On November 24, 2020, the SEC approved proposed amendments to rules governing the offer or sale of securities to employees through compensation programs. The proposed amendments to Rule 701 and Form S-8 are designed to modernize the framework for compensatory securities offerings in light of the significant evolution in compensatory offerings and composition of the workforce. 

At the same time, the SEC proposed a temporary, five-year expansion of Rule 701 and Form S-8 eligibility for compensatory offerings to “gig workers,” subject to various conditions. We plan to publish a summary of that separate proposal in our Securities & Corporate Governance Blog in coming days.

Key changes for Rule 701, which provides an exemption from registration for the issuance of compensatory securities by non-SEC reporting companies, would include:

• Relaxed disclosure requirements, including following business combinations
• Clarification of delivery requirements for equity awards
• Raised caps for ceilings on sales
• Expanded eligibility for consultants organized as entities and for former employees and employees of subsidiaries

Key changes for Form S-8, which sets forth the requirements for registration statements for compensatory offerings by SEC reporting companies, would include: 

• Clarification for use of S-8 for multiple plans and allocations of shares among plans
• New fee calculation and payment methodology for 401(k) and other defined contribution plans – with payment made 90 days following year-end for sales during that year
• Expanded eligibility for consultants organized as entities and for former employees and employees of subsidiaries
• Conforming Form S-8 instructions with current IRS plan review practices for qualified plans

The public comment period for the proposed rule amendments will remain open for 60 days following publication of the release in the Federal Register.

Proposed Amendments to Rule 701

Disclosure Requirements. The SEC proposes to revise the disclosure requirements for transactions exceeding $10 million:

• How the Disclosure Threshold Applies. The heightened disclosures for these transactions would need only be delivered to investors for sales that exceed the $10 million threshold; as a result, the risk of loss of the exemption would not apply to all sales in the applicable 12-month period. The SEC recognizes that the “lookback” risk may be creating undue difficulty in planning compensatory programs or responding to unforeseen new hire situations. 
• Age of Financial Statements. The age of financial statement requirement would be conformed to the corresponding requirement in Part F/S of Form 1-A at the time of sale. In Regulation A offerings, issuers generally must include two years of consolidated balance sheets, statements of comprehensive income, cash flows, and changes in stockholders’ equity. Companies relying on Rule 701 may choose to provide financial statements that comply with the requirements of either Tier 1 or Tier 2.

  Under the proposal, financial statements would need to be available on at least a semi-annual basis and completed within three months after the end of the second and fourth quarters. Companies would no longer be required to prepare financial statements quarterly in order for sales to be made continuously pursuant to Rule 701. The proposal also would be consistent with financial statement updating requirements for registered offerings on Form 20-F, thereby eliminating any disadvantage for non-reporting foreign private issuers (FPIs).

• Financial Statement Content Requirements for FPIs. Foreign private issuers that are eligible for the exemption from Exchange Act registration provided by Rule 12g3-2(b) would be permitted to provide financial statements prepared in accordance with home country accounting standards without reconciliation to GAAP in certain circumstances. All other FPIs would need to continue to provide a reconciliation to GAAP if their financial statements are not prepared in accordance with GAAP or IFRS to comply with Rule 701.

• Alternative Valuation Disclosure. Companies would be permitted to provide alternative valuation information in lieu of financial statements -- specifically an independent valuation report of the securities’ fair market value as determined by an independent appraisal consistent with Section 409A rules.  Companies would be required to provide employees the entire Section 409A independent valuation report. Two conditions would apply:
  • The valuation must be determined in an independent appraisal consistent with Section 409A rules for shares not readily tradable on an established securities market. Companies would not be permitted to rely on 409A rules that permit determination of fair value for tax purposes by other means.
  • The Section 409A independent valuation report would need to be as of a date that is no more than six months before the sale of securities.

  FPIs eligible for the Rule 12g3-2(b) exemption may have a trading market of the necessary depth and liquidity to justify using the 409A valuation standard for stock readily traded on an established securities market. In those cases, the eligible issuer may disclose the fair market value of the stock on the most recent trading day preceding the date of sale.

• Disclosure Requirements for Derivative Securities. Revised Rule 701(e)(6) would distinguish between derivative securities that involve a decision to exercise or convert, and those that do not. The timing obligation to deliver disclosure would vary depending on the situation:
  • Stock Options. A reasonable period of time before the date of exercise or conversion, in the case of a sale that involves a stock option or other derivative security that involves a decision to exercise or convert.
  • RSUs. A reasonable period of time before the date of grant, if the sale involves an RSU or other derivative security that does not involve a decision to exercise or convert. Specific disclosure would not be required at the time of RSU settlement, because the SEC does not view that as involving an investment decision.
  • New Hires. No later than 14 calendar days after the start date of employment, in the case of new hires -- in order to permit the company to address confidentiality concerns. 

