)
of this section ceases to be available.
By the Commission.
Dated: December 3, 2007.
Nancy M. Morris,
Secretary.
[FR Doc. E7–23756 Filed 12–6–07; 8:45 am]
BILLING CODE 8011–01–P
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]]>Agencies
[Federal Register Volume 72, Number 235 (Friday, December 7, 2007)]
[Rules and Regulations]
[Pages 69554-69567]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: E7-23756]
[[Page 69553]]
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Part V
Securities and Exchange Commission
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17 CFR Part 240
Exemption of Compensatory Employee Stock Options From Registration
Under Section 12(G) of the Securities Exchange Act of 1934; Final Rule
Federal Register / Vol. 72, No. 235 / Friday, December 7, 2007 /
Rules and Regulations
[[Page 69554]]
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SECURITIES AND EXCHANGE COMMISSION
17 CFR Part 240
[Release No. 34-56887; International Series Release No. 1305; File No.
S7-14-07]
RIN 3235-AJ91
Exemption of Compensatory Employee Stock Options From
Registration Under Section 12(G) of the Securities Exchange Act of 1934
AGENCY: Securities and Exchange Commission.
ACTION: Final rule.
-----------------------------------------------------------------------
SUMMARY: We are adopting two exemptions from the registration
requirements of the Securities Exchange Act of 1934 for compensatory
employee stock options. The first exemption will be available to
issuers that are not required to file periodic reports under the
Exchange Act. The second exemption will be available to issuers that
are required to file those reports because they have registered under
Exchange Act Section 12 a class of security or are required to file
reports pursuant to Exchange Act Section 15(d). The exemptions will
apply only to the issuer's compensatory employee stock options and will
not extend to the class of securities underlying those options.
DATES: Effective Date: December 7, 2007.
FOR FURTHER INFORMATION CONTACT: Amy M. Starr, Senior Special Counsel
to the Director, at (202) 551-3115, Division of Corporation Finance,
U.S. Securities and Exchange Commission, 100 F Street, NE., Washington,
DC 20549.
SUPPLEMENTARY INFORMATION: We are amending rule 12h-1 \1\ under the
Securities Exchange Act of 1934.\2\
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\1\ 17 CFR 240.12h-1.
\2\ 15 U.S.C. 78a et seq.
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Table of Contents
I. Introduction and Background
A. Proposing Release and Public Comment Letters
B. Employee Stock Options and Exchange Act Section 12(g)
II. Discussion of Exemptions
A. Exemption for Compensatory Employee Stock Options of Issuers
That Are Not Exchange Act Reporting Issuers
1. Eligible Issuers
2. Eligible Compensatory Employee Stock Options
3. Eligible Option Plan Participants
4. Option Terms
a. Compensatory Employee Stock Option Transferability
Restrictions
b. Permitted Exercisability of Compensatory Employee Stock
Options
5. Required Information
6. Issuer Obligation To Impose the Conditions to the Exemption
B. Exemption for Compensatory Employee Stock Options of Exchange
Act Reporting Issuers
C. Registering When No Longer Eligible for Exemption
III. Paperwork Reduction Act
A. Background
B. Summary of Collection of Information
C. Summary of Comments
D. Paperwork Reduction Act Burden Estimates
IV. Cost-Benefit Analysis
A. Background
B. Summary of Amendments
1. Expected Benefits
2. Expected Costs
V. Consideration of Burden on Competition and Promotion of
Efficiency, Competition and Capital Formation Analysis
VI. Regulatory Flexibility Act Certification
VII. Administrative Procedure Act
VIII. Statutory Basis and Text of Rule Amendments
I. Introduction and Background
A. Proposing Release and Public Comment Letters
On July 5, 2007, we proposed amendments to Exchange Act Rule 12h-1
to provide two exemptions from Exchange Act Section 12(g) \3\
registration for compensatory employee stock options.\4\ The first
proposed exemption applied to compensatory employee stock options of an
issuer that did not have a class of security registered under Exchange
Act Section 12 \5\ and was not subject to the reporting requirements of
Exchange Act Section 15(d),\6\ provided certain conditions were met.
The proposed exemption built on a line of no-action letters issued by
the staff of the Division of Corporation Finance that granted relief
from Exchange Act Section 12(g) registration to private, non-reporting
issuers for their compensatory employee stock options.\7\ The second
proposed exemption applied to compensatory employee stock options of
issuers that were required to file periodic reports under the Exchange
Act because they had registered under Section 12 the class of equity
security underlying those options.
---------------------------------------------------------------------------
\3\ 15 U.S.C. 78l(g).
\4\ Exemption of Compensatory Employee Stock Options from
Registration Under Section 12(g) of the Securities Exchange Act of
1934, Release No. 34-56010 (Jul. 10, 2007) [72 FR 37608]
(``Proposing Release'').
\5\ 15 U.S.C. 78l.
\6\ 15 U.S.C. 78o(d).
\7\ See, e.g., no-action letters to Starbucks Corporation
(available Apr. 2, 1992); Kinko's, Inc. (available Nov. 30, 1999);
Mitchell International Holding, Inc. (available Dec. 27, 2000)
(``Mitchell International''); AMIS Holdings, Inc. (available Jul.
30, 2001) (``AMIS Holdings''); Headstrong Corporation (available
Feb. 28, 2003); and VG Holding Corporation (available Oct. 31, 2006)
(``VG Holding'').
---------------------------------------------------------------------------
In response to our request for comment on the Proposing Release, we
received twelve comment letters from various persons, all of whom
expressed support for the need for the proposed exemptions.\8\
Commenters expressed differing concerns about the scope of the
exemptions, and the transferability restrictions and information
conditions of the proposed exemption for private, non-reporting
issuers. After considering commenters' views, we are adopting
amendments to Exchange Act Rule 12h-1, substantially as proposed, with
some modifications including:
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\8\ See letters from American Bar Association, Committee on
Federal Regulation of Securities (``ABA''); America's Community
Bankers (``ACB''); Center for Audit Quality (``CAQ''); Deloitte &
Touche LLP (``D &T''); Drinker Biddle & Reath LLP (``Drinker'');
Ernst & Young LLP (``E &Y''); Freescale Semiconductor
(``Freescale''); KPMG LLP (``KPMG''); Andrew Ross, Partner, Loeb &
Loeb (``Ross''); New York State Society of Certified Public
Accountants (``NYSSCPA''); Pink Sheets LLC (``Pink Sheets''); and
Simpson Thacher & Bartlett LLP (``Simpson'').
