Effective July 9, 2007, the California Corporations Commissioner adopted amendments to the compensatory plan regulations under the California Corporate Securities Law of 1968. The amended rules eliminate many restrictive requirements, such as minimum vesting and pricing, to provide greater flexibility to companies in drafting compensatory benefit plans such as stock option or stock purchase plans.

Under the California Corporations Code (the "Code") Section 25110, it is unlawful for an issuer to offer or sell any securities in California unless the securities have been qualified or are exempt from the qualification requirements. In California, the definition of "securities" includes an option to purchase an issuer’s securities. Pursuant to Section 25102(o) of the Code, the offer or sale of a security that is exempt under Rule 701 ("Rule 701") of the Securities Act of 1933 is also exempt from the California qualification requirements if the security is granted pursuant to a plan or agreement that satisfies the requirements of Sections 260.140.41 or 260.140.42 (depending on whether it is an option plan or purchase plan), 260.140.45, and 260.140.46 of the California Code of Regulations (the "compensatory plan regulations").

Although California state securities laws do not apply when a company’s securities are listed on a national securities exchange, compliance is required for non-public companies, including companies that are traded on a foreign exchange. Compliance with the prior California Code provisions was difficult for many multinational companies who wished to grant stock options to employees working in California.

Amendments

The amendments revise the compensatory plan regulations as follows:

  • The amendments expand the list of eligible persons who may participate under an option plan or purchase plan to include the same eligible persons who are exempt under Rule 701, such as officers, general partners, trustees (where the issuer is a business trust), advisors, and insurance agents who are employees.
  • The amendments eliminate the requirement that the exercise price of an option or the purchase price of a share granted under a compensatory benefit plan must be at least 85% of the fair value at the time of grant or issuance.
  • The amendments eliminate the requirement that options granted under a plan to non-management employees must vest a minimum of 20% per year over 5 years from the date the option is granted.
  • The amendments clarify that shareholder approval of the plan is required within 12 months of adopting the plan or, if later, prior to granting any options in California,1 and allow foreign private issuers to issue options or stock under plans without such approval so long as the number of recipients in California does not exceed 35.
  • The amendments eliminate the restrictions on repurchase rights (i.e., minimum repurchase price, maximum repurchase period, right of repurchase to lapse as to at least 20% of the shares per year).
  • The amendments clarify that for employees terminated other than for cause, options which are exercisable on the termination date may be exercised until the earlier of the expiration date, six months after termination (if cause is death or disability), or 30 days after termination (if cause is other than death or disability).
  • The amendments eliminate the requirement that the shares of common stock issuable under the plans must carry equal voting rights.
  • The amendments eliminate the requirement that the total number of securities issuable under a plan that complies with all the conditions of Rule 701 may not exceed 30% of the then-outstanding securities of the company unless a higher percentage is approved by two-thirds of the outstanding securities entitled to vote.
  • The amendments eliminate the requirement to provide the security holders participating in plans or agreements that comply with all the conditions of Rule 701 with financial statements at least annually.

The compensatory plan regulations have also been used by the California Corporations Commissioner as guidance in determining whether to approve an application to qualify an issuance of securities under a compensatory plan (in an instance where an issuer cannot rely on Rule 701 and therefore an exemption from qualification is not available under Code Section 25102(o)). It should be noted that in this context, however, certain restrictions, such as the restrictions on repurchase rights, the super-majority vote provision and the requirement to distribute financial statements will still apply, absent a variance approved by the Commissioner.

Footnote

1. This addresses a problem that arises for out-of-state issuers seeking to issue securities to individuals in California but who have adopted their plans more than a year prior to making such grants.

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