• Disclosure Requirements following Business Combinations.
  • Derivative securities assumed by an acquiring company would remain exempt from registration, so long as:
    • The target company complied with Rule 701 at the time it originally granted the derivative securities; and
    • The acquiring company, where applicable, complies with the disclosure and timing requirements of Rule 701(e).
  • After closing, in determining whether the amount of securities the acquiring company sold during any consecutive 12-month period exceeds $10 million, securities sold by the target company would not need to be considered.

Rule 701(d) Caps on Amount Sold in 12-Month Period.  Two of the three alternative ceilings on the aggregate sales price or amount of securities sold in reliance on Rule 701 during any consecutive 12-month period would be raised.  As proposed:

• The asset cap would be raised from 15% to 25% of the total assets of the issuer (or of the company’s parent if the company is a wholly-owned subsidiary and the securities represent obligations that the parent fully and unconditionally guarantees) measured at the company’s most recent balance sheet date (if no older than its last fiscal year end).
• The alternative $1 million cap available to any company would be raised to $2 million.
• The third alternative cap – 15% of the outstanding amount of the class of securities being offered and sold – would remain unchanged.

After completion of a business combination transaction, to calculate compliance with paragraph (d)(2), the acquiring company may use a pro forma balance sheet that reflects the transaction or a balance sheet for a date after the completion of the transaction that reflects the total assets and outstanding securities of the combined entity.

Eligible Recipients – Consultants and Advisors Organized as Entities. Rule 701 consultant and advisor eligibility would be extended to include service providers organized as entities that meet the following conditions:

• Substantially all of the activities of the entity involve the performance of services; and
• Substantially all of the ownership interests in the entity are held directly by:
  • No more than 25 natural persons, of whom at least 50 percent perform such services for the issuer through the entity;
  • The estate of a natural person specified above; and
  • Any natural person who acquired ownership interests in the entity by reason of the death of a natural person specified above.

Like a natural person, the entity would also need to satisfy the existing requirement of providing bona fide services that are not in connection with the offer or sale of securities in a capital-raising transaction and do not directly or indirectly promote or maintain a market for the company’s securities.

Eligible Recipients – Former Employees and Subsidiaries.

Former Employees.  Eligible participants would be expanded to include:

• persons who were employed by or providing services to the company, its parents, its subsidiaries or subsidiaries of the company’s parent and who are issued securities after resignation, retirement or other termination as compensation for services rendered during a performance period that ended within 12 months preceding such termination; and
• former employees of an entity that was acquired by the company if the securities are issued in substitution or exchange for securities that were issued to the former employees of the acquired entity on a compensatory basis while such persons were employed by or providing services to the acquired entity.

Consistent with Form S-8, the proposal would also define “employee” for purposes of Rule 701 to include executors, administrators and beneficiaries of the estates of deceased employees, guardians or members of a committee for incompetent former employees, or similar persons duly authorized by law to administer the estate or assets of former employees. 

Employees of Subsidiaries.  The Rule 701 exemption would be extended to plans established by a company’s subsidiaries, whether or not majority-owned -- consistent with Form S-8. This change, among other things, would expand eligibility to subsidiaries consolidated by a company as variable interest entities, such as physicians employed by medical practices controlled by the company.

Preliminary Notes. To comply with current Federal Register formatting requirements, the SEC also proposed a ministerial amendment to Rule 701 to remove the Preliminary Notes and move their provisions without change to Rule 701(a).

Clarifications and Proposed Amendments to Form S-8

The  SEC clarified the application of current rules and also proposed amendments to simplify Form S-8 registration requirements:

Clarification: Registration of Multiple Plans under Current Rules.  The SEC clarified that companies can add multiple plans to an existing Form S-8, stating that – under current rules -- companies may file an automatically effective post-effective amendment to an existing Form S-8 to add employee benefit plans where the new plan does not require the authorization and registration of additional securities for offer and sale.  The SEC is proposing, however, a minor modification to the cover page to clarify that the titles of multiple plans may be listed.

The adopting release contains this example as clarifying guidance:  assume a company has an effective Form S-8 that registers sales of common stock to be issued under its 2010 equity compensation plan and has recently adopted a new 2020 plan to replace the 2010 plan that does not authorize additional shares. Upon effectiveness of the 2020 plan, no further awards may be granted pursuant to the 2010 plan and any shares covered by an award under the 2010 plan will be issued under the 2020 plan. In order to sell under the 2020 plan, the company may register shares for the new plan on a new Form S-8. Alternatively, under current rules, the company could file an automatically effective post-effective amendment to the previously filed Form S-8 to add employee benefit plans, such as the 2020 plan in the example. That post-effective amendment would be required to disclose any material change in the plan of distribution, including that a new plan is being added to an existing Form S-8, and also describe how shares that will not be issued under the previous plans may become authorized for issuance under the current plans. The post-effective amendment also must identify all covered plans on the cover page and describe, if applicable, how the shares that were registered for previous offerings on the Form S-8 pursuant to other plans have instead become authorized for issuance under the newly added plan. At the time of the filing of any post-effective amendment to Form S-8, the company must continue to meet the requirements of the form. The company would also add the signatures and file the required opinions of counsel with the post-effective amendment. The company would thereafter deliver or cause to be delivered in accordance with Rule 428(b)(2)(i) the documents identified in Rule 428(a) as part of the prospectus that describes the new plan.