---------------------------------------------------------------------------
Exemption for private, non-reporting issuers:
--Elimination of transferability and ownership restrictions on holders
of shares issued on exercise of compensatory employee stock options;
and
--Elimination of an issuer's obligation to provide certain required
information to holders of shares received on exercise of compensatory
employee stock options.
Exemption for public reporting issuers:
--Expansion of the category of issuers eligible to rely on the
exemption to include any issuer required to file periodic reports under
Exchange Act Section 13 \9\ or Section 15(d).
---------------------------------------------------------------------------
\9\ 15 U.S.C. 78m.
---------------------------------------------------------------------------
B. Employee Stock Options and Exchange Act Section 12(g)
In the 1980s, private, non-reporting issuers began using
compensatory employee stock options \10\ to compensate a broader range
of employees, including executive, middle, and lower-level employees,
directors, and consultants.\11\ Compensatory
[[Page 69555]]
employee stock options provide a method to use non-cash compensation to
attract, retain, and motivate company employees, directors, and
consultants.\12\ Since the 1990s, a number of private, non-reporting
issuers have granted compensatory employee stock options to 500 or more
employees, directors, and consultants.\13\
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\10\ Throughout this release, for purposes of the exemption for
private, non-reporting issuers, we use the term ``compensatory
employee stock options'' to refer to stock options issued to
employees, directors, consultants, and advisors (to the extent
permitted under Securities Act Rule 701 [17 CFR 230.701]). For
reporting issuers, the phrase also refers to those persons described
in General Instruction A.1(a) to Form S-8 [17 CFR 239.16b].
\11\ The National Center for Employee Ownership surveyed 275
venture capital-backed private businesses in the technology and
telecommunications businesses. Of these firms, 77% provided options
to all employees while 23% provided them only to select employees.
``New Data Show Venture-Backed Companies Still Issue Options
Broadly,'' https://www.nceo.org/library/option_venturebacked.html;
see also J. Hand, 2005 ``Give Everyone a Prize? Employee Stock
Options in Private Venture-Backed Firms,'' Working Paper, Kenan-
Flagler Business School, UNC Chapel Hill, available at https://
ssrn.com/abstracts=599904 (``Hand Paper'') (study investigating the
impacts on the equity values of private venture-backed firms of the
organizational depth to which they grant employee stock options).
Securities Act Rule 701, which provides an exemption from
Securities Act registration for non-reporting issuers for offerings
of securities to employees, directors, consultants and advisors, and
specified others, pursuant to written compensatory benefit plans or
agreements, has given private issuers great flexibility in granting
compensatory employee stock options to employees (and other eligible
persons) at all levels. See Rule 701(c) [17 CFR 230.701(c)]; and
Rule 701 Exempt Offerings Pursuant to Compensatory Arrangements,
Release No. 33-7645 (Mar. 8, 1999) [64 FR 11095] (``Rule 701
Release''). See also Compensatory Benefit Plans and Contracts,
Release No. 33-6768 (Apr. 14, 1988) [53 FR 12918].
\12\ See Hand Paper, note 11 supra.
\13\ See no-action letters cited at note 7 supra.
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Under Exchange Act Section 12(g), an issuer with 500 or more
holders of record of a class of equity security and assets in excess of
$10 million at the end of its most recently ended fiscal year must
register that class of equity security, unless there is an available
exemption from registration.\14\ Stock options, including stock options
issued to employees under stock option plans, are a separate class of
equity security for purposes of the Exchange Act.\15\ Accordingly, an
issuer with 500 or more optionholders and more than $10 million in
assets is required to register that class of options under the Exchange
Act, absent an available exemption. While there is an exemption from
Exchange Act Section 12(g) registration for interests and
participations in certain other types of employee compensation plans
involving securities,\16\ currently there is no exemption for
compensatory employee stock options.
---------------------------------------------------------------------------
\14\ The asset threshold was set originally at $1 million in
Section 12(g). Pursuant to its authority under Section 12(h) of the
Exchange Act, the Commission has increased the amount three times;
from $1 million to $3 million in 1982 (System of Classification for
Purposes of Exempting Smaller Issuers From Certain Reporting and
Other Requirements, Release No. 34-18647 (Apr. 13, 1982)[47 FR
17046]), from $3 million to $5 million in 1986 (Reporting by Small
Issuers, Release No. 34-23406 (Jul. 8, 1986) [51 FR 253601]), and
from $5 million to $10 million in 1996 (Relief from Reporting by
Small Issuers, Release No. 34-37157 (May 1, 1996) [61 FR 21353]).
\15\ Exchange Act Section 3(a)(11) [15 U.S.C. 78c(a)(11)]
defines equity security to include any right to purchase a security
(such as options) and Exchange Act Rule 3a11-1 [17 CFR 240.3a11-1]
explicitly includes options in the definition of equity security for
purposes of Exchange Act Sections 12(g) and 16 [15 U.S.C. 78l(g) and
78p]. Exchange Act Section 12(g)(5) [15 U.S.C. 78l(g)(5)] defines
class to include ``all securities of an issuer which are of
substantially similar character and the holders of which enjoy
substantially similar rights and privileges.''
\16\ The exemption from registration under Exchange Act Section
12(g) which is contained in Exchange Act Rule 12h-1(a), was adopted
in 1965, for ``[a]ny interest or participation in an employee stock
bonus, stock purchase, profit sharing, pension, retirement,
incentive, thrift, savings or similar plan which is not transferable
by the holder except in the event of death or mental incompetency,
or any security issued solely to fund such plans.'' Rule 12h-1 is
intended to exempt from Section 12(g) registration the same types of
employee benefit plan interests as Section 3(a)(2) [15 U.S.C.
