Developments in Securities Regulation, Corporate Governance, Capital Markets, M&A and Other Topics of Interest. MORE

As many know, Exchange Act Rule 14a-3(c) and Rule 14c-3(b) require registrants to mail seven copies of the annual report sent to security holders to the Commission “solely for its information.” A similar provision in Form 10-K requires certain Section 15(d) registrants to furnish to the Commission “for its information” four copies of any annual report to security holders.

The SEC recently posed this question in a CD&I: Can a registrant satisfy these requirements by means other than physical delivery or electronic delivery pursuant to Rule 101(b)(1) of Regulation S-T? According to the CD&I the answer is:

“Yes. The Division will not object if a company posts an electronic version of its annual report to its corporate web site by the dates specified in Rule 14a-3(c), Rule 14c-3(b) and Form 10-K respectively, in lieu of mailing paper copies or submitting it on EDGAR. If the report remains accessible for at least one year after posting, the staff will consider it available for its information.”

The SEC also examined the answer to this question in new CD&I No. 116.25 in the Securities Act Forms series: An issuer with less than $75 million in public float is eligible to use Form S-3 for a primary offering in reliance on Instruction I.B.6, which permits it to sell no more than one-third of its public float within a 12-month period. May it sell securities to the same investor(s), with a portion coming from a takedown from its shelf registration statement for which it is relying on Instruction I.B.6 and a portion coming from a separate private placement that it concurrently registers for resale on a separate Form S-3 in reliance on Instruction I.B.3, if the aggregate number of shares sold exceeds the Instruction I.B.6 limitation that would be available to the issuer at that time?  According to the CD&I the answer is:

“No. Because we believe that this offering structure evades the offering size limitations of Instruction I.B.6, the securities registered for resale on Form S-3 should be counted against the issuer’s available capacity under Instruction I.B.6. Accordingly, an issuer may not rely on Instruction I.B.3 to register the resale of the balance of the securities on Form S-3 unless it has sufficient capacity under Instruction I.B.6 to issue that amount of securities at the time of filing the resale registration statement. If it does not, it would need to either register the resale on Form S-1 or wait until it has sufficient capacity under that instruction to register the resale on Form S-3.”

ISS has announced the adoption of QualityScore, a benchmark of corporate governance. QualityScore was previously known as QuickScore, and before that by the monikers “GRId” and “CGQ.”  Information on QualityScore’s methodology can be found here.

For US companies, the following is a list of some different factors considered in QualityScore as compared to the prior methodology:

  • Proportion of women on the board
  • Proportion of non-executive directors on the board for less than six years
  • Any other mechanisms to encourage director refreshment
  • Confirmation of a formal CEO and key executive officers succession plan
  • Material failures of governance
  • Adequate response by the board to low support for certain management proposals in the U.S.
  • Employment of at least one metric that compares the company’s performance to a benchmark or peer group
  • Tenure of the external auditor
  • Exclusive venue/forum provision
  • Fee shifting provision
  • Representative claim limitation or other significant litigation rights
  • Proxy access bylaw provisions, including:
    • Ownership thresholds
    • Ownership duration thresholds
    • Cap on shareholder nominees to fill board seats
    • Aggregation limits on shareholders to form a nominating group
  • Whether the company can classify its board without shareholder approval
  • Whether shareholders have the right to amend the bylaws
  • Whether the company can materially modify its capital structure without shareholder approval

For more information on the new factors, you can download the QualityScore technical document here.

Issuers who would like to verify the data used to calculate their QualityScore can find more information here.

 

The SEC recently revised Rule 504 of Regulation D to increase the amount of securities that can be offered in any 12-month period from $1,000,000 to $5,000,000. Among other things, Rule 504 allows companies to solicit or advertise their securities to the public in states which require registration of the securities, and require the public filing and delivery to investors of a substantive disclosure document before sale.

