SEC Amends Rule 701, Issues Concept Release on Modernizing Employee Offerings

July 23, 2018

The US Securities and Exchange Commission’s new Rule 701 and concept release may ease a new generation of companies’ ability to offer and issue equity-based compensation, and question the appropriateness and continued utility of Form S-8 with respect to the changing “gig economy.”

On July 18, the US Securities and Exchange Commission (SEC) adopted final rules[1] to amend Securities Act Rule 701[2] (Rule 701), which provides an exemption from the registration requirements of the Securities Act of 1933 (’33 Act)[3] for securities issued as compensation by companies that are not subject to the reporting requirements of the Securities Exchange Act of 1934[4][5] (nonreporting companies).

Under the amendments, a nonreporting company may avail itself of the Rule 701 disclosure exemption for up to $10 million (an increase from $5 million) in aggregate sales or amount of securities sold during any consecutive 12-month period.

The SEC also has asked for public comment on how Rule 701, together with Form S-8, can be further modernized in light of the changing economy and evolving work arrangements.

Background of the Rule 701 Exemption

Offers and sales of securities in the United States must be either (1) registered under the ’33 Act or (2) made pursuant to an available exemption from registration.

Thirty years ago, the SEC adopted Rule 701 to allow nonreporting companies to sell securities to their employees[6] without needing to register the offer and sale of such securities. The Rule 701 exemption allows nonreporting companies to sell, during any consecutive 12-month period, securities equal in aggregate value to the greatest of (1) $1 million, (2) 15% of the total assets of the company, or (3) 15% of the outstanding amount of the class of securities being offered and sold under the Rule 701 exemption.[7]

Currently, companies relying on the Rule 701 exemption may avail themselves of limited disclosure requirements to employee-participants (i.e., only providing a copy of the compensatory benefit plan or relevant contractual agreement to the recipient) until the aggregate sales price of securities issued under the exemption in the prior 12-month period reaches $5 million.[8] Under the amendments, the SEC has doubled this disclosure threshold to $10 million.

After surpassing the threshold, the nonreporting company must deliver a more fulsome disclosure package to all equity compensation recipients in the relevant 12-month period. The additional disclosure includes

  • a copy of the summary plan description required by the Employee Retirement Income Security Act of 1974, as amended (ERISA), or a summary of the plan’s material terms if it is not subject to ERISA;
  • a description of the risks associated with investments in the company’s securities; and
  • the financial statements that otherwise would be required in an offering statement on Form 1-A under Regulation A.[9]

Once the nonreporting company’s offers and sales exceed the threshold, for any subsequent offers or sales, delivery of such additional disclosure must occur within a reasonable period of time prior thereto. If not, the Rule 701 exemption becomes unavailable for prior offers and sales, even those issued before the nonreporting company exceeded the disclosure threshold.

Upon publication of the amendment to Rule 701(e) in the Federal Register, which likely will occur within the next two weeks, the disclosure delivery threshold will be raised to $10 million, both for subsequently initiated and currently ongoing offerings made in reliance on the Rule 701 exemption. This amendment to Rule 701(e) was required by Section 507[10] of the Economic Growth, Regulatory Relief, and Consumer Protection Act, which was signed into law on May 24, 2018.

Call for Public Comment

The SEC also issued a concept release[11] on July 18, in which it requested public comment to further modernize Rule 701, together with Form S-8,[12] in light of the evolution of the forms and types of equity compensation.[13]

The SEC is seeking comment as to whether Rule 701 should be further revised, including

  • whether the definition of the eligible recipients of securities offered and sold in Rule 701 transactions should be expanded in light of the growing “gig economy”[14] and, if so, in what manner;
  • whether Rule 701 should be revised so that the obligation to deliver additional disclosure, or the impact of failure to comply with this obligation, applies only subsequent to the offer and sale of securities conducted after the disclosure threshold is passed;
  • whether Rule 701’s disclosure and delivery requirements should otherwise be softened, broadened, or clarified, and if the SEC should distinguish between the disclosure requirements for domestic and foreign nonreporting companies; and
  • whether the maximum amount of securities that may be offered and sold under Rule 701 should be raised and, if so, how.

