Release No. 33-6768

April 14, 1988

Compensatory Benefit Plans and Contracts

ACTION: Final rules.

SUMMARY: The Commission announces the adoption of a new Rule 701, new temporary Rules 702 and 703, and the new Form 701 which provide an exemption from the registration requirements of the Securities Act of 1933 (the "Securities Act") for offers and sales of securities pursuant to certain compensatory benefit plans or written contracts.

EFFECTIVE DATE: 30 days after publication in the Federal Register.

FOR FURTHER INFORMATION CONTACT: Richard K. Wulff or John D. Reynolds, (202) 272-2644, Office of Small Business Policy Division of Corporation Finance, Securities and Exchange Commission, 450 Fifth Street, N.W., Washington, D.C. 20549.

SUPPLEMENTARY INFORMATION: On January 16, 1987, the Commission published for comment ¹ proposed Rule 701 which would be authorized by section 3(b) of the Securities Act, ² to provide an exemption from the registration requirements of such Act for certain offers and sales of securities made pursuant to the terms of compensatory benefit plans or written compensation agreements by issuers that are not subject to the reporting requirements of section 13 or 15(d) of the Securities Exchange Act of 1934 (the "Exchange Act"). ³ That notice of proposed rulemaking also published for comment a temporary Rule 702 which would establish a notification requirement to the Commission when a certain level of sales had been made pursuant to Rule 701. Form 701 was proposed to serve as the requisite notification. On July 30, 1987, the Commission published for comment ⁴ a reproposal consisting of Rules 701 and 702 and new temporary Rule 703, which would disqualify an issuer from the use of Rule 701 if it were found to have violated Rule 702.

Certain revisions to the proposals have been made and are addressed in this release.

Table of Contents

I. Summary of the New Rules and Form 

The concern which has been raised by many privately-held companies with regard to the regulatory and other costs involved in providing securities as compensatory measures or incentives is sought to be addressed by this regulatory series, designated Rules 701, 702, 703 and Form 701.

A. Rule 701 

The substantive exemptive provision draws its authority from section 3(b) of the Securities Act and permits certain offers and sales of securities in connection with compensatory benefit plans and contracts to be effected without registration under the Securities Act.

(1) Preliminary Notes 

Rule 701 is prefaced by six preliminary notes. The initial four notes are as initially proposed. The first note indicates that the antifraud provisions of the federal securities laws may require that disclosure be made to securities purchasers even though the rule dictates no specific disclosure requirements; furthermore, that the rule only relates to the Securities Acts registration requirements. The second note recognizes the applicability of state law to transactions such as the ones encompassed by Rule 701. The third note indicates that use of the rule does not constitute an exclusive election. The fourth note states that only issuers may use rule 701, for it is not available for resales.

Two new notes have been added, which are designed to emphasize the extent of the exemptions coverage. The fifth preliminary note, included at the suggestion of commenters, makes clear that the purpose of the rule is to facilitate the use of securities for compensation. Rule 701 does not exempt offers and sales designed to raise capital. The final note, common to several of the Commissions exemptive rules, states that plans or schemes designed to evade the registration requirements of the Securities Act, while in technical compliance with Rule 701, are required to be registered.

(2) The Exemptive Provision 

The exemption provided by Rule 701(a) and (b) permits the offer and sale of securities by a non-reporting company pursuant to the terms of compensatory benefit plans or written contracts between the issuer or its parents or majority-owned subsidiaries and their employees, directors, general partners, trustees (if a business trust), officers, consultants and advisers. Although the Commission originally believed that broadening the rule to include consultants could go beyond the compensatory purposes of the provision, commenters have repeatedly stated that this limitation is unnecessary because securities issuances to such parties also can be for compensatory and not capital raising purposes and thus there is no meaningful basis for distinguishing between issuances to them and to employees. The Commission has been persuaded by the commenters on this issue. In addition, the concern expressed by the Commission in the July release about use of the rule for noncompensatory purposes is addressed by new Preliminary Note 5 and the conditions in the exemption requiring a written plan or contract. Consequently, the rule has been modified to extend to consultants and advisers who provide bona fide services to a company, its parents or majority-owned subsidiaries.

