- Pending SEC Rules Could Bring Additional Changes to Exchange Act Registration Requirements
- May 15, 2015 | Authors: Steven B. Boehm; James M. Cain; Cynthia M. Krus; John J. Mahon; Lisa A. Morgan
- Law Firm: Sutherland Asbill & Brennan LLP - Washington Office
In March 2015, the comment period expired for rules proposed by the Securities and Exchange Commission (the “Commission”) to implement Title V and Title VI of the Jumpstart Our Business Startups Act (“JOBS Act”). These sections of the JOBS Act mandated the following changes:
- Revised asset and record holder thresholds before registration is required under Section 12(g) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), which incorporate exclusions for holders that are accredited investors.
- A revised definition of “held of record” which excludes certain shares granted under an “employee compensation plan” in reliance on an exemption from registration under the Securities Act of 1933, as amended (the “Securities Act”).
- A non-exclusive safe harbor for determining whether shares are granted under an “employee compensation plan” for the purposes of excluding holders of such shares from the issuer’s number of record holders.
While the Commission reviews comments submitted with regard to its proposed rules, this legal alert provides an overview of the changes to registration requirements suggested by the proposed rules under Section 12(g) of the Exchange Act and the impact that the proposed rules would have on current practices.
Background, JOBS Act Amendments
Prior to the JOBS Act, Section 12(g) and the Commission’s rules thereunder required an issuer to register a class of its equity securities if, at the end of the issuer’s fiscal year, the securities were “held of record” by 500 or more persons and the issuer’s total assets exceeded $1 million.1 Any issuer was permitted to terminate registration of a class of equity securities if: (1) the number of record holders of that class fell below 300, or (2) the number of record holders of that class fell below 500 and the issuer’s assets were no more than $10 million at the end of each of its last three fiscal years.
The JOBS Act amended Section 12(g), effecting several changes that delay the point at which an issuer must register a class of securities with the Commission. First, the JOBS Act revised the definition of “held of record” to exclude securities held by persons who received the securities pursuant to an employee compensation plan in certain transactions exempt from Securities Act registration. Additionally, the amendments also raised the numerical thresholds for registering for all companies and, for banks and bank holding companies, deregistering a class of securities with the Commission. In this regard, the JOBS Act increased the statutory registration thresholds generally to (1) total assets of $10 million, and (2) either 2,000 record holders or 500 record holders who are not “accredited investors.” For banks and bank holding companies,2 the JOBS Act increased the registration threshold to total assets exceeding $10 million and 2,000 record holders. Finally, the JOBS Act permitted banks and bank holding companies to deregister a class of securities with fewer than 1,200 record holders.
The JOBS Act set forth a number of actions for the Commission to take to implement the revised registration thresholds. First, the amendments required the Commission to define the term “accredited investor” in the context of the new registration thresholds. Second, the amendments instructed the Commission to revise the definition of “held of record” and to establish a non-exclusive safe harbor for issuers to use in determining whether securities were issued pursuant to an exempt employee compensation plan. Finally, the amendments required the Commission to adopt rules to conform to the new registration and deregistration thresholds.
The Commission’s Proposed Rules
In December 2014, the Commission proposed rules to satisfy the JOBS Act mandate under Section 12(g) of the Exchange Act. The rule proposal was subject to a 60-day comment period, which expired in March 2015. As the Commission takes these comments into consideration, issuers should prepare themselves for the SEC’s final rules announcement. In this light, below is a summary of the principal terms of the Commission’s rule proposal.
Accredited Investor Definition. The Commission’s proposed rule would apply the definition of “accredited investor” in Rule 501(a) under the Securities Act in making determinations under Section 12(g). Whether a record holder is an “accredited investor” is a determination that the issuer would make as of the last day of the fiscal year, rather than at the time of the sale of securities.3 In making this determination, the Commission’s proposed rule would require the issuer to take appropriate steps to establish a reasonable belief that the holder of record is an accredited investor. Such a determination would be based on similar concepts as applied to the accredited investor definition in Rule 501(a). Despite being able to rely on a familiar term, issuers will need to update any diligence relied on to make such a determination again at year end.