Revised Rule 504 appears to work well with the current Minnesota securities statute and regulations. Minnesota Statutes Section 80A.50(b) provides for an exemption if the following and other requirements are met:

  • The securities offered must be exempt from registration under the Securities Act of 1933 pursuant to Rule 504 of Regulation D.
  • The issuer is an eligible issuer (i.e., not a public company, an investment company etc.) and no bad actors as defined in the statute.
  • A small corporate offering registration statement must be filed with the Commissioner of Commerce.
  • A small corporate offering registration statement must be on Form U-7, including exhibits required by the instructions thereto, as adopted by the North American Securities Administrators Association.
  • The registration statement must include a copy of the offering document proposed to be delivered to offerees.
  • If no stop order is in effect and no proceeding is pending under section 80A.54, the registration statement becomes effective automatically at the close of business on the 20th day after filing of the registration statement or the last amendment of the registration statement or at such earlier time as the Commissioner of Commerce may designate by rule or order.
  • A copy of the offering document as filed with the administrator must be delivered to each person purchasing the securities prior to sale of the securities to such person.

Minnesota Administrative Rule 2876.3021 must also be consulted. Among other things it provides:

  • Applicants may file a small corporate offering registration statement in a format other than Form U-7 so long as the alternative registration statement contains all of the information required by all items of Form U-7 as adopted by the North American Securities Administrators Association and all of the attachments required by the instructions for Form U-7, or specifically states that any omitted information or attachments are not applicable.
  • Interim financial statements may be unaudited. All other financial statements may be unaudited if reviewed by independent certified public accountants in accordance with the Accounting and Review Service Standards promulgated by the American Institute of Certified Public Accountants and certain other requirements are met. Those requirements include not having previously sold securities in excess of $1,000.000.
  • After the small corporate offering registration statement has been declared effective, and while the offering is still in progress, the registrant must amend or supplement the small corporate offering registration statement to contain such further material information, if any, as may be necessary to make the information in the small corporate offering registration statement not misleading. A copy of the registration statement as changed, revised, or supplemented and clearly marked to show changes from the previously filed version shall be filed with the Commissioner of Commerce and distributed to all offerees.

Under current law and practice, a shareholder of a public company that is asked to vote in a contested election of directors where a slate of directors had been proposed by the company and an activist investor would likely receive two competing proxy cards from the company and the activist that asks the shareholders to vote for the nominees presented:

Company Proxy Card                                     Activist Proxy Card

Company Nominee A                                     Activist Nominee D

Company Nominee B                                     Activist Nominee E

Company Nominee C                                     Activist Nominee F

 

It is entirely possible after reviewing the biographies of all of the director nominees that a shareholder would want to split her vote amongst the nominees from the two camps– for instance Company Nominees A and C and Activist Nominee E. However, the shareholder is not offered this choice and cannot submit both proxy cards because one or both cards would likely be invalidated since a subsequent proxy card revokes a former proxy card under state law.  The shareholder could achieve her goal by attending the shareholder meeting and voting in person but in many circumstances that is not feasible.

The Securities and Exchange Commission would like to solve the shareholder’s dilemma through its proposed amendments to the proxy rules to require the use of a universal proxy card that would require all of the nominees in a contested election to be listed on a single proxy card. The proposed rules also would require disclosure about voting options and voting standards in all contested director elections – including elections involving partial and full slates of directors.

In sentiments echoed by Chairman Mary Jo White and Commission Kara Stein, representatives of the Division of Corporation Finance at the October 26th open meeting where the proposed rules were considered indicated that the proposed changes to the proxy rules are intended to address the disparity in voting experience between shareholders voting in-person at a shareholder meeting and shareholders voting by proxy.

However, as the Commission and its staff noted at the open meeting, few shareholders attend meetings in person and the primary means of voting occur through the proxy process. As such, despite the expressed goal of facilitating “shareholder democracy,” the mechanics and application of a mandatory universal proxy rule could embolden activist investors and special interest groups, encourage additional proxy contests, and alter the landscape of corporate governance in favor of shareholder activists.

Mandatory Use

The use of universal proxy card will be mandatory in all contested elections of directors. The staff of the Division of Corporate Finance indicated that the mandatory aspect of the proposed rules is intended to prevent parties to a contested election from selecting the use of a universal proxy card only where it provided a tactical advantage to the party electing that option.

