The U.S. Securities and Exchange Commission (SEC) recently proposed for comment amendments to Rule 701 and Form S-8 to address the major changes that have taken place in recent years in companies' compensation practices and workforce composition. Rule 701 and Form S-8 are the principal means by which issuers may grant compensatory securities to their workforce.1 These proposed rules are intended to modernize Rule 701 and Form S-8 by expanding the class of eligible recipients of compensatory securities, relaxing and streamlining disclosure requirements and thresholds, and more, and thus are likely to be viewed favorably by most companies.
The SEC also proposed for comment a temporary expansion of Rule 701 and Form S-8 to enable issuers to grant compensatory equity awards to platform (gig) workers, subject to certain conditions.
Amendments to Rule 701 and Form S-8
The SEC has proposed for comment wide-ranging amendments to Rule 701 and Form S-8. Some of the key proposed changes to Rule 701 and Form S-8 include the following:
- The proposed rules would expand the scope of service providers eligible to receive securities under Rule 701 and Form S-8, thus providing companies additional flexibility to use their general equity incentive plans to grant awards to the following new classes of service providers, subject to the terms of the plans:
In addition, the proposed rules would align Rule 701 with the existing scope of Form S-8, so that the meaning of "employee" for purposes of Rule 701 would be expanded 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.
- Certain entity consultants and advisors meeting specified criteria (currently only natural persons and their corporate alter egos are eligible);
- Former service providers, with respect to equity awards granted after termination as compensation for services provided during the 12-month period before such termination (under the current rules, awards to former service providers are covered only if they were providing services to the company at the time of grant);
- Former service providers of acquired companies, with respect to equity awards substituted or exchanged by the acquiring company for compensatory equity awards of the acquired company (under current rules, the substituted/exchanged awards would not be covered because the recipients would not be current service providers of the acquirer at the time of the substitution/exchange); and
- Employees covered by a compensatory arrangement of any subsidiary without regard to whether the subsidiary is majority-owned (i.e., more than 50 percent-owned generally), as required under current Rule 701 rules.
- The proposed rules would raise two of the three limits for the maximum value of equity issuable under the Rule 701 exemption in any consecutive 12-month period. These limits, as amended, would be:
In calculating the applicable thresholds, the proposed rules would, after completion of a business combination, allow the acquirer to use a pro forma balance sheet that reflects the transaction or a balance sheet as of a date after the transaction that reflects the total assets and outstanding securities of the combined entity. Further, the acquirer would not be required to include the sales price and amount of securities for which the acquired entity claimed the exemption during the same 12-month period.
- $2 million (increased from $1 million);
- 25 percent of total assets of the issuer (increased from 15 percent); or
- 15 percent of the outstanding amount of the class of securities offered (no change from the existing limit).
- The proposed rules would relax the disclosure requirements under Rule 701 for sales exceeding $10 million in any consecutive 12-month period, which would result in generally lower compliance costs to non-reporting issuers seeking to rely on Rule 701, including the following:
- Enhanced disclosure requirements under Rule 701(e) (which include the provision of financial statements and other disclosures) will apply only to those sales that exceed the $10 million threshold (rather than a lookback to all sales within the applicable 12-month period, including those occurring before the threshold was exceeded);
- Financial statements will be required to be made available at least semi-annually and completed within three months of the end of the second and fourth quarters (rather than on a quarterly basis as required under current Rule 701 in order to enable continuous sales under the exemption);
- In lieu of disclosing financial statements, non-reporting issuers (other than certain foreign private issuers) will be permitted to provide an independent valuation report prepared in compliance with Section 409A of the Internal Revenue Code, which is effective as of a date no earlier than six months before the sale (the disclosure of valuation reports is not required under the Section 409A rules);
- In the case of restricted stock units (RSUs) or other derivative securities that do not involve a decision to exercise or convert, the Rule 701(e) disclosures will need to be provided to a new hire within 14 calendar days after the date employment begins; however, for grants of stock options or other derivative securities that involve a decision to exercise or convert, or grants of RSUs or similar derivative securities to non-new hires, the issuer would continue to be required to deliver the disclosures within a reasonable period before the date of sale (i.e., the date of exercise or conversion in the case of options or similar derivative securities or the date of grant in the case of RSUs or similar derivative securities); and
- Derivative securities assumed by an acquirer in a business combination will remain exempt from registration so long as i) the acquired company complied with Rule 701 when such securities were granted and ii) the acquirer complies with the disclosure rules of Rule 701(e) (if applicable).
- Post-closing, in calculating the Rule 701 $10 million limit for the acquirer, the value of securities sold by the acquired company will not be included.
