[Federal Register: July 10, 2007 (Volume 72, Number 131)]
[Proposed Rules]
[Page 37607-37624]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr10jy07-29]
[[Page 37607]]
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Part III
Securities and Exchange Commission
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17 CFR Part 240
Exemption of Compensatory Employee Stock Options From Registration
Under Section 12(g) of the Securities Exchange Act of 1934; Proposed
Rule
[[Page 37608]]
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SECURITIES AND EXCHANGE COMMISSION
17 CFR Part 240
[Release No. 34-56010; International Series Release No. 1303; File No.
S7-14-07]
RIN 3235-AJ91
Exemption of Compensatory Employee Stock Options From
Registration Under Section 12(g) of the Securities Exchange Act of 1934
AGENCY: Securities and Exchange Commission.
ACTION: Proposed rule.
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SUMMARY: The Commission is proposing two exemptions from the
registration requirements of the Securities Exchange Act of 1934 for
compensatory employee stock options. The first exemption would be
available to issuers that are not required to file periodic reports
under the Exchange Act. The proposed exemption would apply only to the
issuer's compensatory employee stock options and would not extend to
the class of securities underlying those options. The second exemption
would be available to issuers that are required to file those reports
because they have registered under Exchange Act Section 12 the class of
securities underlying the compensatory employee stock options.
DATES: Comments must be received on or before September 10, 2007.
ADDRESSES: Comments may be submitted by any of the following methods:
Electronic Comments
Use the Commission's Internet comment form (http://www.sec.gov/rules/proposed.shtml.
); or Send an e-mail to rule-comments@sec.gov. Please include
File Number S7-14-07 on the subject line; or
Use the Federal eRulemaking Portal (http://www.regulations.gov
). Follow the instructions for submitting comments.
Paper Comments
Send paper comments in triplicate to Nancy M. Morris,
Secretary, Securities and Exchange Commission, 100 F Street, NE.,
Washington, DC 20549-1090.
All submissions should refer to File Number S7-14-07. This file number
should be included on the subject line if e-mail is used. To help us
process and review your comments more efficiently, please use only one
method. The Commission will post all comments on the Commission's
Internet Web site http://www.sec.gov/rules/proposed.shtml. Comments
also are available for public inspection and copying in the
Commission's Public Reference Room, 100 F Street, NE., Washington, DC
20549. All comments received will be posted without change; we do not
edit personal identifying information from submissions. You should
submit only information that you wish to make available publicly.
FOR FURTHER INFORMATION CONTACT: Amy M. Starr, Senior Special Counsel
to the Director, at (202) 551-3115, Division of Corporation Finance,
U.S. Securities and Exchange Commission, 100 F Street, NE., Washington,
DC 20549.
SUPPLEMENTARY INFORMATION: We are proposing amendments to rule 12h-1\1\
under the Securities Exchange Act of 1934.\2\
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\1\ 17 CFR 240.12h-1.
\2\ 15 U.S.C. 78a et seq.
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I. Introduction and Background
A. Introduction
In the 1980s, private, non-reporting issuers began using
compensatory employee stock options \3\ to compensate a broader range
of employees, including executive, middle, and lower-level employees,
directors, and consultants.\4\ Compensatory employee stock options
provide a method to use non-cash compensation to attract, retain, and
motivate company employees, directors, and consultants.\5\ Since the
1990s, a number of private, non-reporting issuers have granted
compensatory employee stock options to 500 or more employees,
directors, and consultants.\6\
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\3\ Throughout this release, we use the term ``compensatory
employee stock options'' to refer to stock options issued to
employees, directors, consultants, and advisors (to the extent
permitted under Securities Act Rule 701 [17 CFR 230.701]).
\4\ The National Center for Employee Ownership surveyed 275
venture capital-backed private businesses in the technology and
telecommunications businesses. Of these firms, 77% provided options
to all employees while 23% provided them to only select employees.
``New Data Show Venture-Backed Companies Still Issue Options
Broadly,'' http://www.nceo.org/library/option_venturebacked.html;
See also J. Hand, 2005 ``Give Everyone a Prize? Employee Stock
Options in Private Venture-Backed Firms,'' Working Paper, Kenan-
Flagler Business School, UNC Chapel Hill, available at http://ssrn.com/abstracts=599904
(``Hand Paper'') (study investigating the
impacts on the equity values of private venture-backed firms of the
organizational depth to which they grant employee stock options).
Rule 701, which provides an exemption from Securities Act
registration for non-reporting issuers for offerings of securities
to employees, directors, consultants and advisors, and specified
others, pursuant to written compensatory benefit plans or
agreements, has given private issuers great flexibility in granting
compensatory employee stock options to employees (and other eligible
persons) at all levels. See Rule 701(d) [17 CFR 230.701(d)]; Rule
701 Exempt Offerings Pursuant to Compensatory Arrangements, Release
No. 33-7645, 64 FR 11095 (March 8, 1999) (``Rule 701 Release''); See
also Compensatory Benefit Plans and Contracts, Release No. 33-6768,
53 FR 12918 (April 14, 1988).
\5\ See Hand Paper, note 4 supra.
\6\ See e.g., no-action letters to Starbucks Corporation
(available April 2, 1992); Kinko's, Inc. (available Nov. 30, 1999);
Mitchell International Holding, Inc. (available Dec. 27, 2000)
(``Mitchell International''); AMIS Holdings, Inc. (available July
30, 2001) (``AMIS Holdings''); Headstrong Corporation (available
Feb. 28, 2003); and VG Holding Corporation (available Oct. 31, 2006)
(``VG Holding'').
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Under Section 12(g) \7\ of the Exchange Act, an issuer with 500 or
more holders of record of a class of equity security and assets in
excess of $10 million at the end of its most recently ended fiscal year
must register that class of equity security, unless there is an
available exemption from registration.\8\ Stock options, including
stock options issued to employees under stock option plans, are a
separate class of equity security for purposes of the Exchange Act.\9\
Accordingly, an issuer with 500 or more optionholders and more than $10
million in assets is required to register that class of options under
the Exchange Act, absent an available exemption. While there is an
exemption from Exchange Act Section 12(g) registration for interests
and participations in certain other types of employee compensation
plans involving securities,\10\ currently there is no
[[Page 37609]]
exemption for compensatory employee stock options.
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\7\ 15 U.S.C. 78l(g).
\8\ The asset threshold was set originally at $1 million in
Section 12(g). Pursuant to its authority under Section 12(h) of the
Exchange Act, the Commission has increased the amount three times;
from $1 million to $3 million in 1982 [System of Classification for
Purposes of Exempting Smaller Issuers From Certain Reporting and
Other Requirements, Release No. 34-18647 (April 13, 1982)], from $3
million to $5 million in 1986 [Reporting by Small Issuers, Release
No. 34-23406 (July 8, 1986)], and from $5 million to $10 million in
1996 [Relief from Reporting by Small Issuers, Release No. 34-37157
(May 1, 1996)].
\9\ Exchange Act Section 3(a)(11) [15 U.S.C. 78c(11)] defines
equity security to include any right to purchase a security (such as
options) and Exchange Act Rule 3a-11 [17 CFR 240.3a-11] explicitly
includes options in the definition of equity security for purposes
of Exchange Act Sections 12(g) and 16 [15 U.S.C. 78l(g) and 78p].
Exchange Act Section 12(g)(5) [15 U.S.C. 78l(g)(5)] defines class to
include ``all securities of an issuer which are of substantially
similar character and the holders of which enjoy substantially
similar rights and privileges.''
\10\ The exemption from registration under Exchange Act Section
12(g) which is contained in Exchange Act Rule 12h-1(a), was adopted
in 1965, for ``[a]ny interest or participation in an employee stock
bonus, stock purchase, profit sharing, pension, retirement,
incentive, thrift, savings or similar plan which is not transferable
by the holder except in the event of death or mental incompetency,
or any security issued solely to fund such plans.'' Rule 12h-1 is
intended to exempt from Section 12(g) registration the same types of
employee benefit plan interests as Section 3(a)(2) [15 U.S.C.