Bona Fide Nominees

Under the current proxy rules, shareholders voting by proxy are generally required to vote for nominees included on either the company or dissident proxy card and do not have the opportunity to select candidates from both groups. The use of a universal ballot is permitted in a proxy contest only in the uncommon circumstance in which the opposing parties have consented to the other party’s nominees being named in the proxy statement and to serve if elected (in compliance with the “bona fide nominee” rule in Exchange Act Rule 14a-4(d)(1)). Since the required consent is rarely given, the bifurcated system is most common in proxy contests.

The proposed rules would alter the definition of a “bona fide nominee” in Rule 14a-4(d) to include a person who agrees to be named in any proxy statement relating to a company’s next meeting of shareholders at which directors are to be elected.  The amendment would enable parties to include all director nominees on their universal proxy cards.

Notification Requirements

Under the proposed rules, parties to a proxy contest must notify each other of their respective director nominees. Dissidents would be required to provide such notice no later than 60 calendar days prior to the anniversary of the previous year’s annual meeting date while the company would be required to provide the dissident with the names of the nominees no later than 50 calendar days prior to the anniversary of the previous year’s annual meeting date.

In addition, under the rules, dissidents would be required to file their definitive proxy statement with the Commission by the later of 25 calendar days prior to the meeting date or five calendar days after the registrant files its definitive proxy statement.

Solicitation Requirements

Dissidents would be required to solicit shareholders representing at least a majority of the voting power of shares entitled to vote on the election of directors.

In voicing his opposition to a mandatory universal proxy rule at the open meeting, Commissioner Michael Piwowar noted that the rules require dissidents to only solicit a majority of shareholders entitled to vote, not all shareholders. In drawing this distinction, Commissioner Piwowar highlighted that individual retail shareholders would be the most-likely group to be exempted from the solicitation process and noted that these disenfranchised shareholders would be required to navigate the SEC’s EDGAR filing system to find information relating to a proxy contest. Both points served to underscore the proposed rule’s focus on large shareholder groups at the expense of retail investors.

Changes to Proxy Card Requirements

To address various ambiguities and errors in the descriptions of voting standards and requirements for director elections in proxy materials, the proposed rules also mandate specific changes to the voting options on the proxy card and the disclosure in the proxy statement. In particular, under the proposed amendments to Rule 14a-4(b), proxy cards would be required to include an “against” voting option for the election of directors when there is a legal effect to a vote against a nominee and to provide shareholders the ability to “abstain” in a director election governed by a majority voting standard.  The proposed change would eliminate the current ability to provide a “withhold” voting option when an “against” vote has legal effect.  In addition, the proposed amendments to Item 21(b) of Schedule 14A would require disclosure about the effect of a “withhold” vote in an election of directors.

Ambiguous Proxies

It is easy to imagine a scenario in which a shareholder will mistakenly vote for more nominees then the number of directors to be elected, less than the number of nominees to be elected or merely signs the proxy card and not designate any directors. The SEC’s solution to this is to have the proxy card prominently disclose the treatment and effect of a proxy executed in the foregoing manner although it omits any specific guidance on the precise disclosure that the staff expects to see to address this potential area of confusion.

 Effect of the Proposed Rules

In the Economic Analysis section of the proposed rules, the SEC offers little in the way of concrete predictions regarding the effect of the proposed rules on contested elections. The SEC notes that registrants expecting a universal proxy to result in more dissident nominees being elected may incur additional costs due to increased outreach to shareholders to in an effort to mitigate support for dissident nominees.  The SEC believes the effect of the universal proxy are uncertain because it is difficult to predict the extent or direction of any changes in voting behavior as a result of the proposed amendments and to evaluate whether any resulting changes in the members of the board will lead to more or less or less effective board oversight.  The SEC states any changes in voting behavior due to universal proxies are most likely to affect election outcomes that would otherwise have been very close.  The SEC also believes that the election of mixed boards (those where the registrant’s and dissident nominees are elected) would be somewhat more likely under the proposed rules than current rules.  We expect each of these conclusions to be hotly debated over the forthcoming comment period.

