Effective Dec. 7, 2007 the U.S. Securities & Exchange Commission (SEC) adopted a rule making it easier for larger private companies to use certain types of compensatory stock option plans. The rule exempts such plans of qualifying non-reporting companies from Exchange Act registration.
The exemption under the SEC's new Rule 12h-1(f) affects private companies with more than $10 million in assets that have a class of equity securities, with stock options treated as a separate class, held by more than 500 persons . The rule also will impact certain subsidiaries of public companies.
Qualifying companies with stock option plans may reduce their compliance burden by ensuring their plans are properly structured. Qualifying companies that would like to establish stock option plans now have a clear path to doing so with greatly reduced regulatory obligations.
Before the SEC adopted the exemption, private companies with more than $10 million in assets were required to register and file reports under the Exchange Act if they had a class of equity securities held of record by more than 500 persons. Because stock options are considered a separate class of equity securities, companies that granted options to more than 500 persons could potentially be required to register and report as a public company even though they had no market listing and no other broadly held class of securities.
This rule thus posed a particular problem for fast-growing companies embarking on expansion plans that included broad-based stock option programs. As a result, an issuer could be treated as a “public company” and thus would be required to file Exchange Act reports even though it was not yet ready for—or simply did not need to conduct—a public offering.
Conditions of the new Rule
Recognizing this difficulty, and as a part of a program intended to curb the compliance burden on private and smaller public companies, the SEC adopted Rule 12h-1(f), which exempts from Exchange Act registration the compensatory stock option plans of non-reporting companies that meet the following conditions:
- The issuer is not registered or required to file reports under Section 12(g) or Section 15(d) of the Exchange Act. The exemption is also available to subsidiaries of public companies so long as the options are exercisable only for securities of the non-public subsidiary.
- The options are issued as compensation for services (including incentives to provide future services) provided by the employees, officers, directors, consultants and advisors of the issuer and its subsidiaries, corporate parents, or affiliated companies.
- The options must be issued pursuant to one or more written compensatory stock option plans. For purposes of the exemption, all awards issued under any plan or arrangement and exercisable for or convertible into the same class of equity securities are considered to be a single “class of equity securities.”
- The option plan, the award letter, or another contractually binding provision (such as in the certificate of incorporation) must restrict transfers by the option grantee other than:
- To certain family members through gifts or pursuant to domestic relations orders
- To an executor or guardian upon the grantee's death or disability
- To the issuer (including but not limited to transfers upon the issuer's contractual right to repurchase the securities)
- In connection with a change of control or other acquisition of the issuer if, after such transaction, the issuer will no longer be relying on this exemption
The transfer restriction applies both to the option and (until the option is exercised) shares issuable upon exercise of the option.
- If an issuer grants options having a value in excess of $5 million in any 12-month period, the issuer must provide the option holder certain financial information at least every six months, including financial statements that are not more than 180 days old. The information may be provided in paper or by electronic delivery (including by password-protected access) and may be conditioned upon a contractual undertaking by the option holder to treat any such information as confidential.
(Note that the information must be provided at all times when the issuer is relying upon Exchange Act Rule 12h-1(f) as an exemption from Exchange Act registration and reporting, regardless of whether information must be delivered under the exemption from Securities Act registration contained in Securities Act Rule 701.)
The SEC's new exemption aims to simplify the use of equity-based compensation, while still providing adequate information for broadly used plans. The new rule also represents the SEC's attempt to harmonize this Exchange Act provision with the requirements arising under the exemption from registration provided by Rule 701 under the Securities Act.
Readers can access the new exemption, which went into effect upon publication on Dec. 7, 2007, at http://www.sec.gov/rules/final/2007/34-56887.pdf.
The information presented in this summary should not be construed as legal advice, and readers should consult with qualified securities counsel in assessing the availability and scope of the protections afforded by this rule.