Fast-growing private companies have sometimes found themselves subject to public company registration as a result of granting stock options to a large number of employees. The Securities and Exchange Commission has previously provided relief on a case-by-case basis. Now it has adopted a formal exemption to help companies in this situation. Privately-held companies will be able to avoid public company registration even if they have granted options for compensatory purposes to more than 500 people. Companies using this exemption will need to take steps, such as amending their option plans, to impose transfer restrictions limiting the potential development of a trading market for the options and to make certain financial and other information available to optionholders. The SEC also adopted a separate exemption for stock options issued by reporting companies.


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 normally must register that class of equity security under the Securities Exchange Act of 1934. This registration makes the company subject to the full reporting requirements of the Exchange Act. Stock options, including stock options issued to employees under equity compensation plans, are a separate class of equity security for this purpose. The requirement to register if options are granted to 500 people has taken some growth companies by surprise.

Since 1992, the SEC Staff has provided relief through “no-action” letters to private companies facing registration in these circumstances. However, this process involved delays and uncertainties, with relief granted only upon fairly strict conditions. Relief was available only where the company imposed restrictions on transferability of both the options and any shares received on exercise of the options. Most significantly, issuers were required to provide option recipients essentially the same Exchange Act registration statement, annual report and quarterly report information they would receive if the issuer had registered the class of securities under the Exchange Act, including audited annual financial statements and unaudited quarterly financial information, all upon specified timetables, as well as certifications similar to those required of Exchange Act reporting companies under the Sarbanes-Oxley Act.

New Exemption

The SEC has now provided a broader exemption for widely held stock options that is available without the need for a no-action letter or some of the more onerous requirements formerly imposed. The new exemption, in Rule 12h-1(f), retains significant conditions, including ongoing financial statement disclosures to optionholders.

Features of the new exemption include:

  • The exemption covers only compensatory stock options issued under written stock option plans that are limited to employees, directors, consultants, and advisors of the issuer, its parents or majority-owned subsidiaries of the issuer or its parents. These are generally the categories of individuals eligible for the exemption from the registration requirements of the Securities Act of 1933 under Rule 701.
  • The compensatory employee stock options and, prior to exercise, the underlying shares must be non-transferable, except (1) to family members by gift or pursuant to a domestic relations order or (2) on the optionholder’s death or disability, until the issuer becomes a reporting company.

Also, until the issuer becomes a reporting company, no other pledges, hypothecations, gifts, or other transfers of the stock options, or shares issued on exercise of the stock options, prior to exercise, can be permitted other than (i) transfers back to the issuer or its affiliates or (ii) transfers in connection with the issuer’s acquisition if, after the acquisition, the options will no longer be outstanding and the issuer will no longer be relying on the exemption. Short positions and other hedging transactions must be prohibited.

  • The rule will not place any restrictions on the exercise of compensatory stock options.
  • Issuers using the exemption will need to provide the following information, delivered every six months:
  • A balance sheet that is less than 180 days old, plus statements of income, cash flows and other stockholders’ equity for the two most recent fiscal years and any interim period between the end of the last fiscal year and the balance sheet date. The financial statements need not be audited unless there are audited financial statements prepared for another purpose. While the requirements of Regulation S-X will not apply, the financial statements would need to be prepared under GAAP. There are specific provisions relating to financial statements of businesses acquired or to be acquired, and pro forma financial statements for significant business combinations.
  • A brief description of the risks associated with ownership of the securities

This information may be provided by physical or electronic delivery, or by making it available on a password-protected Internet site. Delivery or access may be conditioned upon an optionholder’s agreement to keep the information confidential.

Companies which have been active in granting stock options in amounts exceeding $5 million in a 12-month period, as calculated under Rule 701, will already prepare (or should prepare) this information, since it needs to be delivered to the optionholders a reasonable time before exercise of the option in order to meet the Rule 701 requirements. Unlike Rule 701, however, the new exemption requires delivery of information to all optionholders every six months, and not merely before exercise. Companies which have to date fallen under the $5 million threshold for Rule 701 will need to prepare and provide the required financial information if they need to rely on the new exemption.

There are some important differences between the rule that the SEC originally proposed and the final rule. The SEC had originally proposed (i) to require companies to impose transfer limitations on shares that are received upon exercise of options, as well as other shares of the same class; (ii) to require delivery of the Rule 701-type information to holders of stock who had exercised their options; and (iii) to give optionholders and holders of shares received upon exercise of options access to the company’s books and records. None of those proposals were adopted.

Significantly, the new exemption will require that the relevant conditions – including the transfer restrictions and the obligation to provide financial and risk information – must be included in a company’s written stock option plans, within the terms of the individual stock option agreements, in the company’s articles or by-laws or in another enforceable written agreement, such as a stockholder agreement. It will not be enough, for example, merely to observe the information requirements in practice.

Note that the new exemption will not affect the registration requirements and related exemptions under the Securities Act of 1933 for the offer and sale of any securities, including compensatory stock options. It only applies to stock options and will not affect the registration requirements under the Exchange Act for any class of securities other than options, including for the shares of stock into which options may be converted upon exercise, stock appreciation rights, and restricted stock units (RSUs).

Exemption for Reporting Companies

New Rule 12h-1(g) will extend a similar exemption to companies which are already subject to the reporting requirements of the Exchange Act and which have more than 500 holders of compensatory stock options. Few, if any, reporting companies with over 500 optionholders have in the past registered those options under the Exchange Act, though section 12(g) of that Act seems to require it. This new rule either provides for the first time, or makes clear, that compensatory stock options granted under written option plans need not be registered as a class of equity security under the Exchange Act if they are held, with only insignificant deviations, by persons eligible for such options under Rule 701 or Form S-8. An insignificant deviation is permitted if the issuer makes a good faith effort to comply with the exemption, and the number of stockholders who do not meet the eligibility criteria (e.g., employees, officers, directors, consultants, advisers and permitted transferees) is insignificant both as to the aggregate number of optionholders and the number of outstanding stock options.