 Going Forward 

The Commission will seek public comment on the proposed rules over the next 60 days.   Like similar attempts to implement a formal proxy access rulemaking, the proposed universal proxy rules are expected to generate numerous comments given the high-profile debate and possible divisive consequences of final rules.  How the Commission will reflect this debate in the final version of its universal proxy rule remains to be seen.

Both opponents and supporters of universal proxy should also take note of the possibility that enactment of a final rule may be taken out of the Commission’s hands, altogether. Actions taken in July 2016 by the U.S. House of Representatives added language to a spending bill for the fiscal year beginning October 1 that would explicitly bar the SEC from implementing a finalized universal ballot rule.

ISS announced the launch of its 2017 benchmark voting policy consultation period. The open comment period, which will solicit views from governance stakeholders globally on certain proposed voting policies for 2017, will run through 6:00 p.m. ET on November 10.

Feedback Requested

For U.S. issuers, ISS is requesting feedback from interested market constituents on new or potential changes to the following areas:

  • General Share Issuance Mandates (U.S.-Listed Cross-Market Companies);
  • Restrictions On Binding Shareholder Proposals (U.S.);
  • Executive Pay Assessments (U.S. Cross-Market); and
  • Unilateral Board Actions – Multi Class Capital Structure at IPO Companies (U.S.).

Restrictions on Binding Shareholder Proposals

ISS explains the proposed changes for restrictions on binding shareholder proposals as follows:

Background and Overview

Shareholders’ ability to amend the bylaws is considered a fundamental right. Under SEC Rule 14a-8, shareholders who have held shares valuing at least $2,000 for one year are permitted to submit shareholder proposals, both precatory and binding, to amend bylaws. However, some states allow for companies to restrict this right in their charters.

Over the last several years, shareholders have launched several campaigns at companies that do not provide this right and have specifically submitted precatory proposals on this issue. These campaigns have often been contentious and have generated interest in the wider investor community on prohibitions of binding shareholder proposals. Some companies have offered management proposals as alternatives, that would have required higher holding levels or time periods for shareholders to submit a binding proposal to amend the bylaws, but these often have not been approved.

Key Changes Under Consideration

Vote against or withhold from members of the governance committee if: The company’s charter or articles of incorporation impose undue restrictions on shareholders’ ability to amend the bylaws. Such restrictions include, but are not limited to: outright prohibition on the submission of binding shareholder proposals, or share ownership requirements or time holding requirements in excess of SEC Rule 14a-8. Vote against on an ongoing basis.

Intent and Impact

Some shareholder campaigns in this area have been effective in shining a light on an issue often not readily visible to the wider market. Shareholders’ ability to amend the bylaws is considered a fundamental right and ISS is therefore proposing a new policy item to address this problematic practice.

The SEC has adopted final rules to modernize intrastate securities offerings under Rule 147, adopted new Rule 147A to broaden the availability of the existing safe harbor for intrastate securities offerings and amended Rule 504 of Regulation D to facilitate regional securities offerings by increasing the maximum amount of securities which may be sold under the exemption.

Intrastate Securities Offerings

SEC Rule 147 was originally adopted by the SEC to implement the intrastate exemption in Section 3(a)(11) of the Securities Act. Over time, it has become apparent the rule is too inflexible for wide spread use in modern times, given the prominence of incorporating outside of the state of the principal place of business, the development of the internet and the advent of crowdfunding.

Rule 147 as amended would remain a safe harbor under Section 3(a)(11) of the Securities Act, so that issuers may continue to use the rule for securities offerings relying on current state law exemptions. New Rule 147A would be substantially identical to Rule 147 except that it would allow offers to be accessible to out-of-state residents.  The flexibility is important because out-of-state persons can read about internet based offerings even if they are not allowed to invest. New Rule 147A also permits companies to be incorporated or organized out-of-state.

Both new Rule 147A and amended Rule 147 would include the following provisions:

  • A requirement that the issuer has its “principal place of business” in-state and satisfies at least one “doing business” requirement that would demonstrate the in-state nature of the issuer’s business.
  • A new “reasonable belief” standard for issuers to rely on in determining the residence of the purchaser at the time of the sale of securities.
  • A requirement that issuers obtain a written representation from each purchaser as to residency.
  • A limit on resales to persons residing within the state or territory of the offering for a period of six months from the date of the sale by the issuer to the purchaser.
  • An integration safe harbor that would include any prior offers or sales of securities by the issuer made under another provision, as well as certain subsequent offers or sales of securities by the issuer occurring after the completion of the offering.
  • Legend requirements to offerees and purchasers about the limits on resales.