77c(a)(2)] of the Securities Act of 1933 [15 U.S.C. 77a et seq.]
exempts from Securities Act registration and, thus, does not cover
stock options. See, e.g., L. Loss and J. Seligman, Securities
Regulations, 3d., at Sec. 6-A-4.
---------------------------------------------------------------------------
The addition of Section 12(g) to the Exchange Act in 1964 was
intended ``to extend to investors in certain over-the-counter
securities the same protection now afforded to those in listed
securities by providing that the issuers of certain securities now
traded over the counter shall be subject to the same requirements that
now apply to issuers of securities listed on an exchange.'' \17\
Further, Exchange Act Section 12(g) extended the disclosure and other
Exchange Act safeguards to unlisted securities as a means to prevent
fraud.\18\
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\17\ House of Representatives Report No. 1418 (1964), 88th
Cong., 2d Sess., HR 679, p.1. See also Section 3(c) of the
Securities Act Amendments of 1964, Pub. L. 88-467; 78 Stat. 565.
\18\ Senate Committee Report, No. 379 (1963), 88th Cong., 1st
Sess., p. 63.
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A number of private, non-reporting issuers faced with registration
under Exchange Act Section 12(g) due solely to their compensatory
employee stock options being held by 500 or more holders of record (as
well as having more than $10 million in assets) at the end of their
fiscal year have requested registration relief from our Division of
Corporation Finance.\19\ Since 1992, the Division has provided relief
through no-action letters \20\ to these private issuers when specified
conditions were present. More recently, the Advisory Committee on
Smaller Public Companies, in its Final Report, recommended that we
provide Exchange Act Section 12(g) registration relief for compensatory
employee stock options.\21\
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\19\ The Division has delegated authority to grant (but not
deny) applications for exemption under Exchange Act Section 12(h).
See Rule 200.30-1(e)(7) [17 CFR 200.30-1(e)(7)].
\20\ For the conditions necessary to receive relief under these
letters and orders see, e.g., the no-action letter to Mitchell
International, note 7 supra (for the pre-2001 relief) and the no-
action letters to AMIS Holdings, note 7 supra; ISE Labs, Inc.
(available Jun. 2, 2003); Jazz Semiconductor, Inc. (available Nov.
21, 2005) (``Jazz Semiconductor''); and VG Holding, note 7 supra
(for the expanded relief beginning in 2001).
\21\ Final Report of the Advisory Committee on Smaller Public
Companies to the Securities and Exchange Commission, Apr. 23, 2006
at 87 (``Final Report of the Advisory Committee'').
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As we discussed further in the Proposing Release, we believe that
it is appropriate at this time to adopt two new exemptions from the
registration provisions of Exchange Act Section 12(g) for compensatory
employee stock options issued under employee stock option plans that
are limited to employees, directors, consultants, and advisors of the
issuer, its parents, and majority-owned subsidiaries of the issuer or
its parents.\22\
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\22\ The exemption for private, non-reporting issuers allows
compensatory employee stock options to be held only by those persons
described in Securities Act Rule 701(c) [17 CFR 230.701(c)]
(including permitted transferees), while the exemption for reporting
issuers also allows options to be held by those persons described in
General Instruction A.1(a) to Form S-8. Securities Act Rule 701(c)
lists the categories of persons to whom offers and sales of
securities under written compensatory benefit plans or contracts may
be made in reliance on Securities Act Rule 701 by an issuer, its
parents, and majority-owned subsidiaries of the issuer or its
parents. The categories of persons are: employees (including
specified insurance agents); directors; general partners; trustees
(where the issuer is a business trust); officers; consultants and
advisors (under certain conditions); family members who acquire
their securities from such persons through gifts or domestic
relations orders; and former employees, directors, general partners,
trustees, officers, consultants and advisors only if such persons
were employed by or providing services to the issuer at the time the
securities were offered. The exemption also allows options to be
transferred to (and held by) family members (as described in
Securities Act Rule 701) through gifts or domestic relations orders,
or to an executor or guardian of the optionholder upon the death or
disability of the optionholder. For ease of discussion, in this
release we use the phrase ``employees, directors, consultants and
advisors of the issuer'' to refer to those persons described in
Securities Act Rule 701(c) and transferees permitted by the
exemption. For reporting issuers, the exemption will cover grants of
options made prior to and after the issuer becomes subject to the
Exchange Act reporting requirements.
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II. Discussion of Exemptions
We are adopting two amendments to Exchange Act Rule 12h-1 as
proposed, with some modifications. These amendments will:
Provide an exemption for private, non-reporting issuers
from Exchange Act Section 12(g) registration for compensatory employee
stock options issued under employee stock option plans; and
Provide an exemption from Exchange Act Section 12(g)
registration for compensatory employee stock
[[Page 69556]]
options of issuers that have registered under Exchange Act Section 12 a
class of security or are required to file reports pursuant to Exchange
Act Section 15(d).
Given the differences between issuers that are required to file
periodic reports under the Exchange Act and those issuers that do not
have such an obligation, including the nature of the trading markets
and the amount of publicly available information, we believe that it is
appropriate to adopt separate exemptions for these different types of
issuers.
A. Exemption for Compensatory Employee Stock Options of Issuers That
Are Not Exchange Act Reporting Issuers
We believe it is appropriate to provide an exemption from Exchange
Act registration, based on the factors identified in Exchange Act
Section 12(h),\23\ for compensatory employee stock options of issuers
that are not required to file reports under the Exchange Act.\24\ We
believe that an exemption from Exchange Act registration of
compensatory employee stock options for private, non-reporting issuers
will provide useful certainty to those issuers in their compensation
decisions and will help them avoid becoming subject to the registration
and reporting requirements of the Exchange Act prior to the time they
have public shareholders. The availability of this exemption is subject
to specified limitations, including limitations concerning permitted
optionholders, transferability, and provision of information. We
believe that the conditions to the exemption and the existing statutory
provisions and rules provide holders of compensatory employee stock
options in private, non-reporting issuers appropriate disclosure and
investor protections under the federal securities laws, given the
compensatory circumstances of the securities issuance and the
restrictions on transferability of the compensatory employee stock
options. As such, we believe that the exemption is in the public
interest, in that it would clarify and routinize the basis for an
exemption from Exchange Act Section 12(g) registration for compensatory
employee stock options so private, non-reporting issuers would be able
to continue to use compensatory employee stock options and would
provide appropriate investor protections for optionholders.
