SEC Issues Proposed Amendments Re: Compensatory Offerings (Rule 701 and Form S-8)
On November 24, 2020, the Securities and Exchange Commission (“SEC”) issued two proposed rules relating to compensatory offerings under Rule 701 and Form S-8. The SEC has based its proposed changes in large part on a concept release on this topic, originally published by the SEC in July 2018, and the comments solicited in response.
The SEC recognizes that offers and sales of securities as compensation present different issues than offerings made by issuers seeking to raise capital. In particular, the relationship between the issuer and recipient of securities is often different in a compensatory, rather than capital raising, transaction. Acknowledging this difference, the SEC created Rule 701 and Form S-8. Rule 701 is a safe harbor exemption, which allows non-reporting companies to issue securities pursuant to compensatory arrangements without the burdens of registration required under the Securities Act of 1933, as amended. Reporting companies under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), seeking to register compensatory securities transactions can do so using the specialized Form S-8.
The first proposed rule, Modernization of Rules and Forms for Compensatory Securities Offerings and Sales (the “Modernization Amendment,” Release No. 33-10891, available here) is a general effort to update the parameters and mechanics of Rule 701, Form S-8 and the relationship between the two. The Modernization Amendment is designed to address the significant evolution in compensatory offerings since the SEC last substantively amended these regulations, consistent with principles of investor protection.
The second proposed rule, Temporary Rules to Include Certain “Platform Workers” in Compensatory Offerings under Rule 701 and Form S-8 (the “Platform Workers Amendment,” Release No. 33-10892, available here), expands, on a five-year trial basis, the pool of individuals eligible to receive securities under a Rule 701 exemption or via Form S-8. Through the Platform Workers Amendment, the SEC seeks to address significant developments in the types of compensatory offerings issuers make and the composition of the workforce since Rule 701 and Form S-8 were last substantively amended, paying particular attention to the new types of work relationships that have emerged in the so-called “gig economy.”
Below is a summary of the significant changes contained in the Modernization Amendment and the Platform Workers Amendment (each, an “Amendment”).
The Modernization Amendment
Through the Modernization Amendment, the SEC intends to address changes in compensatory practices, including the types of securities offered, and to modernize and simplify administrative requirements for issuers.
With respect to amending Rule 701, the Modernization Amendment would do the following:
- Revised Disclosure Requirements under Rule 701(e). Revise the additional disclosure requirements under Rule 701(e) for exempt transactions exceeding $10 million, including how the disclosure threshold applies, the type of financial disclosure required, and the frequency with which it must be updated;
- Limit the additional disclosure requirement to only those sales that exceed Rule 701’s $10 million threshold, within any consecutive 12-month period.
- Conform the age of financial statement requirement set forth in Rule 701(e) to the corresponding requirement in Part F/S of Form 1-A (i.e., on at least a semi-annual basis completed within three months after the end of the second and fourth quarters).
- Allow foreign private issuers that are eligible for the exemption from Exchange Act registration provided by Exchange Act Rule 12g3-2(b) to provide financial statements prepared in accordance with home country accounting standards for purposes of Rule 701(e) disclosure without reconciliation to U.S. GAAP in certain circumstances.
- Allow issuers to provide alternative valuation information, specifically an independent valuation report of the securities’ fair market value as determined by an independent appraisal consistent with the rules and regulations under Internal Revenue Code Section 409A, in lieu of financial statements, for purposes of Rule 701(e) disclosure.
- Revised Disclosure Timing for Derivative Securities. Revise the time at which such disclosure is required to be delivered for derivative securities that do not involve a decision by the recipient to exercise or convert in specified circumstances where such derivative securities are granted to new hires;
- If the sale involves a stock option or other derivative security that involves a decision to exercise or convert, the issuer would continue to be required to deliver disclosure a reasonable period of time before the date of exercise or conversion.
- If the sale involves a restricted stock unit (an “RSU”) or other derivative security that does not involve a decision to exercise or convert, the issuer generally would continue to be required to deliver disclosure a reasonable period of time before the date the RSU or similar derivative security is granted.
- For RSUs or similar derivative securities granted in connection with a new employee hire, disclosure would be considered delivered a reasonable period of time before the date of sale if it is provided no later than 14 calendar days after the date the person begins employment.
- Increased Dollar Amount Ceiling. Raise two of the three alternative regulatory ceilings that cap the overall amount of securities that a non-reporting issuer may sell pursuant to the exemption during any consecutive 12-month period:
- The percentage of assets cap would be raised from 15% to 25% of the total assets of the issuer (or of the issuer’s parent if the issuer is a wholly-owned subsidiary and the securities represent obligations that the parent fully and unconditionally guarantees) measured at the issuer’s most recent balance sheet date.
- Alternative $1 million cap would be raised to $2 million, available to any issuer.
- Additional alternative cap of 15% of the outstanding amount of the class of securities being offered and sold would be retained with no changes.
- Expanded Availability. Make the exemption available for offers and sales of securities under a written compensatory benefit plan (or written compensation contract) established by the issuer’s subsidiaries, whether or not majority-owned.
With respect to amending the Form S-8, the Modernization Amendment would do the following:
- General Clarifications. Implement improvements and clarifications to simplify registration on the form, including:
- Clarifying the ability to add multiple plans to a single Form S-8;
- Clarifying the ability to allocate securities among multiple incentive plans on a single Form S-8; and
- Permitting the addition of securities or classes of securities by an automatically effective post-effective amendment.