Rule 504

Current Rule 504 of Regulation D provides an exemption from the registration requirements of the federal securities laws for some companies when they offer and sell up to $1,000,000 of their securities in any 12-month period.

A company can currently use this exemption so long as it is not a blank check company and does not have to file reports under the Securities Exchange Act of 1934. Also, the exemption generally does not allow companies to solicit or advertise their securities to the public, and purchasers receive “restricted” securities, meaning that they may not sell the securities without registration or an applicable exemption.

Rule 504 does allow companies to solicit or advertise their securities to the public and to sell securities that are not restricted, if one of the following circumstances is met:

  • The company registers the offering exclusively in one or more states that require a publicly filed registration statement and delivery of a substantive disclosure document to investors;
  • A company registers and sells the offering in a state that requires registration and disclosure delivery and also sells in a state without those requirements, so long as the company delivers the disclosure documents required by the state where the company registered the offering to all purchasers (including those in the state that has no such requirements); or
  • The company sells exclusively according to state law exemptions that permit general solicitation and advertising, so long as the company sells only to “accredited investors.”

The amendments to Rule 504 would retain the existing framework, while increasing the aggregate amount of securities that may be offered and sold under Rule 504 in any 12-month period from $1 million to $5 million. The amendments also disqualify certain bad actors from participation in Rule 504 offerings.

The final rules also would repeal Rule 505, which permits offerings of up to $5 million annually that must be sold solely to accredited investors or no more than 35 non-accredited investors. The SEC believes Rule 505 is only rarely used today, and will be even less used now that Rule 504 has been amended.

The CFTC quelled a controversy that had emerged regarding its proposed exemption of certain specified energy products transacted in Regional Transmission Organizations (RTO) by doing a “180” on its proposals that otherwise would have made the general anti-fraud, anti-manipulation, and scienter-based prohibitions that still apply to such transactions under the Commodity Exchange Act enforceable through private rights of action. Instead, the CFTC expressly recognized in its Final Order that its RTO exemptions will exempt the specified transactions from the Act’s private right of action provision as well. The Federal Energy Regulatory Commission (FERC), numerous trade organizations, market participants, and others had strongly opposed the CFTC’s proposal to leave the transactions subject to private rights of action, arguing that such a regime would introduce unwarranted inconsistencies and uncertainty in markets that are already heavily regulated by FERC.

Commissioner Giancarlo stated in support of the Order: “As I have observed, preserving the Section 22 private right of action is not necessary in these heavily regulated markets. Both the CFTC and the FERC have the authority to seek redress for the claims of private persons who raise meritorious allegations of fraud or manipulation.”

SEC staff in the Office of Compliance Inspections and Examinations are examining compliance with key whistleblower provisions arising out of the Dodd-Frank Wall Street Reform and Consumer Protection Act. The staff is examining registered investment advisers and registered broker-dealers, reviewing, among other things, compliance manuals, codes of ethics, employment agreements, and severance agreements to determine whether provisions in those documents pertaining to confidentiality of information and reporting of possible securities law violations may raise concerns under Rule 21F-17.

Recent enforcement actions have identified certain provisions of confidentiality or other agreements required by employers as contributing to violations of Rule 21F-17 because they contained language that, by itself or under the circumstances in which the agreements were used, impeded employees and former employees from communicating with the SEC concerning possible securities law violations. According to the SEC this has a potential chilling effect that can be especially pronounced when such documents (e.g., severance agreements) provide that an employee may forfeit all benefits if he or she violates any terms of the agreement.

In examinations where the staff includes a review of registrants’ compliance with Rule 21F-17, the staff is analyzing a variety of documents, including:

  • Compliance manuals;
  • Codes of ethics;
  • Employment agreements; and
  • Severance agreements.

