Release No. 34-56010Exemption of Compensatory Employee Stock Options from Registration Under Section 12(g) of the Securities Exchange Act of 1934AGENCY: Securities and Exchange Commission. ACTION: Proposed rule. SUMMARY: The Commission is proposing two exemptions from the registration requirements of the Securities Exchange Act of 1934 for compensatory employee stock options. The first exemption would be available to issuers that are not required to file periodic reports under the Exchange Act. The proposed exemption would apply only to the issuers compensatory employee stock options and would not extend to the class of securities underlying those options. The second exemption would be available to issuers that are required to file those reports because they have registered under Exchange Act Section 12 the class of securities underlying the compensatory employee stock options. DATES: Comments must be received on or before September 10, 2007. ADDRESSES: Comments may be submitted by any of the following methods: Electronic Comments: Use the Commissions Internet comment form (http://www.sec.gov/rules/proposed.shtml); or Page 1 Send an e-mail to rule-comments@sec.gov. Please include File Number S7-14-07 on the subject line; or Use the Federal eRulemaking Portal (http://www.regulations.gov). Follow the instructions for submitting comments. Paper Comments: Send paper comments in triplicate to Nancy M. Morris, Secretary, Securities and Exchange Commission, 100 F Street, NE, Washington, DC 20549-1090. All submissions should refer to File Number S7-14-07. This file number should be included on the subject line if e-mail is used. To help us process and review your comments more efficiently, please use only one method. The Commission will post all comments on the Commissions Internet Web site http://www.sec.gov/rules/proposed.shtml. Comments also are available for public inspection and copying in the Commissions Public Reference Room, 100 F Street, NE, Washington, DC 20549. All comments received will be posted without change; we do not edit personal identifying information from submissions. You should submit only information that you wish to make available publicly. FOR FURTHER INFORMATION CONTACT: Amy M. Starr, Senior Special Counsel to the Director, at (202) 551-3115, Division of Corporation Finance, U.S. Securities and Exchange Commission, 100 F Street, NE, Washington, DC 20549. SUPPLEMENTARY INFORMATION: We are proposing amendments to rule 12h-11 under the Securities Exchange Act of 1934.2 Page 2 I. INTRODUCTION AND BACKGROUNDA. IntroductionIn the 1980s, private, non-reporting issuers began using compensatory employee stock options3 to compensate a broader range of employees, including executive, middle, and lower-level employees, directors, and consultants.4 Compensatory employee stock options provide a method to use non-cash compensation to attract, retain, and motivate company employees, directors, and consultants.5 Since the 1990s, a number of private, non-reporting issuers have granted compensatory employee stock options to 500 or more employees, directors, and consultants.6 Page 3 Under Section 12(g)7 of the Exchange Act, an issuer with 500 or more holders of record of a class of equity security and assets in excess of $10 million at the end of its most recently ended fiscal year must register that class of equity security, unless there is an available exemption from registration.8 Stock options, including stock options issued to employees under stock option plans, are a separate class of equity security for purposes of the Exchange Act.9 Accordingly, an issuer with 500 or more optionholders and more than $10 million in assets is required to register that class of options under the Exchange Act, absent an available exemption. While there is an exemption from Exchange Act Section 12(g) registration for interests and participations in certain other types of employee compensation plans involving securities,10 currently there is no exemption for compensatory employee stock options. Page 4 We are proposing an exemption for private, non-reporting issuers from Exchange Act Section 12(g) registration for compensatory employee stock options issued under employee stock option plans. We also are proposing an exemption from Exchange Act Section 12(g) registration for compensatory employee stock options of issuers that have registered under Exchange Act Section 12 the class of equity security underlying those options. B. Overview of Applicable Exchange Act ProvisionsThe addition of Section 12(g) to the Exchange Act was intended "to extend to investors in certain over-the-counter securities the same protection now afforded to those in listed securities by providing that the issuers of certain securities now traded over the counter shall be subject to the same requirements that now apply to issuers of securities listed on an exchange."11 Further, Section 12(g) extended the disclosure and other Exchange Act safeguards to unlisted securities as a means to prevent fraud.12 The Commission has noted that the registration requirement of Section 12(g) was aimed at issuers that had "sufficiently active trading markets and public interest and consequently were in need of mandatory disclosure to ensure the protection of investors."13 Exchange Act Section 12(h)14 provides the Commission with exemptive authority with regard to certain provisions of the Exchange Act. Included in Exchange Act Section 12(h) is the authority to create appropriate exemptions from the Exchange Act Page 5 registration requirements. Under Exchange Act Section 12(h), the Commission may exempt a class of securities by rules and regulations or by exemptive order if it "finds, by reason of the number of public investors, amount of trading interest in the securities, the number and extent of the activities of the issuer, income or assets of the issuer, or otherwise, that such action is not inconsistent with the public interest or the protection of investors."15 C. Historical Treatment of Compensatory Employee Stock Options under Exchange Act Section 12(g)A number of private, non-reporting issuers faced with registration under Exchange Act Section 12(g) due solely to their compensatory employee stock options being held by 500 or more holders of record (as well as having more than $10 million in assets) at the end of their fiscal year have requested registration relief from our Division of Corporation Finance.16 Since 1992, the Division has provided relief through no-action letters17 to these private issuers when specified conditions were present. Before 2001, the Divisions no-action relief in this area was conditioned on, among other things, the options terminating at the time employment terminated. Further, that relief was conditioned on the compensatory employee stock options not being exercisable until after either the issuers initial public offering or the time at which the Page 6 issuer was no longer relying on the relief.18 Beginning in 2001, the Division announced modified conditions to registration relief for compensatory employee stock options of private, non-reporting issuers that, due to market conditions, were delayed in their plans to go public.19 Because the Divisions no-action relief applies only to the private, non-reporting issuers compensatory employee stock options, once that issuer has 500 or more holders of record of any other class of equity security (including, for example, common stock outstanding as a result of stock issuances, including option exercises), it would be required to register that other class of equity security under Exchange Act Section 12(g). The Divisions no-action letters providing Exchange Act Section 12(g) registration relief to private, non-reporting issuers currently include the following parameters:20 Scope of Relief:
Eligible Participants: Page 7
Exercisability:
Transferability and Ownership Restrictions:
Information Requirements: Page 8
D. Recommendation of the Advisory Committee on Smaller Public CompaniesThe Advisory Committee on Smaller Public Companies, in its Final Report, recommended that the Commission provide Exchange Act Section 12(g) registration Page 9 relief for compensatory employee stock options.26 In this regard, the Advisory Committee stated: [H]olders of employee stock options received in compensatory transactions are less likely to require the full protections afforded under the registration requirements of the federal securities laws. Therefore, we believe that such stock options should not be a factor in determining the point an issuer becomes subject to the burdens of a reporting company under the Exchange Act.27 E. Overview of the Proposed ExemptionsWe believe that it is appropriate at this time to propose two new exemptions from the registration provisions of Exchange Act Section 12(g) for compensatory employee stock options issued under employee stock option plans that are limited to employees, directors, consultants, and advisors of the issuer, its parents, and majority-owned subsidiaries of the issuer or its parents.28 Given the differences between issuers that are required to file reports under the Exchange Act and those issuers that do not have such an obligation, including the nature of the trading markets and the amount of publicly Page 10 available information, we believe that it is appropriate to propose separate exemptions for these different types of issuers. 1. Exemption for Issuers That Are Not Exchange Act Reporting Issuers We believe that an exemption from Exchange Act registration of compensatory employee stock options for private, non-reporting issuers will provide useful certainty to those issuers in their compensation decisions and will help them avoid becoming subject to the registration and reporting requirements of the Exchange Act prior to the time they have public shareholders.29 Based on the factors identified in Exchange Act Section 12(h), we believe that it is appropriate to provide an exemption from Exchange Act Section 12(g) registration to a specified class of compensatory employee stock options. 30 We believe that the conditions to the proposed exemption and the existing statutory provisions and rules provide holders of compensatory employee stock options in private, non-reporting issuers appropriate disclosure and investor protections under the federal securities laws, given the compensatory circumstances of the securities issuance and the restrictions on transferability of the compensatory employee stock options and shares Page 11 received on exercise of those options. As such, we are proposing to amend Exchange Act Rule 12h-1 to provide an exemption from Exchange Act Section 12(g) registration for compensatory employee stock options issued under written compensatory stock option plans of an issuer that does not have a class of securities registered under Exchange Act Section 12 and is not subject to the reporting requirements of Exchange Act Section 15(d), where the following conditions are present:31