77c(a)(2)] of the Securities Act of 1933 [15 U.S.C. 77a et seq.]
exempts from Securities Act registration and, thus, does not cover
stock options. See e.g., L. Loss and J. Seligman, Securities
Regulations, 3d., at Sec. 6-A-4.
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We are proposing an exemption for private, non-reporting issuers
from Exchange Act Section 12(g) registration for compensatory employee
stock options issued under employee stock option plans. We also are
proposing an exemption from Exchange Act Section 12(g) registration for
compensatory employee stock options of issuers that have registered
under Exchange Act Section 12 the class of equity security underlying
those options.
B. Overview of Applicable Exchange Act Provisions
The addition of Section 12(g) to the Exchange Act was intended ``to
extend to investors in certain over-the-counter securities the same
protection now afforded to those in listed securities by providing that
the issuers of certain securities now traded over the counter shall be
subject to the same requirements that now apply to issuers of
securities listed on an exchange.'' \11\ Further, Section 12(g)
extended the disclosure and other Exchange Act safeguards to unlisted
securities as a means to prevent fraud.\12\ The Commission has noted
that the registration requirement of Section 12(g) was aimed at issuers
that had ``sufficiently active trading markets and public interest and
consequently were in need of mandatory disclosure to ensure the
protection of investors.'' \13\
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\11\ House of Representatives Report No. 1418 (1964), 88th
Cong., 2d Sess., HR 679, p.1. See also Section 3(c) of the
Securities Act Amendments of 1964, Pub.L. 88-467; 78 Stat. 565.
\12\ Senate Committee Report, No. 379 (1963), 88th Cong., 1st
Sess., p. 63.
\13\ Reporting by Small Issuers, Release No. 34-23407 (July 8,
1986).
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Exchange Act Section 12(h) \14\ provides the Commission with
exemptive authority with regard to certain provisions of the Exchange
Act. Included in Exchange Act Section 12(h) is the authority to create
appropriate exemptions from the Exchange Act registration requirements.
Under Exchange Act Section 12(h), the Commission may exempt a class of
securities by rules and regulations or by exemptive order if it
``finds, by reason of the number of public investors, amount of trading
interest in the securities, the number and extent of the activities of
the issuer, income or assets of the issuer, or otherwise, that such
action is not inconsistent with the public interest or the protection
of investors.'' \15\
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\14\ 15 U.S.C. 78l(h).
\15\ Exchange Act Section 12(h) [15 U.S.C. 78l(h)].
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C. Historical Treatment of Compensatory Employee Stock Options Under
Exchange Act Section 12(g)
A number of private, non-reporting issuers faced with registration
under Exchange Act Section 12(g) due solely to their compensatory
employee stock options being held by 500 or more holders of record (as
well as having more than $10 million in assets) at the end of their
fiscal year have requested registration relief from our Division of
Corporation Finance.\16\ Since 1992, the Division has provided relief
through no-action letters \17\ to these private issuers when specified
conditions were present.
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\16\ The Division has delegated authority to grant (but not
deny) applications for exemption under Exchange Act Section 12(h).
See Rule 200.30-1(e)(7) [17 CFR 200.30-1].
\17\ For the conditions necessary to receive relief under these
letters and orders see, for example, the no-action letter to
Mitchell International, note 6 supra (for the pre-2001 relief) and
the no-action letters to AMIS Holdings, note 6 supra; ISE Labs, Inc.
(available June 2, 2003); Jazz Semiconductor, Inc. (available Nov.
21, 2005) (``Jazz Semiconductor''); and VG Holding, note 6 supra
(for the modified relief beginning in 2001).
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Before 2001, the Division's no-action relief in this area was
conditioned on, among other things, the options terminating at the time
employment terminated. Further, that relief was conditioned on the
compensatory employee stock options not being exercisable until after
either the issuer's initial public offering or the time at which the
issuer was no longer relying on the relief.\18\ Beginning in 2001, the
Division announced modified conditions to registration relief for
compensatory employee stock options of private, non-reporting issuers
that, due to market conditions, were delayed in their plans to go
public.\19\ Because the Division's no-action relief applies only to the
private, non-reporting issuer's compensatory employee stock options,
once that issuer has 500 or more holders of record of any other class
of equity security (including, for example, common stock outstanding as
a result of stock issuances, including option exercises), it would be
required to register that other class of equity security under Exchange
Act Section 12(g).
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\18\ See e.g., no-action letters to Kinko's, Inc., note 6 supra;
General Roofing Services, Inc. (available April 5, 2000); and
Mitchell International, note 6 supra.
\19\ See Division of Corporation Finance, Current Issues and
Rulemaking Outline Quarterly Update (March 31, 2001).
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The Division's no-action letters providing Exchange Act Section
12(g) registration relief to private, non-reporting issuers currently
include the following parameters:\20\
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\20\ Following the announcement of the modified conditions to
relief in 2001, issuers were still able to request relief under the
former conditions. Since 2002, however, issuers have received relief
based on the modified factors only. See e.g., no-action letters to
Jazz Semiconductor, note 17 supra; Network General Corporation
(available May 22, 2006); Avago Technologies Limited (available Oct.
6, 2006); and VG Holding, note 6 supra. Our discussion regarding the
current conditions to relief under the no-action letters refers only
to the modified conditions set forth in the most recently issued no-
action letters.
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Scope of Relief
The relief is limited solely to compensatory employee
stock options granted under stock option plans; and
No security appreciation rights or other rights may be
issued in connection with the compensatory employee stock options.
Eligible Participants
The compensatory employee stock options may be issued to a
broad class of participants comprised only of employees, directors, and
consultants (to the extent permitted under Securities Act Rule 701) of
the issuer, its parents, or of majority-owned, direct or indirect,
subsidiaries of the issuer or its parents.
Exercisability
The exercisability of the compensatory employee stock
options need not be limited while the optionholder is an employee,
director, or consultant; however, if the compensatory employee stock
options are not exercisable, there are modified information conditions.
Transferability and Ownership Restrictions
There may be no means through which optionholders may
receive compensation or consideration for the compensatory employee
stock options (or the securities to be received on exercise of the
compensatory employee stock options) before exercise; \21\
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\21\ This would not include payments received on exercise by an
issuer or its affiliates of a repurchase right or obligation with
regard to the options or the shares received on exercise of the
options. See e.g., no-action letter to VG Holding, note 6 supra.
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The compensatory employee stock options must remain non-
transferable in most cases, but the compensatory employee stock options
may transfer on death or disability of the optionholder or to family
members (as defined in Securities Act Rule 701) by gift or pursuant to
domestic relations orders. These permitted transferees are not allowed
to further transfer compensatory employee stock options. There may be
no other pledging,
[[Page 37610]]
hypothecation or donative transfer of compensatory employee stock
options or the securities underlying the options;
The securities received on exercise of the compensatory
employee stock options may not be transferable, except back to the
issuer (or to affiliates of the issuer if the issuer is unable to
repurchase the shares), to family members under Rule 701 by gift or
pursuant to domestic relations orders, or in the event of death or
disability. These permitted transferees are not allowed to further
transfer these securities. There may be no other pledging,
hypothecation or donative transfer of these securities; and
The ability of former employees to retain and exercise
their vested compensatory employee stock options for a period of time
following termination of employment need not be limited.
Information Requirements
The issuer must provide optionholders and holders of
shares received on exercise of compensatory employee stock options with
essentially the same Exchange Act registration statement, annual
report, and quarterly report information they would receive if the
issuer registered the class of securities under Exchange Act Section
12, including audited annual financial statements (prepared in
accordance with generally accepted accounting principles (``GAAP''))
and unaudited quarterly financial information, with the following
specific conditions:
--The registration statement-type document must be delivered promptly
after the issuer receives no-action relief;
--The annual report must be delivered within 90 days after the issuer's
fiscal year end; \22\
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\22\ Since 2006, the time period to deliver the annual report
and the quarterly report was shortened to 90 days and 45 days,
respectively, from the 120 days for the annual report and 60 days
for the quarterly report that was allowed in the earlier no-action
letters relying on the modified conditions. See no-action letters to
VG Holding, note 6 supra and AMIS Holdings, note 6 supra.