In this review, the staff assesses whether these documents contain provisions similar to those in agreements that the SEC has found to violate Rule 21F-17, including provisions that: (a) purport to limit the types of information that an employee may convey to the Commission or other authorities; and (b) require departing employees to waive their rights to any individual monetary recovery in connection with reporting information to the government.

The staff also assesses whether these documents contain other provisions that may, according to the SEC, contribute to violations of Rule 21F-17 in circumstances where their use impedes employees or former employees from communicating with the SEC, such as provisions that:

  • Require an employee to represent that he or she has not assisted in any investigation involving the registrant;
  • Prohibit any and all disclosures of confidential information, without any exception for voluntary communications with the DEC concerning possible securities laws violations;
  • Require an employee to notify and/or obtain consent from the registrant prior to disclosing confidential information, without any exception for voluntary communications with the SEC concerning possible securities laws violations; or
  • Purport to permit disclosures of confidential information only as required by law, without any exception for voluntary communications with the SEC concerning possible securities laws violations.

When examining registrants’ compliance with Rule 21F-17, the staff is citing deficiencies and making referrals to the SEC Division of Enforcement where appropriate.

 

[Update:  See our analysis of the proposed rule here.]

The SEC has announced it will consider proposed rules that permit the use of universal proxy cards in contested elections on October 26, 2016.

The concept of a universal proxy has been on the periphery of the SEC’s rulemaking agenda for some time:

  • The SEC considered requiring implementation of a universal proxy ballot with its overhaul of the proxy rules in 1992 (Release No. 34-31326) but declined noting that while “any such universal ballot is appealing since the shareholder could make such a selection if he or she attended the annual meeting in person” a universal proxy “would represent a substantial change in the SEC’s proxy rules.”
  • Universal proxy again came to the attention of the SEC in 2013, when the SEC’s Investor Advisory Committee made a recommendation for the SEC to explore revisions to the proxy rules to provide proxy contestants with the option to list both the company’s and the contestant’s nominees on one proxy card with respect to short slate elections.
  • In 2014, the Council of Institutional Investors (CII) submitted a rulemaking petition requesting that the SEC amend the proxy rules to require the use of universal proxy in all contested elections and has continued to promote adoption of universal proxy in subsequent correspondence with the SEC.

More recently, in a June 2015 speech, SEC Chair Mary Jo White conveyed the SEC’s current view of the universal proxy ballot: “It is not generally possible for shareholders to pick freely from nominees on each side’s proxy cards unless they attend and vote in person at the meeting. By operation of state law requirements, the proxy rules, and practical considerations, shareholders executing a proxy face an either/or proposition: they can vote for either the entire slate of candidates put forward by management or by a proponent — they cannot pick and choose the individuals that they believe are the best candidates from the two slates . . . Given these obstacles, some have requested that the SEC revise the proxy rules to facilitate the use of a “universal proxy ballot,” a single proxy card that would list both management’s and a proponent’s nominees in contested director elections, allowing shareholders to vote for a mix of nominees of their own choosing.”

The Chair’s 2015 speech carried with it an implicit indication of the rising importance of universal proxy on the SEC’s rulemaking agenda. Following in the path of the SEC’s numerous attempts at implementing proxy access rules, the possibility of forthcoming rulemaking has spurred debate amongst various issuers, investors, and their respective advisors and constituents.  In particular, the proposed rules will likely attract widespread debate on the following issues:

  • Will it increase or decrease shareholder activism?
  • Will it impact the outcome of election contests?
  • Will it embolden activists to run more contests?
  • Will it stimulate increased cooperation and settlements between issuers and activists, thereby decreasing contests?

In the same 2015 speech, Chair White noted some of the decisions the SEC will face in its rulemaking effort:

  • When can a universal ballot could be used?
  • Will it be optional or mandatory?
  • What eligibility requirements will be imposed on shareholders to use universal ballots?
  • What will the ballot would look like?
  • Must both sides must use identical universal ballots?

How the SEC will balance the countervailing viewpoints will be substantially clearer following the SEC open meeting on October 26th.