Questions posed regarding Form S-8 include

  • if Rule 701 is revised to broaden the eligible recipients of securities under the rule, whether corresponding changes should be made to Form S-8;
  • how Form S-8 may be simplified to reduce administrative burdens and costs, and whether Form S-8 should be revised such that a company could register, on a single form, the offers and sales pursuant to all employee benefit plans that a company sponsors;
  • whether the registration requirements of Form S-8 itself should be simplified, including specifically with respect to the use of Form S-8 in connection with Section 401(k) plans;[15]
  • whether the SEC should implement a “pay-as-you-go” basis to Form S-8 (similar to what currently is available to well-known seasoned issuers conducting shelf registration statement takedowns); and
  • whether, and in what capacity, Form S-8 remains relevant, and what the impacts would be of rescinding Form S-8.

The SEC will receive comments until 60 days after the publication of the concept release in the Federal Register. We anticipate that the concept release also will be published in the Federal Register within the next two weeks.

Practice Point

Failure to comply with the enhanced disclosure requirements of Rule 701 can lead to SEC penalties (as has occurred recently in practice). Although the increased threshold provides an added cushion for nonreporting companies, it is important to carefully track Rule 701 offerings.


If you have any questions or would like more information on the issues discussed in this LawFlash, please contact any of the following Morgan Lewis lawyers:

Laurie Cerveny
Michael Conza
Bryan Keighery
Julio Vega

Torsten Schwarze

Hong Kong
June Chan
Eli Gao
Louise Liu
Edwin Luk
Billy Wong

Thomas J. Cartwright
Timothy J. Corbett
Iain Wright

Carter Brod

New York
Thomas P. Giblin, Jr.
Howard A. Kenny
Christina Melendi
David W. Pollak
Kimberly M. Reisler

Palo Alto
Albert Lung

Justin W. Chairman
James W. McKenzie
Joanne R. Soslow

Celia Soehner

Bernard Lui
Joo Khin Ng

Washington, DC
David A. Sirignano
George G. Yearsich

[1] SEC Release 33-10520.

[2] 17 CFR § 230.701. Please note that as of the date of this LawFlash, the copy of Rule 701 hosted on the Government Publishing Officer’s website has not been updated to reflect the amendment, which will be effective on the date that the SEC’s adopting release regarding the final rule implementing the amendment is published in the Federal Register.

[3] 15 USC §§ 77a et seq.

[4] 15 USC §§ 78a et seq.

[5] Additionally, to rely upon the exemption provided by Rule 701, a company may not be an investment company registered or required to be registered under the Investment Company Act of 1940 (15 USC §§ 80a-1 et seq.)

[6] The exemption applies to the offer and sale of securities under a plan or agreement between a nonreporting company (or its parents, majority-owned subsidiaries, or majority-owned subsidiaries of its parent) and the company’s employees, officers, directors, partners, trustees, consultants, and advisors. Consultants and advisors may participate in a Rule 701 offering only if they are natural persons and provide bona fide services to the company, and such services are not in connection with a capital-raising transaction and do not promote or maintain a market for the company’s securities.

[7] Rule 701 offerings are not subject to integration with any other offers or sales, whether or not registered under the ’33 Act.

[8] Further, Rule 701 transactions are subject to the antifraud provisions of the federal securities laws.

[9] 17 CFR § 239.90. These financial statements must be as of a date no more than 180 days before the sale of securities relying on Rule 701.

[10] Pub. L. 115-174, 132 Stat. 1296 (2018).

[11] SEC Release 33-10521.

[12] Form S-8 may be used by reporting companies to register, under the ’33 Act, the offer and sale of securities issued under compensatory arrangements.

[13] 17 CFR § 239.16b. Form S-8 is a simplified registration statement, and is only available to register compensatory sales of securities issued under an employee benefit plan to employees, consultants, and advisers, and de facto employees of the issuer, its subsidiaries, or its parents. To use Form S-8, an issuer must be a reporting company and have filed all reports required during the preceding 12 months or such shorter period that it was a reporting company. Form S-8 cannot be used by shell companies.

[14] Defining alternative work arrangements as temporary help agency workers, on-call workers, contract workers, and independent contractors or freelancers. In a statement regarding the Rule 701 amendment and concept release, Commissioner Hester Peirce stated that Lyft drivers exemplify the type of person whom the modernization efforts could benefit.

[15] Here, the SEC has asked whether “registering a specific number of shares results in Section 5 compliance problems when plan sales exceed the number of shares registered, such as for Section 401(k) plans and similar defined contribution retirement savings plans? If so, how should we address this issue?”