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--The quarterly reports must be delivered within 45 days after the end
of the issuer's fiscal quarter; \23\
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\23\ Id.
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--The issuer may condition delivery of the information to an
optionholder on the optionholder signing an appropriate confidentiality
agreement but it must make the information available for examination at
the issuer's offices by optionholders and holders of shares received on
exercise of options unwilling to enter into confidentiality agreements;
--The issuer must provide certifications similar to those required of
reporting issuers; \24\ and
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\24\ The certification condition requires that the issuer's
chief executive officer and chief financial officer include a
certification as required by the first three paragraphs of the
certification required under Item 601(b)(31) of Regulation S-K [17
CFR 229.601(b)(31)]. See e.g., no-action letter to VG Holding, note
6 supra.
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--The issuer must provide specified information relating to option
vesting and changes in the stock option plan.\25\
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\25\ See e.g., no-action letter to VG Holding, note 6 supra.
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D. Recommendation of the Advisory Committee on Smaller Public Companies
The Advisory Committee on Smaller Public Companies, in its Final
Report, recommended that the Commission provide Exchange Act Section
12(g) registration relief for compensatory employee stock options.\26\
In this regard, the Advisory Committee stated:
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\26\ Final Report of the Advisory Committee on Smaller Public
Companies to the Securities and Exchange Commission, April 23, 2006
(``Final Report of the Advisory Committee'').
[H]olders of employee stock options received in compensatory
transactions are less likely to require the full protections
afforded under the registration requirements of the federal
securities laws. Therefore, we believe that such stock options
should not be a factor in determining the point an issuer becomes
subject to the burdens of a reporting company under the Exchange
Act.\27\
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\27\ Id at p. 87.
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E. Overview of the Proposed Exemptions
We believe that it is appropriate at this time to propose two new
exemptions from the registration provisions of Exchange Act Section
12(g) for compensatory employee stock options issued under employee
stock option plans that are limited to employees, directors,
consultants, and advisors of the issuer, its parents, and majority-
owned subsidiaries of the issuer or its parents.\28\ Given the
differences between issuers that are required to file reports under the
Exchange Act and those issuers that do not have such an obligation,
including the nature of the trading markets and the amount of publicly
available information, we believe that it is appropriate to propose
separate exemptions for these different types of issuers.
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\28\ The proposed exemptions would allow compensatory employee
stock options to be held only by those persons described in
Securities Act Rule 701(c) [17 CFR 230.701(c)]. Securities Act Rule
701(c) lists the categories of persons to whom offers and sales of
securities under written compensatory benefit plans or contracts may
be made in reliance on Rule 701 by an issuer, its parents, and
majority-owned subsidiaries of the issuer or its parents. The
categories of persons are: Employees (including specified insurance
agents); directors; general partners; trustees (where the issuer is
a business trust); officers; consultants and advisors (under certain
conditions); family members who acquire their securities from such
persons through gifts or domestic relations orders; and former
employees, directors, general partners, trustees, officers,
consultants and advisors only if such persons were employed by or
providing services to the issuer at the time the securities were
offered. As we note, the proposed amendments use the term ``those
persons described in Rule 701(c)'' to refer to these permitted
holders. For ease of discussion, in this release we use the phrase
``employees, directors, consultants and advisors of the issuer'' to
refer to those persons described in Securities Act Rule 701(c).
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1. Exemption for Issuers That Are Not Exchange Act Reporting Issuers
We believe that an exemption from Exchange Act registration of
compensatory employee stock options for private, non-reporting issuers
will provide useful certainty to those issuers in their compensation
decisions and will help them avoid becoming subject to the registration
and reporting requirements of the Exchange Act prior to the time they
have public shareholders.\29\ Based on the factors identified in
Exchange Act Section 12(h), we believe that it is appropriate to
provide an exemption from Exchange Act Section 12(g) registration to a
specified class of compensatory employee stock options.\30\ We believe
that the conditions to the proposed exemption and the existing
statutory provisions and rules provide holders of compensatory employee
stock options in private, non-reporting issuers appropriate disclosure
and investor protections under the federal securities laws, given the
compensatory circumstances of the securities issuance
[[Page 37611]]
and the restrictions on transferability of the compensatory employee
stock options and shares received on exercise of those options. As
such, we are proposing to amend Exchange Act Rule 12h-1 to provide an
exemption from Exchange Act Section 12(g) registration for compensatory
employee stock options issued under written compensatory stock option
plans of an issuer that does not have a class of securities registered
under Exchange Act Section 12 and is not subject to the reporting
requirements of Exchange Act Section 15(d), where the following
conditions are present: \31\
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\29\ While we agree that an exemption from Exchange Act Section
12(g) registration for compensatory employee stock options is
appropriate, in this regard, we do not agree with the Advisory
Committee statement that holders of employee stock options received
in compensatory transactions do not require the full protections
afforded under the registration requirements of the federal
securities laws.
\30\ We believe that our proposal is consistent with the
exemption provided for other employee benefit plans in Exchange Act
Rule 12h-1, which is not available for stock option plans, the
compensatory employee stock options issued pursuant to such plans,
or the securities issued on exercise of such compensatory employee
stock options. We believe that the characteristics of many employee
benefit plans, which are by their own terms limited to employees,
not available to the general public, and subject to transfer
restrictions, obviate the need for applicability of all the rules
and regulations aimed at public trading markets. In addition,
because many of the proposed conditions refer to certain Securities
Act Rule 701 definitions and requirements, we believe that the
proposed exemption from Exchange Act Section 12(g) registration will
allow non-reporting issuers to continue to rely on Securities Act
Rule 701 in offering and selling compensatory employee stock options
and the shares issued on exercise of those options.
\31\ The conditions build on and modify the current conditions
to relief in the no-action requests discussed above. For example,
the transferability restrictions in the proposed exemption are more
clearly defined; there is no proposed restriction on the
exercisability of the compensatory employee stock options; and the
level of disclosure required to be provided to optionholders and
holders of shares received on exercise of those options is the same
level of information that private, non-reporting issuers relying on
Securities Act Rule 701 for the offers and sales of those options
and securities may be required to provide, rather than the level of
information an issuer with public shareholders is required to
provide. See the discussion under ``Proposed Exemption For
Compensatory Employee Stock Options of Issuers That Are Not Exchange
Act Reporting Issuers,'' below.
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Eligible optionholders are limited to employees,
directors, consultants, and advisors of the issuer;
Transferability by optionholders and holders of shares
received on exercise of the options of compensatory employee stock
options, shares received, or to be received, on exercise of those
options, and shares of the same class as those underlying those options
is restricted; and
Risk and financial information is provided to
optionholders and holders of shares received on exercise of those
options that is of the type that would be required under Rule 701 if
securities sold in reliance on Rule 701 exceeded $5 million in a 12-
month period.\32\
\32\ See the discussion under ``Required Information,'' below.
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The proposed exemption would apply only to a private, non-reporting
issuer's compensatory employee stock options and would not extend to
the class of securities underlying those options.\33\
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\33\ A private, non-reporting issuer would have to apply the
registration requirements of Exchange Act Section 12 to the class of
equity security underlying the compensatory employee stock options
without regard to the proposed exemption. For the class of equity
security underlying the options, for which there could be public
shareholders, no transferability restrictions, and trading interest,
we do not believe a Section 12 registration exemption would be
appropriate.
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The proposed restrictions on the type of issuer eligible to rely on
the exemption, the limitation on who may be granted and hold the
compensatory employee stock options, the transferability restrictions,
and the limitation of the exemption to the compensatory employee stock
options are intended to assure that there is no trading in the options
or shares received on exercise of the options and that there are no
public investors in the compensatory employee stock options that need
the full range of protections that Exchange Act registration and
reporting afford. In light of the circumstances under which private,
non-reporting issuers issue compensatory employee stock options, the
terms of those options, and the information provision requirements of
the proposed exemption, we believe that the proposed amended rule
contains appropriate conditions to an exemption of such compensatory
employee stock options of private, non-reporting issuers from
registration under Exchange Act Section 12(g). As such, we believe that
the proposed exemption is in the public interest, in that it would
clarify and routinize the basis for an exemption from Exchange Act
Section 12(g) registration for compensatory employee stock options so
private, non-reporting issuers would be able to continue to issue
compensatory employee stock options and would provide appropriate
investor protections for optionholders and holders of shares received
on exercise of the options.