The proposed exemption would apply only to a private, non-reporting issuers compensatory employee stock options and would not extend to the class of securities underlying those options.33 Page 12 The proposed restrictions on the type of issuer eligible to rely on the exemption, the limitation on who may be granted and hold the compensatory employee stock options, the transferability restrictions, and the limitation of the exemption to the compensatory employee stock options are intended to assure that there is no trading in the options or shares received on exercise of the options and that there are no public investors in the compensatory employee stock options that need the full range of protections that Exchange Act registration and reporting afford. In light of the circumstances under which private, non-reporting issuers issue compensatory employee stock options, the terms of those options, and the information provision requirements of the proposed exemption, we believe that the proposed amended rule contains appropriate conditions to an exemption of such compensatory employee stock options of private, non-reporting issuers from registration under Exchange Act Section 12(g). As such, we believe that the proposed exemption is in the public interest, in that it would clarify and routinize the basis for an exemption from Exchange Act Section 12(g) registration for compensatory employee stock options so private, non-reporting issuers would be able to continue to issue compensatory employee stock options and would provide appropriate investor protections for optionholders and holders of shares received on exercise of the options. 2. Exemption for Exchange Act Reporting Issuers We are proposing to amend Exchange Act Rule 12h-1 to provide an exemption for compensatory employee stock options of issuers that are required to file reports under the Exchange Act because they have registered under Exchange Act Section 12 the class of equity security underlying those options. The proposed exemption would be available Page 13 would apply to the compensatory employee stock options and the securities issuable on exercise of the compensatory employee stock options. only where the options were issued pursuant to a written compensatory stock option plan and the class of persons eligible to receive or hold the options is limited appropriately. We believe that the proposed exemption of compensatory employee stock options from Exchange Act registration is appropriate for purposes of investor protection and the public interest because the optionholders would have access to the issuers publicly filed Exchange Act reports and the appropriate provisions of Exchange Act Sections 13, 14, and 1634 II. DISCUSSION OF PROPOSALSWe are proposing two amendments to Exchange Act Rule 12h-1. These amendments would:
A. Proposed Exemption For Compensatory Employee Stock Options of Issuers That Are Not Exchange Act Reporting IssuersWe believe it is appropriate to provide an exemption from Exchange Act registration for compensatory employee stock options of issuers that are not required to file reports under the Exchange Act. The availability of this proposed exemption would be subject to specified limitations, including limitations concerning permitted optionholders, transferability and provision of information. Page 14 1. Eligible Issuers The proposed amendment would provide an exemption from Exchange Act Section 12(g) registration for compensatory employee stock options of the following types of issuers:
The proposed exemption is intended to be available only to those issuers that are not reporting under the Exchange Act. As such, the proposed exemption would terminate once the issuer became subject to the reporting requirements of the Exchange Act.36 Request for Comment
2. Eligible Compensatory Employee Stock Options The proposed exemption for compensatory employee stock options would: Page 15
The proposed exemption would cover all compensatory employee stock options of an issuer meeting the conditions of the exemption, even if the compensatory employee stock options were issued under separate written option plans. For this purpose, the compensatory employee stock options would be considered to belong to the same class of equity security if the same class of securities would be issuable on exercise of the compensatory employee stock options.39 The proposed exemption would apply to the compensatory employee stock options only and not to the securities issued (or to be issued) on exercise of the compensatory employee stock options. Thus, the issuer would have to apply the registration requirements of Exchange Act Section 12 to the class of equity security Page 16 underlying the compensatory employee stock options without regard to the proposed exemption.40 Request for Comment
3. Eligible Option Plan Participants The proposed exemption would be available only where the class of persons eligible to receive compensatory employee stock options under the stock option plans is limited to those persons described in the exemption. These eligible optionholders would be the same as those participants permitted under Rule 701 and would include:41
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We have proposed that the exemption be limited to those situations where compensatory employee stock options may be held only by those persons who are permitted to hold or be granted compensatory employee stock options under Securities Act Rule 701. We believe that the experience of issuers and their counsels with Rule 701 will ease compliance with and limit uncertainty regarding the exemption.42 Just as Securities Act Rule 701 was designed specifically not to be available for capital-raising transactions, the proposed exemption would apply only to employee stock options issued for compensatory purposes. The restrictions on the eligible participants in the stock option plans are intended to assure that the proposed exemption is limited to employee stock options issued solely for compensatory purposes.43 Request for Comment
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4. Option Terms a. Compensatory Employee Stock Option and Share Transferability Restrictions The proposed exemption would be available only where there are certain restrictions on the transferability by an optionholder or holder of shares received on exercise of a compensatory employee stock option of those options, the shares issuable on exercise of those options, or shares of the same class of equity security as those underlying those options.44 Specifically, the proposed exemption would be available only if: 45
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Under the proposal, the exemption would not be available if optionholders and holders of shares received on exercise of compensatory employee stock options could Page 20 enter into agreements, prior to or after the exercise of those options, that would allow those holders to monetize or receive compensation from or consideration for such compensatory employee stock options, the shares to be received upon exercise of those options, or shares of the same class of equity security as those underlying those options. Thus, the proposed conditions provide that, except with regard to the limited permitted transfers specified in the proposed conditions, an optionholder cannot be permitted to pledge, hypothecate, or otherwise transfer the compensatory employee stock options, the shares underlying those options, or shares of the same class of equity security as those underlying those options, including through a short position, a "put equivalent position," or a "call equivalent position," until the issuer becomes subject to the reporting requirements of the Exchange Act. The proposed exemption would be conditioned on a similar restriction on the holders of shares received on exercise of the options. The proposed restrictions on transfer of the compensatory employee stock options, the shares underlying those options, and shares of the same class of equity security as those underlying those options by an optionholder or holder of shares received on exercise of an option are intended to limit the possibility for a trading market to develop for the compensatory employee stock options or the securities issued on exercise of those options while the issuer is relying on the proposed exemption. These restrictions also are intended to assure that an optionholder or holder of shares received on exercise of an option is not able to profit