Company Name: American Bar Association (ABA)
Public Availability Date: August 3, 1999 

[LETTER OF INQUIRY]

July 30, 1999

Richard K. Wulff, Esquire
ChiefOffice of Small Business Policy
Division of Corporation Finance
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549

Re: Request for Interpretive Letter on Rule 701

Dear Mr. Wulff:

When members of the Securities and Exchange Commission Staff recently met with representatives of the American Bar Association's Joint Committee on Employee Benefits, the Staff was asked several questions by representatives of the Joint Committee regarding the transition to Rule 701 as amended effective April 7, 1999 (Release No. 33-7645; File No. S7-5-98). The discussion centered on the transition rules relating to compensatory stock options to purchase an issuer's common stock. The Staff requested our views as to the transition provisions that should be implemented by the Staff in interpreting amended Rule 701.

This letter has been prepared by members of the Committee on Federal Regulation of Securities of the Business Law Section of the American Bar Association and has been reviewed with members of the Federal Regulation of Securities Subcommittee of the Employee Benefits Committee of the ABA Tax Section. It does not represent an official ABA position.

Background

Rule 701 as amended provides among other things that the aggregate sales price or the amount of securities sold in reliance on the rule during any consecutive 12-month period must not exceed the greatest of the following:

(i) $1,000,000;

(ii) 15% of the total assets of the issuer (or of the issuer's parent if the issuer is a wholly-owned subsidiary and the securities represent obligations that the parent fully and unconditionally guarantees), measured at the issuer's most recent balance sheet date (if no older than its last fiscal year end); or

(iii) 15% of the outstanding amount of the class of securities being offered and sold in reliance on the rule, measured at the issuer's most recent balance sheet date (if no older than its last fiscal year end).

In addition, issuers must provide purchasers with specified information if aggregate awards exceed $5,000,000.

As amended, Rule 701 provides that options must be valued based on their exercise price. In addition, the amendments made clear that the determination must be made on the option grant date, without regard to whether the option is currently exercisable. The adopting release stated that the rule for options takes account of the difficulty in keeping track of outstanding options, when they become exercisable and when they might be exercised. The Commission stated its belief that this method of determining the available exemption should make no difference from an investor protection point of view since the 12-month limit will still apply.

Transition Rules

Neither the adopting release nor the language of the amendments deals with the transition from the rule in effect before April 7, 1999, the effective date of the amendments. Several questions have arisen that require clarification.

Look-Back Period before and after the Effective Date

We believe that the 12-month look-back period from a date on which an issuer determines the applicable Rule 701 limitations should include any portion of that period that preceded the effective date of the amendments. In other words, the amendments did not, in effect, allow issuers to start with a clean slate in applying the applicable limitations.

Counting Pre-Effective Date Options

If an issuer applied the Rule 701 limits prior to the recent amendments to the entire portion of an option, whether or not it was exercisable on the date of grant (see Leisner (December 21, 1995)), the remaining availability under the new Rule 701 limits can be easily determined. In that case, an issuer would count options granted prior to the effective date but within 12 months of the determination in accordance with the provisions of the new rule (but it would not count options granted earlier that were still outstanding). Assuming the issuer complied with the old Rule 701 limits, it could not have exceeded the new limits.

However, many issuers relied on Section 2(3) of the Securities Act of 1933 and included only exercisable options into the calculation of outstanding offers for purposes of determining compliance with the old Rule 701 limits. That method is no longer available. However, requiring an issuer to now count such options based on their date of grant could result in an issuer having exceeded the old Rule 701 limits at some time in the past. We believe that the best way to prevent this inadvertent result is to permit issuers who have elected to count options as offers only as they become exercisable to elect among the following transition choices, in whole or in part.

Grant Date Method. An issuer may elect to count against the old Rule 701 limits the unexercisable portion of options granted before April 7, 1999 at the time of grant if doing so would not cause the old Rule 701 limits to have been exceeded. In effect, issuers would be permitted to change its method of counting options to the extent that doing so did not cause it to exceed the old Rule 701 limits. Note that these grants would also count as sales if they fell within 12 months of any sale on or after April 7, 1999 to which the new Rule 701 limits apply.

Effective Date Method. An issuer may instead elect to treat all unexercisable options outstanding on the effective date of the amendments as if they were sales on that date. The new Rule 701 limits would apply to this determination. Any sales or options that became exercisable within the 12 months before the effective date would have to be taken into account in determining whether the issuer exceeded the new Rule 701 limits.

Exercisable Date Method. An issuer may continue to exclude from any Rule 701 calculation portions of any option granted before the effective date that were not exercisable on the effective date. The issuer would count them as sales under new Rule 701 at the time they become exercisable.

Note that the Effective Date Method and the Exercisable Date Method would apply to the portion of any option granted before the effective date of the amendments that was not counted under the old Rule 701 limits.

These approaches would not present the calculation problem noted in the adopting release because issuers know when the options will become exercisable (as contrasted to when they will be exercised) and would be able to take them into account when granting new options. Furthermore, an issuer could simplify the required calculations by electing to count all previously granted unexercisable options at the effective date of the amendments. There would not be a potential for abuse since the exemption limitations of the new rule would still have to be met (with only the measurement date for the old options changing, which, as the Commission noted in the adopting release, should make no difference to investors).

Please confirm that any of these methods of dealing with options that were not exercisable at the effective date of the amendments and that had not been counted toward the old Rule 701 limits is acceptable.

Information Requirements

The transition issue for options also implicates the information requirements. We believe that sales made during the look-back period, applied as discussed above, should be taken into account in determining whether the $5,000,000 amount has been exceeded so as to require compliance with the information provisions. However, the need to provide information should not apply to options granted during the look-back period and before the effective date of the amendments to the extent that they are counted under old Rule 701.

Please confirm that this application of the information requirements is correct.

We appreciate your consideration of these issues. Please feel free to contact any of the undersigned if you would like to discuss these issues further.

Very truly yours,

Pamela Baker
Jean E. Harris
Keith F. Higgins
John J. Huber
Stanley Keller
Gloria W. Nusbacher
Anne G. Plimpton
Louis Rorimer
Susan P. Serota
Scott P. Spector
Ann Yvonne Walker
[STAFF REPLY LETTER]
August 3, 1999

RESPONSE OF THE OFFICE OF SMALL BUSINESS

DIVISION OF CORPORATION FINANCE

Re: American Bar Association

Incoming letter dated July 30, 1999

With respect to issues of transition from the former Rule 701 to the new version, the grant date method, the effective date method and the exercisable date method you describe, each appear to be appropriate ways of handling unexercisable options under the new provision.

We concur with your view that options issued in reliance upon the prior version of Rule 701 regardless of their exercisability would not be subject to the new disclosure requirements at the time of the option grants.

Because this position is based upon representations made in your letter, any different facts or conditions might require a different conclusion.

Sincerely,

Richard K. Wulff, Chief

Office of Small Business