2. Exemption for Exchange Act Reporting Issuers
We are proposing to amend Exchange Act Rule 12h-1 to provide an
exemption for compensatory employee stock options of issuers that are
required to file reports under the Exchange Act because they have
registered under Exchange Act Section 12 the class of equity security
underlying those options. The proposed exemption would be available
only where the options were issued pursuant to a written compensatory
stock option plan and the class of persons eligible to receive or hold
the options is limited appropriately. We believe that the proposed
exemption of compensatory employee stock options from Exchange Act
registration is appropriate for purposes of investor protection and the
public interest because the optionholders would have access to the
issuer's publicly filed Exchange Act reports and the appropriate
provisions of Exchange Act Sections 13, 14, and 16 \34\ would apply to
the compensatory employee stock options and the securities issuable on
exercise of the compensatory employee stock options.
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\34\ 15 U.S.C. 78m, 78n, and 78p.
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II. Discussion of Proposals
We are proposing two amendments to Exchange Act Rule 12h-1. These
amendments would:
Provide an exemption for private, non-reporting issuers
from Exchange Act Section 12(g) registration for compensatory employee
stock options issued under employee stock option plans; and
Provide an exemption from Exchange Act Section 12(g)
registration for compensatory employee stock options issued by issuers
that have registered under Exchange Act Section 12 the class of equity
security underlying the compensatory employee stock options.
A. Proposed Exemption for Compensatory Employee Stock Options of
Issuers That Are Not Exchange Act Reporting Issuers
We believe it is appropriate to provide an exemption from Exchange
Act registration for compensatory employee stock options of issuers
that are not required to file reports under the Exchange Act. The
availability of this proposed exemption would be subject to specified
limitations, including limitations concerning permitted optionholders,
transferability and provision of information.
1. Eligible Issuers
The proposed amendment would provide an exemption from Exchange Act
Section 12(g) registration for compensatory employee stock options of
the following types of issuers:
Issuers that do not have a class of securities registered
under Exchange Act Section 12; and
Issuers that are not subject to the reporting requirements
of Exchange Act Section 15(d).\35\
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\35\ Under Section 15(d) of the Exchange Act, an issuer's ``duty
to file [reports under Section 15(d) is] automatically suspended if
and so long as any issue of securities of such issuer is registered
pursuant to section 12 of this title.''[15 U.S.C. 780(d)].
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The proposed exemption is intended to be available only to those
issuers that are not reporting under the Exchange Act. As such, the
proposed exemption would terminate once the issuer became subject to
the reporting requirements of the Exchange Act.\36\
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\36\ The proposed exemption under Exchange Act Section 12 would
allow issuers 60 calendar days to register the class of options once
an issuer was no longer able to rely on the proposed exemption.
Currently, the no-action letter relief terminates once an issuer
becomes subject to the Exchange Act reporting requirements. See
e.g., no-action letter to VG Holding, note 6 supra.
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[[Page 37612]]
Request for Comment
Should the proposed exemption be available to any private,
non-reporting issuer? If not, which categories of non-reporting issuers
should be ineligible for the exemption?
Should the proposed exemption be available to those
issuers that file Exchange Act reports and, thus, hold themselves out
as Exchange Act reporting issuers, but who have neither a class of
securities registered under Exchange Act Section 12 nor an existing
reporting obligation under Exchange Act Section 15(d) (also known as
``voluntary filers'')? Should ``voluntary filers'' be treated
differently under the proposed exemption if they do not have any public
shareholders of any class of their equity securities?
2. Eligible Compensatory Employee Stock Options
The proposed exemption for compensatory employee stock options
would:
Apply only to compensatory employee stock options that are
issued under a written compensatory stock option plan \37\ that is
limited to employees, directors, consultants, and advisors of the
issuer; \38\
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\37\ Securities Act Rule 701 is available only for offers and
sales of compensatory employee stock options and the shares issuable
upon exercise of those options that are issued under written
compensatory employee benefit plans of an issuer, its parents, or
majority-owned subsidiaries of the issuer or its parents. See
Securities Act Rule 701(c) [17 CFR 230.701(c)]. Thus, the proposed
requirement that the options be issued under written compensatory
stock option plans would not impose a new obligation on issuers
relying on Securities Act Rule 701 in offering and selling its
compensatory employee stock options or the shares issued on exercise
of those options.
\38\ The proposed exemption for the compensatory employee stock
options would not extend to other rights issued in connection with
the compensatory employee stock options, such as stock appreciation
rights. Any such other rights would be evaluated separately for
purposes of Exchange Act Section 12(g) registration.
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Apply to all compensatory employee stock options issued
under all of the issuer's written compensatory stock option plans on a
combined basis where the securities underlying the compensatory
employee stock options are of the same class of securities, with the
proposed exemptive conditions applying to the compensatory employee
stock options issued under each option plan; and
Not extend to any class of securities received or to be
received on exercise of the compensatory employee stock options.
The proposed exemption would cover all compensatory employee stock
options of an issuer meeting the conditions of the exemption, even if
the compensatory employee stock options were issued under separate
written option plans. For this purpose, the compensatory employee stock
options would be considered to belong to the same class of equity
security if the same class of securities would be issuable on exercise
of the compensatory employee stock options.\39\
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\39\ See Exchange Act Section 12(g)(5) [15 U.S.C. 78l(g)(5)].
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The proposed exemption would apply to the compensatory employee
stock options only and not to the securities issued (or to be issued)
on exercise of the compensatory employee stock options. Thus, the
issuer would have to apply the registration requirements of Exchange
Act Section 12 to the class of equity security underlying the
compensatory employee stock options without regard to the proposed
exemption.\40\
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\40\ For example, if an issuer had more than $10 million in
assets and 500 or more holders of a class of equity security
underlying the compensatory employee stock options as of the end of
its fiscal year, it would have to register under Exchange Act
Section 12 that class of equity security.
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Request for Comment
Should the exemption cover all compensatory employee stock
options issued under all employee stock option plans of a private, non-
reporting issuer?
Are there employee stock option plans that are not written
that should be included? If so, what types of unwritten plans should be
included and why?
Are there employee stock options issued under written
stock option contracts, other than written stock option plans, that
should be included? If so, what types of written stock option contracts
should be included and why?
We have proposed to provide that the exemption would apply
to all of the issuer's option plans on a combined basis where the
securities underlying the compensatory employee stock options are of
the same class of securities, while the options may be held by
employees, directors, consultants, or advisors of an issuer, its
parents, or majority-owned subsidiaries of the issuer or its parents.
Should the class of options covered by the proposed exemption include
only options issued by the issuer under its written compensatory plans
or should the class of options covered by the proposed exemption also
include options on the issuer's securities that are issued under
written compensatory plans of the issuer's parent, its majority-owned
subsidiaries or majority-owned subsidiaries of the issuer? Please
explain.
3. Eligible Option Plan Participants
The proposed exemption would be available only where the class of
persons eligible to receive compensatory employee stock options under
the stock option plans is limited to those persons described in the
exemption. These eligible optionholders would be the same as those
participants permitted under Rule 701 and would include: \41\
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\41\ See the discussion at note 28 supra.
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Employees of the issuer, its parents, or majority-owned,
direct or indirect, subsidiaries of the issuer or its parents;
Directors of the issuer, its parents, or majority-owned,
direct or indirect, subsidiaries of the issuer or its parents; and
Consultants and advisors of the issuer, its parents, or
majority-owned, direct or indirect, subsidiaries of the issuer or its
parents.
We have proposed that the exemption be limited to those situations
where compensatory employee stock options may be held only by those
persons who are permitted to hold or be granted compensatory employee
stock options under Securities Act Rule 701. We believe that the
experience of issuers and their counsels with Rule 701 will ease
compliance with and limit uncertainty regarding the exemption.\42\
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\42\ In this regard, we note that this category of eligible
optionholders is broader than the category of persons to whom
employee benefit securities, including compensatory employee stock
options may be offered and sold by reporting issuers using a Form S-
8 registration statement. See General Instruction 1(a) to Form S-8
[17 CFR 239.16b].
