I’m sure all of my readers know that Form S-8 is used by public companies to register shares that will be issued under an employee stock plan with the SEC. In it’s January-February 2015 issue, The Corporate Counsel took a closer a look at some of the technical requirements of Form S-8. Here are a few things I learned from the article.
Fee Offsets Are Complicated
Companies wishing to register shares on a Form S-8 must pay a registration fee to the SEC. This fee is based on the value of the stock to be issued under the plan and the total number of shares to be issued. Where shares registered under prior S-8 filings will not be issued, companies can use the fees associated with these unissued shares to offset the fees to file a new Form S-8. But there’s a catch: the offering covered by the S-8 that the fees will be transferred from has to be completed, terminated or withdrawn and the new S-8 has to be filed within five years of when the original S-8 was filed. Because most stock plans have a term of ten years (and the offering isn’t viewed as completed until there are no further outstanding options/awards under the plan), this means that this offset often available. This is covered in the Securities Act Rules CDI Question 240.11.
No Share Offsets
Shares cannot be carried forward from one form S-8 to another. Thus, if shares from an expiring plan (and covered under the Form S-8 filed for that plan) will be transferred to a new plan, the shares have be registered again on the Form S-8 filed for the new plan (and are included in the calculation of the registration fee for the new plan).
New Form S-8 Must Be Filed to Register New Share Allocation
Where shares are newly allocated to an existing plan, a new Form S-8 must be filed to register those shares. They cannot be registered by amending the prior Form S-8 filed for the plan. But, the good news is that a abbreviated format can be used for the new Form S-8. The Corporate Counsel says:
In this scenario, General Instruction E to Form S-8 provides that, for the registration of additional securities of the same class covered by an existing Form S-8 relating to an employee benefit plan, the issuer may file an abbreviated registration statement containing only a cover page, a statement that the contents of the earlier registration statement—identified by file number—are incorporated by reference, the signature page, any required opinions and consents, and any information required in the new registration statement that is not in the earlier registration statement.
Share Counting
I was surprised to learn that it may be not permissible to count share usage for Form S-8 purposes the same way shares are counted against the share reserve. According to the article:
A recommended approach for dealing with forfeited shares is to treat the original restricted stock grant and the subsequent re-grant as two separate issuances for purposes of counting the amount of shares remaining on the Form S-8. But be aware that when counting shares this way, an issuer can deplete shares registered on Form S-8 faster than it depletes the plan capacity shares, so the issuer should keep a separate ledger for both the Form S-8 and the plan share counting. Also note that this approach might be overly conservative for some practitioners who do not believe that the issuer needs to count the forfeited shares as having been issued against the total, particularly with respect to options. There is also a concern that this approach can lead to problems in determining the real share reserve for other purposes, such as for accounting purposes.
The article further notes:
Options and stock-settled SARs should be counted when exercised for the full gross amount exercised (i.e., unreduced for any net exercise or withholding), while stock awards should be counted when granted. For performance stock awards, the conservative approach is that they should be counted at grant for the target number of shares—with any shares actually issued in excess of target counted at the time of issuance.
The House Financial Services Committee has recently been engaged in efforts to help start-up companies raise capital, including a bill (H.R. 4571) that directs the SEC to increase the threshold (from $5 million to $20 million) at which companies are required to provide additional disclosures to employees under Rule 701.
Background
Privately held companies typically rely on Rule 701 to issue stock through compensatory awards granted to employees. Where a company has relied on Rule 701 for the issuance of more than $5 million worth of stock in a 12-month period, the company is required to provide additional disclosures to employees, including the financial statements of the company prepared in accordance with US GAAP, risks associated with purchasing the company’s stock, and a summary of the material terms of the plan.
Proposed Change
The legislation passed by the House Financial Services Committee directs the SEC to increase the $5 million threshold to $20 million and further requires that this amount be indexed to inflation on a five-year basis. The bill makes no other changes to Rule 701.
The $5 million threshold has been in place since Rule 701 was adopted in 1988. Originally, Rule 701 actually capped issuances at $5 million; in 1999 the Rule was amended to merely require additional disclosures when this threshold is exceeded.
This threshold is frequently a concern for private companies, especially technology start-ups and others that grant equity broadly throughout their employee population. Anyone who has tried to buy real estate recently in California knows that $5 million in today’s economy isn’t what it was in 1988. According to the inflation calculator on the Bureau of Labor Statistics website, $5 million in 1988 had the buying power of a little over $10 million today; half the amount of the increase proposed by the House Finance Committee. We guess if the House Finance Committee is going to go for something, they might as well go for broke (or perhaps the bill sponsors felt they needed a little room for negotiation).
Next Steps
This legislation still needs to be voted on by the full House, then by the Senate, and then signed into law by the President. GovTrack.us (where you can sign up to receive email, Twitter, or Facebook updates on the bill) gives the bill only a 31% chance of passing. And after the bill is signed into law, the SEC has to draft a proposed rule, solicit comments, review the comments and issue a final rule before the change will take effect.
But, what is particularly interesting here is that—unlike some other limits I’d like to see adjusted for inflation (the ESPP $25,000 limit and the ISO $100,000 limit come to mind)—Congressional action isn’t necessary for Rule 701 to change. This is a rule promulgated by the SEC; as such, it could be modified by the SEC with or without direction from Congress. The SEC revamped Rule 144 in 2007; it’s been a lot longer than that since Rule 701 was updated. Perhaps this legislation will put this issue on the SEC’s radar.
