Just under the wire to satisfy a Congressional mandate, the SEC today voted unanimously to adopt an amendment to Rule 701(e) to raise the threshold that triggers the requirement for delivery of additional disclosure to investors. The Commissioners also voted to issue a concept release soliciting comment on potential revisions to modernize Rule 701 and Form S-8, as Chair Jay Clayton observed, in light of "developments and innovations in labor markets and compensation practices." The amendment to Rule 701(e) will become effective immediately on publication in the Federal Register. Companies that "have commenced an offering in the current 12-month period will be able to apply the new $10 million disclosure threshold immediately upon effectiveness of the amendment." Here is the press release, here are the final rules, and here is the concept release.
Rule 701 allows non-reporting companies to sell securities for compensatory purposes without the requirement to register the offer and sale of the shares with the SEC. Currently, under the so-called "soft cap" of Rule 701(e), a company is required to provide financial statements, risk factors and other disclosures if the aggregate sales price or amount of securities sold by the company under Rule 701 during any consecutive 12-month period exceeds $5 million. If aggregate sales during that period exceed that threshold, however, the company "must deliver those additional disclosures a reasonable period of time before the date of sale to all investors in the 12-month period." As Commissioner Kara Stein explained, the underlying theory is that the larger the offering, in the absence of accompanying investor protections, the greater the possibility of harm.
As discussed in this PubCo post, the Economic Growth, Regulatory Relief, and Consumer Protection Act, which was signed into law in May, required the SEC, not later than 60 days after enactment of the new Act, to revise Section (e) of Rule 701 to raise the threshold that triggers the requirement for delivery of additional disclosure to investors from $5 million to $10 million. The Act also requires that the amount be indexed for inflation every five years to reflect the change in the Consumer Price Index for All Urban Consumers published by the Bureau of Labor Statistics, rounding to the nearest $1,000,000. As amended, Rule 701(e) will otherwise continue to operate in the same manner as currently. Did you sleep through the proposal? No, but since the amendment was adopted under a specific statutory mandate and involved "no exercise of agency discretion," no proposal was issued for public comment prior to adoption.
Commissioner Stein observed that, while she was uncertain of the costs and benefits of the amendment to the rule, in light of the Congressional mandate, she didn't have much choice but to vote in favor of the amendment. The other Commissioners seemed quite happy to vote in favor of the rule change.
The SEC also voted to issue a concept release requesting public comment on ways to modernize Rule 701 and Form S-8, especially given that Rule 701 has not been updated since 1999. Should the timing and content of the required disclosures under Rule 701 be modified? Should there be changes to the consequences of failure to comply with the disclosure or other requirements? Similarly, other forms of equity compensation, such as RSUs, have become more prevalent in recent years. How should they be treated under Rule 701?
But the most interesting question raised in the concept release relates to how, or if, the rule should be modified to reflect changes in the society at large in the relationships between workers—notice I didn't say "employees"—and companies in the almost 20 years since the rule was last amended. In particular, the release asks us to consider whether the conditions for eligibility should be revised in light of the "gig" economy and evolving worker-company relationships. Rule 701 provides a special accommodation for the issuance of equity for compensatory purposes to employees, directors and consultants that is distinct from the rules that typically apply in ordinary capital-raising transactions. Should this accommodation be expanded? Should companies be permitted to issue shares without the need for registration and related disclosure to non-traditional workers who may be providing services under alternative work arrangements or contractual relationships, sometimes with multiple companies, that may be short term or freelance in nature? If so, what parameters should apply? What activities should the worker be required to engage in? Do companies even want to issue equity as compensation to motivate these workers? Would an expansion of the rule lead to more gig workers? What effect would a liberalization of the rule have on incentives to companies to "go public and stay public," a rite of passage the SEC has recently championed, or on incentives to remain private? With regard to Form S-8, the simplified registration form for securities issued under employee plans, the questions included how to reduce costs, whether to further streamline the form, whether to allow use of a single S-8 for all plans and whether issuers should be permitted to pay fees on an as-you-go basis.
Although neither the Commissioners nor the Staff addressed many of the specifics of the concept release, reference was made at the open meeting to recommendations regarding Rule 701 from the SEC Advisory Committee on Small and Emerging Companies. For a discussion of the Committee's recommendations, see this PubCo post. Chair Clayton indicated that the SEC "would benefit from comments from a broad range of constituencies."
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