from the compensatory employee stock options or the securities received or to be received on exercise of those options (except from permitted transfers to the issuer or its affiliates as discussed above), until the issuer becomes subject to the reporting requirements of the Exchange Act. Page 21 While, in most cases, the securities of private, non-reporting issuers that are issued on exercise of compensatory employee stock options are deemed to be restricted securities as defined in Securities Act Rule 144,51 we believe that the proposed transferability restrictions are necessary to limit further the possibility of a market developing in the securities issued or issuable on exercise of immediately exercisable compensatory employee stock options while the issuer is not reporting under the Exchange Act. Thus, the proposed amendments would require that the issuers securities received on exercise of compensatory employee stock options be restricted as to transfer until the issuer becomes subject to the reporting requirements of the Exchange Act.52 The proposed transfer restrictions for the compensatory employee stock options and the shares received or to be received on exercise of those options are consistent in most respects with the transfer restrictions on compensatory securities in Securities Act Rule 701.53 In addition, we understand that private, non-reporting issuers generally restrict the transferability of shares received on exercise of compensatory employee stock options until the issuer becomes subject to the reporting requirements of the Exchange Act. As such, we believe that transferability restrictions should not impose additional constraints on such private, non-reporting issuers. Request for Comment Page 22
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b. Permitted Exercisability of Compensatory Employee Stock Options The proposed exemption would not require that there be any restriction on the timing of the exercise of the compensatory employee stock options:
Request for Comment
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5. Required Information The proposed exemption would require the issuer to provide information to optionholders and holders of shares received on exercise of compensatory employee stock options. This condition would require the issuer, for purposes of the proposed exemption, to provide the following information to optionholders (and holders of shares received on exercise of compensatory employee stock options):55
The issuer would be permitted to provide the required information (other than the issuers books and records) to the optionholders and holders of shares received on exercise of compensatory employee stock options either by: Page 25
The basis of the information requirement in the proposed exemption is the information that would be required to be provided pursuant to the exemption from Securities Act registration provided in Securities Act Rule 701 if securities sold in reliance on Securities Act Rule 701 in a 12-month period exceeded $5 million. In Securities Act Rule 701, we established the type of information that employees holding compensatory employee stock options must be provided before the exercise of those options.58 The Securities Act Rule 701 information provisions provide optionholders and other persons who purchase securities without registration under Rule 701 with important information. We believe that the ongoing provision of the same information is necessary and appropriate for purposes of the proposed exemption from Exchange Act registration.59 Page 26 Securities Act Rule 701 provides that the required information must be provided to an optionholder a reasonable period of time before the date of exercise of the compensatory employee stock options. Rule 701 also requires that the required financial statements must be as of a date no more than 180 days before the sale of the securities (which in the case of compensatory employee stock options is the date of exercise of the options). We believe that the proposed exemption from Exchange Act registration presents the need for ongoing information to be provided to optionholders and holders of shares received on exercise of those options. As such, the proposed exemption would require that the optionholders and holders of shares received on exercise of the compensatory employee stock options always be provided the required financial statements that are not more than 180 days old. While requiring private, non-reporting issuers to provide information, the proposed exemption would allow flexibility in the means of providing the information by permitting physical, electronic, or Internet-based delivery. Under the proposal, the issuer would be required to make its books and records available for inspection by the optionholder and holders of shares received on exercise of compensatory employee stock options to the same extent that they are available to other shareholders of the issuer. To permit issuers to safeguard proprietary or confidential information that may be contained in the information to be provided, the proposed exemption would permit provision of the disclosure to be conditioned on the optionholder (or holder of shares received on exercise of compensatory employee stock options) agreeing to maintain the Page 27 As proposed, if an optionholder (or holder of shares) chooses not to enter into such a confidentiality agreement, the exemption would permit the issuer to choose to not provide the information to that optionholder or holder of shares received on exercise of options if it allows inspection of the documents at one of the described issuer offices. confidentiality of the information.60 In the no-action registration relief provided to issuers to date, the staff of the Division of Corporation Finance has provided that relief only where the issuer commits to providing essentially the same Exchange Act information and reports as if it was subject to the Exchange Act reporting requirements. We believe that our experience with Securities Act Rule 701 and the combined conditions of the proposed exemption, including the eligibility and transferability provisions, alleviate the need for that level of information in the context of an on-going reporting exemption relating to compensatory employee stock options.61 As such, we believe that the scope of information that the optionholders and holders of shares will be provided under the proposed exemption is not inconsistent with investor protection and the public interest.62 Page 28 Request for Comment
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6. Issuer Obligation to Impose the Conditions to the Proposed Exemption For the proposed exemption to be available, a private, non-reporting issuer would be required to include the necessary limitations and conditions either in the written stock option plans or within the terms of the individual written option agreements. In addition, the transferability restrictions on the shares received on exercise of the compensatory employee stock options also must be included in the issuers by-laws, certificate of incorporation, or a stock purchase or stockholder agreement between the issuer and the Page 30 exercising optionholder or holder of shares received on exercise of an option. We believe that the self-executing nature of the proposed exemption necessitates the inclusion of the conditions to the exemption in an enforceable agreement between the issuer, the optionholders, and the holders of shares received on exercise of an option, or in the issuers by-laws or certificate of incorporation. Request for Comment
B. Proposed Exemption for Compensatory Employee Stock Options of Exchange Act Reporting IssuersTo provide certainty regarding the obligations of issuers that already have registered the securities underlying the compensatory employee stock options under the Exchange Act, we believe it is appropriate to provide an exemption from Exchange Act registration for compensatory employee stock options of these reporting issuers.66 The proposed exemption would be available only for an issuer that has registered under Exchange Act Section 12 the class of equity security underlying the compensatory employee stock options. Such a registration gives rise to a requirement to file the reports Page 31 required under Exchange Act Section 13.67 The filing of these reports is essential to the proposed exemption, as we believe the exemption is appropriate because the Exchange Act reports of those issuers will provide the appropriate information to optionholders. As with the proposed exemption for private, non-reporting issuers, the proposed exemption for issuers subject to the reporting requirements of the Exchange Act would be available only where the options were issued pursuant to a written compensatory stock option plan and where the class of persons eligible to receive or hold compensatory employee stock options under the stock option plans was limited to those participants permitted under Securities Act Rule 701.68 The proposed exemption from Section 12(g) registration for compensatory employee stock options of Exchange Act reporting issuers would not include any information conditions, other than those arising from the registration of the class of equity security underlying the options. As proposed, the availability of the exemption would not be conditioned on the issuer being current in its Exchange Act reporting. We have not proposed such a condition, as it would seem inappropriate for the issuer to lose the exemption, and be required to register a class of compensatory employee stock options under Exchange Act Section 12(g), because it was late in filing a required Exchange Act report and, for the days before that report was filed, was not "current" in its Exchange Act reporting. We are requesting comment as to whether it would be appropriate to include a requirement in the exemption regarding the issuers ongoing satisfaction of its Exchange Act reporting obligations. Page 32 While the proposed exemption would apply to the registration of compensatory employee stock options as a separate class of equity security, the protections of Exchange Act Sections 13(e) and 14(e) will continue to apply to offers for those compensatory employee stock options. Further, the requirements of Exchange Act Section 16 also will apply to the equity securities underlying the compensatory employee stock options and the beneficial ownership reporting requirements of Exchange Act Sections 13(d) and 13(g)69 will continue to apply if the compensatory employee stock options are exercisable for Exchange Act Section 12 registered securities. 