In December 2014, the Securities and Exchange Commission (SEC) proposed rules to implement Title V and Title VI of the Jumpstart Our Business Startups Act (JOBS Act), which permit early stage companies to defer registration under Section 12(g) of the Securities Exchange Act of 1934 (Exchange Act) until they have a larger shareholder base and give them greater flexibility in offering equity compensation without triggering the Section 12(g) registration requirements.  The SEC is seeking public comments on the proposed rules until March 2, 2015.

In summary, the proposed rules would:

• • Amend the rules governing registration and termination of registration mechanics under Section 12(g) and suspension of reporting under Section 15(d) of the Exchange Act to reflect the new, relaxed holder of record thresholds established by the JOBS Act.
  • Clarify the meaning of “accredited investor” for determining which holders of record are accredited investors under the new Section 12(g) thresholds, and establish the end of the company’s fiscal year as the time for determining accredited investor status for this purpose.
  • Amend the definition of “held of record” for purposes of the Section 12(g) thresholds to exclude securities held by persons who acquired the securities under an “employee compensation plan” in a transaction exempt from registration under the Securities Act of 1933 (Securities Act), as well as persons who acquired the securities in a transaction that did not involve a “sale.”
  • Create a nonexclusive safe harbor under which a person will be deemed to have received securities pursuant to an “employee compensation plan” for purposes of Section 12(g) if the securities were received pursuant to a “compensatory benefit plan” transaction that satisfies the conditions of Rule 701(c) of the Securities Act.

This update highlights key provisions of the proposed rules.

Proposed Rules Implement Exchange Act Registration Threshold Relief

Exchange Act Registration Threshold—2,000 Holders or 500 Unaccredited Investors.  Prior to the JOBS Act, Section 12(g) and SEC rules required a company to register a class of equity securities if, on the last day of its most recent fiscal year, the securities were “held of record” by 500 or more persons and the company had total assets exceeding $10 million.  The proposed rules implement the relaxed registration thresholds set forth in the JOBS Act by requiring registration under Section 12(g) only if, on the last day of a company’s most recent fiscal year, the company had total assets of more than $10 million and the class of equity securities is held of record by either 2,000 persons or 500 persons who are not accredited investors.

• • Regulation D Accredited Investor Definition Applies.  For purposes of the new Section 12(g) accredited investor threshold, the proposed rules would apply the current definition of “accredited investor” found in Rule 501(a) of the Securities Act for Regulation D offerings.  The proposing release states that “applying the familiar concepts of the accredited investor definition in Rule 501(a) to the registration threshold in Section 12(g)(a) would facilitate compliance for issuers.”  Rule 501(a) provides that an accredited investor is any person who comes within any of eight enumerated categories, or whom the issuer “reasonably believes comes within those categories . . . at the time of the sale of the securities to that person.”
  • Companies Would Determine Accredited Investor Status as of Fiscal Year End.  The proposed rules would require companies to determine the accredited investor status of holders of record as of the last day of a company’s fiscal year, rather than at the time the holders of record acquired their securities.  Accordingly, the proposing release notes that a company “will need to determine, based on facts and circumstances, whether it can rely upon prior information to form a reasonable basis for believing that the security holder continues to be accredited as of the end of the fiscal year.”  The SEC acknowledges in the proposing release that companies “may have difficulty determining whether existing security holders are accredited investors,” and is soliciting comments on whether a safe harbor or guidance for determining accredited investor status under Section 12(g) would be appropriate.
  • Special Thresholds for Banks and Bank Holding Companies Extended to Saving and Loan Holding Companies.  The proposed rules implement the relaxed Section 12(g) registration thresholds set forth in the JOBS Act for banks and bank holding companies of 2,000 record holders without regard to the number of nonaccredited investors, and the proposed rules would also extend this threshold to savings and loan holding companies.  Under the proposed rules, banks and bank holding companies may also immediately terminate registration or suspend reporting obligations if the number of record holders drops below 1,200, and the proposed rules would also extend this threshold to savings and loan holding companies.