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\23\ Exchange Act Section 12(h) provides for exemptive authority
with regard to certain provisions of the Exchange Act. Included in
Exchange Act Section 12(h) is the authority to create appropriate
exemptions from the Exchange Act registration requirements. Under
Exchange Act Section 12(h), the Commission may exempt a class of
securities by rules and regulations or by order if it ``finds, by
reason of the number of public investors, amount of trading interest
in the securities, the number and extent of the activities of the
issuer, income or assets of the issuer, or otherwise, that such
action is not inconsistent with the public interest or the
protection of investors.'' Exchange Act Section 12(h) [15 U.S.C.
78l(h)].
\24\ We believe that the exemption is consistent with the
exemption provided for other employee benefit plans in Exchange Act
Rule 12h-1, which is not available for stock option plans, the
compensatory employee stock options issued pursuant to such plans,
or the securities issued on exercise of such compensatory employee
stock options. We believe that the characteristics of many employee
benefit plans, which are by their own terms limited to employees,
not available to the general public, and subject to transfer
restrictions, obviate the need for applicability of all the rules
and regulations aimed at public trading markets. In addition,
because many of the conditions in the exemption refer to certain
Securities Act Rule 701 definitions and requirements, we believe
that the exemption from Exchange Act Section 12(g) registration will
allow non-reporting issuers to continue to rely on Securities Act
Rule 701 in offering and selling compensatory employee stock options
and the shares issued on exercise of those options.
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1. Eligible Issuers
The amendment we are adopting today will provide an exemption from
Exchange Act Section 12(g) registration for compensatory employee stock
options of the following types of issuers:
Issuers that do not have a class of securities registered
under Exchange Act Section 12; and
Issuers that are not subject to the reporting requirements
of Exchange Act Section 15(d).\25\
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\25\ Under Exchange Act Section 15(d), an issuer's ``duty to
file [reports under Section 15(d) is] automatically suspended if and
so long as any issue of securities of such issuer is registered
pursuant to section 12 of this title.'' [15 U.S.C. 78o(d)].
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The exemption will be available only to those issuers that are not
required to report under the Exchange Act. As such, the exemption will
terminate once the issuer becomes subject to the reporting requirements
of the Exchange Act. The exemption also will terminate if the issuer no
longer satisfies the conditions to the exemption.\26\
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\26\ The exemption under Exchange Act Section 12 will allow
issuers 120 calendar days to register the class of options once an
issuer no longer is able to rely on the exemption. Currently, the
no-action letter relief terminates once an issuer becomes subject to
the Exchange Act reporting requirements. See, e.g., no-action letter
to VG Holding, note 7 supra. Moreover, the exemption will not be
available if the issuer was required, but failed, to register
another class of equity security under the Exchange Act.
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2. Eligible Compensatory Employee Stock Options
The exemption for compensatory employee stock options will:
Apply only to compensatory employee stock options that are
issued under a written compensatory stock option plan \27\ that is
limited to employees, directors, consultants, and advisors of the
issuer, its parents, or majority-owned subsidiaries of the issuer or
its parents; \28\
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\27\ Securities Act Rule 701 is available only for offers and
sales of compensatory employee stock options and the shares issuable
upon exercise of those options that are issued under written
compensatory employee benefit plans of an issuer, its parents, or
majority-owned subsidiaries of the issuer or its parents. See
Securities Act Rule 701(c) [17 CFR 230.701(c)]. Thus, the
requirement that the options be issued under written compensatory
stock option plans will not impose a new obligation on issuers
relying on Securities Act Rule 701 in offering and selling
compensatory employee stock options or the shares issued on exercise
of those options.
\28\ The exemption for the compensatory employee stock options
will not extend to other rights issued in connection with the
compensatory employee stock options, such as stock appreciation
rights. Any such other rights will be evaluated separately for
purposes of Exchange Act Section 12(g) registration. Some commenters
had requested that the exemption apply to all compensation
arrangements involving securities, including restricted stock units,
stock appreciation rights, and other rights or securities. See
letters from ABA and Freescale. Consistent with the scope of the
staff no-action letters granting Section 12(g) registration relief
for compensatory employee stock options, at this time we believe the
exemption should address only compensatory employee stock options.
We, therefore, are not expanding the scope of the exemption beyond
compensatory employee stock options.
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Apply to all compensatory employee stock options issued
under all written compensatory stock option plans on a combined basis
where the securities underlying the compensatory employee stock options
are of the same class of securities of the issuer, with the exemptive
conditions applying to the compensatory employee stock options issued
under each option plan; and
Not extend to any class of securities received or to be
received on exercise of the compensatory employee stock options.
The exemption covers all compensatory employee stock options
meeting the conditions of the exemption, even if the compensatory
employee stock options are issued under separate written option plans
of the issuer, its parents, or majority-owned subsidiaries of the
issuer or its parents.\29\ For the purpose of the exemption, the
compensatory employee stock options will be considered to belong to the
same class of equity security of the issuer if the same class of
securities of the issuer will be issuable on exercise of the
compensatory employee stock options.\30\ While one commenter
[[Page 69557]]
requested that we allow companies to determine whether a particular
group of compensatory employee stock options was the same class as
other compensatory employee stock options for purposes of determining
whether it had met the 500 holder threshold,\31\ we are adopting the
exemption as proposed in this regard.\32\ We believe that, solely for
purposes of determining whether the Rule 12h-1 exemption is available,
it is important to establish uniformity in evaluating whether there are
500 or more holders of compensatory employee stock options and so that
issuers appropriately analyze when Exchange Act Section 12(g) applies
to their compensatory employee stock options.\33\
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\29\ In response to comment (see letter from ABA), we have
clarified that the options may be granted under plans of the issuer,
its parents, and majority-owned subsidiaries of the issuer or its
parents.