Last week, I highlighted areas of JOBS that impact stock plan administrators. This week, I take a look at another area of JOBS with relevance to equity compensation–the shareholder threshold that triggers registration under the 1934 Act.
Shareholder Threshold for Required Registration Private companies with $10 million in assets that have shareholders in excess of a specified amount are required to register with the SEC and then become subject to public reporting requirements. JOBS raises this threshold from 500 to 2,000 shareholders, provided that no more than 499 of the shareholders are nonaccredited investors. (For reasons that I cannot fathom, the nonaccredited investor requirement doesn’t apply to banks–10 points to anyone that knows why this is. Maybe banks just have better lobbyists.)
Interestingly, some commentators have pointed out (e.g., see the Alston + Bird memo included with the NASPP alert on JOBS) that this enables companies to delay going public, which seems contrary to the purpose of JOBS.
Stock Compensation Exempted
JOBS also exempts shareholders that acquired their stock through company benefit plans from this threshold. SEC regulations and a recently issued no-action letter (see “No Action on RSUs“, February 29, 2012) already exempted options and RSUs from the threshold, but now actual shares of stock acquired through these and other compensatory arrangements are also exempted.
Private companies will now be able to allow their employees to purchase stock before they go public without triggering the registration requirement regardless of how many employees they have. This could be a little dangerous in that employees that don’t have much investing experience sometimes don’t understand the potential pitfalls of investing in high-risk, illiquid stocks. I believe that, in most cases although there are certainly some exceptions, it doesn’t make sense for rank-and-file employees to buy or (incur taxable income on) their employer’s stock before that stock is liquid.
In a series of FAQs issued last week, the SEC clarified that this exemption applies regardless of whether the individual holding stock received through a company stock plan is a current or former employee. It isn’t clear, however, whether the exemption will continue to apply if the individual sells the stock acquired under a company plan (e.g., on one of the secondary markets) to another investor.
Deregistering
For non-banks, the threshold for deregistering did not change, so companies that have already been forced to register and are now filing public reports will have to continue to do so until they have fewer than 300 shareholders (or less than $10 million in assets). For banks, the deregistration threshold did increase, to 1,300 shareholders (again, I have no idea why banks get special treatment).
NASPP “To Do” List We have so much going on here at the NASPP that it can be hard to keep track of it all, so we keep an ongoing “to do” list for you here in our blog.
Register for the NASPP’s newly updated online Stock Plan Fundamentals program–it’s not too late to get into the course; the first webcast has been archived for you to listen to at your convenience.
Don’t miss your local NASPP chapter meetings in the Carolinas, Chicago, Michigan, Orange County, and Wisconsin. I will be speaking, along with Emily Cervino of the CEP Institute, at the Chicago and Wisconsin chapters–I hope to see you there!
It seems like just yesterday I was blogging about the SEC exempting stock options from the 500-holder limit for private companies, but it turns out that I never blogged about that because it happened back in 2007, before we had The NASPP Blog. Time flies and here we are almost five years later and the SEC has provided broad no-action relief from the same limit for RSUs.
What the Heck?
For those of you that aren’t sure what I’m talking about, let’s take a step back. Under U.S. securities laws, private companies that have more than $10 million in assets and more than 500 holders in any company security are required to register with the SEC under the 1934 Act. Most private companies are loath to exceed this threshold because registration causes them to be subject to pretty much all the same public reporting requirements as public companies–Forms 10-Q and 10-K., Form 8-K, Section 16, the whole shebang. It’s all the onerous parts of being a public company but without the upside of raising a bunch of money in an IPO and having publicly traded securities.
Stock options are a type of security, as are RSUs. Now the rule is that the company can’t have more than 500 holders in a single class of securities, so a company could have 499 shareholders and 499 option holders and 499 RSU holders without triggering the registration requirement (so long as none of the optionees exercised their options and none of the RSUs were paid out). But if a company had, say, 501 option holders, the company could be required to register with the SEC. This is a problem for private companies with, say, more than 500 employees that want to grant stock options to all their employees.
So, in 2007, after issuing numerous no-action letters on the matter, the SEC carved out an exception providing that compensatory employee stock options don’t count for purposes of the 500-holder limit, provided the options meet certain requirements. (See the NASPP alert, “SEC Exempts Stock Options from Registration for Private Companies,” December 15, 2007).
Now RSUs, Too
The 2007 exemption, however, didn’t extend to RSUs. So, where a private company wanted to grant RSUs to more than 500 employees, the company had to either register with the SEC or request relief from the registration requirement via a no-action letter–even if the RSUs, by their terms, could not possibly ever be paid out before the IPO.
Earlier this month, however, the SEC granted no-action relief for RSUs to the law firm Fenwick & West. By granting relief to a law firm, rather than a specific company, this no-action letter serves as broad relief for all private companies that wish to offer RSUs to their employees.
The RSUs must meet certain conditions to be eligible for relief–the awards must be granted by a private company, granted to individuals providing service to the company as defined under Rule 701, and transferable under only limited circumstances. In addition, the company must disclose information relating to its financials and risk factors to employees.
But Not Stock Acquired Under RSUs and Options
The relief described above extends only to options and RSUs themselves; it doesn’t cover stock employees acquire under options or RSUs. That stock still counts towards the 500-holder limit.
NASPP “To Do” List We have so much going on here at the NASPP that it can be hard to keep track of it all, so we keep an ongoing “to do” list for you here in our blog.