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Just as Securities Act Rule 701 was designed specifically not to be
available for capital-raising transactions, the proposed exemption
would apply only to employee stock options issued for compensatory
purposes. The restrictions on the eligible participants in the stock
option plans are intended to assure that the proposed exemption is
limited to employee stock options issued solely for compensatory
purposes.\43\
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\43\ All option grants and exercises must, of course, comply
with the requirements of the Securities Act.
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Request for Comment
Should the proposal limit further the types of persons
eligible to hold compensatory employee stock options for purposes of
the exemption? If so, what types of persons should not be eligible?
Is the use of the Securities Act Rule 701 definitions of
eligible participants appropriate for purposes of the proposed
exemption? If not, what definitions should be used to characterize the
optionholders who
[[Page 37613]]
have received the compensatory employee stock options solely for
compensatory purposes and why should another definition be used?
Would the proposed eligibility conditions affect an
issuer's ability to rely on compensatory employee stock options to
attract, retain, and motivate employees, directors, consultants, and
advisors of the issuer?
4. Option Terms
a. Compensatory Employee Stock Option and Share Transferability
Restrictions
The proposed exemption would be available only where there are
certain restrictions on the transferability by an optionholder or
holder of shares received on exercise of a compensatory employee stock
option of those options, the shares issuable on exercise of those
options, or shares of the same class of equity security as those
underlying those options.\44\ Specifically, the proposed exemption
would be available only if: \45\
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\44\ The proposed exemption would not impose any limitations on
the ability of current or former employees, directors, consultants,
or advisors of an issuer to retain or exercise their compensatory
employee stock options. The current no-action letters do, however,
contain certain limitations on retention of both vested and unvested
compensatory employee stock options. See e.g., no-action letter to
VG Holding, note 6 supra.
\45\ The current no-action letters contain similar conditions on
transferability, although the proposed rule clarifies the
limitations on the ability to engage in certain derivative
transactions, such as restrictions on an optionholder or holder of
shares received on exercise of options from entering into a ``put
equivalent position'' or ``call equivalent position'' until the
issuer become subject to the reporting requirements of the Exchange
Act. See e.g., no-action letter to VG Holding, note 6 supra.
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The compensatory employee stock options and the shares
received or to be received on exercise of those options could not be
transferred except: \46\
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\46\ The proposed transferability restrictions would not
supersede other transferability restrictions imposed for other
reasons, including under the Internal Revenue Code of 1986, as
amended [26 U.S.C. 422(b)(5)].
--To family members (as defined in Rule 701) by gift or pursuant to
domestic relations orders; or
--On death or disability of the optionholder; \47\
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\47\ These permitted transferees are intended to be the same as
those permitted under Securities Act Rule 701(c). See note 28 supra.
Optionholders or holders of shares received on exercise of
the compensatory employee stock options through a permitted transfer
from the original holder could not transfer those options or shares
further;
There could be no other permitted pledges, gifts,
hypothecations, or other transfers of the compensatory employee stock
options, shares issued or issuable on exercise of those options, or
shares of the same class of equity security as those underlying those
options by the optionholder or holder of shares received on exercise of
an option, other than transfers back to the issuer (or to affiliates of
the issuer if the issuer is unable to repurchase those options or
shares received on exercise of those options), until the issuer becomes
subject to the reporting requirements of the Exchange Act; \48\
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\48\ If an express prohibition on transfer is not permitted
under applicable state law, the proposed exemption would be
available if the issuer retained the obligation, either directly or
by assignment to an affiliate of the company, to repurchase the
option or the shares issued on exercise of the options until the
issuer becomes subject to the reporting requirements of the Exchange
Act. This repurchase obligation would have to be contained in the
stock option agreement pursuant to which the option is exercised, in
a separate stockholders agreement, in the issuer's by-laws, or
certificate of incorporation. See the discussion under ``Issuer
Obligation to Impose the Conditions to the Proposed Exemption,''
below.
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The compensatory employee stock options, the securities
issued or issuable upon exercise of those options, or shares of the
same class of equity security as those underlying those options could
not be the subject of a short position, a ``put equivalent position''
\49\ or a ``call equivalent position'' \50\ by the optionholder or
holder of shares received on exercise of an option until the issuer
becomes subject to the reporting requirements of the Exchange Act; and
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\49\ 17 CFR 240.16a-1(h). Rule 16a-1(h) defines a ``put
equivalent position'' as a derivative security position that
increases in value as the value of the underlying equity decreases,
including, but not limited to, a long put option and a short call
option position.
\50\ 17 CFR 240.16a-1(b). Rule 16a-1(b) defines a ``call
equivalent position'' as a derivative security position that
increases in value as the value of the underlying equity increases,
including, but not limited to, a long convertible security, a long
call option, and a short put option position.
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There could be no market or available process or
methodology that would permit optionholders or holders of shares
received on exercise of an option to receive any consideration or
compensation for the options, the shares issuable on exercise of the
options, or shares of the same class of equity security as those
underlying the options, except from permitted transfers to the issuer
or its affiliates as discussed above, until the issuer becomes subject
to the reporting requirements of the Exchange Act.
Under the proposal, the exemption would not be available if
optionholders and holders of shares received on exercise of
compensatory employee stock options could enter into agreements, prior
to or after the exercise of those options, that would allow those
holders to monetize or receive compensation from or consideration for
such compensatory employee stock options, the shares to be received
upon exercise of those options, or shares of the same class of equity
security as those underlying those options. Thus, the proposed
conditions provide that, except with regard to the limited permitted
transfers specified in the proposed conditions, an optionholder cannot
be permitted to pledge, hypothecate, or otherwise transfer the
compensatory employee stock options, the shares underlying those
options, or shares of the same class of equity security as those
underlying those options, including through a short position, a ``put
equivalent position,'' or a ``call equivalent position,'' until the
issuer becomes subject to the reporting requirements of the Exchange
Act. The proposed exemption would be conditioned on a similar
restriction on the holders of shares received on exercise of the
options.
The proposed restrictions on transfer of the compensatory employee
stock options, the shares underlying those options, and shares of the
same class of equity security as those underlying those options by an
optionholder or holder of shares received on exercise of an option are
intended to limit the possibility for a trading market to develop for
the compensatory employee stock options or the securities issued on
exercise of those options while the issuer is relying on the proposed
exemption. These restrictions also are intended to assure that an
optionholder or holder of shares received on exercise of an option is
not able to profit from the compensatory employee stock options or the
securities received or to be received on exercise of those options
(except from permitted transfers to the issuer or its affiliates as
discussed above), until the issuer becomes subject to the reporting
requirements of the Exchange Act.
While, in most cases, the securities of private, non-reporting
issuers that are issued on exercise of compensatory employee stock
options are deemed to be restricted securities as defined in Securities
Act Rule 144,\51\ we believe that the proposed transferability
restrictions are necessary to limit further the possibility of a market
developing in the securities issued or issuable on exercise of
immediately exercisable compensatory employee stock options while the
issuer is not reporting under the Exchange Act. Thus, the proposed
[[Page 37614]]
amendments would require that the issuer's securities received on
exercise of compensatory employee stock options be restricted as to
transfer until the issuer becomes subject to the reporting requirements
of the Exchange Act.\52\
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\51\ 17 CFR 230.144. See, e.g., Securities Act Rule 701(g).
\52\ After an issuer becomes subject to the reporting
requirements of the Exchange Act, the issuer would be able to rely
on the exemption for Exchange Act reporting issuers only if it
becomes subject to Exchange Act reporting as a result of its
Exchange Act Section 12 registration of the class of equity security
underlying the compensatory employee stock options.
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The proposed transfer restrictions for the compensatory employee
stock options and the shares received or to be received on exercise of
those options are consistent in most respects with the transfer
restrictions on compensatory securities in Securities Act Rule 701.\53\
In addition, we understand that private, non-reporting issuers
generally restrict the transferability of shares received on exercise
of compensatory employee stock options until the issuer becomes subject
to the reporting requirements of the Exchange Act. As such, we believe
that transferability restrictions should not impose additional
constraints on such private, non-reporting issuers.
