Preventing Exchange Act Reporting Obligations After The JOBS Act

by Stinson Leonard Street - Dodd-Frank and the Jobs Act

In General

Growing companies need to be aware of the requirements of Section 12(g) of the Exchange Act.  If the thresholds of Section 12(g) are crossed, which look principally to the number of shareholders, the company must generally begin filing the same reports under the Securities Exchange Act of 1934 as any company listed on the NYSE or Nasdaq. Therefore the issue needs to be considered when raising capital and granting employees equity, and is especially important to venture funded and other entities that use employee equity as a significant component of compensation.

Ignoring special accommodations for bank holding companies, the JOBS Act amended Section 12(g) and Section 15(d) of the Exchange Act as follows:

  • The holders of record threshold for triggering Section 12(g) registration for issuers (other than banks and bank holding companies) has been raised from 500 or more persons to either (1) 2,000 or more persons or (2) 500 or more persons who are not accredited investors.
  • In calculating the number of holders of record for purposes of determining whether Section 12(g) registration is required with respect to a class of equity security, issuers (including banks and bank holding companies) may exclude persons who received the securities pursuant to an employee compensation plan in transactions exempted from the registration requirements of Section 5 of the Securities Act.

As a result, we discuss the following critical issues in depth:

  • How do you count the number of holders, and do you need to look beyond the share register?
  • What can an issuer do to make sure its shareholders remain accredited investors?
  • What is important to maintain an exemption for securities issued pursuant to an employee benefit plan?

Counting Holders

While seemingly straightforward, numerous complexities can arise.  Exchange Act Rule 12g5-1, which addresses the definition of “held of record” provides among other things, the following counting rules:

  • Securities identified as held of record by a corporation, a partnership, a trust whether or not the trustees are named, or other organization shall be included as so held by one person.
  • Securities identified as held of record by one or more persons as trustees, executors, guardians, custodians or in other fiduciary capacities with respect to a single trust, estate or account shall be included as held of record by one person.
  • Securities held by two or more persons as co-owners shall be included as held by one person.
  • Securities registered in substantially similar names where the issuer has reason to believe because of the address or other indications that such names represent the same person, may be included as held of record by one person.

Packing multiple holders into a special purpose vehicle to hold the securities and the hoped for ability to count them as one holder probably doesn’t work.  The rule provides that notwithstanding the foregoing points, securities held, to the knowledge of the issuer, subject to a voting trust, deposit agreement or similar arrangement shall be included as held of record by the record holders of the voting trust certificates, certificates of deposit, receipts or similar evidences of interest in such securities, provided, however, that the issuer may rely in good faith on such information as is received in response to its request from a non-affiliated issuer of the certificates or evidences of interest.

The SEC has confirmed in CDIs that institutional custodians, such as Cede & Co. and other commercial depositories, are not single holders of record for purposes of the Exchange Act’s registration and periodic reporting provisions. Instead, each of the depository’s accounts for which the securities are held is a single record holder.  The SEC has also confirmed in CDIs that securities held in street name by a broker-dealer are held of record under the rule only by the broker-dealer. The SEC originally proposed a version of the rule that would have looked through to the beneficial owners of the street-name securities, but adopted the rule in a form that does not produce this result.

Employee Benefit Plans

It is important to understand that options and other benefit plan securities can potentially trigger Exchange Act registration.  See Exemption Of Compensatory Employee Stock Options From Registration Under Section 12(g) Of The Securities Exchange Act Of 1934 (Release No. 34-56887).  However, the SEC has confirmed in CDI’s the directives in the JOBS Act that that an issuer may exclude persons who received securities pursuant to an employee compensation plan in Securities Act-exempt transactions whether or not the person is a current employee of the issuer. Although Section 503 of the JOBS Act directs the Commission to adopt “safe harbor” provisions that issuers can follow when determining whether holders of their securities received the securities pursuant to an employee compensation plan in transactions that were exempt from the registration requirements of Section 5 of the Securities Act of 1933, the lack of a safe harbor does not affect the application of Exchange Act Section 12(g)(5).


The SEC has proposed in Regulation Crowdfunding, as directed by the JOBS Act, that securities issued pursuant to the crowdfunding exemption are not counted when determining whether Exchange Act Thresholds are crossed. The JOBS Act requires the SEC to exempt securities issued under Section 4(a)(6) from the registration requirements of the Exchange Act.  Proposed Rule 12g-6 provides that securities issued pursuant to an offering made under Section 4(a)(6) would be permanently exempted from the record holder count under Section 12(g). An issuer seeking to exclude a person from the record holder count would have the responsibility for demonstrating that the securities held by the person were initially issued in an offering made under Section 4(a)(6).

Practical Implications

Given the foregoing, issuers that anticipate having numerous shareholders should consider the following:

  • Organizational documents should prohibit transfers to transferees that are not accredited investors.  Prior to permitting any such transfer, the issuer should require the proposed transferee to submit data that confirms the transferee is an accredited investor.
  • Organizational documents should require accredited investors to annually recertify that they remain accredited investors and if not perhaps a redemption right at an agreed value should exist.
  • Any securities issued pursuant to benefit plans should scrupulously comply with Securities Act exemptions and documentation of compliance should basically be maintained “forever” so that the exemption from Exchange Act registration can be proved.
  • Resist the urge to encourage investors to use special purpose entities to aggregate investors to avoid Exchange Act registration but if it happens make sure there are procedures in the special purpose entities’ organizational documents to maintain exemptions as set forth above.
  • Have procedures to track securities issued under Regulation Crowdfunding so that initial holders and transferees can be excluded when calculating Exchange Act registration thresholds.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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