On December 18, 2014, the Securities and Exchange Commission (the “SEC”) proposed rules to implement the Jumpstart Our Business Startups Act (the “JOBS Act”) mandate to revise the thresholds for registration, termination of registration, and suspension of reporting under Section 12(g) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). These proposed rules enable privately-held companies to attract larger capital investments from more diverse investors and engage in successive capital raising activities before having to register under the Exchange Act. 

The proposed rules would:

  • amend 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;
  • revise 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; and
  • apply the definition of “accredited investor” in Rule 501(a) of the Securities Act of 1933, as amended (the “Securities Act”), 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 proposed rules also would amend the definition of “held of record” used in determining whether an issuer is required to register a class of equity securities under Exchange Act Section 12(g)(1) to permit the exclusion of certain securities held by persons who received them pursuant to an “employee compensation plan.” 

Finally, the proposed rules exclude from the count of “record holders” persons who acquired their stock solely through the issuer’s compensatory benefit plans in non-registered transactions, specifically including stock issued in transactions exempted under SEC Rule 701. 

See the full text of the SEC’s proposed rules (Release Nos. 33-9693 and 34-73876). 

Increased Thresholds for Registration and Reporting Obligations 

Generally, the SEC is proposing to amend the rules to reflect the new, higher thresholds for registration, termination of registration and suspension of reporting set forth in the JOBS Act. Additionally, the SEC is proposing rules to apply the same thresholds to savings and loan holding companies that apply to banks and bank holding companies. 

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. Prior to the enactment of the JOBS Act, Section 12(g) required an issuer to register a class of securities if, at the end of the issuer’s fiscal year, the securities were “held of record” by 500 or more persons and the issuer had $10 million in total assets. Furthermore, an issuer was able to terminate that registration if the number of record holders of that class fell below 300, or the number of record holders of that class fell below 500 and the issuer’s total assets were no more than $10 million at the end of each of its last three fiscal years. 

Under revised thresholds set forth in the JOBS Act, 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. The JOBS Act also 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. The SEC’s proposed rules implement the JOBS Act’s new, higher thresholds and provide that savings and loan holdings 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. 

While not mentioned in the SEC release, the SEC’s proposed Exchange Act Rule 12g-6 permanently exempts holders of securities issued in Federal crowdfunding exempt offerings from counting towards the holders of record threshold. The proposed Rule 12g-6 not only exempts the initial holder of the securities, but also any subsequent holders of the securities who acquired them in resale transactions. As a result, issuers will not need to restrict resales of crowdfunding offered securities out of a concern that subsequent holders will cause the issuer to exceed 500 holders of record who are not accredited investors. It is important to note that securities issued pursuant to state crowdfunding offering exemptions are not exempt from counting towards the holders of record threshold. 

Accredited Investor 

Under the proposed rules, an issuer that is not a bank, bank holding company or savings and loan holding company is required to register a class of equity securities if it has more than $10 million in total assets and its securities are “held of record” by either 2,000 persons, or 500 persons who are not accredited investors. The proposed rules define “accredited investor” by reference to Securities Act Rule 501(a), which is the “accredited investor” definition used in connection with Regulation D offerings. The proposed rules provide that the “accredited investor” determination would be made as of the last day of the fiscal year (Securities Act Rule 501(a) otherwise defines “accredited investor” as being determined at the time of the sale of securities). 

While the proposed rules define what constitutes an accredited investor for purposes of determining whether an issuer must register a class of equity securities, they do not provide any additional guidance for companies to use in confirming a shareholder’s status as an accredited investor. In the release, the SEC notes that issuers may have difficulty in determining whether existing security holders are accredited investors for purposes of the new thresholds 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, the SEC rejects a blanket safe harbor which would permit issuers to rely on information gathered during a securities offering. An issuer may be able to rely on prior information if it can determine, based on facts and circumstances, whether the prior information provides 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 also notes that without further guidance, 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. Given the difference in making an accredited investor determination under the Securities Act, which is in the context of an investment decision, and the Exchange Act, which is for the purposes of an issuer determining registration obligations, the SEC is considering whether a different approach than that used under Rule 506 would be appropriate for determining registration obligations. The release then goes on to solicit comments on the structure and desirability of a safe harbor or other guidance on how issuers may establish a reasonable belief that a security holder is an accredited investor. 

Employee Compensation Plans 

The JOBS Act also directed the SEC to revise the definition of “held of record” to exclude securities held by persons who received the securities under an “employee compensation plan” in transactions exempted from the registration requirements of Section 5 of the Securities Act and to create a safe harbor that issuers can follow when making that determination. By its terms, the new statutory exclusion applies solely for purposes of determining whether an issuer is required to register a class of securities under the Exchange Act. It does not apply to a determination of whether such registration may be terminated or suspended. 

The SEC’s proposed rules revise the definition of “held of record” to exclude securities that are either:

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

The proposed rules are intended by the SEC 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 transactions would not have been counted under the proposed definition of “held of record,” then the securities issued in exchange would also not be counted under the 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. 

The proposed rules also 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. The proposed rules rely on the current definition of “compensatory benefit plan” in Rule 701 and the conditions in Rule 701(c). 

Potential Implications 

The increased thresholds for requiring registration under the Exchange Act and the exclusions for certain issuances from the calculation of the number of holders of record for such purposes have the potential to impact private equity financings and compensation practices of privately-held companies. Privately-held companies may be to attract larger capital investments from more diverse investors or engage in successive capital raising activities before having to make a decision as to whether to register under the Exchange Act or to conduct an initial public offering. 

In addition, because of the ability of a privately-held company to further delay going public under the new holder of record thresholds, a more robust secondary market may develop for the equity securities of privately-held companies. Privately held-companies may also have an increased freedom to pursue compensation strategies involving the issuance of equity based awards without the concern that it may result in an inadvertent Exchange Act registration requirement. 

The special provisions relating to Exchange Act registration and deregistration of a class of equity securities issued by banks, bank holding companies and savings and loan holding companies provide greater flexibility for such entities to engage in additional private capital raising without the concerns of SEC registration. Small banks will be able to more easily raise capital, both privately and in public offerings exempt under Section 3(a)(2) of the Securities Act (i.e., shares issued by a bank), without being required to register under the Exchange Act. In addition, banks, bank holding companies and savings and loan holding companies may deregister even at a time when they have a significant shareholder base. 

Additional Information 

The SEC will seek public comment on the proposed rule amendments for 60 days following their publication in the Federal Register.