The SEC believes this guidance will (1) reduce the administrative burdens to the extent companies previously believed that filing an entirely new Form S-8 for each new plan was required; (2) help facilitate the use of a single Form S-8 for all employee benefit plans, if the company chooses to do so; and (3) reduce the problems associated with fee transfers between multiple registration statements that have registered ongoing offers and sales that cannot be terminated.

Clarification:  Securities Allocation among Incentive Plans. The SEC clarified that - under current rules - companies are not required to allocate registered securities among incentive plans and may use a single Form S-8 for multiple incentive plans.  However, the SEC is proposing several clarifying amendments. 

For companies utilizing this flexibility, the initial registration statement would be required to list the types of securities covered by the registration statement and identify the plan or plans pursuant to which the company intended to issue securities as of that date. The full title of each plan would be required to be listed on the face of the registration statement on the appropriate line. The Part I information delivered pursuant to Rule 428 with respect to each plan would be required to be specific to that plan. If any Part II information relates specifically to one plan, the company would be required to disclose that relationship clearly. The registration statement would not need to assign or allocate the securities to particular incentive plans. In this way, the form may be used to create a pool of shares that may be issued under various plans as necessary. However, companies would need to track their offers and sales of shares to ensure they have sufficient capacity registered for the various plans. 

The SEC believes this clarification will (1) promote efficiency and flexibility because it will eliminate any doubt about whether authorized but unissued shares under a plan that expires would be immediately available for issuance under another authorized plan and (2) reduce administrative burdens for companies that believe they must use a separate Form S-8 for each plan, such as multiple signature pages or auditor consents.

The SEC also notes that companies must continue to prepare and deliver a plan-specific prospectus, according to current requirements, and thus investors would continue to receive the same information as is currently required for any Form S-8 offering. 

Addition of Securities or Classes of Securities to Form S-8. Rule 413 would be amended to allow companies to add securities to an existing Form S-8 by filing an automatically effective post-effective amendment. Companies would no longer be required to file a new Form S-8 to register the offering of additional shares under an existing or new incentive plan. Similarly, if a company were to adopt a new employee benefit plan which made available a new class of security on a compensatory basis, the company would only be required to file an automatically effective post-effective amendment to its existing Form S-8 to add the new plan and the new class of security to the registration fee table and any additional disclosure that would be required to inform investors about the new class of security.

The amendments would not eliminate the requirement to register plan interests as separate securities or the obligation to file an annual report on Form 11-K with respect to those interests.

Fee Calculation and Fee Payments for Defined Contribution Plans.  Rule 457 would be amended to require registration for defined contributions plans, such as 401(k) plans, based on the aggregate offering price of all the securities sold. Second, a new fee payment method would permit companies to pay the fee for all sales made pursuant to defined contribution plan offerings during a given fiscal year no later than 90 days after fiscal year end. 

• Fee Calculation for Defined Contribution Plans. All companies registering shares to be offered and sold pursuant to defined contribution plans, including companies previously using 457(o) – where the registration fee is based on the maximum aggregate offering price of shares registered -- would thereafter use Rule 416(d) to register an indeterminate amount of securities.  Additionally, they would need to calculate their registration fee under proposed Rule 457(h)(4) by multiplying the aggregate offering price of securities sold during the fiscal year by the fee payment rate in effect on the payment date, and then pay such fee in accordance with the proposed requirements of Rule 456(e).

  Where necessary, companies would refer to such fee calculation in the “Calculation of Registration Fee Table” in the S-8 or post-effective amendment filed to pay the required fee. 

  The amendments would eliminate the need to track offers and sales of individual shares within unitized plans and reduce the risks of violating Section 5 by allowing offers and sales to be accounted and paid for based on a known aggregate offering dollar amount after contributions are made to the company stock fund. For plans that are not defined contribution plans, such as incentive plans, companies must continue to register a maximum number of securities issuable under the plan that are covered by the registration statement, as currently contemplated by Rule 457(h)(1). A company may rely on these provisions on the same registration statement if the fee table clearly explains how the registration fees are being calculated for the different types of plans.

  For this purpose, “defined contribution plan” would mean “an employee benefit plan (as defined in §230.405) that provides for specified or determinable contributions by the employee, employer, or both to an individual account for each employee participant where the amount of benefits paid depends, in addition to the level of contributions, on the return on the investment.”

