On June 23, the Staff of the Division of Corporation Finance (Staff) of the Securities and Exchange Commission released new Compliance and Disclosure Interpretations (C&DIs) relating to Rule 701 of the Securities Act of 1933, as amended, primarily in the context of a merger transaction. Rule 701 provides a safe harbor exemption for equity securities issued pursuant to employee benefit plans and contracts.

In the new C&DIs, the Staff provided the following guidance:

Rule 701

  • In a merger transaction, the acquirer does not need an exemption for the assumption of derivative securities (e.g., stock options) of the target where, by their terms, those derivative securities become derivative securities for an economically equivalent amount of acquirer securities, so long as at the time of the grant by the target, the compensatory benefit plan under which the derivative securities were issued permitted this assumption without the consent of the holders of the derivative securities. (C&DI 271.17)
  • The exercise or conversion of derivative securities assumed in a merger transaction would be eligible for exemption under Rule 701 if the target complied with Rule 701 at the time such assumed derivative securities were originally granted, subject, to the extent applicable, to compliance with Rule 701(e), which requires an issuer to provide specified information (including risk factors and financial information) in the case of sales of securities pursuant to Rule 701 exceeding $5 million in any 12-month period. (C&DI 271.18)

Rule 701(d)

  • Following the completion of a merger transaction, for purposes of determining the amount of securities that the acquirer may sell under Rule 701(d), which limits the amount of securities that may be sold under Rule 701 in any 12-month period to the greatest of (1) $1 million; (2) 15 percent of the issuer’s total assets; and (3) 15 percent of the outstanding amount of securities of the class being offered, the acquirer is required to include the aggregate sales price and amount of securities previously claimed to have been sold by the target under Rule 701 during the same 12-month period for which the acquirer is making its determination. (C&DI 271.19)
  • Following the completion of a merger transaction, in order to calculate compliance with Rule 701(d)(2), an acquirer may use for purposes of the total assets test (1) a pro forma balance sheet as of its most recent balance sheet date reflecting the merger transaction as of such date; or (2) a balance sheet date after the merger transaction that reflects the total assets and outstanding securities of the combined entity. (C&DI 271.20)

Rule 701(e)

  • If the target in a merger transaction was required to provide investors with disclosure pursuant to Rule 701(e) for its derivative securities with respect to such derivative securities that are then assumed by the acquirer and may be exercised or converted following the merger transaction, the acquirer would assume the target’s disclosure obligations and need to provide such information meeting the timing and other requirements of Rule 701(e), a reasonable period of time before the date of exercise or conversion. (C&DI 271.22)
  • Following the completion of a merger transaction, when determining whether the amount of securities sold by the acquirer during any consecutive 12-month period exceeds $5 million (and therefore triggers disclosure obligations pursuant to Rule 701(e)), the acquirer must include any securities that the target sold during such 12-month period. (C&DI 271.23)
  • Where an obligation to provide disclosure pursuant to Rule 701(e) is triggered, Rule 701(e)(4) requires an issuer to provide investors with the financial statements required to be furnished by Part F/S of Form 1-A within a reasonable time before the date of sale. When an issuer’s disclosure obligation under Rule 701(e) is triggered, the issuer may in any case elect to provide financial statements that follow the requirements of either Tier 1 or Tier 2 Regulation A offerings. (C&DI 271.21)

The complete text of all C&DIs can be found here.