.10 Introduction -
Compensation arrangements frequently involve the offer and sale of issuer securities; these arrangements must comply with the Securities Act of 1933,1 as amended.2 The 1933 Act requires that any offer or sale of a security be registered with the Securities and Exchange Commission (SEC) unless the security involved is an exempt security or otherwise subject to an exemption from registration. The 1933 Act has no special exemption from this basic rule for offerings to employees of the issuer; however, certain rules and exemptions under the 1933 Act help facilitate offerings of issuer securities to employees.
This chapter discusses the scope of the 1933 Act as applied to securities offerings in connection with compensatory arrangements, the use of the Form S-8 registration statement, and the principal exemptions from registration that issuers typically rely on to avoid registration under the 1933 Act. This chapter also discusses certain limitations under the 1933 Act on the resale of issuer securities.
This chapter is limited to the federal securities laws of the U.S. and doesn't address state (often called "Blue Sky"), local, or foreign laws with respect to the offer and sale of securities. Rules that apply to security offerings directed at the public at large (as opposed to those limited to employees or others who perform services for the issuer), or involving a principal purpose of capital raising (as opposed to being compensatory in nature) are not discussed in this chapter.
.20 Scope of the 1933 Act -
Whether a compensation plan or arrangement is subject to the 1933 Act is determined by a three-part analysis:
(1) the issuer must determine whether a non-exempt security is involved;
(2) assuming a non-exempt security is present, the issuer must determine whether there is an offer and sale of the security; and
(3) if the compensatory arrangement involves the offer and sale of a non-exempt security, the issuer must register the offering under the 1933 Act or determine that it fits within an exemption from registration.
Each of these determinations is examined separately below. For more on registration requirements under the 1933 Act, see The 1933 Act, 44 CPS §II.D.; 362 T.M., Securities Law Aspects of Employee Benefit Plans, §II.D.
.20.10 Definition of a Security -
For the 1933 Act to apply to a compensation arrangement either the arrangement must include a non-exempt security or the employee's interest in the arrangement itself must constitute a non-exempt security. The 1933 Act broadly defines "security" to encompass stock, options, warrants, participation interests, bonds, debentures, and investment contracts.3 A typical employer long-term incentive plan includes many award types that fall under the 1933 Act's definition of a security. Options, warrants, shares of employer common stock and contractual entitlements to receive employer common stock or its value (such as restricted stock units)-all commonly available under these plans-constitute securities under this definition.
Certain securities are expressly exempt from the requirements of the 1933 Act.4 In the context of compensatory arrangements, the most relevant exemption is for interests in tax-qualified retirement plans5 that do not permit employees the option to allocate their own money to the purchase of issuer securities held by these plans.6 Most interests in defined benefit pension plans would be exempted securities, re-exempted securities, whereas interests in a typical 401(k) plan that permits participants to invest in an issuer common stock fund, or has a self-directed "brokerage window" through which participants can invest in issuer common stock, are not exempt.7
In SEC v. W. J. Howey Inc., 8 the U.S. Supreme Court established a four-prong test to analyze whether an investment contract is a security. Under the so-called Howey test, an investment contract is a security if it is a contract, transaction, or scheme whereby "(1) a person invests his money (2) in a common enterprise and (3) is led to expect profits (4) solely from the efforts from the promoter or third party."9 The Howey test requires, among other things, that the purchaser of the investment contract provide money or other tangible consideration.
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1. 15 U.S.C. ch. 2A, subch. I.
2. 1933 Act § 5, 15 U.S.C. § 77e et seq.
3. The 1933 Act states that a security is "any note, stock, treasury stock, bond, debenture, evidence of indebtedness, certificate of interest or participation in any profit-sharing agreement, collateral-trust certificate, pre-organization certificate or subscription, transferable share, investment contract, voting-trust certificate, certificate of deposit for a security, fractional undivided interest in oil, gas, or other mineral rights, any put, call, straddle, option, or privilege on any security, certificate of deposit, or group or index of securities (including any interest therein or based on the value thereof) or any put, call, straddle, option, or privilege entered into on a national securities exchange relating to foreign currency, or, in general, any interest or instrument commonly known as a "security" or any certificate of interest or participation in, temporary or interim certificate for, receipt for, guarantee of, or warrant or right to subscribe to or purchase, any of the foregoing." See 1933 Act § 2(a)(1), 15 U.S.C. § 77b(a)(1).
4. 1933 Act § 3(a)(2), 15 U.S.C. § 77c(a)(2).
5. A tax-qualified retirement plan is a plan that satisfies the requirements of IRC § 401(a). The sponsor of, and the participants in, a tax-qualified plan receive favorable tax treatment under the tax code.
6. 1933 Act § 3(a)(2), 15 U.S.C. § 77c(a)(2). This exemption applies to both the interests of plans in investment vehicles maintained by banks and insurance companies and to the interests of participants in the plans. See Employee Benefit Plans, Securities Act Release 33-6188 (Feb. 1, 1980).
7. However, a 401(k) plan that grants an employer matching contribution in employer stock may not be required to register the shares granted in connection with the match. See, e.g., Bank of Los Angeles, SEC No-Action Letter, SEC NAL 29937 (Sept. 25, 1987); Commonwealth Bancshares Corp., SEC No-Action Letter, SEC NAL 16275 (Feb. 9, 1987); Monsanto Co., SEC No-Action Letter, SEC NAL 12013 (Sept. 16, 1983). But see Securities and Exchange Commission, Division of Corporation Finance, Manual of Publicly Available Telephone Interpretations, § G.88 (July 1997) (suggesting that employer stock used for 401(k) matching contributions must be registered on Form S-8, whereas employer stock used for an automatic, profit-sharing contributions need not be registered). See also Securities and Exchange Commission, Division of Corporation Finance, Compliance and Disclosure Interpretations (C&DI): Securities Act Forms § 126.19 (Jan. 26, 2009) and § 126.41 (Sep. 21, 2016) (last updated Sept. 21, 2020).
8. SEC v. W. J. Howey Inc., 328 U.S. 293 (1946).
9. SEC v. W. J. Howey Inc., 328 U.S. 293, 298-99 (1946). The basic test set out by the court in Howey continues to apply. See, e.g., IN RE ENRON CORPORATION SECURITIES, DERIVATIVE & 'ERISA' LITIGATION, 238 F. Supp. 3d 799 (S.D. Tex. 2017) ("In Howey, the Supreme Court established a test to determine whether a financial relationship constituted an 'investment contract,'").
Originally Published by Bloomberg Law's Executive Compensation Guide.
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