70 The proposed exemption, therefore, would be available only to an issuer that had registered under Exchange Act Section 12 the class of equity security to be issued on exercise of the compensatory employee stock options. As a result, the proposed exemption would not be available to an issuer that is required to file Exchange Act reports solely pursuant to Exchange Act Section 15(d). Request for Comment Should the proposed exemption apply to any issuer that is required to file Exchange Act periodic reports, whether or not the issuer has registered the class of equity security underlying the compensatory employee stock options under Exchange Act Section 12? If so, why? Should the proposed exemption be available only to issuers that are current in their Exchange Act reporting obligations? Should the proposed exemption be available only to issuers that, at the end of their fiscal years, are current in their Exchange Act reporting obligations? If so, why? If not, why not? Page 33
C. Transition ProvisionsThe proposed exemption from Exchange Act Section 12(g) registration for compensatory employee stock options for private, non-reporting issuers would not affect the no-action relief from Exchange Act Section 12(g) registration of compensatory employee stock options that issuers have received from our Division of Corporation Finance. While the existing no-action letters will remain unaffected by the proposed exemption if adopted, issuers who have received such letters would be able, of course, to rely instead on the proposed exemption. The proposed exemptions are self-executing. If the issuer becomes ineligible to rely on an applicable proposed exemption, the issuer would be permitted up to 60 Page 34 calendar days from the date it became ineligible to rely on the proposed exemption to file a registration statement to register under Exchange Act Section 12(g) the class of compensatory employee stock options or, in the case of a reporting issuer, the class of equity security underlying such options. Request for Comment
D. General Request for CommentWe request and encourage any interested person to submit comments on the proposed exemptions and any other matters that might have an impact on the proposed exemptions. With respect to any comments, we note that such comments are of greatest assistance to our rulemaking initiative if accompanied by supporting data and analysis of the issues addressed in those comments. III. PAPERWORK REDUCTION ACT ANALYSISA. BackgroundCertain provisions of the proposed amendments to Rule 12h-171 contain "collection of information" requirements within the meaning of the Paperwork Reduction Act of 1995 ("PRA").72 We are submitting these to the Office of Management and Page 35 Budget ("OMB") for review and approval in accordance with the PRA.73 An agency may not conduct or sponsor, and a person is not required to respond to, a collection of information unless it displays a currently valid OMB control number. The title for this information is: Exchange Act Rule 12h-1. The hours and costs associated with preparation of notices, maintaining Internet sites, and preparation of information to be disclosed to optionholders and holders of shares received on exercise of compensatory employee stock options for private, non-reporting issuers relying on the proposed exemption from Exchange Act Section 12(g)74 registration constitute cost burdens imposed by the collection of information. The proposed exemption available to reporting issuers would not constitute new collections of information. The proposed amendments would not affect existing collections of information. The proposed exemptions from Exchange Act Section 12(g) registration would be adopted pursuant to the Exchange Act. The information collection requirements related to the proposed exemption for private, non-reporting issuers would be a condition to reliance on the exemption. There is no mandatory retention period for the information disclosed and the information disclosed is not required to be filed with the Commission. B. Summary of Collection of InformationOur proposed amendments to Exchange Act Rule 12h-1 would provide an exemption for private, non-reporting issuers from Exchange Act Section 12(g) Page 36 registration for compensatory employee stock options issued under employee stock option plans. The proposed amendments also would provide an exemption from Exchange Act Section 12(g) registration for compensatory employee stock options of issuers that have registered under Exchange Act Section 12 the class of equity security underlying those options. The proposed requirements regarding notice of information availability, Internet availability of information, and, for certain issuers, the preparation of information related to the proposed exemption from Exchange Act Section 12(g) for compensatory employee stock options of private, non-reporting issuers would, if adopted, constitute a new collection of information under the Exchange Act. The proposed information provision in the proposed exemption for private, non-reporting issuers would not be a new collection of information for those private, non-reporting issuers that also are required to provide such information to optionholders pursuant to Securities Act Rule 70175 or that already prepare and provide such information to their shareholders. The collection of information would be required for those private, non-reporting issuers that rely on the proposed exemption because they had 500 or more optionholders and more than $10 million in assets at the end of their fiscal year. The issuers likely to use the proposed exemption would be those private, non-reporting issuers that had more than $10 million in assets and had used stock options to compensate employees, directors, consultants, and advisors on a broad basis. The proposed exemption from Section 12(g) registration for compensatory employee stock options of reporting issuers that have registered under Exchange Act Section 12(g) the class of equity security Page 37 underlying such options does not impose any new collection of information on these reporting issuers. C. Paperwork Reduction Act Burden EstimatesIf the proposed exemption for private, non-reporting issuers is adopted, we estimate that the annual burden for responding to the collection of information in the proposed exemption would not increase significantly for most private, non-reporting issuers, due to the current disclosure provisions of Securities Act Rule 701 and the probability that such issuers already prepare such information for other purposes. The costs may increase for those private, non-reporting issuers who are not relying on Securities Act Rule 701 when they grant compensatory employee stock options or who do not prepare the information for other purposes. The cost of providing such information may increase because of the requirement in the proposed exemption for private, non-reporting issuers to provide the required information. We seek comment on the number of private, non-reporting issuers that would rely on the proposed exemption that already prepare the information required by the proposed exemption for other purposes. Our estimates represent the burden for private, non-reporting issuers eligible to rely on the proposed exemption. Because the registration provisions of Section 12(g) apply only to an issuer with 500 or more holders of record of a class of equity security and assets in excess of $10 million at the end of its most recently ended fiscal year, only those private, non-reporting issuers satisfying those thresholds would be subject to the collection of information. The Division of Corporation Finance has granted no-action relief from registration of compensatory employee stock options to 30 private, non- Page 38 reporting issuers during the period 1992 through 2006. If we assume that approximately 3 new private, non-reporting issuers would be relying on the proposed exemption each year and that a certain number of private, non-reporting issuers will no longer be relying on the exemption because they have become reporting issuers, have been acquired, or have terminated business, we estimate that approximately 40 private, non-reporting issuers each year may be relying on the exemption. The proposed exemption for private, non-reporting issuers would terminate once such issuer became subject to the reporting requirements of the Exchange Act. Thus, the number of private, non-reporting issuers that may rely on the proposed exemption may vary from year to year. For purposes of the PRA, we estimate the annual paperwork burden for private, non-reporting issuers desiring to rely on the proposed exemption and to comply with our proposed collection of information requirements to be approximately 20 hours of in-house issuer personnel time and to be approximately $24,000 for the