Reproposed Rule 701 would have permitted offers up to $5 million and sales up to 15% of total assets in each of an issuers fiscal years. In no event would sales in excess of $5 million have been permitted in any fiscal year. The Commission is concerned that a sales ceiling based solely on total assets would restrict the usefulness of the exemption to certain non-reporting companies, including new companies and service companies with low asset levels and start-up companies with research and development costs that may not have been capitalized. The final rule provides an alternative to the asset-based formula and permits in any event a minimum level of offers and sales. Under the rule, the amount of securities that may be subject to outstanding offers in reliance on Rule 701 plus the amount of securities sold in the preceding 12 months in reliance on Rule 701 may not exceed the greater of $500,000 or amounts determined under two different formulas. One formula limits this amount to 15% of the issuers total assets measured at the end of the issuers last fiscal year. The second formula restricts the amount to no more than 15% of the outstanding securities of the class being offered. In any case, the aggregate offering price of securities subject to outstanding offers and sold in the preceding 12 months may not exceed $5 million. The revisions to the levels of permissible offers and sales as well as the rolling 12-month period are intended to increase the flexibility and utility of the exemptive provision.

Under the rule, the aggregate amount of offers in any 12-month period may not exceed the permissible level of sales in such period. Therefore, the proposed provisions which would have permitted additional sales in the event of the effectiveness of a registration statement, the announcement of a business combination or the termination of employment as a result of the death or disability of a participant are unnecessary and have been deleted.

No change has been made in the provisions which make the exemption available for transactions within the description of the rule but commenced prior to its effectiveness, if the ultimate sales occur after the rules adoption. As proposed, offers made by an issuer prior to its becoming subject to the Exchange Act reporting provisions may be consummated afterwards in reliance upon Rule 701. Issuers registered or required to be registered under the Investment Company Act of 1940 ⁵ may not use Rule 701.

In view of the compensatory nature of the transactions covered by the rule, aggregation principles only consider offerings under Rule 701 within the preceding 12-month period. The ceilings for other transactions made in reliance upon different rules promulgated pursuant to section 3(b) of the Securities Act are not affected by Rule 701 offers and sales. The addition of the formula permitting a number of shares to be offered and sold necessitates additional wording to the aggregation principles, which now exclude numbers of shares from the respective calculations as well.

The possible integration of Rule 701 offerings with other offerings is a matter of concern and has been repeatedly raised by commenters and noted by the Commission. Rule 701 addresses this concern by specifically stating that all offers and sales pursuant to its rubric are deemed to be a part of a single, discrete offering; consequently, Rule 701 transactions need not be integrated into any other offering made by the issuer or vice versa. It should be noted, however, that as public offerings are permitted under Rule 701, a general solicitation issue may result where offering materials for a Rule 701 transaction are generally used and an issuer is relying upon some other exemption for a limited offering involving the same or a similar compensation plan or arrangement.

Rule 701 specifies that all cash, property, notes, cancellation of indebtedness and other consideration should be included in calculating the aggregate offering price of securities issued in reliance on the rule. Services rendered by an employee as part of his or her regular employment would not be considered additional consideration. ⁶ However, if securities are issued to consultants or advisers as payment for services, the value of such services should be included in the aggregate offering price.

A definition of "compensatory benefit plan" is contained in the rule, which is patterned on Rule 405. ⁷ In addition, the rule dictates that both plans and contracts relating to compensation be in writing and be delivered to participants. In this way, all parties involved in the transactions will have appropriate information in hand with respect to the governing terms of the transactions. As proposed, interests that would be separate securities in compensatory benefit plans ⁸ also are exempted by virtue of Rule 701.

The July reproposal required that the benefit plan be established by the issuer. As long as the issuance of the securities has been authorized by the issuer, there does not appear to be a need to require that the issuer also establish the plan; thus that requirement has been eliminated.