\30\ See Exchange Act Section 12(g)(5) [15 U.S.C. 78l(g)(5)].
\31\ See letter from ABA.
\32\ One commenter suggested that the class of options should
only include those options issued after the effective date of the
exemption that satisfied the conditions of the exemption. See letter
from Drinker. We are not adopting such a provision. Under the
Exchange Act, the class of equity security is not determined based
on when the securities are issued. The exemption provides that the
class of compensatory employee stock options for purposes of the
exemption includes all compensatory employee stock options on the
same class of the issuer's securities regardless of whether the plan
is a plan of the issuer, its parents, or majority-owned subsidiaries
of the issuer or its parents. No distinction is made in the
exemption as to when those options are issued.
\33\ This provision will not affect the separate class analysis
under Exchange Act Section 12(g)(5) for other purposes.
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The exemption, as adopted, applies to the compensatory employee
stock options only and not to the securities issued (or to be issued)
on exercise of the compensatory employee stock options. Thus, the
issuer will have to apply the registration requirements of Exchange Act
Section 12 to the class of equity security underlying the compensatory
employee stock options without regard to the exemption.\34\
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\34\ For example, if an issuer had more than $10 million in
assets and 500 or more holders of a class of equity security
underlying the compensatory employee stock options as of the end of
its fiscal year, it would have to register under Exchange Act
Section 12 that class of equity security.
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3. Eligible Option Plan Participants
The exemption is available only where the class of persons eligible
to receive compensatory employee stock options under the stock option
plans is limited to those persons described in the exemption. These
eligible optionholders are the same as those participants permitted
under Securities Act Rule 701 and include: \35\
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\35\ See the discussion at note 22 supra.
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Employees of the issuer, its parents, or majority-owned,
direct or indirect, subsidiaries of the issuer or its parents;
Directors of the issuer, its parents, or majority-owned,
direct or indirect, subsidiaries of the issuer or its parents; and
Consultants and advisors of the issuer, its parents, or
majority-owned, direct or indirect, subsidiaries of the issuer or its
parents.
As adopted, the exemption is limited to those situations where
compensatory employee stock options may be held only by those persons
who are permitted to hold or be granted compensatory employee stock
options under Securities Act Rule 701 and their permitted
transferees.\36\ We believe that the experience of issuers and their
counsels with Securities Act Rule 701 will ease compliance with and
limit uncertainty regarding the exemption.\37\
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\36\ In this regard, we note that this category of eligible
optionholders is broader than the category of persons to whom
employee benefit securities, including compensatory employee stock
options, may be offered and sold by reporting issuers using a Form
S-8 registration statement. See General Instruction A.1(a) to Form
S-8. As we note below, the exemption for reporting issuers will
allow eligible optionholders to satisfy the definitions contained in
either Securities Act Rule 701 or Form S-8 because an issuer may
grant options both prior to and after it becomes subject to the
periodic reporting requirements of the Exchange Act.
\37\ Some commenters were concerned that the terms of
outstanding options may not contain all the restrictive provisions
of the exemption. (See letters from Drinker and Ross). We believe
that our elimination of the restrictions on holders of shares
received on exercise of an option and the modification of the
transferability conditions affecting optionholders should address
these concerns.
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Just as Securities Act Rule 701 was designed specifically not to be
available for capital-raising transactions, the exemption will apply
only to employee stock options issued for compensatory purposes. The
restrictions on the eligible participants in the stock option plans are
intended to assure that the exemption is limited to employee stock
options issued solely for compensatory purposes.\38\
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\38\ All option grants and exercises must, of course, comply
with the requirements of the Securities Act.
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4. Option Terms
a. Compensatory Employee Stock Option Transferability Restrictions
The exemption is available only where there are certain
restrictions on the transferability by an optionholder of those options
and, prior to the exercise of the options, the shares issuable on
exercise of those options.\39\ Specifically, the exemption is available
only if:
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\39\ The exemption does not impose any limitations on the
ability of current or former employees, directors, consultants, or
advisors of an issuer to retain or exercise their compensatory
employee stock options.
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The compensatory employee stock options and, prior to
exercise, the shares to be received on exercise of those options cannot
be transferred except, as permitted by the exemption: \40\
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\40\ The transferability restrictions are not intended to
supersede other transferability restrictions imposed for other
reasons, including under the Internal Revenue Code of 1986, as
amended [26 U.S.C. 422(b)(5)].
--To family members (as defined in Securities Act Rule 701) by gift or
pursuant to domestic relations orders; and
--On death or disability of the optionholder; \41\
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\41\ These permitted transferees are intended to be the same as
those permitted under Securities Act Rule 701(c) as well as
executors or guardians of an optionholder on the death or disability
of the optionholder. See note 22 supra.
There can be no other permitted pledges, gifts,
hypothecations, or other transfers of the compensatory employee stock
options, or shares issuable on exercise of those options, prior to
exercise, until the issuer becomes subject to the reporting
requirements of the Exchange Act or is no longer relying on the
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exemption; provided that there may be:
--Transfers back to the issuer; or
--Transfers in connection with a change of control or other acquisition
transactions involving the issuer if, following such transaction, the
options no longer will be outstanding and the issuer no longer will be
relying on the exemption; \42\ and
\42\ After an issuer becomes subject to the reporting
requirements of the Exchange Act, the issuer will be able to rely on
the exemption for Exchange Act reporting issuers only if it becomes
subject to Exchange Act reporting as a result of its Exchange Act
Section 12 registration of a class of security or pursuant to
Exchange Act Section 15(d).
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The compensatory employee stock options or the securities
issuable upon exercise of those options cannot be the subject of a
short position, a ``put equivalent position'' \43\ or a ``call
equivalent position'' \44\ by the optionholder, prior to exercise,
until the issuer becomes subject to the reporting requirements of the
Exchange Act or is no longer relying on the exemption; provided that
the options may be subject to repurchase rights of the issuer or the
optionholder may participate in a change of control or other
acquisition transaction involving the issuer.
