On May 3, the SEC adopted changes to Exchange Act rules dictated by the Jumpstart Our Business Startups Act (JOBS Act) and the Fixing America’s Surface Transportation Act (FAST Act). The amendments conform the rules to statutory provisions that increased the asset and holder-of-record thresholds that obligate an issuer to register a class of equity securities under the Exchange Act and file reports with the SEC, and then, following registration, permit it to terminate the registration and exit the SEC reporting system.
The changes to the thresholds were effective upon enactment of the two statutes in 2012 and 2015. Because the SEC did not adopt registration and termination provisions more permissive than those approved by Congress, the rule changes do not affect the current registration obligations of non-reporting companies or the current deregistration rights of reporting companies. The principal interest in the changes lies in the SEC’s clarification of the manner in which “accredited investor” status should be evaluated and in which the definition of “held of record” should be construed in applying the thresholds.
The final amendments were adopted in a form substantially similar to the amendments which the SEC proposed in December 2014. The amendments are described in SEC Release No. 34-77757 and will become effective on June 9, 2016.
Entering the reporting system: Exchange Act registration
An issuer is required to register a class of equity securities (other than exempted securities) under Section 12(g)(1) of the Exchange Act within 120 days after its fiscal year-end if, on the last day of its fiscal year, (a) the issuer has total assets exceeding $10 million and (b) the class of equity securities is “held of record” by a specified minimum number of persons. The SEC has amended Rule 12g-2 under the Exchange Act to bring both registration thresholds into line with those adopted by the JOBS Act and the FAST Act.
Unlike the $10 million total asset threshold under Section 12(g)(1) and amended Rule 12g-2, the holder-of-record threshold varies with the nature of the issuer.
- Issuers other than banks, bank holding companies and savings and loan holding companies become subject to Exchange Act registration if a class of their equity securities is held of record at fiscal year-end by either at least (a) 2,000 persons or (b) 500 persons who are not “accredited investors.”
- For banks, bank holding companies and savings and loan holding companies, there is no separate registration threshold based on the number of record holders who are not accredited investors. Those issuers become subject to Exchange Act registration if a class of their equity securities is held of record at fiscal year-end by at least 2,000 persons.
Exiting the reporting system: Exchange Act deregistration
The SEC has revised Exchange Act Rules 12g-2 and 12g-3 to reflect the statutory holder-of-record threshold for banks, bank holding companies and savings and loan holding companies to terminate their Exchange Act registration under Section 12(g) and suspend their reporting obligations under Section 15(d). Such an issuer may exit the reporting system with respect to a registered class of securities if, on the last day of the fiscal year, the class is held of record by fewer than 1,200 persons. (The JOBS Act and the FAST Act did not change the deregistration and suspension threshold of 300 holders of record that has long applied to other types of issuers.) The SEC also adopted a number of related rule amendments, including amendments that enable a bank, bank holding company or savings and loan holding company to cease filing Exchange Act reports immediately upon its filing with the SEC of a form in which it certifies that it has fewer than 1,200 holders of record of its securities.
Evaluation of accredited investor status
To rely on the new, higher Section 12(g) registration threshold established by the JOBS Act, an issuer that is not a bank, bank holding company or savings and loan holding company will have to determine each year which of its record holders are accredited investors. Congress left to the SEC the task of defining how such issuers should perform this annual assessment of their investor base. The SEC has provided some guidance on this issue in its amendments to Rule 12g-1 and its commentary in the rule release. In its approach, the SEC indicated that it was seeking to facilitate compliance by using “familiar concepts” for the accredited investor determination.
Definition of “accredited investor.” Amended Rule 12g-1 applies to the threshold determination the definition of “accredited investor” contained in Rule 501(a) of Regulation D under the Securities Act. Rule 501(a) specifies eight categories of investors that come within the definition.
Date of determination. Amended Rule 12g-1 states that, for purposes of the registration assessment, the issuer must make the accredited investor determination as of the last day of its fiscal year rather than at the time of the sale of securities to the issuer’s holders (as provided in Rule 501(a) for determinations made in connection with securities offerings conducted under Regulation D). In deciding not to adopt alternative determination dates urged by some commenters on the rule proposal, the SEC said that it was persuaded that a year-end determination date was appropriate because an issuer must consider whether it meets the registration threshold at the end of each fiscal year.