(3) Limitations on Resales 

As proposed, securities issued in a Rule 701 transaction were to have the status of securities acquired in a transaction under section 4(2) of the Securities Act, reflecting the Commissions concern that resales without an appropriate exemption or registration would permit Rule 701 to be used to carry out distributions beyond the employee-consultant group covered by the Rule. To obviate any confusion that might result from a reference to the "non-public" offering exemption in a rule which permits public offerings, Rule 701 securities have been defined to be "restricted securities" for purposes of Rule 144 ⁹ and may be resold if the terms of that rule are fully complied with, including the holding period, notwithstanding that the offering may not be a private placement. The issuers obligation to ensure that no improper distribution of these securities occurs without registration or appropriate exemption is now specified in the text of the Rule. When an issuer becomes subject to the reporting provisions of the Exchange Act, shares acquired in Rule 701 transactions may be resold 90 days thereafter without compliance with paragraphs (c), (d), (e) and (h) of Rule 144 if the person is not an affiliate of the issuer or under Rule 144 without compliance with paragraph (d), if an affiliate.

B. Temporary Rules 702 and 703 

Rule 702 requires the filing of Form 701, a notification with the Commission no later than 30 days following the first sales which bring aggregate Rule 701 sales over $100,000, not $50,000 as proposed. Commenters suggested that a higher threshold for the filing requirement might cause more issuers to become aware of the responsibility before the notice became due thus resulting in broader compliance with the provision. To further broad compliance, the Commission has adopted the suggestion of the commenters. Annual amendments are required within 30 days after the close of the issuers fiscal year. Failure to comply with the provisions of Rule 702 constitutes a violation of the Rule, for which the Commission can seek judicial relief. Rule 703 constitutes an issuer disqualifier from the use of Rule 701 where the issuer has been found to have violated Rule 702. The Commission has the authority to waive these disqualifications in appropriate cases for good cause shown by the issuer. In order to facilitate the processing of these waiver requests, the Commission is amending its delegation of authority rules to indicate that the Director of the Division of Corporation Finance may grant such applications. ¹⁰ 

Both Rules 702 and 703 have been adopted on a temporary basis of five years. After that time, the Commission will review the need for these requirements.

C. Form 701 

Form 701 is a one-page notification, requiring disclosure about the issuer and the compensatory arrangements pursuant to which the securities are being offered. It also requires information about the amounts of securities offered and sold, the issuers total assets and outstanding securities of the class offered. Changes to Form 701 have been made to conform the information requested to the terms of the rule.

II. Availability of Final Regulatory Flexibility Analysis 

A Final Regulatory Flexibility Analysis in accordance with the Regulatory Flexibility Act regarding Rules 701, 702, 703 and Form 701 has been prepared. A summary of the corresponding Initial Regulatory Flexibility Analysis was included in the proposing release. Members of the public who wish to obtain a copy of the Final Regulatory Flexibility Analysis should contact John D. Reynolds in the Office of Small Business Policy, Division of Corporation Finance, U.S. Securities and Exchange Commission, 450 Fifth Street, N.W., Washington, D.C. 20549.

III. Cost-Benefit Analysis 

No specific data was provided on the Commissions request for costs and benefits of the proposals. It does appear however that there may be significant savings especially to small issuers and considerable benefits to compensated persons who have in the past been deprived of the opportunity to receive securities as an incentive or in payment for their services. The Commission believes that the rules will not adversely affect investor protection.

IV. Statutory Basis and Text of the Rules 

The new rules and Form are being adopted pursuant to sections 3(b) and 19(a) of the Securities Act.

List of Subjects in 17 CFR Parts 200, 230 and 239

Administrative practice and procedure, freedom of information, privacy, securities.

Reporting and recordkeeping requirements, securities.

TEXT OF AMENDMENTS

Accordingly, Title 17, Chapter II of the Code of Federal Regulations is amended as follows: 

PART 200-ORGANIZATION: CONDUCT AND ETHICS: AND INFORMATION REQUESTS 

1. The authority citation for Part 200 continues to read, in part, as follows: 

AUTHORITY: Secs. 19, 23, 48 Stat. 85, 901, as amended, sec. 20, 49 Stat. 833, sec. 319, 53 Stat. 1173, secs. 38, 211, 54 Stat. 841, 851; 15 U.S.C. 77s, 78w, 79t, 77sss, 80a-37, 80b-11, unless otherwise noted. * * * 

2. Section 200.30-1 is amended by adding a new paragraph (j) as follows: 

§200.30-1 Delegation of authority to Director of Division of Corporation Finance.

