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Jul 20, 2018

SEC Issues Final Rules to Increase Rule 701 Enhanced Disclosure Threshold

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Publishes Concept Release to Explore Rule 701 and Form S-8 Reform

The Adopting Release

On June 18, 2018, the Securities and Exchange Commission (SEC) issued final rules to amend Securities Act Rule 701, which provides an exemption from registration for securities issued by private companies for compensatory arrangements. The amendment increases, from $5 million to $10 million[1], the amount of securities that a company can issue to employees and other service providers in reliance on Rule 701 in any consecutive 12-month period without triggering enhanced disclosure obligations.[2]

Practical Implications

Issuers that have commenced an offering in the current 12-month period will be able to apply the new $10 million disclosure threshold immediately. Many private companies rely on Rule 701 as an important tool to efficiently issue stock and options to recruit and retain talent. The increased threshold should encourage more private companies to use equity compensation by mitigating the burdens and concerns of the enhanced disclosure requirements, including the additional expense of making such information available and the desire to not disclose detailed financial information. Companies should continue to diligently track the aggregate value of securities granted (or expected to be granted) in any consecutive 12-month period in order to determine compliance with the offering limitations in Rule 701, as well as to determine if the enhanced disclosure obligation will be triggered. Failure to comply with the enhanced disclosure requirement subjects a company to the risk of SEC enforcement action.[3]

Importantly, we note that the new rule did not change the existing requirement that enhanced disclosure must be provided to any person who receives securities under Rule 701 at any point during the relevant 12-month period to the extent that the $10 million threshold is exceeded.[4] Even if a company has not yet exceeded the threshold at the time of a particular issuance, a company should consider providing the enhanced disclosure if it has a reasonable belief that its aggregate issuances within any 12-month period (including such issuance) would exceed the threshold. This requirement has been the subject of calls for reform as it imposes significant practical challenges for companies seeking to rely on Rule 701.

Concurrent Concept Release to Explore Further Reform

Concurrently with the issuance of the final rules amending Rule 701, the SEC also published a concept release seeking comments on possible ways to modernize rules pertaining to securities offerings attendant to compensatory arrangements (Rule 701 and Form S-8). The comment period will remain open for 60 days. Since the SEC last substantively amended these rules in 1999, the types of compensatory offerings in use and the composition of the workforce have both evolved. The concept release coupled with the Rule 701 amendment demonstrates the SEC’s focus on updating the regulatory framework to complement marketplace changes. We will publish a memo on the concept release in the near term.

Footnotes

[1] Subject to indexing for inflation based on the Consumer Price Index every five years, rounding to the nearest $1 million, pursuant to Section 507 of the Economic Growth, Regulatory Relief, and Consumer Protection Act.
[2] For background and our perspective on the amendment, please see our client memorandum announcing the now implemented amendment: “Rule 701 Enhanced Disclosure Threshold to Increase.”
[3] In our recent client memorandum “Private Company Fined for Failure to Comply with Rule 701 in Option Exercises,” we discuss a widely-publicized SEC enforcement action against Credit Karma for its failure to provide the Rule 701-required enhanced disclosure.
[4] SEC Compliance and Disclosure Interpretation 271.12, available at: https://www.sec.gov/divisions/corpfin/guidance/securitiesactrules-interps.htm.

Authors and Contributors

Richard Alsop

Partner

Capital Markets

+1 212 848 7333

+1 212 848 7333

New York

John J. Cannon III

Partner

Compensation, Governance & ERISA

+1 212 848 8159

+1 212 848 8159

New York

J. Russel Denton

Partner

Emerging Growth

+1 512 647 1906

+1 512 647 1906

Austin

Christopher Forrester

Partner

Capital Markets

+1 650 838 3772

+1 650 838 3772

Menlo Park

Stephen T. Giove

Partner

Capital Markets

+1 212 848 7325

+1 212 848 7325

New York

Harald Halbhuber

Partner

Capital Markets

+1 212 848 7150

+1 212 848 7150

New York

Kenneth J. Laverriere

Partner

Compensation, Governance & ERISA

+1 212 848 8172

+1 212 848 8172

New York

Doreen E. Lilienfeld

Partner

Compensation, Governance & ERISA

+1 212 848 7171

+1 212 848 7171

New York

J. Matthew Lyons

Partner

Emerging Growth

+1 512 647 1901

+1 512 647 1901

Austin

Lona Nallengara

Partner

Capital Markets

+1 212 848 8414

+1 212 848 8414

New York

Alan Bickerstaff

Partner

Emerging Growth

+1 512 647 1903

+1 512 647 1903

Austin

Gillian Emmett Moldowan

Partner

Compensation, Governance & ERISA

+1 212 848 5356

+1 212 848 5356

New York

Linda Rappaport

Of Counsel

Compensation, Governance & ERISA

+1 212 848 7004

+1 212 848 7004

New York

Arielle L. Katzman

Associate

Capital Markets

+1 212 848 4451

+1 212 848 4451

New York

Matthew Behrens

Associate

Compensation, Governance & ERISA

+1 212 848 7045

+1 212 848 7045

New York