Method of determination. The use of Rule 501(a)’s definition of accredited investor raises the question of how an issuer should determine a security holder’s status on an annual basis. Rule 501(a) provides that an accredited investor is any person who comes within one or more of the eight categories of investors specified in the rule, or who the issuer “reasonably believes” comes within any such category. The SEC offered the following views on establishment of a reasonable belief concerning accredited investor status in the Section 12(g) registration context:
- Reasonable belief: The SEC said that whether an issuer has a reasonable belief as to a person’s accredited investor status for Section 12(g) purposes “depends on the particular facts and circumstances surrounding the determination.” In adopting a facts-and-circumstances approach, the SEC decided not to incorporate into the Section 12(g) determination process the more stringent requirement under Securities Act Rule 506(c) that issuers “take reasonable steps to verify” accredited investor status, which applies to issuers using general solicitation to offer securities under that rule.
The principal issue raised by commenters on this aspect of the rule proposal was whether issuers may rely on information previously provided by their security holders, such as at the time of their purchase of securities, as indicative of the holders’ current accredited investor status. The SEC responded that, in those circumstances, the issuer would “need to determine, based on facts and circumstances, whether prior information provides a basis for a reasonable belief that the security holder continues to be an accredited investor as of the last day of the fiscal year.”
The SEC’s statement suggests that an issuer should consider both (a) the nature of the information on which the issuer previously relied in making an accreditation assessment and (b) the age of that information. The SEC expressed particular concern that sole reliance on previously obtained information “could result in the use of outdated and unreliable information” in the status determination. In response to hypothetical circumstances proposed in one comment, however, the SEC acknowledged that, depending on the particular facts and circumstances, information used for accredited investor determinations made in offerings during the three months before the issuer’s fiscal year-end or self-certifications by investors as to their accredited investor status in an offering more than three months but less than twelve months before fiscal year-end could provide a reasonable basis for making an accredited investor determination as of the end of the fiscal year.
The SEC clarified in the release that if, after the issuer has made its status determination as of the end of the fiscal year, it is subsequently determined that an investor did not, in fact, come within one of the accredited investor categories, the issuer may rely on that determination for the fiscal year if it had a reasonable belief that the investor was accredited at the time it made the determination.
- No safe harbor: The SEC declined the invitation of some commenters on the rule proposal to adopt a safe harbor for establishing a reasonable belief that a security holder is an accredited investor for Section 12(g) purposes. The SEC said it eschewed this approach in part out of concern that any such safe harbor “would become a de facto minimum standard.” Noting that its rules do not provide a safe harbor for reasonable belief determinations to be made under Rule 501(a) for offerings exempt from Securities Act registration, the SEC concluded that the determinations required for Section 12(g) do not present a more compelling case for having a safe harbor. The SEC expressed the view that the reasonable belief standard under Rule 501(a) provides issuers with both a familiar context and “appropriate flexibility” in making the required determination.
Revision of “held of record” definition
When Congress changed the registration thresholds in the JOBS Act, it amended Section 12(g)(5) of the Exchange Act to exclude from the “held of record” definition securities held by persons who received them pursuant to an “employee compensation plan” in transactions exempt from the registration requirements of Section 5 of the Securities Act. Under the amended definition, a person who holds only securities of the issuer received under an employee compensation plan in an exempt transaction will not be counted as a holder of record. The statutory exclusion by its terms applies only for purposes of determining the issuer’s registration obligation under Section 12(g) and not for purposes of determining whether an issuer may terminate registration of a class of securities.
The JOBS Act directed the SEC to amend the definition of “held of record” to implement the statutory exclusion and to adopt a safe harbor that issuers may use when determining whether holders of their securities received them pursuant to an employee compensation plan in transactions exempt from Securities Act registration requirements.