* * * * *

(j) With respect to the Securities Act of 1933 (15 U.S.C. 77a et seq.) and Rule 701 thereunder (§230.701 of this chapter), to authorize the granting of applications under Rule 703(b)(§230.703(b) of this chapter) upon a showing of good cause that it is not necessary under the circumstances that an exemption under Rule 701 be denied.

Part 230-GENERAL RULES AND REGULATIONS, SECURITIES ACT OF 1933

3. The authority citation for Part 230 continues to read, in part, as follows: 

AUTHORITY: Sections 230.100 to 230.174 issued under Sec. 19, 48 Stat. 85 as amended; 15 U.S.C. 77s, * * * 

4. By revising §230.144(a)(3) to read as follows: 

§230.144 Persons deemed not to be engaged in a distribution and therefore not underwriters.

* * * * *

(a) * * * 

(3) The term "restricted securities" means securities that are acquired directly or indirectly from the issuer, or from an affiliate of the issuer, in a transaction or chain of transactions not involving any public offering, or securities acquired from the issuer that are subject to the resale limitations of Regulation D or Rule 701(c) (§230.701(c) of this chapter) under the Act, or securities that are subject to the resale limitations of Regulation D and are acquired in a transaction or chain of transactions not involving any public offering.

* * * * *

5. By adding a new §230.701 to read as follows: §230.701 Exemption for offers and sales of securities pursuant to certain compensatory benefit plans and contracts relating to compensation.

PRELIMINARY NOTES

(1) Nothing in this rule is intended to be or should be construed as in any way relieving issuers or persons acting on behalf of issuers from providing disclosure to employees or other persons within the scope of the rule adequate to satisfy the antifraud provisions of the federal securities laws. The rule only provides an exemption from the registration requirements of the Securities Act of 1933 (the "Act") 15 U.S.C. 77a et seq..

(2) Nothing in the rule obviates the need to comply with any applicable state law relating to the offer and sale of securities.

(3) Attempted compliance with the rule does not act as an exclusive election; the issuer can also claim the availability of any other applicable exemption.

(4) The rule is only available to the issuer of the securities and not to any affiliate of the issuer or to any other person for reselling the securities. The rule provides an exemption only for the transactions in which the securities are offered or sold by the issuer, not for the securities themselves.

(5) In view of the primary purpose of the rule, which is to provide an exemption from the registration requirements of the Act for securities issued in compensatory circumstances, the rule is not available for plans or schemes to circumvent this purpose, such as to raise capital. In such cases, registration or some other exemption from registration under the Act is required.

(6) The exemption provided by the rule is not available to any issuer for any transaction which, while in technical compliance with such rule, is part of a plan or scheme to evade the registration provisions of the Act. In such cases, registration under the Act is required.

(a) Exemption. Offers and sales of securities that satisfy the provisions of paragraphs (b) and (c) of this §230.701 by an issuer that is not subject to the reporting requirements of section 13 or 15(d) of the Securities Exchange Act of 1934 (the "Exchange Act") 15 U.S.C. 78a et seq. and is not an investment company registered or required to be registered under the Investment Company Act of 1940 15 U.S.C. 80a-1 et seq. shall be exempt from the provisions of section 5 of the Act by virtue of section 3(b) of the Act. Issuers may rely on this rule with respect to offers made prior to the adoption of this §230.701 if in accordance with this section had it been in effect, or offers made pursuant to this §230.701 prior to the issuer becoming subject to the reporting requirements of section 13 or 15(d) of the Exchange Act, and sales consummating such offers may be made thereafter in reliance upon this provision.

(b) Conditions to be met. 

(1) An exemption under this §230.701 applies only to offers and sales of an issuers securities (i) pursuant to a written compensatory benefit plan and interests in such a plan established by that issuer, its parents or majority-owned subsidiaries for the participation of their employees, directors, general partners, trustees (where the issuer is a business trust), officers, or consultants or advisers, provided that bona fide services shall be rendered by consultants or advisers and such services must not be in connection with the offer and sale of securities in a capital-raising transaction, or (ii) pursuant to a written contract relating to the compensation of such persons.