Definition of “Held of Record”. The proposed rule would amend the definition of “held of record” established by Exchange Act Rule 12g5-1 to exclude securities that are either:
- Held by persons who received the securities pursuant to an employee compensation plan in transactions exempt from Section 5 or that did not involve a sale within the meaning of Section 2(a)(3) of the Securities Act, or
- Held by persons eligible to receive securities from the issuer pursuant to Securities Act Rule 701(c).
The first exclusion would be beneficial to issuers who rely on the “no sale” theory when making compensatory grants to certain employees. By applying the concepts from Rule 701(c), the second exclusion would cover securities issued pursuant to a written employee compensation plan to an issuer’s employees, directors, general partners, trustees (where the issuer is a business trust), officers, or consultants and advisors, and their family members who acquire such securities from such persons through gifts or domestic relations orders. The second exclusion would also cover securities issued to former employees, directors, general partners, trustees, officers, consultants and advisors who received such securities while providing services to the issuer. This exclusion would be beneficial to issuers engaging in restructurings, business combinations and similar transactions where securities previously issued pursuant to an employee compensation plan are surrendered and exchanged for new securities. The new securities would be deemed to have a compensatory purpose by virtue of replacing the surrendered securities, and therefore would not be counted under the proposed definition of “held of record”.
Safe Harbor for Determining Holders of Record. The proposed rule would establish a non-exclusive safe harbor to help issuers determine whether securities were issued under an employee compensation plan within the scope of the exception from the definition of “held of record”. The safe harbor would be available for securities issued in connection with a written plan to:
- Plan participants listed in Rule 701(c), including employees, directors, general partners, trustees (where the issuer is a business trust), officers and certain consultants and advisors, and
- Family members4 who acquire the securities from a plan participant via gift or domestic relations order or “in connection with options transferred to them by the plan participant through gifts or domestic relations orders.”
Once these persons subsequently transfer the securities, whether or not for value, the proposed rules would dictate that the securities would be held of record by the transferee for purposes of determining whether the issuer is subject to the registration and reporting requirements of Section 12(g)(1).
Suspending Reporting and Terminating Registration. The Commission’s proposed rules would also amend the procedures to permit banks and bank holding companies to terminate reporting responsibilities under Section 13 and suspend reporting responsibilities under Section 15 of the Exchange Act immediately upon meeting the termination thresholds and filing a certification with the Commission. Banks and bank holding companies would otherwise be required to wait 90 days after filing such a certification in order to terminate their Section 12(g) registration and suspend reporting obligations.
Application of Thresholds to Savings and Loan Holding Companies. Although not covered by Title VI of the JOBS Act, the Commission’s rule proposal extends the same thresholds for Section 12(g) registration and termination of Section 12(g) registration and suspension of Section 15(d) reporting to savings and loan holding companies. The Commission’s proposed rule would establish an exemption for savings and loan holding companies from the registration requirement that mirrors the exemption for banks and bank holding companies established by the JOBS Act.
Foreign Private Issuers. Foreign private issuers5 may be required to register a class of equity securities if such issuer meets the asset thresholds under Section 12(g) and has 300 or more U.S. resident holders. Exchange Act Rule 12(g)3-2 provides for the use of the “held of record” definition established in Rule 12(g)5-1 for determining whether the foreign private issuer meets the 300 U.S. resident holder threshold. Therefore, foreign private issuers would be able to take advantage of the revised definition of “held of record” and rely on the safe harbor when making their determination of the number of U.S. resident holders.
1 Under authority granted under Section 12(h), the Commission increased the amount of assets threshold to $10 million in 1996. See Relief From Reporting by Small Issuers, Release No. 34-37157 (May 1, 1996) [61 FR 21353 (May 9, 1996)].
2 As defined in Section 2 of the Bank Holding Company Act of 1956.
3 Securities Act Rule 501(a) otherwise defines “accredited investor” as being determined at the time of the sale of securities.
4 As defined in Rule 701(c).
5 As defined in Exchange Act Rule 3b-4(c).