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\43\ 17 CFR 240.16a-1(h). Rule 16a-1(h) defines a ``put
equivalent position'' as a derivative security position that
increases in value as the value of the underlying equity decreases,
including, but not limited to, a long put option and a short call
option position.
\44\ 17 CFR 240.16a-1(b). Rule 16a-1(b) defines a ``call
equivalent position'' as a derivative security position that
increases in value as the value of the underlying equity increases,
including, but not limited to, a long convertible security, a long
call option, and a short put option position.
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As adopted, the conditions provide that, except with regard to the
limited
[[Page 69558]]
permitted transfers specified in the conditions, an optionholder cannot
be permitted, prior to exercise, to pledge, hypothecate, or otherwise
transfer the compensatory employee stock options or the shares
underlying those options, including through a short position, a ``put
equivalent position,'' or a ``call equivalent position,'' until the
issuer becomes subject to the reporting requirements of the Exchange
Act or is no longer relying on the exemption.\45\ For the exemption to
be available, these transfer restrictions will have to apply to options
outstanding at the time that the issuer is relying on the exemption.
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\45\ The current no-action letters contain similar conditions on
transferability of the options, although the rule as adopted
clarifies the limitations on the ability of optionholders to engage
in certain derivative transactions prior to exercise, such as
restrictions on an optionholder from entering into a ``put
equivalent position'' or ``call equivalent position'' until the
issuer becomes subject to the reporting requirements of the Exchange
Act, or is no longer relying on the exemption. See, e.g., no-action
letter to VG Holding, note 7 supra. In addition, the amendment as
adopted does not restrict holders of shares following exercise of
compensatory employee stock options.
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The restrictions on transfer of the compensatory employee stock
options and the shares underlying those options, prior to exercise, are
intended to limit the possibility for a trading market to develop for
the compensatory employee stock options while the issuer is relying on
the exemption. These restrictions also are intended to assure that an
optionholder is not able to profit from the compensatory employee stock
options or the securities to be received on exercise of those options
(except from permitted payments or transfers as described in the
exemption), until the issuer becomes subject to the reporting
requirements of the Exchange Act or is no longer relying on the
exemption.
In response to comments, we have modified the transferability
condition to permit optionholders to receive compensation for their
options from the issuer or arising from a change of control or other
acquisition transaction after which the options no longer will be
outstanding and the issuer no longer will be relying on the
exemption.\46\
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\46\ See letters from ABA, Ross, and Simpson.
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Commenters also were concerned that a requirement for an issuer to
repurchase the shares or options due to state law limitations on
transfer restrictions could have adverse accounting consequences to
companies.\47\ As a result, we have modified the transferability
conditions to eliminate a requirement for an issuer to repurchase
options if an express prohibition on transfer of options is not
permitted under applicable state law. Instead, the condition permits
the issuer to provide that it may repurchase the options in the event
of an impermissible transfer. Issuers also may provide that the options
terminate in such an event. We note that compensatory employee stock
option plans or written stock option agreements generally restrict the
persons who may exercise the options, so providing for a termination of
an option in the event of an impermissible transfer would, in many
cases, already be contemplated by the terms of the written stock option
agreement or plan.
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\47\ See letters from CAQ, D&T, E&Y, and KPMG.
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We proposed that the transferability restrictions apply to holders
of shares issued on exercise of the options. In response to
comments,\48\ we have not adopted this condition of the exemption. We
understand from commenters that private, non-reporting issuers normally
already have shareholder agreements and other mechanisms to restrict
the transfer of shares received on exercise of options prior to the
time the issuer becomes subject to the reporting requirements of the
Exchange Act or is involved in a change of control or other acquisition
transaction involving the issuer.\49\ We also understand that private,
non-reporting issuers do not anticipate that optionholders will
exercise their options prior to a liquidity event, such as an initial
public offering or sale of the company, or prior to termination of the
options.\50\
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\48\ See letters from ABA, Drinker, Ross, and Simpson.
\49\ See letters from ABA, Freescale, Ross, and Simpson.
\50\ In expressing their views that the proposed transferability
restrictions should not be expected to affect a private company's
ability to value the compensatory employee stock options under
Financial Accounting Standards Board Statement of Financial
Accounting Standards No. 123R (revised 2004) Share-Based Payment
(FAS 123R), some commenters noted that in valuing employee stock
options for purposes of FAS 123R, private, non-reporting issuers use
an expected term assumption that does not anticipate early exercise
of the options. See letters from CAQ, E&Y, and KPMG. These
commenters noted that employees of non-public companies normally do
not have an incentive to exercise a vested option early due to the
lack of a market for the underlying shares. These commenters
observed that non-public company employees typically hold their
options until they have incentive to exercise such as at the end of
their terms, termination of employment, or until a liquidity event,
such as an initial public offering or sale of the company occurs.
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We are not adopting as a condition to the exemption separate
transferability restrictions on holders of the shares received on
exercise of the compensatory employee stock options. While we
acknowledged in the Proposing Release the existence of company-imposed
and securities law transferability restrictions, we are persuaded to
modify the exemption in light of the additional concerns that
commenters believed the proposed transferability restrictions would
raise. In modifying the exemption, we have considered the treatment of
compensatory employee stock options under Securities Act Rule 701 as
restricted securities as defined in Securities Act Rule 144,\51\ the
fact that optionholders typically do not exercise their options prior
to their termination or a liquidity event and the fact that, if
exercised, most private companies take steps to restrict
transferability of shares received on exercise of compensatory employee
stock options, so that there is a limited possibility of a market
developing in the securities issued on exercise of immediately
exercisable compensatory employee stock options. In addition, we have
considered a commenter's view that imposing separate transferability
restrictions on the holders of shares received on exercise of
compensatory employee stock options may affect a company's decision to
use stock options for compensatory purposes.\52\ We also note that the
exemptions we are adopting today do not impact the continued potential
applicability of Exchange Act Section 12(g) to the securities issued on
exercise of the options.
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\51\ 17 CFR 230.144. See, e.g., Securities Act Rule 701(g).