(2) For purposes of §230.701 and 702, a compensatory benefit plan means any purchase, savings, option, bonus, stock appreciation, profit sharing, thrift, incentive, pension or similar plan.

(3) The issuer, its parent or majority-owned subsidiary shall provide each participant in a compensatory benefit plan with a copy of such plan. A copy of a written contract relating to compensation shall be provided to the parties.

(4)(i) Aggregate offering price means the sum of all cash, property, notes, cancellation of debt or other consideration to be received by the issuer for the issuance of the securities. Non-cash consideration should be valued in reference to bona fide sales of that consideration made within a reasonable time, or, in the absence of sales, on the fair value as determined by an accepted standard.

(ii) No adjustment to the aggregate offering price in this section shall be made for other offerings made in reliance upon other rules or regulations adopted pursuant to section 3(b) of the Act. The aggregate offering price under other rules and regulations adopted pursuant to section 3(b) shall not be reduced by offerings made under this §230.701.

(iii) The number of shares permitted to be offered and sold under §230.701(b)(5)(ii) shall not be reduced by the number of shares offered or sold in reliance upon other rules or regulations adopted pursuant to section 3(b) of the Act, or vice versa.

(5) The amount of securities offered and sold in reliance on §230.701 shall not exceed the greater of $500,000 or the amount determined by (b)(5)(i) or (ii) of this section; provided, however, that the aggregate offering price of securities of the issuer subject to outstanding offers made in reliance on §230.701 plus securities of the issuer sold in the preceding 12 months in reliance on §230.701 shall in no event exceed $5,000,000.

(i) The aggregate offering price of securities of the issuer subject to outstanding offers in reliance on §230.701 plus securities of the issuer sold in the preceding 12 months in reliance on §230.701 shall not exceed 15% of the total assets of the issuer, measured at the end of its last fiscal year; or 

(ii) The number of securities of the issuer subject to outstanding offers in reliance on §230.701 plus securities of the issuer sold in the preceding 12 months in reliance on §230.701 shall not exceed 15% of the outstanding securities of that class. The outstanding securities of a class shall include securities of that class issuable pursuant to the exercise of outstanding options, warrants, rights or conversion of convertible securities, unless such options, warrants, rights or convertible securities were issued under §230.701. If the securities offered or sold under §230.701 are convertible securities, the number of securities subject to outstanding offers and sold under this subsection shall be deemed to be the shares of the securities into which such securities may be converted.

(6) Offers and sales exempt pursuant to this §230.701 are deemed to be a part of a single, discrete offering and are not subject to integration with any other offering or sale whether registered under the Act or otherwise exempt from the registration requirements of the Act.

(c) Resale Limitations 

(1) Securities issued pursuant to this §230.701 are deemed to be "restricted securities" as defined in §230.144.

(2) Resales of such securities must be in compliance with the registration requirements of the Act or an exemption therefrom.

(3) Ninety days after the issuer becomes subject to the reporting requirements of section 13 or 15(d) of the Exchange Act, securities issued in a §230.701 transaction may be resold by persons other than affiliates in reliance on §230.144 without compliance with paragraphs (c), (d), (e) and (h) thereof, and by affiliates without compliance with paragraph (d) thereof.

6. By adding a new temporary §230.702(T) to read as follows: 

§230.702(T) Notice of sales pursuant to an exemption under §230.701.

(a) The issuer shall file with the Commission five copies of a notice on Form 701 17 CFR 239.701 not later than 30 days after the first sale of securities which brings the aggregate sales pursuant to benefit plans and/or contracts relating to compensation exempt from the registration requirements of the Act by §230.701 above $100,000 and thereafter annually within 30 days following the end of the issuers fiscal year.

(b) One copy of every notice on Form 701 shall be manually signed by a person duly authorized by the issuer.

(c) New filings and annual amendments must contain all the information requested on Form 701. Corrected filings need only report the name of the issuer and plan and the information being corrected. A separate filing is not required for each plan or contract relating to compensation.

(d) A notice on Form 701 is considered filed with the Commission under paragraph (a) of this §230.702 on the date of its receipt at the Commissions principal offices in Washington, D.C.