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\53\ Securities Act Rule 701(c) and (g). The securities sold in
Rule 701 transactions are deemed to be restricted securities as
defined in Securities Act Rule 144 [17 CFR 230.144]. The transfer
restrictions in the proposed exemption are more restrictive than
those in Rule 701.
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Request for Comment
Should there be any other restrictions on the
transferability by the optionholder or holder of shares received on
exercise of the options of the compensatory employee stock options, the
shares received on exercise of those options, or shares of the same
class of equity security as those underlying those options prior to the
issuer becoming subject to the reporting requirements of the Exchange
Act?
Should there be any other restrictions on the
transferability of the securities received or to be received on
exercise of the compensatory employee stock options or shares of the
same class of equity security as the shares underlying those options?
Should an optionholder be allowed to enter into agreements
to transfer the shares to be received on exercise of the compensatory
employee stock options or shares of the same class of equity security
as the shares underlying those options prior to the exercise of those
options while the issuer is relying on the exemption? If yes, why
should an optionholder be able to enter into such arrangements and how
would such arrangements affect whether an optionholder has received
value for the compensatory employee stock options?
Should there be restrictions on permitted transferees of
compensatory employee stock options being able to further transfer such
options? Should the permitted transferees be able to further transfer
such options to other permitted transferees by gift, pursuant to
domestic relations orders, or on death or disability? What types of
other transfers, if any, should be permitted and why?
Do the proposed restrictive provisions sufficiently cover
hedging transactions by optionholders or holders of shares received on
exercise of the options that would permit such persons to circumvent
the proposed transferability conditions in the proposed exemption?
Should the proposed exemption provide explicitly that the
issuer may repurchase the compensatory employee stock options or shares
received on exercise of those options if the issuer is unable to
prohibit transfers of such options or shares under state law?
Should the restrictive provisions of the proposed
exemption apply to the securities received on exercise of the
compensatory employee stock options for so long as the issuer is
relying on the proposed exemption? If not, please explain.
Should the transfer restrictions on the shares received on
exercise of the compensatory employee stock options, following such
exercise, be a condition to the proposed exemption only if the issuer
does not restrict the transferability of any of the shares of the same
class of its equity security prior to the issuer becoming subject to
the reporting requirements of the Exchange Act?
The proposed exemption provides that there can be no
market or methodology that would permit optionholders or holders of
shares received on exercise of an option to profit from or monetize the
options, the shares received on exercise of the options, or shares of
the same class of equity security as those underlying the options.
These proposed restrictions are not intended to interfere with any
means by which the issuer values its compensatory employee stock
options for purposes of Statement of Financial Accounting Standards No.
123R (``Statement No. 123R'').\54\ Do the proposed conditions affect an
issuer's ability to value compensatory employee stock options for
purposes of Statement 123R? If so, how would the valuation ability be
affected? If affected, what alternative provisions should we consider
that would not interfere with such valuation, yet not permit an
optionholder or holder of shares received on exercise of an option to
monetize or profit from the option, the shares received or to be
received on exercise of the options, or shares of the same class of
equity security as those underlying the options, prior to the issuer
becoming subject to the reporting requirements of the Exchange Act?
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\54\ See Financial Accounting Standards Board Statement of
Financial Accounting Standards No. 123 (revised 2004) Share-Based
Payment.
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b. Permitted Exercisability of Compensatory Employee Stock Options
The proposed exemption would not require that there be any
restriction on the timing of the exercise of the compensatory employee
stock options:
By the optionholder (regardless of whether the
optionholder continues to be an employee, director, consultant or
advisor of the issuer);
In the event of the death or disability of the
optionholder, by the estate or guardian of the optionholder; or
By a family member (as defined in Rule 701) who acquired
the options through a gift or domestic relations order.
Request for Comment
Should there be any restriction on the exercisability of
the compensatory employee stock options while an issuer is relying on
the proposed exemption?
Should the compensatory employee stock options be required
to terminate if the optionholder is no longer an employee, director,
consultant or advisor of the issuer? If so, under what conditions
should the options terminate?
Should the proposed exemption be available only if the
compensatory employee stock options are exercisable only for a limited
time period after the optionholder ceases to be an employee, director,
consultant or advisor of the issuer? If so, should such a limitation on
exercise be different if such a cessation is because of death or
disability, or because of a termination with cause or without cause?
What limited time period should apply and why?
5. Required Information
The proposed exemption would require the issuer to provide
information to optionholders and holders of shares received on exercise
of compensatory employee stock options. This condition would require
the issuer, for purposes of the proposed exemption, to provide the
following information to optionholders (and holders of shares
[[Page 37615]]
received on exercise of compensatory employee stock options):\55\
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\55\ The information conditions may terminate once the company
becomes subject to the reporting requirements of the Exchange Act.
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The same risk and financial information that would be
required to be provided under Securities Act Rule 701 if securities
sold in reliance on Securities Act Rule 701 in a 12-month period
exceeded $5 million, with the optionholders and holders of shares
received on exercise of the compensatory employee stock options always
having been provided required financial statements that are not more
than 180 days old;\56\ and
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\56\ See Securities Act Rule 701(e) [17 CFR 230.701(e)] for a
description of the risk factor and financial statement requirements.
The required information would have to be provided under the terms
of the proposed exemption regardless of whether the issuer would be
required to provide the information under Rule 701 (for example
because the issuer did not sell $5 million in securities in a 12-
month period in reliance on Rule 701).
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The issuer's books and records, including corporate
governance documents, to the same extent that they are available to
other shareholders of the issuer.
The issuer would be permitted to provide the required information
(other than the issuer's books and records) to the optionholders and
holders of shares received on exercise of compensatory employee stock
options either by:
Physical or electronic \57\ delivery of the information;
or
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\57\ Electronic delivery of such information would have to be
made in compliance with the Commission's interpretations regarding
the electronic delivery of information. See e.g., ``Use of
Electronic Media,'' Release No. 34-42728 (April 28, 2000).
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Notice to the optionholders and holders of shares received
on exercise of compensatory employee stock options of:
--The availability of the information on a password-protected Internet
site; and
--Any password needed to access the information.
The basis of the information requirement in the proposed exemption
is the information that would be required to be provided pursuant to
the exemption from Securities Act registration provided in Securities
Act Rule 701 if securities sold in reliance on Securities Act Rule 701
in a 12-month period exceeded $5 million. In Securities Act Rule 701,
we established the type of information that employees holding
compensatory employee stock options must be provided before the
exercise of those options.\58\ The Securities Act Rule 701 information
provisions provide optionholders and other persons who purchase
securities without registration under Rule 701 with important
information. We believe that the ongoing provision of the same
information is necessary and appropriate for purposes of the proposed
exemption from Exchange Act registration.\59\
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\58\ See Rule 701 Release, note 4 supra. ``The type and amount
of disclosure needed in a compensatory securities transaction
differs from that needed in a capital-raising transaction. In a bona
fide compensatory arrangement, the issuer is concerned primarily
with compensating the employee-investor rather than maximizing its
proceeds from the sale. Because the compensated individual has some
business relationship, perhaps extending over a long period of time,
with the securities issuer, that person will have acquired some, and
in many cases, a substantial amount of knowledge about the
enterprise. The amount and type of disclosure required for this
person is not the same as for the typical investor with no
particular connection with the issuer.'' Id.
\59\ As the Commission reminded issuers when it adopted the
amendments to Securities Act Rule 701 in 1999, issuers should be
aware that compliance with the minimum disclosure standards for Rule
701 may not necessarily satisfy the antifraud standards of the
securities laws. See Rule 701 Release, note 4 supra. (Preliminary
Note 1 to Rule 701 states that issuers and other persons acting on
their behalf have an obligation to provide investors with disclosure
adequate to satisfy the antifraud provisions of the federal
securities laws.) We recognize that the Advisory Committee has
recommended modifications to Rule 701 that would affect the
thresholds that would trigger the disclosure provisions of that
rule. Our proposals do not address the Advisory Committee's
recommendations regarding Rule 701. See Final Report of the Advisory
Committee, at p. 92-93.
