As mandated by the JOBS Act, the SEC has issued proposed amendments to revise the rules related to the thresholds for registration, termination of registration, and suspension of reporting under Section 12(g) of the Exchange Act.

Overview

The proposal would implement the mandate of the JOBS Act by:

  • Amending Exchange Act Rules 12g-1 through 4 and 12h-3 which govern the procedures relating to registration, termination of registration under Section 12(g), and suspension of reporting obligations under Section 15(d) to reflect the new thresholds established by the JOBS Act
  • Revising the rules so that savings and loan holding companies are treated in a similar manner to banks and bank holding companies for the purposes of registration, termination of registration, or suspension of their Exchange Act reporting obligations
  • Applying the definition of “accredited investor” in Securities Act Rule 501(a) to determinations as to which record holders are accredited investors for purposes of Exchange Act Section 12(g)(1).  The accredited investor determination would be made as of the last day of the fiscal year.

The proposal also would amend the definition of “held of record” to provide that when determining whether an issuer is required to register a class of equity securities with the SEC under Exchange Act Section 12(g)(1), an issuer may exclude securities:

  • Held by persons who received them under an employee compensation plan in transactions exempt from the registration requirements of Section 5 of the Securities Act or that did not involve a sale within the meaning of Section 2(a)(3) of the Securities Act
  • In certain circumstances, held by persons who received them in exchange for securities received under an employee compensation plan

The SEC also is proposing a non-exclusive safe harbor under which a person will be deemed to have received the securities under an employee compensation plan if the person received them under a compensatory benefit plan in transactions that met the conditions of Securities Act Rule 701(c).

The JOBS Act revised Exchange Act Section 12(g) to raise the threshold at which an issuer is required to register a class of equity securities.  Under the revised threshold, an issuer that is not a bank or bank holding company is required to register a class of equity securities under the Exchange Act if it has more than $10 million of total assets and the securities are “held of record” by either 2,000 persons, or 500 persons who are not accredited investors.  An issuer that is a bank or bank holding company is required to register a class of equity securities if it has more than $10 million of total assets and the securities are “held of record” by 2,000 or more persons.

In addition, the JOBS Act raised the threshold at which a bank or a bank holding company may terminate or suspend the registration of a class of securities under the Exchange Act from 300 to 1,200 persons.

Accredited Investors

As noted, an issuer that is not a bank or bank holding company is required to register a class of equity securities under the Exchange Act if it has more than $10 million of total assets and the securities are “held of record” by either 2,000 persons, or 500 persons who are not accredited investors.  Under the proposed rule “accredited investor” is defined by reference to Securities Act Rule 501(a), the familiar definition used for Regulation D offerings.

The SEC recognizes that issuers may have difficulty determining whether existing security holders are accredited investors for purposes of the threshold in Section 12(g)(1) and that providing a safe harbor or other guidance could help to mitigate costs for issuers seeking to determine accredited investor status.  However, in the release, the SEC rejected a blanket safe harbor where issuers could rely on information gathered during a securities offering. The SEC believes such reliance could result in the use of outdated information that may no longer be reliable.  The practice may be permissible if an issuer can determine, based on facts and circumstances, if it can rely upon prior information to form a reasonable basis for believing that the security holder continues to be an accredited investor as of the last day of the fiscal year.

The SEC noted that without guidance from the Commission, when making the determination at fiscal year-end of whether a security holder is an accredited investor for purposes of Exchange Act Section 12(g)(1), issuers would likely use procedures similar to those used when relying on Rule 506.  A footnote then states “The procedures used in a Rule 506 offering may vary depending on a number of factors, including the nature of the purchaser and whether the offering is pursuant to Rule 506(b) or Rule 506(c). Rule 506(c) requires an issuer to take reasonable steps to verify that purchasers of securities sold in such offering are accredited investors. As we previously recognized when we adopted Rule 506(c), “issuers may have to apply a stricter and more costly process to determine accredited investor status than what they currently use.””

Given the difference in making the determination under the Securities Act, which is in the context of an investment decision, and under the Exchange Act, which is for the purpose of determining registration obligations, the SEC is considering whether a different approach than that used under Rule 506 would be appropriate for determining Exchange Act registration obligations.  The release then goes on to solicit comment on how a safe harbor could be established and whether it would be desirable.

Employee Compensation Plans

Exchange Act Section 12(g)(5), as amended by Section 502 of the JOBS Act, provides that the definition of “held of record” shall not include securities held by persons who received them pursuant to an “employee compensation plan” in transactions exempted from the registration requirements of Section 5 of the Securities Act.  By its express terms, this new statutory exclusion applies solely for purposes of determining whether an issuer is required to register a class of equity securities under the Exchange Act.   It does not apply to a determination of whether such registration may be terminated or suspended.