services of outside professionals.76 These estimates include the time and the cost of preparing and reviewing the information and making the information available to optionholders and holders of shares received on exercise of the options. We assume that the same number of private, non-reporting issuers would rely on the proposed exemption each year. We estimate that 25% of the burden of preparation and provision of the information required by the proposed exemption is carried by the issuer internally and that 75% of the burden is carried by outside professionals retained by the issuer at an Page 39 average cost of $400 per hour.77 The portion of the burden carried by outside professionals is reflected as a cost, while the portion of the burden carried by the issuer internally is reflected in hours. We request comment and supporting empirical data on the number of private, non-reporting issuers that would rely on the proposed exemption and the burden and cost of preparing and providing the information required by the proposed exemption. D. Request for CommentWe request comment in order to evaluate the accuracy of our estimate of the burden of the collections of information.78 Any member of the public may direct to us any comments concerning the accuracy of these burden estimates. Persons who desire to submit comments on the collection of information requirements should direct their comments to the OMB, Attention: Desk Officer for the Securities and Exchange Commission, Office of Information and Regulatory Affairs, Washington DC 20503, and should send a copy of the comments to Nancy M. Morris, Secretary, Securities and Exchange Commission, 100 F Street NE, Washington DC 20549-1090, with reference to File No. S7-14-07. Requests for materials submitted to the OMB by us with regard to this collection of information should be in writing, refer to File No. S7-14-07, and be submitted to the Securities and Exchange Commission, Office of Filings and Information Services, Branch of Records Management, 6432 General Green Way, Alexandria, VA 22312. Because the OMB is required to make a decision concerning the collections of Page 40 information between 30 and 60 days after publication, your comments are best assured of having their full effect if the OMB receives them within 30 days of publication. IV. COST-BENEFIT ANALYSISA. BackgroundCompensatory stock options provide a method to use non-cash compensation to attract, retain, and motivate issuer employees, directors and consultants. Since the 1990s, a number of private, non-reporting issuers have granted compensatory employee stock options to 500 or more employees, directors, and consultants. Compensatory employee stock options also are used routinely by issuers required to report under the Exchange Act. Stock options, including stock options issued to employees under stock option plans, are a separate class of equity security for purposes of the Exchange Act. Under Section 12(g) of the Exchange Act, an issuer with 500 or more holders of record of a class of equity security and assets in excess of $10 million at the end of its most recently ended fiscal year must register that class of equity security, unless there is an available exemption from registration. While there is an exemption from Exchange Act Section 12(g) registration for interests and participations in certain other types of employee compensation plans involving securities, currently there is no exemption for compensatory employee stock options. B. Summary of Proposed AmendmentsWe are proposing two exemptions from the registration provisions of Exchange Act Section 12(g) for compensatory employee stock options issued under employee stock Page 41 option plans that are limited to employees, directors, consultants, and advisors of the issuer. One proposed amendment to Rule 12h-1 would provide an exemption from Exchange Act Section 12(g) registration for compensatory employee stock options of an issuer that does not have a class of securities registered under Section 12 and is not subject to the reporting requirements of Exchange Act Section 15(d), where the following conditions are present:
The second proposed amendment to Exchange Act Rule 12h-1 would provide an exemption for compensatory employee stock options of issuers that are required to file reports under the Exchange Act because they have registered under Exchange Act Section 12 the class of equity security underlying those options. 1. Expected Benefits Benefits of the proposed exemption for private, non-reporting issuers are likely to include the following: (1) lower costs to, and reduced uncertainty for, private, non-reporting issuers desiring relief from registration under Section 12(g) for compensatory employee stock options issued to employees, directors, consultants, and advisors for compensatory purposes; (2) benefits to private, non-reporting issuers in designing and Page 42 implementing employee stock option plans without regard to concerns arising from Exchange Section 12(g) registration of the compensatory employee stock options; (3) benefits to private, non-reporting issuers arising from the use of electronic or Internet-based methods of providing the information necessary to satisfy the information requirement of the proposed exemption; and (4) benefits to optionholders and holders of shares received on exercise of options of private, non-reporting issuers arising from the required provision of information under the proposed exemption. Private, non-reporting issuers would benefit from cost savings as a result of the proposed exemption from Section 12(g) registration of their compensatory employee stock options. A number of private, non-reporting issuers that have 500 or more optionholders and assets in excess of $10 million have hired attorneys and requested no-action relief from the Division of Corporation Finance with regard to the registration of the options. The conditions to no-action relief from the Division include information provision conditions that are more extensive than in the proposed exemption. The proposed exemption, which would be self-executing if the provisions of the exemption were satisfied, would reduce the legal and other costs to a private, non-reporting issuer arising from the no-action request and relief. Such cost savings include reduced legal and accounting fees arising from both the request for no-action relief and for preparation of reports equivalent to Exchange Act reports of a reporting issuer on an ongoing basis. Because we expect that a number of the issuers that may take advantage of the proposed exemption may be smaller issuers, these cost savings could be significant relative to revenues. Page 43 The proposed amendments would require the same information that the issuer otherwise would be required to provide if securities sold in reliance on Securities Act Rule 701 exceeded $5 million during any consecutive 12-month period. Thus, for private, non-reporting issuers with a significant number of optionholders (and with more than $10 million in assets at the end of its fiscal year), it is likely that such issuer either already is obligated to provide the same information to optionholders due to sales of securities in reliance on Securities Act Rule 701, or already prepares and, as such, provides such information to its shareholders. Further, any private, non-reporting issuer that has received no-action relief regarding registration of its compensatory employee stock options will face reduced disclosure costs under the proposed exemption. The proposed amendment also would benefit private, non-reporting issuers by providing the less expensive alternative of electronic or Internet-based methods of providing the information necessary to satisfy the information requirement of the proposed exemption. Private, non-reporting issuers also would benefit from the certainty that the proposed exemption would provide in designing and implementing compensation programs and employee stock option plans. The proposed amendments would identify the eligibility provisions and transfer restrictions that would need to be contained in compensatory stock option plans or agreements, thereby lessening the need for issuers, at the time that Section 12(g) registration relief is needed for the compensatory employee stock options, to amend their stock option plans and outstanding options to include provisions that would be necessary to obtain no-action relief. The proposed exemption would help private, non-reporting issuers avoid becoming subject to the registration and Page 44 reporting requirements of the Exchange Act prior to the time they have public shareholders. Optionholders and holders of shares received on exercise of options also would benefit from the proposed exemption. The proposed exemption assures the provision of the information, including financial information that is not more than 180 days old, to optionholders and holders of shares received on exercise of options. Employees, directors, consultants, and advisors would benefit from the proposed exemption because private, non-reporting issuers would be able to use options for compensatory purposes without concern that the option grants would subject the issuer to Exchange Act registration. The proposed exemption for reporting issuers also would benefit optionholders and holders of shares received on exercise of options. Optionholders and holders of shares received on exercise of options would have access to the issuers publicly filed Exchange Act reports. Further, certain provisions of Sections 13, 14, and 16 would apply to the options and the securities issuable on exercise of the options. Holders of shares issued on exercise of those options would have the same rights as other shareholders of the issuer. Thus, the proposed exemption eliminates a possible disincentive for issuers to use certain compensatory employee stock options. This may be a benefit if this type of compensation is useful in attracting and retaining qualified employees that increase the issuers competitiveness. 