\52\ See letter from ABA. See also, letter from Ross.
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We also are not adopting the proposed restriction on other shares
of the same class of equity security as those underlying the options.
We believe that this restriction is no longer necessary because we have
not adopted transferability restrictions on holders of securities
received on exercise of compensatory employee stock options. In
addition, we have taken into account one commenter's concern that the
transferability restrictions on the optionholder with respect to shares
of the same class as those issuable on exercise of the options would
affect an optionholder's ability to dispose of other securities of the
issuer that the optionholder owned.\53\
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\53\ See letter from Ross.
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As proposed, the exemption would have provided that there could be
no market, process, or methodology that would permit optionholders,
prior to exercise, to receive compensation or consideration for their
options, the shares issuable on exercise of the options, or shares of
the same class of equity security as those underlying those options.
Commenters noted that generally there is no market for the securities
underlying the options while
[[Page 69559]]
the issuer is a private, non-reporting entity.\54\ Commenters were
concerned that optionholders should not be disadvantaged from receiving
payments from an issuer or in connection with a change of control or
other corporate transaction involving an issuer, either with respect to
their options or shares of the issuer they already own.\55\ In light of
these comments, we do not believe the exemption should impair an
optionholder's ability to participate in transactions involving the
issuer's securities they already own and we do not believe the
exemption should restrict an issuer or other shareholders from engaging
in particular transactions due to the issuer's reliance on the
exemption.
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\54\ See letters from ABA, Freescale, Ross, and Simpson.
\55\ See letters from ABA, Freescale, Ross, and Simpson.
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b. Permitted Exercisability of Compensatory Employee Stock Options
The exemption will not require that there be any restriction on the
timing of the exercise of the compensatory employee stock options:
By the optionholder (regardless of whether the
optionholder continues to be an employee, director, consultant or
advisor of the issuer);
In the event of the death or disability of the
optionholder, by the estate or guardian of the optionholder; or
By a family member (as defined in Securities Act Rule 701)
who acquired the options through a gift or domestic relations order.
5. Required Information
We are adopting the proposed requirement that the issuer provide
information to optionholders with certain modifications. In response to
comment, we are not adopting a requirement for issuers to provide
information to holders of shares received on exercise of compensatory
employee stock options after exercise or for issuers to provide
optionholders access to their books and records.\56\
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\56\ See letter from ABA.
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As adopted, the information condition will require the issuer, for
purposes of the exemption, to periodically provide the following
information to optionholders: \57\
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\57\ In response to comment (see letters from ABA and Ross), we
are clarifying that the information conditions may commence once a
company has 500 or more optionholders and may terminate once the
company becomes subject to the reporting requirements of the
Exchange Act or is no longer relying on the exemption.
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The same risk and financial information that would be
required to be provided under Securities Act Rule 701 if securities
sold in reliance on Securities Act Rule 701 in a 12-month period
exceeded $5 million (as such provision may be modified \58\), with the
optionholders being provided every six months required information,
including financial statements that are not more than 180 days old.\59\
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\58\ One commenter suggested that the exemption take into
account changes in the dollar threshold in Securities Act Rule 701.
See letter from ABA. The rule text, as proposed and adopted, refers
only to the relevant paragraph of Securities Act Rule 701 and does
not include a separate dollar threshold. Therefore, any change in
the dollar threshold in Securities Act Rule 701 would apply to the
exemption.
\59\ See Securities Act Rule 701(e) [17 CFR 230.701(e)] for a
description of the risk factor and financial statement requirements.
The required information will have to be provided under the terms of
the exemption, once an issuer is relying on the exemption regardless
of whether the issuer would be required to provide the information
under Securities Act Rule 701 (for example, because the issuer did
not sell $5 million in securities in a 12-month period in reliance
on Securities Act Rule 701). The financial statement requirements
under Securities Act Rule 701 refers to financial statements of Part
F/S of Form 1-A [17 CFR 239.90]. Part F/S of Form 1-A does not
require audited financial statements unless an issuer has prepared
them for other purposes. Otherwise, Part F/S of Form 1-A permits an
issuer to provide two years of unaudited financial statements.
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The issuer will be permitted to provide the required information to
the optionholders either by:
Physical or electronic \60\ delivery of the information;
or
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\60\ Electronic delivery of such information will have to be
made in compliance with the Commission's interpretations regarding
the electronic delivery of information. See, e.g., ``Use of
Electronic Media,'' Release No. 34-42728 (Apr. 28, 2000) [65 FR
25843].
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Notice to the optionholders of:
--The availability of the information on an Internet site that may be
password-protected; \61\ and
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\61\ A password-protected closed-system intranet site accessible
to employees also would be a permitted method to provide the
required information to those persons having access to such site.
---------------------------------------------------------------------------
--Any password needed to access the information.
In Securities Act Rule 701, we established the type of information
that employees holding compensatory employee stock options must be
provided before the exercise of those options.\62\ The Securities Act
Rule 701 information provisions provide optionholders and other persons
who purchase securities without registration under Securities Act Rule
701 with important information. While one commenter objected to the
provision of information condition,\63\ we believe that the ongoing
provision of the same information is necessary and appropriate for
purposes of the exemption from Exchange Act registration.\64\ While
requiring private, non-reporting issuers to provide information, as
adopted, the exemption will allow flexibility in the means of providing
the information by permitting physical, electronic, or Internet-based
delivery.
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\62\ See Rule 701 Release, note 11 supra. ``The type and amount
of disclosure needed in a compensatory securities transaction
differs from that needed in a capital-raising transaction. In a bona
fide compensatory arrangement, the issuer is concerned primarily
with compensating the employee-investor rather than maximizing its
proceeds from the sale. Because the compensated individual has some
business relationship, perhaps extending over a long period of time,
with the securities issuer, that person will have acquired some, and
in many cases, a substantial amount of knowledge about the
enterprise. The amount and type of disclosure required for this
person is not the same as for the typical investor with no
particular connection with the issuer.'' Id.
\63\ See letter from ABA.