- The proposed rules would simplify and clarify Form S-8 requirements, including the following:
- Multiple plans may be added to an existing Form S-8 via an automatically effective post-effective amendment where a new plan does not require the authorization and registration of additional securities (for example, when an issuer adopts a new plan to replace an expiring plan and is not seeking to authorize additional securities);
- Issuers may use a single Form S-8 to register securities issuable pursuant to multiple incentive plans and are not required to allocate the registered securities among the plans;
- Amend Rule 413 under the Securities Act to allow issuers to add securities or a new class of security via an automatically effective post-effective amendment to an existing Form S-8 rather than filing a new Form S 8;
- Issuers no longer will be required to describe the tax effects of a plan on the issuer; however, a description of participant tax consequences and the statement on whether or not the plan is qualified under Internal Revenue Code section 401(a) still would be required;
- For offerings under defined contribution plans, such as 401(k) plans, Rule 416(d) under the Securities Act would be revised to provide that the Form S-8 would be deemed to register an indeterminate amount of securities to be offered and sold pursuant to the plan and Rules 456 and 457 under the Securities Act would be revised to provide that applicable registration fees would be calculated annually based on the total offering price of all securities sold during the plan year, and such fee would be payable no later than 90 days after the end of the plan year via filing a post-effective amendment to the Form S-8 solely for that purpose (under current rules the applicable registration fee is payable at the time of filing of the Form S-8 based on the total amount of securities registered); and
- For offerings under plans that are subject to the Employee Retirement Income Security Act (ERISA), an issuer will no longer be required to undertake to submit any plan amendment to the Internal Revenue Service (the IRS) for a favorable determination letter and determination letters on an amended plan will no longer be required to be filed (as the IRS currently is issuing such letters on plan amendments in very limited cases). Instead, an issuer either may undertake to maintain the plan's compliance with ERISA and make timely plan changes to maintain such compliance or file a legal opinion on the amended plan's compliance with ERISA.
Equity Compensation to "Platform Workers"
The SEC proposed for comment amendments to Rule 701 and Form S-8 to enable issuers to temporarily use such rules to offer certain equity compensation to "platform workers" such as ride-sharing drivers, food delivery drivers, and other gig economy workers who provide services available through the issuer's technology-based platform or system.
Due to the nature of these modern work relationships, there was concern that platform workers might not be considered employees, consultants, advisors, or de-facto employees eligible to receive compensatory equity awards under existing Rule 701 and Form S-8 rules. The proposed changes would be effective for five years, after which the SEC intends to assess whether to modify or expand the changes on an extended or permanent basis.
To be able to use the proposed changes to Rule 701 or Form S-8 to grant equity to platform workers, the following conditions must be met:
- The platform worker must, pursuant to a written contract or agreement, provide bona fide services by means of an internet-based or other widespread, technology-based marketplace platform or system operated and controlled by the issuer;
- The applicable securities must be issued pursuant to a written compensatory arrangement (and not for services in connection with the offer or sale of securities in a capital-raising transaction or that promote or maintain a market for the issuer's securities);
- No more than 15 percent of the value of the compensation received by the worker from the issuer for platform services during a 12-month period and no more than $75,000 of such compensation received during a 36-month period may be securities, with the value determined on the grant date of such securities;
- The amount and terms of any securities issued to the platform worker may not be subject to individual bargaining or the worker's ability to elect between payment in securities or cash; and
- With respect to Rule 701 only, the issuer must take reasonable steps to prohibit the transfer of the securities issued to a platform worker, other than to the issuer or by operation of law.
Of note, the proposed rule adds platform workers as an additional class of persons temporarily eligible to participate in the issuer's Rule 701 offers and sales. Thus, any sales to platform workers would be required to be included in calculating the applicable limits on the maximum value of equity that an issuer may sell under Rule 701, the thresholds for the enhanced disclosure requirements under Rule 701(e), and so forth.
In order to assist the SEC in assessing the success of these proposed amendments, companies that issue securities to platform workers under the proposed rules will be required to furnish certain information to the SEC every six months. The disclosure would not be publicly available or furnished on EDGAR, but would be provided directly to the Division of Corporation Finance. However, the SEC also noted that failure to make the disclosure would not result in the loss of the exemption.
These proposals have a 60-day comment period, which began on December 11, 2020, the date of publication in the Federal Register, and is scheduled to end on February 9, 2021. In addition to the items listed above, comments also are requested on several other topics, including whether Rule 701 should be expanded to better facilitate employee stock purchase plans adopted in connection with an initial public offering. Instructions on how to submit comments to the SEC can be found here.
No timetable for the effectiveness of the proposed rules was announced and it may depend on the comments received. In addition, while the broader amendment proposals were approved unanimously, the two Democrat-appointed SEC commissioners dissented on the proposed platform worker amendments, thus calling into question whether those changes will be implemented or revised by the new administration.
1 Rule 701 under the Securities Act of 1933 (the Securities Act) provides a limited exemption from registration for certain offers and sales of securities issuable by private company issuers pursuant to compensatory arrangements, and Form S-8 is the short form Securities Act registration statement that certain public company issuers may use to register their compensatory securities offerings and sales.