The Securities and Exchange Commission during its open meeting on Wednesday issued final rules that would raise the threshold for the enhanced disclosure requirement under Securities Act Rule 701, which allows companies to more easily pay their employees in stock.
Under current federal securities laws, every offer and sale of securities must be registered or be subject to an exemption from registration. These requirements apply even when a company decides to issue stock to its own employees.
“The Commission has long recognized that securities offerings done for compensatory purposes present different issues than securities offerings that raise capital,” William Hinman, director of the Division of Corporation Finance, said at the open meeting.
Rather than requiring a private company to register employee stock offerings, or requiring a public company to go through the traditional registration process for these types of offerings, the Commission adopted Rule 701, which applies solely to private and pre-IPO companies, and Form S-8, a simplified registration form for public companies to use to issue securities for employee equity plans.
Like the Commission’s other regulatory accommodations, Rule 701 and Form S-8 require that certain conditions be met for a company to use them.
Specifically, Rule 701 allows non-reporting companies to sell securities for compensatory purposes without the requirement to register the offer and sale of such securities with the Commission. It’s a popular exemption that many companies use to grant options and other equity-based compensation to employees and others with whom they engage for services, such as consultants and advisers.
As mandated by the recently enacted Economic Growth, Regulatory Relief, and Consumer Protection Act, the amendment increases from $5 million to $10 million the aggregate sales price or amount of securities sold during any consecutive 12-month period. Under this increased threshold—last revised in 1999—if a company sells more than $10 million in securities in a 12-month period, the company must provide additional financial and other disclosures to the investors that received the securities during that period, including employee investors.
“This requirement was born out of the Commission’s concern that the larger the offering—even in the context of employee compensation—the greater the possibility of investor harm if there isn’t accompanying investor protections, like financial disclosure,” said SEC Commissioner Kara Stein. “While I am still uncertain of all the costs and benefits of such an increase, Congress did not give us discretion. Accordingly, I will support this recommendation.”
“We have all heard how stock compensation can help align employee incentives with company success, or help a company recruit and retain talent, but we also have heard how stock compensation ultimately may not provide the right incentives, or may not help a company or its employees in the long run. A corollary to the question presented, then, is whether more companies should be able to use these tools.”
Kara Stein, Commissioner, SEC
Increasing the disclosure threshold effectively enables private companies that wish to offer equity-based compensation to issue more grants without the compliance burden of having to make more extensive disclosure requirements. As such, prudent private companies should look to this rule change as an opportunity to review future stock compensatory plans to fully maximize the opportunities afforded by Rule 701.
“Issuers that have commenced an offering in the current 12-month period will be able to apply the new $10 million threshold immediately upon effectiveness of the amendment,” said Adam Turk, special counsel in the Office of Chief Counsel, Division of Corporation Finance.
“In view of the important and evolving nature of equity compensation practices, we are presenting a second release in this area,” Hinman said. That second release recommended by the SEC staff was a “concept release,” soliciting comment on ways to modernize Rule 701 and Form S-8 in response to the marked evolution in both the types of compensation practices issuers make and the composition of the workforce, since the Commission last substantively amended Rule 701 and Form S-8 in 1999.
“We must do all we can to ensure our regulatory framework reflects changes in our marketplace, including our labor markets,” said SEC Chairman Jay Clayton.
During the open meeting, Stein said the main question the SEC seeks comments on is “whether companies should be allowed to issue stock compensation to even more people without having to register the offering with the Commission.” Among other issues, the concept release seeks feedback on whether the rule’s definition of employee should be broadened considering the so-called “gig economy.”
“For example, some companies now enter into contractual arrangements with people that may be short-term, part-time, or freelance in nature,” Stein noted. “Other companies allow individuals to use their Internet platforms. These individuals may provide services or products to end users—such as ride-sharing, food delivery, or even hand-made crafts—but they do not necessarily enter into traditional employer-employee relationships.” As a result, companies may not be able to pay them in stock using the current exemption under Rule 701, which requires that the individual be an employee.
“We have all heard how stock compensation can help align employee incentives with company success, or help a company recruit and retain talent, but we also have heard how stock compensation ultimately may not provide the right incentives, or may not help a company or its employees in the long run,” Stein said. “A corollary to the question presented, then, is whether more companies should be able to use these tools.”
She presented a list of questions to consider:
Would allowing companies to issue stock to workers with whom they have short-term contractual arrangements be consistent with the rule’s underlying goals?
What parameters should be set around the relationship between a company and its workers? Would broadening the existing parameters result in companies hiring more independent contractors, instead of full-time employees?
Does the existing rule already cover such relationships?
How often do companies that have these sorts of arrangements want, or need, to issue securities to these types of workers, in the first instance?
Concerning Form S-8, the release seeks comment on a host of issues, particularly whether there are ways to further reduce the costs associated with filing the form. Stein said she is particularly interested in hearing from commenters on what exactly the costs relate to, and what they are in real numbers: “Do they relate to the registration fee, the cost of obtaining an auditor’s consent, or other matters?”
“Form S-8 provides clear benefits to companies and their employees alike. It allows companies a simpler way to register offerings of stock that are made just to their employees,” Stein added. “This, in turn, allows their employees to freely trade this stock, which may provide the company with increased liquidity. In this regard, we should remember that Form S-8 already attempts to reduce costs for those who provide stock compensation to their employees.”
The public comment period will remain open for 60 days following publication of the concept release in the Federal Register.