by Cydney Posner
Yesterday, the SEC adopted final rule amendments to implement certain sections of the JOBS Act and the FAST Act. The amendments were adopted substantially as proposed in December 2014 (and once again without holding an open SEC meeting). The amendments revise SEC rules to reflect the new, higher thresholds for registration, termination of registration and suspension of reporting that were included in the JOBS Act and the FAST Act. In addition, as mandated by the JOBS Act, the amendments revise the definition of “held of record” under Exchange Act rules to exclude certain securities held by persons who received them pursuant to 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 changes will become effective 30 days after publication in the Federal Register. The SEC press release proudly announces that “[a]ll JOBS Act mandates are now complete” (or perhaps that’s just an expression of relief).
As you might recall, 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. In December 2014, the SEC proposed implementing amendments to conform current rules to these already operative changes, as well as the required new safe harbor.(See this PubCo post.)
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 these institutions are allowed to 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 2014 rule proposal would have implemented the new threshold for banks and bank holding companies; however, the FAST Act subsequently made those same adjustments for banks applicable to savings and loan holding companies, and the final amendments implement that change for all of these institutions.
More specifically, the final amendments 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 new JOBS Act thresholds:
- Raise the threshold for registration to either 2,000 holders of record or 500 holders of record that are not accredited investors, whichever first occurs;
- For banks, bank holding companies and savings and loan holding companies, raise the threshold for termination of registration or suspension of Exchange Act reporting obligations for a class of securities held of record by fewer than 1,200 persons.
- 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 final rule retains the requirement that the accredited investor determination be made as of the last day of the fiscal year, rather than at the time of the sale of the securities. Under amended Rule 12g-1, an issuer will need to determine, based on facts and circumstances, whether prior information provides a basis for a reasonable belief that the security holder continues to be an accredited investor as of the last day of the fiscal year. The SEC elected not to establish a safe harbor or provide additional guidance on this issue. However, the release does indicate “concern that permitting issuers to rely solely on previously obtained information, which in some cases could be years or decades old, could result in the use of outdated and unreliable information when making the determination.” However, reliance on “accredited investor determinations made in offerings during the three months prior to fiscal year-end or on self-certification by investors if the offering occurred more than three months but less than twelve months prior to fiscal year-end” could provide a reasonable basis for determining status as of the last day of the fiscal year, but only after consideration of all the facts and circumstances.
- 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, or not subject to, the registration requirements of Section 5 (e.g., under the “no-sale” theory relating to the issuance of compensatory grants to broad groups of employees pursuant to broad-based stock bonus plans, or under Section 3 as exempt securities);
- Held by persons who received them in transactions exempt from, or not subject to, the registration requirements of Section 5 from the issuer, a predecessor of the issuer or an acquired company in substitution or exchange for excludable securities under Rule 12g5-1(a)(8)(i)(A) (i.e., the bullet above, exempt employee compensation plan transactions), as long as the persons were eligible to receive securities pursuant to Rule 701(c) at the time the excludable securities were originally issued to them. This final rule amendment reflects changes from the proposal designed to provide issuers the flexibility to engage in business combinations and similar transactions by clarifying and expanding the relief to encompass securities held by former employees of the issuer or its predecessors or acquired companies.
The exemption relies on the definition of a “compensatory benefit plan” under Rule 701, which is defined as “any purchase, savings, option, bonus, stock appreciation, profit sharing, thrift, incentive, deferred compensation, pension or similar plan.” The new exclusion applies solely for purposes of calculating the number of holders of record of a class of equity securities for purposes of determining the issuer’s registration obligation under Section 12(g)(1).
- Adopt a non-exclusive safe harbor under Rule 12g5-1(a)(8) under which
- an issuer may deem a person to have received the securities pursuant to an employee compensation plan if the plan and the person who received the securities pursuant to the plan met the plan and participant conditions of Rule 701(c); and
- an issuer may, solely for the purposes of Section 12(g), deem the securities to have been issued in a transaction exempt from, or not subject to, the registration requirements of Section 5 if the issuer had a reasonable belief at the time of the issuance that the securities were issued in such a transaction.
Notably, the safe harbor may be available 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)— are not met. Thus, the safe harbor is available for holders of securities received in other employee compensation plan transactions exempted from, or not subject to, the registration requirements of Section 5, such as securities issued under Section 4(a)(2), Reg A, Reg D or Reg S, as long as they also meet the conditions of Rule 701(c). The release notes that the safe harbor provides an issuer with relief from the burden of establishing that earlier issuances of securities satisfied an appropriate exemption on an annual basis provided the issuer had a reasonable belief that it had complied with the appropriate registration requirements or the conditions of an applicable exemption at the time of issuance. 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. Family members (as defined in Rule 701(c)) who receive the equity securities as a result of the employee’s (or former employee’s) gift, domestic relations order or death are also considered persons who received “the securities pursuant to an employee compensation plan” for purposes of Rule 12g5-1(a)(8). However, once the securities have been transferred to holders not specified in Rule 701(c), whether or not for value, they would need to be counted as “held of record” by the transferee. Because the safe harbor is non-exclusive, failure to satisfy all of its conditions would not preclude reliance on Section 12(g)(5) or other provisions of the rule.
In addition, the safe harbor is available for foreign private issuers in making their determinations of the number of U.S. resident holders under Exchange Act Rule 12g3-2(a). (That rule exempts foreign private issuers that meet the asset and shareholder threshold for registration under Section 12(g) from registering any class of securities under that section if the class of securities is held by fewer than 300 holders resident in the U.S.) However, the issuer is not permitted to exclude securities held by persons who received the securities pursuant to an employee compensation plan.