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Securities Act Rule 701 provides that the required information must
be provided to an optionholder a reasonable period of time before the
date of exercise of the compensatory employee stock options. Rule 701
also requires that the required financial statements must be as of a
date no more than 180 days before the sale of the securities (which in
the case of compensatory employee stock options is the date of exercise
of the options). We believe that the proposed exemption from Exchange
Act registration presents the need for ongoing information to be
provided to optionholders and holders of shares received on exercise of
those options. As such, the proposed exemption would require that the
optionholders and holders of shares received on exercise of the
compensatory employee stock options always be provided the required
financial statements that are not more than 180 days old.
While requiring private, non-reporting issuers to provide
information, the proposed exemption would allow flexibility in the
means of providing the information by permitting physical, electronic,
or Internet-based delivery. Under the proposal, the issuer would be
required to make its books and records available for inspection by the
optionholder and holders of shares received on exercise of compensatory
employee stock options to the same extent that they are available to
other shareholders of the issuer.
To permit issuers to safeguard proprietary or confidential
information that may be contained in the information to be provided,
the proposed exemption would permit provision of the disclosure to be
conditioned on the optionholder (or holder of shares received on
exercise of compensatory employee stock options) agreeing to maintain
the confidentiality of the information.\60\ As proposed, if an
optionholder (or holder of shares) chooses not to enter into such a
confidentiality agreement, the exemption would permit the issuer to
choose to not provide the information to that optionholder or holder of
shares received on exercise of options if it allows inspection of the
documents at one of the described issuer offices.
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\60\ This proposed provision is consistent with the related
information required under Securities Act Rule 701.
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In the no-action registration relief provided to issuers to date,
the staff of the Division of Corporation Finance has provided that
relief only where the issuer commits to providing essentially the same
Exchange Act information and reports as if it was subject to the
Exchange Act reporting requirements. We believe that our experience
with Securities Act Rule 701 and the combined conditions of the
proposed exemption, including the eligibility and transferability
provisions, alleviate the need for that level of information in the
context of an on-going reporting exemption relating to compensatory
employee stock options.\61\ As such, we believe that the scope of
information that the optionholders and holders of shares will be
provided under the proposed exemption is not inconsistent
[[Page 37616]]
with investor protection and the public interest.\62\
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\61\ As the Commission also recognized when it adopted the
Securities Act Rule 701 amendments in 1999, and because many issuers
that have 500 or more optionholders and more than $10 million in
assets are likely to have received venture capital financing (see
for example the data in the Hand Paper, note 4 supra), we believe
that many of these issuers already have prepared the type of
disclosure required in their normal course of business, either for
using other exemptions, such as Regulation D, or for other purposes.
As a result, the disclosure requirement generally would be less
burdensome for them. In adopting the amendments to Rule 701, we
stated that a minimum level of disclosure was essential to meet even
the reduced level of information needed to inform compensatory-type
investors such as employees and consultants. See Rule 701 Release,
note 4 supra.
\62\ For a private, non-reporting issuer with a significant
number of optionholders (and with more than $10 million in assets at
the end of its fiscal year), we believe it is likely that such
issuer either already is obligated to provide the same information
to optionholders due to sales of securities in reliance on
Securities Act Rule 701 or already prepares and, as such, provides
such information to its shareholders. As a result, it is likely that
optionholders and holders of shares received on exercise of those
options already will have received such disclosures in connection
with the option grants and exercises and, because of the proposed
transferability restrictions on the compensatory employee stock
options and the shares received or to be received on exercise of
those options, will not have further investment decisions to make,
until the issuer becomes subject to the reporting requirements of
the Exchange Act. Consequently, we believe that the disclosure
required under the proposed exemption is the appropriate level of
disclosure to be provided option holders and holders of shares
received on exercise of those options until the issuer becomes
subject to the reporting requirements of the Exchange Act.
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Request for Comment
Should the proposed exemption require additional
information to be provided? If so, what additional information should
be required?
Should the proposed exemption require that audited
financial statements be provided in all cases, even if the issuer does
not otherwise prepare audited financial statements?
Should the proposed exemption also require that the
information be provided in specified time frames prior to the exercise
of the compensatory employee stock options?
Should the proposed exemption require that the information
be provided to holders of shares received on exercise of the
compensatory employee stock options until the issuer becomes subject to
the reporting requirements of the Exchange Act or for so long as the
issuer is relying on the proposed exemption? If not, should there be
restrictions on the information provided and, if so, what restrictions
should be imposed and why?
Should the proposed exemption apply to holders of shares
received on exercise of compensatory employee stock options only if the
issuer has a repurchase right in the event of an attempted transfer of
the shares? If so, what information would be provided to a holder of
shares prior to the issuer becoming a reporting issuer under the
Exchange Act?
As proposed, the issuer could provide the required
information by physical, electronic, or Internet-based delivery. Is it
appropriate to allow issuers to choose how to satisfy this requirement
by using these alternate means? What role should investor preference
play?
Should the condition specifying the manner in which the
information should be provided mandate that the information be
available through a password-protected Internet site?
The proposed exemption would require that issuers make
their books and records available to optionholders and to holders of
shares received on exercise of the options to the same extent they are
available to other shareholders of the issuer. Is this an appropriate
information requirement for the proposed exemption? If not, why not?
What books and records and corporate governance documents do private,
non-reporting issuers provide to optionholders and holders of shares
received on exercise of options? Would this condition affect issuers'
practices of granting options to consultants and advisors? If so, why?
As proposed, the exemption does not require private, non-
reporting issuers to provide optionholders or holders of shares
received on exercise of an option with the information that would be
required to be disclosed by our issuer tender offer rules (Exchange Act
Rule 13e-4) \63\ or going private transaction rules (Exchange Act Rule
13e-3) \64\ if the compensatory employee stock options (or shares
received on exercise of those options) were registered pursuant to
Exchange Act Section 12(g). Should the information disclosure
requirements of the proposed exemption be expanded to require
disclosure of additional information such as any information that would
otherwise be required by Rule 13e-3 or Rule 13e-4? If so, what
information should be required to be provided?
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\63\ 17 CFR 240.13e-4.
\64\ 17 CFR 240.13e-3.
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In addition, beneficial ownership of compensatory employee
stock options not Exchange Act Section 12-registered in reliance on the
proposed exemption would not trigger the beneficial ownership reporting
requirements in Exchange Act Regulation 13D-G \65\ unless the options
were exercisable for Section 12 registered securities within 60 days.
Is this the correct result?
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\65\ 17 CFR 240.13d-1 through 240.13d-102.
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6. Issuer Obligation To Impose the Conditions to the Proposed Exemption
For the proposed exemption to be available, a private, non-
reporting issuer would be required to include the necessary limitations
and conditions either in the written stock option plans or within the
terms of the individual written option agreements. In addition, the
transferability restrictions on the shares received on exercise of the
compensatory employee stock options also must be included in the
issuer's by-laws, certificate of incorporation, or a stock purchase or
stockholder agreement between the issuer and the exercising
optionholder or holder of shares received on exercise of an option. We
believe that the self-executing nature of the proposed exemption
necessitates the inclusion of the conditions to the exemption in an
enforceable agreement between the issuer, the optionholders, and the
holders of shares received on exercise of an option, or in the issuer's
by-laws or certificate of incorporation.
Request for Comment
Should the proposed exemption require that the conditions
be contained in a particular written document or should the proposed
exemption allow the conditions to be contained in any agreement between
the issuer, the optionholders, and the holders of shares received on
exercise of an option?
Should the proposed exemption permit any of the
conditions, including the transferability restrictions on the shares
received on exercise of the compensatory employee stock options, to be
included in the issuer's by-laws or certificate of incorporation?