(e) This section shall be effective until 5 years from the effective date of the final rule.

7. By adding a new temporary §230.703(T) to read as follows: 

§230.703(T) Disqualifying provision relating to an exemption under §230.701.

(a) No exemption under §230.701 shall be available for an issuer if such issuer, any of its predecessors or affiliates have been subject to any order, judgment, or decree of any court of competent jurisdiction temporarily, preliminarily or permanently enjoining such person for failure to comply with §230.702.

(b) Paragraph (a) of this section shall not apply if the Commission determines, upon a showing of good cause, that it is not necessary under the circumstances that the exemption be denied.

(c) This section shall be effective until 5 years from the effective date of the final rule.

PART 239-FORMS PRESCRIBED UNDER THE SECURITIES ACT OF 1933 

8. The authority citation for Part 239 continues to read, in part, as follows: 

AUTHORITY: The Securities Act of 1933, 15 U.S.C. 77a, et seq. 

9. By adding §239.701 (Form 701) to read as follows: §239.701, Form 701, report of sales of securities pursuant to a compensatory benefit plan or contract relating to compensation.

This form shall be used for the report of sales of securities pursuant to a compensatory benefit plan or contract relating to compensation under Rule 701 (§230.701 of this chapter).

By the Commission.

Jonathan G. Katz

Secretary

Form 701 does not appear in the Code of Federal Regulations

This graph could not be reproduced.

Instructions

ALL RESPONSES SHOULD BE TYPED OR PRINTED

Who Must File: All issuers making an offering of securities pursuant to a compensatory benefit plan or contract relating to compensation in reliance upon the exemption provided by Rule 701, 17 CFR 230.701.

When To File: A notice must be filed no later than 30 days after the first sale of securities pursuant to compensatory benefit plans or contracts relating to compensation which cause aggregate sales to exceed $100,000, and thereafter annually within 30 days after the issuers fiscal year end. A notice is deemed filed with the U.S. Securities and Exchange Commission on the date it is received by the Commission at the address below.

Where To File: U.S. Securities and Exchange Commission, 450 Fifth Street, N.W., Washington, D.C. 20549.

Copies Required: Five (5) copies of this notice must be filed with the Commission, one of which must be manually signed. Any copies not manually signed must be photocopies of the manually signed copy or bear printed signatures.

Information Required: New filings and annual amendments must contain all information requested. Corrected filings need only report the name of the issuer and plan and the information being corrected. A separate filing is not required for each plan or contract relating to compensation.

WHOLE DOLLAR AMOUNTS ARE REQUESTED; CENTS SHOULD BE ROUNDED TO THE NEAREST DOLLAR AMOUNT.

Filing Fee: There is no filing fee.

¹ Release No. 33-6683 (January 16, 1987) 52 FR 3015. This proposal generated 26 comment letters.

² 15 U.S.C. 77a et seq.

³ 15 U.S.C. 78a et seq. Foreign issuers submitting home country reports pursuant to Rule 12g3-2 17 CFR 240.12g3-2 are eligible to rely on Rule 701. This position will permit U.S. employees to participate in securities offerings made under compensatory arrangements of such foreign issuers.

⁴ Release No. 33-6726 (July 30, 1987) 52 FR 29033. The Commission received an additional 9 comment letters regarding these revised proposals. The comment letters and summaries of the comments for the initial proposals and the reproposals (File No. S7-28-87) are available for public inspection and copying at the Commissions Public Reference Room, 450 Fifth Street, N.W., Washington, D.C. 20549.

⁵ 15 U.S.C. 80a-1 et seq.

⁶ It should be noted that generally accepted accounting principles require that compensation expense be recorded for any securities issued at less than fair market value.

⁷ 17 CFR 230.405.

⁸See Release Nos. 33-6281 (January 15, 1981) 46 FR 8446, 33-6188 (February 1, 1990) 45 FR 8960.

⁹ 17 CFR 230.144.

¹⁰ In this regard, the Commission finds that in accordance with Section 553(b) of the Administrative Procedure Act, 5 U.S.C. 553(b), this action relates solely to agency organization, procedure or practice and thus obviates the necessity for notice and prior publication.