2. Expected Costs Issuers would be required to satisfy the provisions of the proposed amendments, if adopted, to avoid registering under Section 12(g) their compensatory employee stock Page 45 options if the registration thresholds are met at the end of the issuers fiscal year. Private, non-reporting issuers may incur certain costs to rely on the proposed exemption including (1) costs to amend their existing employee stock option plans if the plans and option grants do not contain the restrictive and information provisions of the proposed exemption; (2) costs arising from preparing and providing the information required by the proposed exemption to the extent that the issuer does not already prepare or provide such information for other purposes; and (3) costs of maintaining an Internet site on which the information may be available if the issuer chooses to use that method to provide the required information to optionholders and holders of shares received on exercise of options. We believe that the provisions of the proposed exemption are consistent in many respects with the restrictive provisions of other laws and rules governing option grants and, thus, the costs to private, non-reporting issuers should not be increased. The proposed exemption provisions also are consistent with or are more flexible than the existing conditions for obtaining no-action relief from the Division of Corporation Finance. Therefore, the costs to private, non-reporting issuers to prepare the information required by the proposed exemption may be the same or less than the current costs to the issuer relying on registration relief provided in a no-action letter issued by the Division of Corporation Finance. Those private, non-reporting issuers who do not already prepare the required information will face costs if they desire to avail themselves of the proposed exemption. In addition to the costs discussed in the Paperwork Reduction Act Analysis,79 as Page 46 described below, issuers may face costs in maintaining the confidentiality of the information required to be provided, including preparation and enforcement of confidentiality agreements entered into with optionholders and holders of shares received on exercise of options. It should be noted, however, that these increased costs would be borne voluntarily, as it is within the issuers control as to the number of optionholders it may have. Issuers would be able to perform their own cost-benefit analysis to determine whether to comply with the conditions to the exemption or avoid issuing options to 500 or more optionholders. Private, non-reporting issuers may incur costs in providing the information required under the exemption. These costs may include printing and sending the information or making the information available on an Internet site. We request comment on the magnitude of these potential costs and whether there are any other additional potential costs. The Division of Corporation Finance has granted no-action relief from registration of compensatory employee stock options to 30 private, non-reporting issuers during the period 1992 through 2006. If we assume that approximately 3 new private, non-reporting issuers would be relying on the proposed exemption each year and that a certain number of private, non-reporting issuers will no longer be relying on the exemption because they have become reporting issuers, have been acquired, or have terminated business, we estimate that approximately 40 private, non-reporting issuers each year may be relying on the exemption. The proposed exemption for private, non-reporting issuers would terminate once such issuer became subject to the reporting Page 47 requirements of the Exchange Act. Thus, the number of private, non-reporting issuers that may rely on the proposed exemption may vary from year to year. For purposes of the Paperwork Reduction Act, the Commission staff has estimated that the annual paperwork burden for private, non-reporting issuers desiring to rely on the proposed exemption and to comply with our proposed collection of information requirements to be approximately 20 hours of in-house issuer personnel time, which is equivalent to $3,500, and to be approximately $24,000 for the services of outside professionals, for a total paperwork burden cost of $27,500.80 These estimates include the time and the cost of preparing and reviewing the information and making the information available to optionholders and holders of shares received on exercise of the options. The Commission staff assumed that the same number of private, non-reporting issuers would rely on the proposed exemption each year. The Commission staff estimated that 25% of the burden of preparation and provision of the information required by the proposed exemption would be carried by the private, non-reporting issuer internally and that 75% of the burden would be carried by outside professionals retained by the private, non-reporting issuer at an average cost of $400 per hour.81 Although a private, non-reporting issuer relying on the proposed exemption would benefit from cost savings associated with not having to register the compensatory employee stock options as a separate class of equity security under the Exchange Act, or Page 48 obtaining no-action relief, by not doing so, an optionholder or holder of shares received on exercise of an option would not have the benefit of the disclosures contained in Exchange Act reports that the issuer otherwise would be obligated to file with us, including audited financial statements, or the disclosures required to be provided under the terms of the no-action relief. Optionholders and holders of shares received on exercise of options also would not be able to freely sell their options or shares received on exercise of such options while the private, non-reporting issuer is relying on the proposed exemption. Optionholders and holders of shares received on exercise of such options would not be able realize value from the options or shares until after the private, non-reporting issuer becomes subject to the reporting requirements of the Exchange Act. Many private, non-reporting issuers that grant options, however, currently restrict the transfer of securities held by holders of shares received on exercise of options, in most cases until after the issuer becomes subject to the reporting requirements of the Exchange Act or unless the issuer is acquired by another entity. In some cases, private, non-reporting issuers retain the right to repurchase options or shares received on exercise of an option. Any exercise of such repurchase right by the issuer would be a cost to such issuer. Request for Comment We request comment on the costs and benefits to optionholders, holders of shares received on exercise of compensatory employee stock options, private, non-reporting issuers, reporting issuers, and others who may be affected by the proposed exemptions in Rule 12h-1. We request your views on the costs and benefits described above as well as on any other costs and benefits that could result from adoption of the proposed Page 49 exemptions. We also request data to quantify the costs and value of the benefits identified. V. CONSIDERATION OF IMPACT ON THE ECONOMY, BURDEN ON COMPETITION AND PROMOTION OF EFFICIENCY, COMPETITION AND CAPITAL FORMATION ANALYSISSection 23(a)(2)82 of the Exchange Act requires us, when adopting rules under the Exchange Act, to consider the impact that any new rule would have on competition. In addition, Section 23(a)(2) prohibits us from adopting any rule that would impose a burden on competition not necessary or appropriate in furtherance of the purposes of the Exchange Act. We are proposing an exemption for private, non-reporting issuers from Exchange Act Section 12(g) registration for compensatory employee stock options issued under employee stock option plans. We also are proposing an exemption from Exchange Act Section 12(g) registration for compensatory employee stock options of issuers that have registered under Exchange Act Section 12 the class of equity security underlying those options. We expect that the proposed exemption for private, non-reporting issuers from Exchange Act registration of compensatory employee stock options will provide necessary certainty to those issuers in their compensation decisions and will help them avoid becoming subject to the registration and reporting requirements of the Exchange Act prior to the time they have public shareholders. We anticipate that the exemption would save such private, non-reporting issuers significant costs and would not require that their confidential issuer information become public prior to the issuer voluntarily determining to become a public reporting issuer. Further, we anticipate that the proposed Page 50 exemption would continue to provide private, non-reporting issuers freedom to determine appropriate methods of compensating their employees, directors, consultants, and advisors without concern that they would be required to register their compensatory employee stock options as a class of equity security under Exchange Act Section 12. Thus, the proposed exemption eliminates a possible disincentive for issuers to use certain compensatory employee stock options. This may be a benefit if this type of compensation is useful in attracting and retaining qualified employees that increase the private, non-reporting issuers competitiveness. The proposed exemption for reporting