• New Fee Payment Method for Sales Pursuant to Defined Contribution Plans. In order to alleviate the problem of inadvertently registering too many or too few securities to be sold under an S-8 for a 401(k) or similar plan, companies would be deemed to have registered the offer and sale of an indeterminate amount of securities pursuant to defined contribution plans. The new fee payment method would be mandatory, which the SEC believes would be easier for both companies and the staff to administer.

  Any fees associated with sales in a given fiscal year would be required to be paid -- within 90 calendar days after the plan’s fiscal year end -- by filing an automatically effective post-effective amendment to the S-8. The filing would need only contain (1) the cover page, including the calculation of the registration fee table, (2) the required signatures and (3) a newly proposed box on the cover page that would be checked to indicate that the amendment is being filed to pay filing fees using the method required by Rule 456(e). This post-effective amendment would only be used to pay fees and not for any other purpose, such as adding plans or shares to the S-8. 

  If a company ceases operations -- whether upon the merger, liquidation, or sale of substantially all issuer’s assets -- the plan’s fiscal year would be deemed to end on the closing date. Ninety days later, the company would be required to make a final payment for shares that were sold as of the plan’s last fiscal year-end.

Additional Requests for Comment on Counting the Shares Registered on Form S-8 for Defined Contribution Plans.  In response to requests for guidance on various uncertainties surrounding share counting, the SEC provided its “preliminary” views -- for which it requested comments:

“Currently, Section 5 of the Securities Act requires registration of the offer and sale of the securities to the investing employee under the plan because it is a separate transaction from the initial offer and sale of the securities to the divesting employee. Although current practice may vary, because each offer and sale of a security needs to be registered or exempt from registration, we preliminarily believe that when employees divest and other employees invest in issuer securities within the plan, an issuer should not “net” or “offset” these plan transactions against each other in determining the number of shares to deduct from the total number of shares to be offered and sold pursuant to the Form S-8. If such securities become available for a subsequent sale, after their earlier sale pursuant to a registration statement, we preliminarily believe the fact that those shares may be the “same” shares that were part of a previous, registered transaction does not negate the fact that the subsequent sale involves a different transaction by the issuer and the plan.”[footnote omitted]

Conforming Form S-8 Eligibility to Rule 701.  Form S-8 eligibility would be expanded to conform to the proposed Rule 701 amendments discussed above to include:

• Former employees with respect to acquisitions as compensation for such service to the company during a performance period ending within 12 months preceding the former employee’s resignation, retirement or other termination and former employees of acquired entities with respect to equity awards granted in connection with the acquisition to replace awards issued by the target during employment there; and
• Certain consultants and advisors organized as entities, subject to the same conditions as Rule 701, as discussed above. 

Conforming changes would also be made to the definition of “employee benefit plan” to ensure that the scope of consultants or advisors that are eligible to participate in an employee benefit plan is consistent with the changes to Form S-8.

Conforming Form S-8 Instructions with Current IRS Plan Review Practices. Amendments to Item 8(b) would permit an undertaking that companies will maintain a qualified plan’s compliance with ERISA and make changes required to maintain such compliance in a timely manner. Because of IRS changed practices, the amendments also would eliminate the requirement that companies undertake to submit any amendment to the plan to the IRS and to file a copy of the IRS determination letter that the amended plan is qualified under Section 401 of the Internal Revenue Code. 

If the company does not provide the undertaking described above, existing requirements would continue to apply regarding plan amendments and filing a legal opinion as to compliance with ERISA.

Further, the issuer-specific determination letter or opinion requirements in S-K Item 601(b)(5)(ii) and the opinion requirement in S-K Item 601(b)(5)(iii) would be eliminated for companies that adopt a third-party plan that has been approved by the IRS if they file the IRS opinion letter issued to the pre-approved plan’s provider. Companies relying on proposed Item 8(c) would not need to obtain their own determination letter from the IRS or otherwise provide an opinion of counsel unless they make revisions to the pre-approved plan that may call into question whether the revised plan is still qualified.

Revisions to Item 1(f) of Form S-8; Tax Effects of Plan Participation. Item 1(f) of Form S-8 would be amended to eliminate the requirement to describe the tax effects of plan participation on the company.

Requests for Comment

The SEC requests comment on virtually all aspects of the proposals described above.  Additionally, the following additional topics were raised:

• Whether the requirement to describe tax consequences to employees in Form S-8 and to state whether or not the plan is qualified under Section 401(a) of the Internal Revenue Code provides relevant information
• Whether it is appropriate to continue to require the Form S-8 to be signed by the trustees or administrators on behalf of the employee benefit plan, rather than the employer/sponsor
• Alternative approaches to facilitate participation by employees in an ESPP in connection with any IPO

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