Excluded securities. The SEC amended the definition of “held of record” to provide that when determining whether it is required to register a class of equity securities pursuant to Section 12(g), an issuer may exclude securities that are held by the following persons:
- Persons who received the securities under an employee compensation plan in transactions that were (a) exempt from the registration requirements of Section 5 of the Securities Act, such as private offerings, or (b) not subject to those registration requirements, such as compensatory grants to employees in transactions that do not involve a “sale” of securities within the meaning of the Securities Act, or transactions involving exempt securities, such as sales of securities made pursuant to Section 3 of the Securities Act.
- Persons who received the securities in transactions exempt from, or not subject to, Securities Act registration requirements from (a) the issuer, (b) a predecessor of the issuer or (c) an acquired company in substitution or exchange for excludable securities referred to in the bullet above, as long as the persons were eligible to receive securities pursuant to Rule 701(c) under the Securities Act at the time the excludable securities were originally issued to them. The SEC thus clarified that the statutory exclusion extends to securities issued in certain business combinations and similar transactions that replace securities previously issued pursuant to an employee compensation plan.
Non-exclusive safe harbor. As mandated by the JOBS Act, the rule amendments include a non-exclusive safe harbor under Rule 12g5-1(a)(8) which is intended to provide certainty with respect to the employee compensation plan condition and the exempt offering condition of the statutory exclusion. The safe harbor provides that an issuer may deem a person to have received the securities pursuant to an employee compensation plan if the plan and the person who received the securities under the plan met the plan and participant conditions of Rule 701(c) under the Securities Act (even if the other conditions of Rule 701, including issuer eligibility, volume limitations and disclosure delivery requirements, are not satisfied). Rule 701, which has been in effect since 1988, is relied upon by many non-reporting issuers to exempt from Securities Act registration requirements the issuance of equity securities to their employees through an employee compensation plan.
In relying on the conditions of Rule 701(c) for the new safe harbor, the SEC again emphasized its intention to “apply well understood principles of an existing Securities Act exemption to the new Exchange Act registration determination created by the JOBS Act.” Rather than defining the term “employee compensation plan” for purposes of determining when the new exclusion applies, the SEC relies on the existing definition of “compensatory benefit plan” in Rule 701, which includes “any purchase, savings, option, bonus, stock appreciation, profit sharing, thrift, incentive, deferred compensation, pension or similar plan.” Plan participants covered under the safe harbor are those specified in Rule 701(c), including employees, directors, general partners, certain trustees, officers, and certain consultants and advisors. In addition, family members (as defined in Rule 701(c)(3)) who received the equity securities from such persons through gifts or domestic relations orders or upon death are considered persons who received the securities pursuant to an employee compensation plan for purposes of the amended rules. Once the securities have been transferred to holders not specified in Rule 701(c), however, the securities would need to be counted as “held of record” by the transferee for purposes of the Section 12(g) calculation.
The safe harbor permits an issuer (solely for Section 12(g) purposes) to deem the securities to have been issued in a transaction exempt from, or not subject to, Securities Act registration requirements if the issuer had a reasonable belief at the time of the issuance that the securities were issued in such a transaction. The SEC noted in the rule release that the purpose of this provision is to relieve an issuer from the burden of establishing on an annual basis that earlier issuances of securities satisfied an appropriate exemption, so long as the issuer had a reasonable belief at the time of issuance that it had complied with the appropriate registration requirements or the conditions of an available exemption.
Foreign private issuers. Non-reporting foreign private issuers frequently rely on the exemption from registration provided by Rule 12g3-2(a) under the Exchange Act, rather than the rules discussed above. Rule 12g3-2(a) provides that a foreign private issuer that meets the asset and holder-of-record thresholds for registration under Section 12(g) is exempt from registering any class of securities under Section 12(g) if the class is held of record by fewer than 300 holders resident in the United States. The new safe harbor is available for foreign private issuers in making their determinations of the number of U.S. resident holders under Rule 12g3-2(a), so that a foreign private issuer may exclude employee compensation plan securities for purposes of the Rule 12g3-2(a) calculation. A foreign private issuer, however, may not exclude such securities for purposes of determining its status as a foreign private issuer under Securities Act and Exchange Act rules.