\64\ As the Commission reminded issuers when it adopted the
amendments to Securities Act Rule 701 in 1999, issuers should be
aware that compliance with the minimum disclosure standards for
Securities Act Rule 701 may not necessarily satisfy the antifraud
standards of the securities laws. See Rule 701 Release, note 11
supra. (Preliminary Note 1 to Rule 701 states that issuers and other
persons acting on their behalf have an obligation to provide
investors with disclosure adequate to satisfy the antifraud
provisions of the federal securities laws.) We recognize that the
Advisory Committee has recommended modifications to Securities Act
Rule 701 that would affect the thresholds that would trigger the
disclosure provisions of that rule. Our amendments do not address
the Advisory Committee's recommendations regarding Securities Act
Rule 701. See Final Report of the Advisory Committee, note 21 supra,
at p. 92-93.
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Securities Act Rule 701 provides that the required information must
be provided to an optionholder a reasonable period of time before the
date of exercise of the compensatory employee stock options. Securities
Act Rule 701 also requires that the required financial statements be as
of a date no more than 180 days before the sale of the securities
(which in the case of compensatory employee stock options is the date
of exercise of the options). We believe that the exemption from
Exchange Act registration presents the need for ongoing information to
be provided to optionholders. As such, the exemption requires that,
once an issuer has 500 or more optionholders, the optionholders must be
provided every six months the required information, including financial
statements that are not more than 180 days old.
We believe that our experience with Securities Act Rule 701 and the
combined conditions of the exemption, including the eligibility and
transferability provisions, make it appropriate to require the same
risk and financial information as required under Securities Act Rule
701, as noted above, rather than essentially the same
[[Page 69560]]
Exchange Act information and reports as if it was subject to the
Exchange Act reporting requirements in the context of an ongoing
reporting exemption relating to compensatory employee stock
options.\65\ As such, we believe that the scope of information that the
optionholders will be provided under the exemption is not inconsistent
with investor protection and the public interest.\66\
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\65\ As the Commission also recognized when it adopted the
Securities Act Rule 701 amendments in 1999, and because many issuers
that have 500 or more optionholders and more than $10 million in
assets are likely to have received venture capital financing (see
for example the data in the Hand Paper, note 11 supra), we believe
that many of these issuers already have prepared the type of
disclosure required in their normal course of business, either for
using other exemptions, such as Regulation D, or for other purposes.
As a result, the disclosure requirement generally will be less
burdensome for them. In adopting the amendments to Securities Act
Rule 701, we stated that a minimum level of disclosure was essential
to meet even the reduced level of information needed to inform
compensatory-type investors such as employees and consultants. See
Rule 701 Release, note 11 supra.
\66\ For a private, non-reporting issuer with a significant
number of optionholders (and with more than $10 million in assets at
the end of its fiscal year), we believe it is likely that such
issuer either already is obligated to provide the same information
to optionholders due to sales of securities in reliance on
Securities Act Rule 701 or already prepares and, as such, provides
such information to its shareholders. One commenter also stated that
many private, non-reporting issuers prepare financial statements,
including audited financial statements, for other purposes. See
letter from E&Y. Moreover, because of the transferability
restrictions on the compensatory employee stock options and, prior
to exercise, the shares to be received on exercise of those options,
optionholders will have limited investment decisions to make, until
the issuer becomes subject to the reporting requirements of the
Exchange Act or is engaged in an acquisition transaction affecting
the options. Consequently, we believe that the disclosure required
under the exemption is the appropriate level of disclosure to be
provided optionholders until the issuer becomes subject to the
reporting requirements of the Exchange Act or is no longer relying
on the exemption.
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One commenter objected to the proposed condition that the issuer
make its books and records available for inspection by the optionholder
and holders of shares received on exercise of compensatory employee
stock options to the same extent that they are available to other
shareholders of the issuer.\67\ This commenter stated that such a
requirement may go beyond or be inconsistent with state law
requirements. We are not adopting the books and records element of the
information condition. We believe that holders of such shares can
exercise their state law rights to inspect corporate books and records.
Moreover, because optionholders, as such, are not shareholders, we
agree with the commenter that it is not necessary to extend the books
and records inspection right to them if it is not already provided for
under applicable state law.
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\67\ See letter from ABA.
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To permit issuers to safeguard proprietary or confidential
information that may be contained in the information to be provided,
the exemption will permit provision of the disclosure to be conditioned
on the optionholder agreeing to maintain the confidentiality of the
information.\68\ In response to a commenter,\69\ we are not adopting
the proposed provision that would have required an issuer to allow
inspection of the documents at one of the described issuer offices if
an optionholder chooses not to enter into such a confidentiality
agreement. Under the exemption, as adopted, the issuer is not required
to provide the information to a particular optionholder if the holder
does not agree to keep the information to be provided pursuant to the
exemption confidential.\70\ Therefore, the exemption, as adopted,
permits an issuer to take steps to protect the confidentiality of its
information.
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\68\ This provision is consistent with the related information
provision under Securities Act Rule 701.
\69\ See letter from ABA.
\70\ This provision does not affect an issuer's information
delivery obligation under Securities Act Rule 701.
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The proposal also would have required that the issuer provide the
required information to holders of shares received on exercise of
options. We have revised the information condition to apply only to
optionholders in light of concern regarding the potential misuse of
information by non-employees or former employees of a company.\71\ The
amendments, as adopted, do not condition the exemption on
transferability restrictions on the underlying shares similar to those
applicable to the compensatory employee stock options. One commenter
expressed concern that the information delivery conditions would treat
these company shareholders differently than other company
shareholders.\72\ Since the exemption applies only to the compensatory
employee stock options and not to the shares received on exercise of
the compensatory employee stock options, we believe our revisions
should address concerns in this regard and provide companies
flexibility in addressing confidentiality and share transferability
issues.
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\71\ See letter from ABA.
\72\ See letter from ABA.
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6. Issuer Obligation To Impose the Conditions to the Exemption
We are adopting essentially as proposed the requirement that, for
the exemption to be available, a private, non-reporting issuer must
include the necessary limitations and conditions in the written stock
option plans, within the terms of the individual written option
agreements, or in anoth