- Simplified Share Count and Fee Payments. Implement improvements to simplify share counting and fee payments on the form, including:
- Requiring the registration of an aggregate offering amount of securities for defined contribution plans; and
- Implementing a new fee payment method for registration of offers and sales pursuant to defined contribution plans.
- Conformity with IRS Practices. Conforming Form S-8 instructions with current IRS plan review practices.
- Elimination of Tax Effects Description Requirement. Revise Item 1(f) of Form S-8 to eliminate the requirement to describe the tax effects of plan participation on the issuer.
Lastly, with respect to both the Rule 701 and Form S-8, the Modernization Amendment would do the following:
- Expanded Availability
- Extend consultant and advisor eligibility to entities meeting specified ownership criteria designed to link the securities to the performance of services.
- Expand eligibility for former employees to specified post-termination grants and former employees of acquired entities.
- Availability would be further expanded by the Platform Workers Amendment, discussed below.
The Platform Workers Amendment
While the Modernization Amendment is broad in scope and objectives, the SEC has narrowly tailored the Platform Workers Amendment to address the evolving relationship between issuers and their workforce, by increasing the pool of individuals eligible to receive securities under Rule 701 or via Form S-8. Specifically, the Platform Workers Amendment would permit an issuer to offer and sell securities to those workers who provide services available through the issuer’s internet-based marketplace platform or through another widespread, technology-based marketplace platform or system (“platform workers”).
The work could involve the individual providing services to end users, such as ride-sharing, food delivery, household repairs, dog-sitting, or tech support, or using the platform to sell goods or lease property to third parties, and other new work relationships that may yet evolve. The SEC recognizes that these new work relationships have become increasingly significant to the broader U.S. economy.
Under the Platform Workers Amendment, an issuer would be able to use the Rule 701 exemption to offer and sell its securities on a compensatory basis to platform workers who, pursuant to a written contract or agreement, provide bona fide services by means of an internet-based platform or other widespread, technology-based marketplace platform or system provided by the issuer if the following criteria are met:
- Issuer Control of Platform. The issuer operates and controls the platform, as demonstrated by its ability to provide access to the platform, to establish the principal terms of service for using the platform and terms and conditions by which the platform worker receives payment for the services provided through the platform, and to accept and remove platform workers participating in the platform;
- Written Compensatory Arrangement. The issuance of securities to participating platform workers is pursuant to a compensatory arrangement, as evidenced by a written compensation plan, contract, or agreement, and is not for services that are in connection with the offer or sale of securities in a capital-raising transaction, or services that directly or indirectly promote or maintain a market for the issuer’s securities;
- Cap on Compensation Percentage. No more than 15 percent of the value of compensation received by a participating worker from the issuer for services provided by means of the platform during a 12-month period, and no more than $75,000 of such compensation received from the issuer during a 36-month period, shall consist of securities, with such value determined at the time the securities are granted;
- Individual Bargaining Prohibited. The amount and terms of any securities issued to a platform worker may not be subject to individual bargaining or the worker’s ability to elect between payment in securities or cash; and
- Restrictions on Transfer. The issuer must take reasonable steps to prohibit the transfer of the securities issued to a platform worker pursuant to this exemption, other than a transfer to the issuer or by operation of law.
The above changes would be in effect on a trial basis, for five years, after which they would terminate absent any further action by the SEC. So that it may better evaluate the effect of the Platform Workers Amendment during the trial period, the SEC is also proposing that any issuer that issues securities to platform workers would be required to furnish information to the SEC at six-month intervals, regarding:
- Eligibility Criteria. The criteria used to determine eligibility for awards, whether those criteria are the same as for other compensatory transactions, and whether those criteria, including any revisions to the criteria, are communicated to platform workers in advance as an incentive;
- Type and Terms of Securities. The type and terms of securities issued and whether they are the same as for other compensatory transactions by the issuer during that interval;
- Reasonable Steps to Prohibit Transfer. If pursuant to Rule 701, the reasonable steps taken to prohibit the transfer of the securities sold pursuant to this temporary rule;
- Percentage of Overall Securities. The percentage of overall outstanding securities that the amount issued cumulatively under this temporary rule represents; and
- Various Other Issuance Statistics.
- During the interval, the number of platform workers, the number of non-platform workers, the number of platform workers who received securities pursuant to the temporary rule, and the number of non-platform workers who received securities pursuant to the issuer’s Rule 701 or Form S-8 issuances;
- Both in absolute amounts and as a percentage of the issuer’s total Rule 701 or Form S-8 issuances during the interval:
- The aggregate number of securities issued to platform workers; and
- The aggregate dollar amount of securities issued to platform workers.
All of these proposed changes, except for the proposed transferability restriction, would apply similarly to permit a reporting issuer under the Exchange Act to register the offer and sale of its securities to its platform workers using Form S-8.
Lastly, the Platform Workers Amendment would extend the exclusion from the definition of “held of record” and corresponding safe harbor, under the Exchange Act, which currently applies to securities held by persons who received them pursuant to an employee compensation plan, to also include securities held by persons who received them pursuant to a compensation plan for platform workers under the proposed Platform Workers Amendment. Unlike the other changes set forth above, this proposed exclusion and safe harbor would be permanent.
Deadlines for Comment
Comments on either of the proposed Amendments are due 60 days after publication of the respective Amendment in the Federal Register. Specific requests for comments can be found throughout the respective publications, available at the links at the top of this Client Alert.
For additional information related to anything contained in this Client Alert, please contact one of the authors listed above, or any member of our Securities Law Practice Group.