On October 19th, the Division of Corporation Finance released three new and revised Compliance and Disclosure Interpretations (C&DIs) concerning the Securities Act. Revised C&DI 271.04 and new C&DI 271.21 relate to exempt offerings and sales of securities under Rule 701 of the Securities Act while revised C&DI 532.06 relates to the holding period for securities issued under Rule 144 of the Securities Act.

The revised Rule 701 interpretation (C&DI 271.04) clarifies that issuers reporting under the Exchange Act are not required to register the offer and sale of shares issuable upon the exercise of options where the issuance of such shares became the obligation of the reporting issuer following its acquisition of a private company not previously subject to the reporting requirements under the Exchange Act.

Revised C&DI 271.04 reverses the staff’s prior interpretation with respect to Rule 701 and logically extends the exemption for sales of securities by non-reporting companies under Rule 701(b)(2) to a reporting company’s issuance of securities upon exercise of options assumed from an acquired private company issuer. The interpretation also clarifies that disclosures appearing in the acquirer’s Exchange Act reports will satisfy the disclosure requirements triggered by Rule 701(e).

The staff’s prior interpretation is reproduced below:

Question 271.04

Question: A company that is not subject to the reporting requirements of Exchange Act Section 13 or 15(d) issued options in reliance on Rule 701. This company is acquired by another company, which is subject to the reporting requirements of Exchange Act Section 13(a) or 15(d) and assumes the private company’s outstanding options so that they become exercisable for shares of the acquiring company. May the acquiring company rely on Rule 701(b)(2) to exempt their exercise?

Answer: No. [Jan. 26, 2009]

The new Rule 701 interpretation (C&DI 271.24) deals with exempt offers and sales of restricted stock units (RSUs) awards to employees and the timing requirements for delivery of the additional information specified in paragraphs (1) through (4) of Rule 701(e) triggered if the issuer sells an aggregate amount of securities (including the RSUs) in excess of $5 million over a 12-month period. The interpretation specifies that under such circumstances, the issuer is obligated to deliver the required information “a reasonable period of time before the date of the sale” and provides that “[f]or the sale of an RSU award that relies on Rule 701 for exemption, the date of sale is the date it is granted.” As a result, for grants of RSUs in reliance on Rule 701, an issuer must provide the required information a reasonable time before the date the RSU award is granted. The new interpretation also clarifies that despite the fact that RSUs are typically considered derivatives, Item 701(e)(6) (relating to the exercise or conversion of derivative securities) does not apply because such RSUs do not need to be exercised or converted.

The third C&DI issued by Corp Fin (C&DI 532.06) revises the staff’s prior interpretive response with respect to the holding period for restricted securities issued pursuant to a written agreement under Rule 144(d) and, specifically, when such holding period begins to run. Under the prior interpretation (issued January 2009), the staff indicated that “where restricted securities are issued to an employee in connection with an individually negotiated employment agreement” such employee’s holding period “begins to run at the time the securities vest, assuming any conditions, such as continued employment, have been fulfilled.”

The newly revised C&DI 532.06 cites to the applicability of Question 23 of Securities Act Release No. 6099 (Aug. 2, 1979) and its reference to holding periods under Rule 144(d) as beginning when “the person who will receive the securities is deemed to have paid for the securities and thereby assumed the full risk of economic loss with respect to them.” The interpretation further clarifies that for restricted securities received by an employee pursuant to an “individually negotiated employment agreement,” the holding period “commences when investment risk for the securities passes to the employee,” as follows:

  • “For full value awards, if the vesting of the securities is conditioned solely on continued employment and/or satisfaction of performance conditions that are not tied to the employee’s individual performance and the employee pays no further consideration for the securities, that date would be the date of the agreement;” and
  • “For awards that require additional payment upon exercise, conversion or settlement, that date would be the date on which such payment is made.”

The staff’s prior interpretation is reproduced below:

532.06 Question 22 of Securities Act Release No. 6099 (Aug. 2, 1979), dealing with the holding period under Rule 144(d) for restricted securities under an employee benefit plan, does not apply where restricted securities are issued to an employee in connection with an individually negotiated employment agreement. The employee’s holding period begins to run at the time the securities vest, assuming any conditions, such as continued employment, have been fulfilled. [Jan. 26, 2009]