by Cydney Posner
At the end of last week, the SEC issued a press release indicating that it had voted to propose various amendments to implement portions of the JOBS Act. (In a departure from the norm, the SEC did not hold an open meeting to approve issuance of the proposal.) In sum, the proposal would amend rules under Section 12(g) of the Exchange Act to reflect the new, higher thresholds for registration, termination of registration and suspension of reporting that were set forth in the JOBS Act; apply the definition of “accredited investor” in Rule 501(a) to determinations regarding the need for registration under Section 12(g)(1); and revise the definition of “held of record” to exclude certain securities held by persons who received them under employee compensation plans and establish a non-exclusive safe harbor for determining whether securities are “held of record” for purposes of registration under Section 12(g). The SEC proposing release can be found here.
Prior to the JOBS Act, a company that had more than $10 million in total assets and a class of equity securities “held of record” by 500 or more persons at the end of its fiscal year was required to register under the Exchange Act. In effect, companies were required to “go public” and to comply with various reporting and other obligations without the benefits typically associated with an IPO. The Jobs Act amended Section 12(g)(1) of the Exchange Act to raise the threshold for the number of holders of record that trigger registration to either 2,000 holders of record or 500 holders of record that are not accredited investors, whichever first occurs. While the JOBS Act required the SEC to amend its rules to be consistent with these amendments, the change in the registration threshold was immediately effective, notwithstanding the absence of new regulations by the SEC (except for the exclusion of crowdfunding investors from the shareholder count). Under the JOBS Act, the SEC was also required to adopt safe harbor provisions for securities held by persons who received them pursuant to an employee compensation plan, but that was not a condition to the effectiveness of the exclusion of these holders from the shareholder count. For the most part, the proposed rules simply conform current rules to these already operative changes, and propose the required new safe harbor.
The JOBS Act also amended the Exchange Act to allow banks and bank holding companies to terminate registration for a class of securities under Section 12(g) or suspend reporting under Section 15(d)(1) if that class was held of record by fewer than 1,200 persons. The JOBS Act did not change the threshold for other issuers who wanted to “go dark” and, as a result, companies other than banks or bank holding companies are allowed terminate registration and suspend their filing obligations only after the registered class of securities is held of record by fewer than 300 persons (or fewer than 500 persons if the company has total assets of $10 million or less). The rule proposal implements the new threshold for banks and bank holding companies; however, notwithstanding comments received urging the SEC to make comparable changes for non-bank public companies, the SEC elected not to do so.
More specifically, the proposal would do the following:
- Amend Exchange Act Rules 12g-1 through 4 and 12h-3, which govern the procedures relating to registration, termination of registration under Section 12(g), and suspension of reporting obligations under Section 15(d), to reflect the newer JOBS Act thresholds (either 2,000 holders of record or 500 holders of record that are not accredited investors, whichever first occurs);
- Amend the rules to treat savings and loan holding companies similarly to banks and bank holding companies with regard to registration, termination of registration, or suspension of their Exchange Act reporting obligations;
- Apply the definition of “accredited investor” in Rule 501(a) (I.e., any person who comes within, or who the issuer reasonably believes comes within, any of eight enumerated categories) to determinations as to which record holders are accredited investors for purposes of Section 12(g)(1). The accredited investor determination would be made as of the last day of the fiscal year, rather than at the time of the sale of the securities. As a result, this determination may be difficult for issuers to implement because, as the release notes, “an issuer will need to determine, based on facts and circumstances, whether it can rely upon prior information to form a reasonable basis for believing that the security holder continues to be an accredited investor as of the last day of the fiscal year.” The SEC is, however, considering whether another approach may be more appropriate.
Also consistent with the JOBS Act, the proposal would amend the definition of “held of record” in Rule 12g5-1 to provide that, when determining whether an issuer is required to register under Section 12(g)(1), the issuer may exclude securities:
- Held by persons who received them under an employee compensation plan in transactions that were exempt from registration under Section 5 or that did not involve a sale within the meaning of Section 2(a)(3) of the Securities Act (i.e., under the “no-sale” theory relating to the issuance of compensatory grants to broad groups of employees pursuant to broad-based stock bonus plans);
- Held by persons eligible to receive securities from the issuer pursuant to Rule 701(c) who received the securities in a transaction exempt from the registration requirements of Section 5 in exchange for securities excludable under the proposed Rule 12g5-1(a)(7) safe harbor (discussed below). This proposed exclusion “is intended to facilitate the ability of an issuer to conduct restructurings, business combinations and similar transactions that are exempt from Securities Act registration so that if the securities being surrendered in such a transaction would not have been counted under the proposed definition of ‘held of record,’ the securities issued in the exchange also would not be counted under this definition.”
The exemption is limited to offers and sales of securities under a written compensatory benefit plan established by the issuer for the participation of its employees and other specified persons. Under Rule 701, a “compensatory benefit plan” is defined as “any purchase, savings, option, bonus, stock appreciation, profit sharing, thrift, incentive, deferred compensation, pension or similar plan.” Notably, the release advises that the “new statutory exclusion applies solely for purposes of determining whether an issuer is required to register a class of equity securities under the Exchange Act and does not apply to a determination of whether such registration may be terminated or suspended.”
The SEC has also proposed a non-exclusive safe harbor (proposed Rule 12g5-1(a)(7)) under which a person will be deemed to have received the securities pursuant to an employee compensation plan if the person received them under a compensatory benefit plan in transactions that met the conditions of Rule 701(c). The safe harbor would be available whether the securities were issued under Rule 701(c) or “issued in transactions otherwise exempted from, or not subject to, the registration requirements of the Securities Act that satisfy the conditions of Rule 701(c), even if all the other conditions of Rule 701, such as issuer eligibility in Rule 701(b)(1), the volume limitations in Rule 701(d) or the disclosure delivery provisions in Rule 701(e), were not met. Thus, the safe harbor would be available for holders of securities received in other employee compensation plan transactions exempted from, or not subject to, the registration requirements of Section 5 of the Securities Act, such as securities issued in reliance on Section 4(a)(2), Reg D, or Reg S, that meet the conditions of Rule 701(c).” Issuers could rely on the safe harbor for issuances to those plan participants enumerated in Rule 701(c), including employees, directors, general partners, trustees, officers and certain consultants and advisors, as well as permitted family member transferees through gifts or domestic relations orders. Once the securities are transferred, however, they would need to be counted as “held of record.” In addition, the safe harbor would be available for foreign private issuers in making their determinations of the number of U.S. resident holders under Exchange Act Rule 12g3-2(a).