issuers will provide certainty regarding the obligations of issuers that already have registered under the Exchange Act the securities underlying compensatory employee stock options to register those options under the Exchange Act. In addition, in the case of these reporting issuers, the optionholders would have access to the issuers publicly filed Exchange Act reports and the appropriate provisions of Sections 13, 14, and 16 would apply to the compensatory employee stock options and the equity securities issuable on exercise of those options. Section 3(f)83 of the Exchange Act requires us, when engaging in rulemaking that requires us to consider or determine whether an action is necessary or appropriate in the public interest, to consider, in addition to the protection of investors, whether the action will promote efficiency, competition, and capital formation. We anticipate that the proposed amendments, if adopted, would allow private, non-reporting issuers to continue to maintain the confidentiality of information regarding their business and operations through the use of confidentiality agreements with Page 51 optionholders and holders of shares received on exercise of the options. For issuers that are voluntarily reporting under the Exchange Act or those reporting issuers that are subject to Exchange Act reporting under Section 15(d), the proposed exemption from Section 12(g) for compensatory employee stock options would be unavailable and such issuers would be required to register under Exchange Act Section 12 the class of equity security underlying the options in order to take advantage of the proposed exemption. We believe that the proposed exemption from Exchange Act registration for the compensatory stock options may beneficially affect the issuers ability to compete for employees because it will allow such issuers to continue to use employee stock options in their compensation programs, thus enabling them to compete for such employees with both private, non-reporting issuers and public reporting issuers. The proposed exemption also will provide an eligible issuer a more efficient, self-executing exemption from Exchange Act Section 12(g) registration of compensatory employee stock options, instead of such issuer having to seek no-action relief. The proposed exemptions do not relate to or affect capital formation, as the compensatory employee stock options covered by the proposed exemptions are issued for compensatory and not capital raising purposes. The proposed exemptions would allow eligible issuers to continue to have freedom to determine appropriate methods of compensating their employees, directors, consultants, and advisors. For private, non-reporting issuers, these compensation decisions could be made without concern that the issuer would become subject to the Exchange Act reporting requirements before they had public shareholders. Request for Comment Page 52 We request comment on whether the proposed rule would impose a burden on competition or whether it would promote efficiency, competition, and capital formation. Commenters are requested to provide empirical data and other factual support for their views if possible. VI. INITIAL REGULATORY FLEXIBILITY ANALYSISThis Initial Regulatory Flexibility Analysis has been prepared in accordance with 5 U.S.C. 603. It relates to proposed amendments to Rule 12h-1 that would provide two exemptions from the registration provisions of Exchange Act Section 12(g) for compensatory employee stock options issued under employee stock option plans that are limited to employees, directors, consultants, and advisors of the issuer, its parents, and the majority-owned subsidiaries of the issuer or its parents. A. Reasons for the Proposed ActionCompensatory stock options provide a method to use non-cash compensation to attract, retain, and motivate issuer employees, directors and consultants. Since the 1990s, a number of private, non-reporting issuers have granted compensatory employee stock options to 500 or more employees, directors, and consultants. Compensatory employee stock options routinely are used by issuers required to report under the Exchange Act as well. Stock options, including stock options issued to employees under stock option plans, are a separate class of equity security for purposes of the Exchange Act. Under Section 12(g) of the Exchange Act, an issuer with 500 or more holders of record of a class of equity security and assets in excess of $10 million at the end of its most recently ended fiscal year must register that class of equity security, unless there is an available Page 53 exemption from registration. While there is an exemption from Section 12(g) registration for interests and participations in certain other types of employee compensation plans involving securities, currently there is no exemption for compensatory employee stock options. B. ObjectivesThe primary objective of the proposed amendments is to provide two exemptions from Exchange Act Section 12(g) registration for compensatory employee stock options. One proposed exemption would be for compensatory employee stock options of issuers that do not have a class of securities registered under Section 12 and are not subject to the reporting requirements of Exchange Act Section 15(d). The second proposed exemption would be for compensatory employee stock options of issuers that are required to file reports under the Exchange Act because they have registered under Exchange Act Section 12 the class of equity security underlying those options. Codifying an exemption from registration for compensatory employee stock options will provide necessary certainty to issuers in their compensation decisions and will help private non-reporting issuers avoid becoming subject to the registration and reporting requirements of the Exchange Act prior to the time they have public shareholders. For reporting issuers that have registered under Section 12 the class of security underlying the compensatory employee stock options, we believe the proposed exemption of compensatory employee stock options from Exchange Act registration is appropriate because the optionholders would have access to the issuers publicly filed Exchange Act reports and the appropriate provisions of Sections 13, 14, and 16 would apply to the compensatory employee stock options and the equity securities issuable on Page 54 exercise of those options. The proposed exemptions would allow private, non-reporting issuers, as well as reporting issuers, to continue to reward and retain employees with the issuers securities. C. Legal BasisWe are proposing the amendments to Rule 12h-1 under the authority set forth in Sections 12,84 23,85 and 3686 of the Securities Exchange Act of 1934, as amended. D. Small Entities Subject to the Proposed RulesThe proposed exemptions would not affect issuers that are small entities. Exchange Act Rule 0-10(a)87 defines an issuer to be a "small business" or "small organization" for purposes of the Regulatory Flexibility Act if it had total assets of $5 million or less on the last day of its most recent fiscal year. The registration requirements of Section 12(g) arise only if an issuer has more than $10 million in assets and has 500 or more holders of a class of equity security at the end of its most recently ended fiscal year. Small entities do not satisfy the asset threshold of Section 12(g) and therefore the proposed exemptions would not be needed by such entities until their asset size increased to more than $10 million at the end of a fiscal year. Because the registration requirements of Section 12(g) are not implicated unless an entity has assets in excess of $10 million at the end of a fiscal year, we conclude that there are not a large number of small entities that may be impacted. We request comment on this conclusion, including any available empirical data. Page 55 E. Reporting, Recordkeeping and Other Compliance RequirementsThe proposed exemptions would not affect small entities. The proposed amendments would require the same information that the issuer otherwise would be required to provide if securities sold in reliance on Securities Act Rule 701 exceeded $5 million during any consecutive 12-month period. Thus, for private, non-reporting issuers with a significant number of optionholders (and with more than $10 million in assets at the end of its fiscal year), it is likely that such issuer either already is obligated to provide the same information to optionholders due to sales of securities in reliance on Securities Act Rule 701 or already prepares and provides such information to its shareholders. F. Duplicative, Overlapping or Conflicting Federal RulesWe believe that there are no rules that conflict with or duplicate the proposed amendments to Exchange Act Rule 12h-1. G. Significant AlternativesThe Regulatory Flexibility Act directs us to consider significant alternatives that would accomplish the stated objective, while minimizing any significant adverse impact on small entities. Insofar as the amendments only apply to entities that are subject to Section 12(g) registration with regard to a class of equity security and, therefore, do not apply to small entities, we did not consider any alternatives to the proposed amendments specifically with respect to small entities. In connection with the proposed exemptions, we considered alternatives related to the scope of issuers eligible for the exemption, the information required to be provided, and transfer restrictions on the options and shares issuable on exercise of the options. Page 56 We encourage the submission of comments with respect to any aspect of this Initial Regulatory Flexibility Analysis. Commenters are asked to describe the nature of any impact and provide empirical data supporting the extent of any impact on small entities. Such comments will be considered in the preparation of the Final Regulatory Flexibility Analysis, if the proposed amendments are adopted, and will be placed in the same public file as comments on the proposed amendments. VII. SMALL BUSINESS REGULATORY ENFORCEMENT FAIRNESS ACTFor purposes of the Small Business Regulatory Enforcement Fairness Act of 199688 ("SBREFA"), a rule is "major" if it has resulted, or is likely to result in:
We request comment on whether our proposed exemptions would be a "major rule" for purposes of SBREFA. We solicit comment and empirical data on:
VIII. STATUTORY BASIS AND TEXT OF PROPOSED RULE AMENDMENTSWe are proposing to amend Exchange Act Rule 12h-1 under the authority in Sections 12, 23, and 36 of the Securities Exchange Act of 1934, as amended. Page 57 17 CFR Part 240 Reporting and recordkeeping requirements, Securities. TEXT OF PROPOSED RULE For the reasons set out in the preamble, we propose to amend Title 17, Chapter II of the Code of Federal Regulations as follows: PART 240 - GENERAL RULES AND REGULATIONS, SECURITIES 1. The authority citation for Part 240 continues to read in part as follows: Authority: 15 U.S.C. 77c, 77d, 77g, 77j, 77s, 77z-2, 77z-3, 77eee, 77ggg, 77nnn, 77sss, 77ttt, 78c, 78d, 78e, 78f, 78g, 78i, 78j, 78j-1, 78k, 78k-1, 78l, 78m, 78n, 78o, 78p, 78q, 78s, 78u-5, 78w, 78x, 78ll, 78mm, 80a-20, 80a-23, 80a-29, 80a-37, 80b-3, 80b-4, 80b-11, and 7201 et seq.; and 18 U.S.C. 1350, unless otherwise noted. 2. Amend 240.12h-1 to add paragraphs (f) and (g) to read as follows: 240.12h-1 Exemptions from registration under section 12(g) of the Act * * * * * (f)(1) Stock options issued under written compensatory stock option plans of an issuer under the following conditions: (i) The issuer of the stock options does not have a class of security registered under section 12 of the Act and is not required to file reports pursuant to section 15(d) of the Act; Page 58 Note to paragraph (f)(1)(ii): All stock options issued under all of the issuers written compensatory stock option plans on the same class of equity security will be considered part of the same class of equity security for purposes of the provisions of this section. (iii) The stock options are held only by those persons described in Rule 701(c) under the Securities Act (17 CFR 230.701(c)); (iv) The stock options and the shares issuable upon exercise of such stock options are restricted as to transfer by the optionholder or holder of the shares received on exercise of the option other than to persons who are family members (as defined in Rule 701(c)(3) under the Securities Act (17 CFR 230.701(c)(3)) through gifts or domestic relations orders, or to an executor or guardian of the optionholder or holder of shares received on exercise of such stock option upon the death or disability of the optionholder or holder of shares, until the issuer becomes subject to the reporting requirements of section 13 or 15(d) of the Act; provided that the optionholder or holder of shares may transfer the options or shares to the issuer (or its designated affiliate if the issuer is unable to repurchase the options or shares) if applicable law prohibits a restriction on transfer; Note to paragraph (f)(1)(iv): For purposes of this section, optionholders and holders of shares received on exercise of an option may include any permitted transferee under paragraph (f)(1)(iv) of this section; provided that such permitted transferees may not further transfer the stock options or shares issuable upon exercise of such stock options; Page 59 restricted as to any pledge, hypothecation, or other transfer, including any short position, any "put equivalent position" (as defined in 240.16a-1(h) of this chapter), or any "call equivalent position" (as defined in 240.16a-1(b) of this chapter) by the optionholder or holder of shares received on exercise of an option, except as permitted in paragraph (f)(1)(iv) of this section, until the issuer becomes subject to the reporting requirements of section 13 or 15(d) of the Act; (vi) There can be no market or available process or methodology that permits an optionholder or holder of shares received on exercise of an option to receive any consideration or compensation for the options, the shares issuable on exercise of the options, or shares of the same class of equity security as those underlying the options, except as permitted in paragraph (f)(1)(iv) of this section, until the issuer becomes subject to the reporting requirements of section 13 or 15(d) of the Act ; Note to paragraphs (f)(1)(iv), (f)(1)(v), and (f)(1)(vi): The transferability restrictions in paragraphs (f)(1)(iv), (f)(1)(v), and (f)(1)(vi) of this section must be contained in either the written compensatory stock option plan, individual written compensatory stock option agreement, or other stock purchase or stockholder agreement to which the issuer and the optionholder or holder of shares are a signatory or party, or in the issuers by-laws, certificate of incorporation; and Page 60 (A) The information described in Rules 701(e)(3), (4), and (5) under the Securities Act (17 CFR 230.701(e)(3), (4), and (5)), with such information provided either by physical or electronic delivery to the optionholders and holders of shares received on exercise of an option or by written notice to the optionholders and holders of shares received on exercise of an option of the availability of the information on a password-protected Internet site and of any password needed to access the information; and (B) Access to the issuers books and records, including corporate governance documents, to the same extent that they are available to other shareholders of the issuer. Note to paragraph (f)(1)(vii): The issuer may request that the optionholder or holder of shares received on exercise of an option agree to keep the information to be provided pursuant to this section confidential. If an optionholder or holder of shares received on exercise of an option does not agree to keep the information to be provided pursuant to this section confidential, then the issuer is not required to provide the information; provided, that the issuer must then allow the optionholder or holder of shares received on exercise of an option to inspect the information and documents at one of the issuers offices that is at or near where the optionholder or holder of shares received on exercise of an option is or was employed or retained by the issuer. Page 61 (g) (1) Stock options issued under written compensatory stock option plans of an issuer under the following conditions: (i) The issuer of the stock options has registered the class of equity security issuable on exercise of the options under section 12 of the Act; (ii) The stock options have been issued by the issuer pursuant to one or more written compensatory stock option plans established by the issuer, its parents, its majority-owned subsidiaries or majority-owned subsidiaries of the issuers parents; Note to paragraph (g)(1)(ii): All stock options issued under all of the issuers written compensatory stock option plans on the same class of equity security will be considered part of the same class of equity security for purposes of the provisions of this section; and (iii) The stock options are held only by those persons described in Rule 701(c) under the Securities Act (17 CFR 230.701(c)). (2) If the exemption provided by paragraph (g)(1) of this section ceases to be available, the issuer of the compensatory stock options that is relying on the exemption provided by this section must file a registration statement to register the class of options or the class of equity security issuable on exercise of the options under section 12 of the Act within 60 calendar days after the conditions in paragraph (g)(1) of this section are no longer satisfied. By the Commission. Nancy M. Morris Page 62 2 15 U.S.C. 78a et. seq. 3 Throughout this release, we use the term "compensatory employee stock options" to refer to stock options issued to employees, directors, consultants, and advisors (to the extent permitted under Securities Act Rule 701 [17 CFR 230.701]). 4 The National Center for Employee Ownership surveyed 275 venture capital-backed private businesses in the technology and telecommunications businesses. Of these firms, 77% provided options to all employees while 23% provided them to only select employees. "New Data Show Venture-Backed Companies Still Issue Options Broadly," http://www.nceo.org/library/option_venturebacked.html; See also J. Hand, 2005 "Give Everyone a Prize? Employee Stock Options in Private Venture-Backed Firms," Working Paper, Kenan-Flagler Business School, UNC Chapel Hill, available at http://ssrn.com/abstracts=599904 ("Hand Paper") (study investigating the impacts on the equity values of private venture-backed firms of the organizational depth to which they grant employee stock options). Rule 701, which provides an exemption from Securities Act registration for non-reporting issuers for offerings of securities to employees, directors, consultants and advisors, and specified others, pursuant to written compensatory benefit plans or agreements, has given private issuers great flexibility in granting compensatory employee stock options to employees (and other eligible persons) at all levels. See Rule 701(d) [17 CFR 230.701(d)]; Rule 701 Exempt Offerings Pursuant to Compensatory Arrangementss, Release No. 33-7645, 64 FR 11095 (March 8, 1999) ("Rule 701 Release"); See also Compensatory Benefit Plans and Contracts, Release No. 33-6768, 53 FR 12918 (April 14, 1988). 5 See Hand Paper, note 4 supra. 6 See e.g., no-action le |
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