The term-end crunch continues! Yesterday, the SEC voted, without an open meeting, to issue two separate proposals to amend Rule 701 and Form S-8, both “substantially informed by public comment” received in response to the SEC’s July 2018 Concept Release on Compensatory Security Offerings and Sales. First, the SEC is proposing new amendments, on a temporary five-year trial basis, that would allow a company to provide equity compensation to a slice of “gig” workers—specifically only “platform workers” who provide services through the company’s technology-based platform—subject to percentage limits (no more than 15% of annual compensation), dollar limits (no more than $75,000 in three years) and other conditions. The proposal is structured as temporary to allow the SEC an opportunity to assess whether issuances are being made for legitimate compensatory purposes and not for capital-raising purposes, whether the issuances benefit companies, platform workers and other investors in the “gig economy,” and whether there are any unintended consequences. To help with that assessment, looking toward an evaluation of whether to make the rule permanent, the SEC will require participating companies to furnish certain information to the SEC at six-month intervals. Second, the SEC is also proposing amendments to Rule 701 and Form S-8 designed to modernize the framework for compensatory securities offerings in light of the significant evolution in compensatory offerings and composition of the workforce since the SEC last substantively amended those regulations. Both proposals will be open for public comment for 60 days.
This post hits the highlights based on the press releases. I plan to publish an update to this post with more detail about the proposals at a later time, so stay tuned.
The 2018 concept release (see this PubCo post) requested public comment on ways to modernize Rule 701 and Form S-8, especially given that Rule 701 had not been updated since 1999. Should the timing and content of the required disclosures under Rule 701 be modified? Should there be changes to the consequences of failure to comply with the disclosure or other requirements? Similarly, other forms of equity compensation, such as RSUs, have become more prevalent in recent years. How should they be treated under Rule 701?
But the most interesting question raised in the concept release—and the most relevant in light of these new proposals—related to how, or if, the rule should be modified to reflect changes in the society at large in the relationships between workers—notice I didn’t say “employees”—and companies in the 20 years since the rule was last amended. In particular, the release asked us to consider whether the conditions for eligibility should be revised in light of the “gig” economy and evolving worker-company relationships. Rule 701 provides a special accommodation for the issuance of equity for compensatory purposes to employees, directors and consultants that is distinct from the rules that typically apply in ordinary capital-raising transactions. Should this accommodation be expanded? Should companies be permitted to issue shares without the need for registration and related disclosure to non-traditional workers who may be providing services under alternative work arrangements or contractual relationships, sometimes with multiple companies, that may be short term or freelance in nature? If so, what parameters should apply? What activities should the worker be required to engage in? Do companies even want to issue equity as compensation to motivate these workers? Would an expansion of the rule lead to more gig workers? What effect would a liberalization of the rule have on incentives to companies to “go public and stay public,” a rite of passage the SEC has recently championed, or on incentives to remain private? With regard to Form S-8, the simplified registration form for securities issued under employee plans, the questions included how to reduce costs, whether to further streamline the form, whether to allow use of a single S-8 for all plans and whether issuers should be permitted to pay fees on an as-you-go basis.
Commissioners Hester Peirce and Elad Roisman supported the temporary exception for platform workers. In their view, the proposed rules would expand available vehicles for compensatory sales that are “well-understood and widely used” for a temporary five-year period for certain gig workers. Participating companies would provide information to help the SEC assess the program. And the proposal “includes guardrails to ensure that issuances to gig workers are compensatory in nature and not conducted for capital-raising purposes.” They are looking forward to the input of gig workers and others. Their question was whether the program should be expanded to include workers that sell goods on platforms, not just those who provide services. At the end of the day, they viewed the “proposal as a way to improve benefits for these important workers and to introduce them to the powerful role that our capital markets can play in building a nest egg for retirement and for passing along to the next generation.”
Commissioners Allison Lee and Caroline Crenshaw supported release of the proposal for a “package of technical updates” to Rule 701 and Form S-8 because that proposal “appears to include tailored adjustments designed to enhance the functioning of our rules for all market participant,” but support for the platform worker trial program? Not so much. They could not support that proposal “because there is no sound policy justification for singling out a subtype of alternative workers for this exemption—those who provide services through internet- or technology-based platforms.” The proposal is presented as an accommodation to the evolving gig economy, they say, and the data presented in the proposal relates to “all manner of alternative work arrangements, discussing independent contractors, freelancers, temporary help agency workers, on-call workers, contract workers, and other types of informal paid activities.” But the exemption in the temporary trial program “singles out platform workers, a narrowly defined sub-category of alternative workers,” and the release “does not reconcile the discrepancy between the broader data set analyzed, and the more narrow subset of workers” eligible for the trial program. The two commissioners could not “find any principled basis for the policy choice to single out a specific platform-based business model for a particular competitive advantage.”