Section 503 of the JOBS Act instructs the SEC to amend the definition of “held of record” to implement the amendment in Section 502 and to adopt a safe harbor that issuers can use when determining whether holders of their securities received them pursuant to an employee compensation plan in exempt transactions.  Instead of creating a new definition for the term “employee compensation plan,” the SEC is proposing to revise the definition of “held of record.” Separately, the proposed rules establish a non-exclusive safe harbor that relies on the current definition of “compensatory benefit plan” in Rule 701 and the conditions in Rule 701(c).

The General Rule

The SEC is proposing to amend the definition of “held of record” to provide that when determining whether an issuer is required to register a class of equity securities with the SEC pursuant to Exchange Act Section 12(g)(1) an issuer may exclude securities that are either:

  • held by persons who received the securities pursuant to an employee compensation plan in transactions exempt from the registration requirements of Section 5 of the Securities Act or that did not involve a sale within the meaning of Section 2(a)(3) of the Securities Act; or
  • held by persons eligible to receive securities from the issuer pursuant to Exchange Act Rule 701(c) who received the securities in a transaction exempt from the registration requirements of Section 5 of the Securities Act in exchange for securities excludable under proposed Rule 12g5-1(a)(7).

The SEC notes that the proposal goes beyond what is required by the JOBS Act.  Specifically a number of companies issue securities to employees without Securities Act registration on the basis that the issuance is not a sale under Section 2(a)(3) of the Securities Act and therefore do not trigger the registration requirement of Securities Act Section 5, which applies only to the offer and sale of securities. While securities issued to employees in transactions that do not involve a sale under Section 2(a)(3) are not technically “transactions exempted from the registration requirements of section 5,” they are similar to other compensatory issuances to employees in exempt transactions in that the issuer provides the awards to employees for a compensatory purpose. The SEC is therefore proposing to exclude such “no sale” issuances from the definition of “held of record” in Rule 12g5-1 for purposes of determining an issuer’s obligation to register a class of securities under the Exchange Act.

Another area goes beyond what is required by the JOBS Act — the proposed rule would also permit an issuer to exclude holders who are persons eligible to receive securities from the issuer pursuant to Rule 701(c) and who acquired the securities in exchange for securities excludable under the proposed definition.  The proposed exclusion is intended to facilitate the ability of an issuer to conduct restructurings, business combinations and similar transactions that are exempt from Securities Act registration.  If the securities being surrendered in such a transaction would not have been counted under the proposed definition of “held of record,” the securities issued in the exchange also would not be counted under this definition.  The securities issued in the exchange would be deemed to have a compensatory purpose because they would replace other securities previously issued pursuant to an employee compensation plan.

Non-Exclusive Safe Harbor

The SEC is proposing a non-exclusive safe harbor under proposed Rule 12g5-1(a)(7) that would provide that a person will be deemed to have received the securities pursuant to an employee compensation plan if such person received them pursuant to a compensatory benefit plan in transactions that met the conditions of Securities Act Rule 701(c).

An issuer would be able to rely on the safe harbor for determining the holders of securities issued in reliance on Securities Act Rule 701, as well as holders of securities issued in transactions otherwise exempted from, or not subject to, the registration requirements of the Securities Act that satisfy the conditions of Rule 701(c).  This applies even if all the other conditions of Rule 701, such as issuer eligibility in Rule 701(b)(1), the volume limitations in Rule 701(d) or the disclosure delivery provisions in Rule 701(e), were not met. Thus, the safe harbor would be available for holders of securities received in other employee compensation plan transactions exempted from, or not subject to, the registration requirements of Section 5 of the Securities Act, such as securities issued in reliance on Securities Act Section 4(a)(2), Regulation D of the Securities Act, or Regulation S of the Securities Act, that meet the conditions of Rule 701(c).

The safe harbor would be available for the plan participants enumerated in Rule 701(c), including employees, directors, general partners, trustees, officers and certain consultants and advisors.  The safe harbor also would be available for permitted family member transferees with respect to securities acquired by gift or domestic relations order, or securities acquired by them in connection with options transferred to them by the plan participant through gifts or domestic relations orders.

The safe harbor would be limited to holders who are persons specified in Rule 701(c) who received the securities under specified circumstances.  Once these persons subsequently transfer the securities, whether or not for value, the securities would need to be counted as held of record by the transferee for purposes of determining whether the issuer is subject to the registration and reporting requirements of Exchange Act Section 12(g)(1).