Excludes Holders of Exempt Equity Compensation.  The JOBS Act excludes from the definition of securities “held of record” for purposes of Section 12(g) securities held by persons who received them pursuant to an “employee compensation plan” in a transaction exempt from the registration requirements of Section 5 of the Securities Act and directs the SEC to create a safe harbor for companies making that determination.  By its terms, the statutory exclusion applies solely for purposes of determining whether a company is required to register under Section 12(g) and does not apply for purposes of determining whether a company may terminate or suspend its reporting obligations.

• • New Definition of “Held of Record” for Section 12(g) Thresholds.  The proposed rules would amend the definition of “held of record” to provide that, in determining whether a company is required to register a class of equity securities under Section 12(g), the company may exclude securities that are:
    • Held by persons who received them under an “employee compensation plan” in transactions exempt from the registration requirements of Section 5 of the Securities Act or that did not involve a “sale” within the meaning of Section 2(a)(3) of the Securities Act.
    • Held by persons eligible to receive securities from the company pursuant to Rule 701(c) of the Securities Act who received the securities in a transaction exempt from the registration requirements of the Securities Act in exchange for securities that would be excluded under this definition.  The proposing release notes that this is intended to “facilitate the ability of an issuer to conduct restructuring, business combinations and similar transactions that are exempt from Securities Act registration so that if the securities being surrendered in such a transaction would not have been counted under the proposed definition of ‘held of record,’ the securities issued in exchange would also not be counted under this definition.”
  • Nonexclusive Safe Harbor for Identifying Exempt Equity Compensation Holders.  Rather than creating a new definition of “employee compensation plan,” the proposed rules would establish a nonexclusive safe harbor that excludes shareholders from the definition of “held of record” if they received their securities pursuant to a “compensatory benefit plan” as defined in Rule 701 under the Securities Act that satisfies the conditions of Rule 701(c).  The proposed safe harbor would require transactions to satisfy only the conditions of Rule 701(c), and not the other conditions of Rule 701, such as company eligibility, volume limitations or disclosure delivery requirements.
    • Conditions of Rule 701(c).  Rule 701(c) exempts the offer and sale of company securities to employees, directors, general partners and officers of the company, its parents or certain majority-owned subsidiaries, as well as to certain consultants and advisors, under a written compensatory benefit plan or compensation contract.  Rule 701(c) also exempts sales to former employees, directors, general partners, trustees, officers, consultants and advisors, but only if such persons were employed by or providing services to the company at the time the securities were offered.  Rule 701(c) also covers as permitted transferees “family members,” as defined in the rule, who acquire securities from these persons through gifts or domestic relations orders.  However, the proposed rules clarify that if a permitted transferee subsequently transfers the securities, whether or not for value, the securities held by the resulting transferees would be considered “held of record” for purposes of determining whether the company is subject to the Section 12(g) registration requirements.
    • Exemptions From Section 5 of the Securities Act. The nonexclusive safe harbor would be available to exclude from the definition of “holder of record” any holders who received securities in employee compensation plan transactions exempted from, or not subject to, the registration requirements of Section 5 of the Securities Act, which would include securities issued in reliance on the exemptions provided under Rule 701 of the Securities Act, Section 4(a)(2) of the Securities Act, Regulation D or Regulation S, as long as the transaction meets the conditions of Rule 701(c).
    • Foreign Private Issuers May Rely on Safe Harbor.  Foreign private issuers would also be able to rely on this safe harbor when making a determination of the number of U.S. resident holders under Exchange Act Rule 12g2-1(a).

Additional Information

This update highlights key provisions of the proposed rules. You can read the full text of the proposed rules here. You can find more information about these issues and discussions of other recent cases, laws, regulations and rule proposals of interest to companies involved in M&A transactions on our website.

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