Proposal to permit compensatory offerings to platform workers. According to the press release regarding the proposed temporary rules for oferings to platform workers, the proposal would amend Rule 701, adding a five-year temporary trial provision that would allow non-reporting companies to compensate certain platform workers with equity, subject to specified conditions. The same temporary rules would allow sales by public companies using Form S-8.
Under the amendments, a company would be able to offer and sell its securities on a compensatory basis under the Rule 701 exemption to platform workers who, pursuant to a written contract or agreement, “provide bona fide services by means of an internet-based platform or other widespread, technology-based marketplace platform or system” provided by the company if:
- “the issuer operates and controls the platform, as demonstrated by its ability to provide access to the platform, to establish the principal terms of service for using the platform and terms and conditions by which the platform worker receives payment for the services provided through the platform, and by its ability to accept and remove platform workers participating in the platform;
- the issuance of securities to participating platform workers is pursuant to a compensatory arrangement, as evidenced by a written compensation plan, contract, or agreement, and is not for services that are in connection with the offer or sale of securities in a capital-raising transaction, or services that directly or indirectly promote or maintain a market for the issuer’s securities;
- no more than 15% of the value of compensation received by a participating worker from the issuer for services provided by means of the platform during a 12-month period, and no more than $75,000 of such compensation received from the issuer during a 36-month period, shall consist of securities, with such value determined at the time the securities are granted;
- the amount and terms of any securities issued to a platform worker may not be subject to individual bargaining or the worker’s ability to elect between payment in securities or cash; and
- the issuer must take reasonable steps to prohibit the transfer of the securities issued to a platform worker pursuant to this exemption, other than a transfer to the issuer or by operation of law.”
The same conditions proposed for Rule 701 issuances would apply to issuances to platform workers on Form S-8, except for the proposed transferability restriction. The proposed amendments would apply only to platform workers who provide services, not to those whose activities relate “to the sale or transfer of permanent ownership of discrete, tangible goods,” although the SEC could decide to expand eligibility, depending on the results of the initial temporary program.
Proposal to modernize framework for compensatory offerings. According to the press release regarding the second proposal to modernize the framework for compensatory sales under Rule 701 and Form S-8, the highlights of the proposal include the following:
“With respect to Rule 701, the proposed amendments would:
- Revise the additional disclosure requirements for Rule 701 exempt transactions exceeding $10 million, including how the disclosure threshold applies, the type of financial disclosure required, and the frequency with which it must be updated;
- Revise the time at which such disclosure is required to be delivered for derivative securities that do not involve a decision by the recipient to exercise or convert in specified circumstances where such derivative securities are granted to new hires;
- Raise two of the three alternative regulatory ceilings that cap the overall amount of securities that a non-reporting issuer may sell pursuant to the exemption during any consecutive 12-month period; and
- Make the exemption available for offers and sales of securities under a written compensatory benefit plan established by the issuer’s subsidiaries, whether or not majority-owned.
“With respect to Form S-8, the proposed amendments would:
- Implement improvements and clarifications to simplify registration on the form, including:
- Clarifying the ability to add multiple plans to a single Form S-8;
- Clarifying the ability to allocate securities among multiple incentive plans on a single Form S-8; and
- Permitting the addition of securities or classes of securities by automatically effective post-effective amendment.
- Implement improvements to simplify share counting and fee payments on the form, including:
- Requiring the registration of an aggregate offering amount of securities for defined contribution plans;
- Implementing a new fee payment method for registration of offers and sales pursuant to defined contribution plans; and
- Conforming Form S-8 instructions with current IRS plan review practices.
- Revise Item 1(f) of Form S-8 to eliminate the requirement to describe the tax effects of plan participation on the issuer.
“With respect to both Rule 701 and Form S-8, the proposals would:
- Extend consultant and advisor eligibility to entities meeting specified ownership criteria designed to link the securities to the performance of services; and
- Expand eligibility for former employees to specified post-termination grants and former employees of acquired entities.”