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President Donald Trump on May 24 signed into law the Economic Growth, Regulatory Relief, and Consumer Protection Act (the Act), which principally addresses amendments to the Dodd Frank Act affecting financial institutions. However, the Act also contains several provisions with respect to the federal securities laws. Section 507 of the Act directs the US Securities and Exchange Commission (SEC) to amend Rule 701 under the Securities Act of 1933 (the Securities Act) by increasing, from $5 million to $10 million, the amount of securities that an eligible company can sell under the rule during a 12-month period without being subject to the rule’s enhanced disclosure requirements. (The Act also calls for an inflation adjustment to this amount every five years.)

SEC Rule 701 provides an exemption from the registration provisions of the Securities Act that enables companies not subject to reporting requirements under the Securities Exchange Act of 1934 (non-reporting companies) to offer or sell securities (including securities issuable under stock options and restricted stock units) for compensatory purposes to employees and certain service providers of the company, its parents, its majority-owned subsidiaries, or majority-owned subsidiaries of the company's parent. The exemption is available so long as the amount of securities sold during a 12-month period does not exceed the greatest of

  1. $1 million;
  2. 15% of the company’s assets at the company’s most recent balance sheet date (if no older than the company’s last fiscal year end); or
  3. 15% of outstanding securities of the class whose securities are being sold in reliance on Rule 701, measured at the company’s most recent balance sheet date (if no older than the company’s last fiscal year end).

Currently, a company is subject to enhanced disclosure requirements if aggregate sales of its securities in reliance on Rule 701 exceed $5 million in a 12-month period. Such disclosures include the provision of detailed financial statements and risk disclosures. (For purposes of the rule’s limitations on sales and the enhanced disclosure threshold, a sale is deemed to take place at the time of grant of a stock option rather than at the time of exercise.)

Many non-reporting companies rely on the Rule 701 exemption, and seek to limit their offerings to avoid reaching the $5 million threshold that would require enhanced, and oftentimes burdensome, disclosure. Companies that remain below the $5 million threshold need only provide a copy of the benefit plan or compensatory contract under which the securities are granted, although additional disclosures to address antifraud considerations may be prudent.

The increase to the threshold for enhanced disclosure should have a meaningful impact on how non-reporting companies compensate their employees and other service providers. The changes to Rule 701 mandated by the Act will likely help ease the burden on non-reporting companies, making the Rule 701 exemption even more attractive, and lead to an increase in equity-based compensation for employees and other service providers of companies relying on the exemption.

While the SEC has up to 60 days from the date of the Act—July 23, 2018—to implement changes, please feel free to reach out to the authors or your Morgan Lewis contact to discuss how these changes might impact your company and its equity programs.