B. Proposed Exemption for Compensatory Employee Stock Options of
Exchange Act Reporting Issuers
To provide certainty regarding the obligations of issuers that
already have registered the securities underlying the compensatory
employee stock options under the Exchange Act, we believe it is
appropriate to provide an exemption from Exchange Act registration for
compensatory employee stock options of these reporting issuers.\66\ The
proposed exemption would be available only for an issuer that has
registered under Exchange Act Section 12 the class of equity security
underlying the compensatory employee stock options. Such a registration
gives rise to a requirement to file the reports required under Exchange
Act Section 13.\67\ The filing of these reports is essential to the
proposed exemption, as we believe the
[[Page 37617]]
exemption is appropriate because the Exchange Act reports of those
issuers will provide the appropriate information to optionholders.
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\66\ Public reporting issuers may be unclear regarding the need
to comply with the Exchange Act Section 12(g) registration
requirements for compensatory employee stock options if the issuer
has registered under Exchange Act Section 12 the class of equity
security underlying those options or has registered under the
Securities Act the offer and sale of the options and the shares
issuable on exercise of the options on Form S-8. Consequently, we
believe the proposed exemption will provide important guidance
regarding, and an appropriate exemption to eligible issuers from,
the Exchange Act registration requirement for compensatory employee
stock options.
\67\ 15 U.S.C. 78m.
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As with the proposed exemption for private, non-reporting issuers,
the proposed exemption for issuers subject to the reporting
requirements of the Exchange Act would be available only where the
options were issued pursuant to a written compensatory stock option
plan and where the class of persons eligible to receive or hold
compensatory employee stock options under the stock option plans was
limited to those participants permitted under Securities Act Rule
701.\68\ The proposed exemption from Section 12(g) registration for
compensatory employee stock options of Exchange Act reporting issuers
would not include any information conditions, other than those arising
from the registration of the class of equity security underlying the
options.
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\68\ See the discussion under ``Eligible Option Plan
Participants,'' above, for a description of the eligible
optionholders.
---------------------------------------------------------------------------
As proposed, the availability of the exemption would not be
conditioned on the issuer being current in its Exchange Act reporting.
We have not proposed such a condition, as it would seem inappropriate
for the issuer to lose the exemption, and be required to register a
class of compensatory employee stock options under Exchange Act Section
12(g), because it was late in filing a required Exchange Act report
and, for the days before that report was filed, was not ``current'' in
its Exchange Act reporting. We are requesting comment as to whether it
would be appropriate to include a requirement in the exemption
regarding the issuer's ongoing satisfaction of its Exchange Act
reporting obligations.
While the proposed exemption would apply to the registration of
compensatory employee stock options as a separate class of equity
security, the protections of Exchange Act Sections 13(e) and 14(e) will
continue to apply to offers for those compensatory employee stock
options. Further, the requirements of Exchange Act Section 16 also will
apply to the equity securities underlying the compensatory employee
stock options and the beneficial ownership reporting requirements of
Exchange Act Sections 13(d) and 13(g) \69\ will continue to apply if
the compensatory employee stock options are exercisable for Exchange
Act Section 12 registered securities.\70\ The proposed exemption,
therefore, would be available only to an issuer that had registered
under Exchange Act Section 12 the class of equity security to be issued
on exercise of the compensatory employee stock options. As a result,
the proposed exemption would not be available to an issuer that is
required to file Exchange Act reports solely pursuant to Exchange Act
Section 15(d).
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\69\ 15 U.S.C. 78m(d) and (g).
\70\ The provisions of Exchange Act Section 16 would apply to
the options if the securities to be issued upon exercise of the
options are registered as a class of equity security under Section
12. See 15 U.S.C. 78p and the rules promulgated thereunder. As a
result, we do not believe it is necessary for compensatory employee
stock options to be subject to Section 16 as a separate class of
equity security.
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Request for Comment
Should the proposed exemption apply to any issuer that is
required to file Exchange Act periodic reports, whether or not the
issuer has registered the class of equity security underlying the
compensatory employee stock options under Exchange Act Section 12? If
so, why?
Should the proposed exemption be available only to issuers
that are current in their Exchange Act reporting obligations? Should
the proposed exemption be available only to issuers that, at the end of
their fiscal years, are current in their Exchange Act reporting
obligations? If so, why? If not, why not?
Should the proposed exemption be available to issuers that
are required to file reports under the Exchange Act solely pursuant to
Section 15(d)? If so, why?
How would the exclusion from the proposed exemption affect
issuers required to file reports solely pursuant to Section 15(d) of
the Exchange Act? How many issuers would be affected?
Should the proposed exemption be available to those
issuers that are not required to file Exchange Act reports but file
such reports on a voluntary basis (also known as ``voluntary filers'')
and, if so, why?
Should the proposed exemption apply only to the reporting
obligations under Section 13(a) of the Exchange Act and not to the
application of other Exchange Act provisions, such as the tender offer
provisions of Section 13(e) and Section 14(e) of the Exchange Act?
Please explain.
Is the use of the Securities Act Rule 701 definitions of
eligible participants appropriate for purposes of the proposed
exemption? If not, what definitions should be used to characterize the
eligible optionholders? Should the eligible optionholders only be those
persons permitted to be offered and sold options pursuant to a
registration statement on Form S-8? If so, why?
Should there be any restrictions on the transferability or
ownership of the compensatory employee stock options, the shares
received on exercise of those options, or shares of the same class of
equity security as those underlying those options under the proposed
exemption for reporting issuers?
C. Transition Provisions
The proposed exemption from Exchange Act Section 12(g) registration
for compensatory employee stock options for private, non-reporting
issuers would not affect the no-action relief from Exchange Act Section
12(g) registration of compensatory employee stock options that issuers
have received from our Division of Corporation Finance. While the
existing no-action letters will remain unaffected by the proposed
exemption if adopted, issuers who have received such letters would be
able, of course, to rely instead on the proposed exemption.
The proposed exemptions are self-executing. If the issuer becomes
ineligible to rely on an applicable proposed exemption, the issuer
would be permitted up to 60 calendar days from the date it became
ineligible to rely on the proposed exemption to file a registration
statement to register under Exchange Act Section 12(g) the class of
compensatory employee stock options or, in the case of a reporting
issuer, the class of equity security underlying such options.
Request for Comment
Do the proposed transition provisions of 60 calendar days
provide enough time for private, non-reporting and reporting issuers to
comply with the Exchange Act Section 12 registration requirements upon
the loss of an exemption for the compensatory employee stock options?
Should it be 30 calendar days? 90 calendar days? If not, what time
frame should be provided and why?
Should the proposed exemptions be exclusive exemptions for
Section 12 registration of compensatory employee stock options?
D. General Request for Comment
We request and encourage any interested person to submit comments
on the proposed exemptions and any other matters that might have an
impact on the proposed exemptions. With respect to any comments, we
note that such comments are of greatest assistance to our rulemaking
initiative if accompanied by supporting data and analysis of the issues
addressed in those comments.
[[Page 37618]]
III. Paperwork Reduction Act Analysis
A. Background
Certain provisions of the proposed amendments to Rule 12h-1 \71\
contain ``collection of information'' requirements within the meaning
of the Paperwork Reduction Act of 1995 (``PRA'').\72\ We are submitting
these to the Office of Management and Budget (``OMB'') for review and
approval in accordance with the PRA.\73\ An agency may not conduct or
sponsor, and a person is not required to respond to, a collection of
information unless it displays a currently valid OMB control number.
The title for this information is:
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\71\ 17 CFR 240.12h-1.
\72\ 44 U.S.C. 3501 et seq.
\73\ 44 U.S.C. 3507(d) and 5 CFR 1320.11.
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Exchange Act Rule 12h-1.
The hours and costs associated with preparation of notices,
maintaining Internet sites, and preparation of information to be
disclosed to optionholders and holders of shares received on exercise
of compensatory employee stock options for private, non-reporting
issuers relying on the proposed exemption from Exchange Act Section
12(g) \74\ registration constitute cost burdens imposed by the
collection of information. The proposed exemption available to
reporting issuers would not constitute new collections of information.
The proposed amendments would not affect existing collections of
information.
---------------------------------------------------------------------------
\74\ 15 U.S.C. 78l(g).
---------------------------------------------------------------------------
The proposed exemptions from Exchange Act Section 12(g)
registration would be adopted pursuant to the Exchange Act. The
information collection requirements related to the proposed exemption
for private, non-reporting issuers would be a condition to reliance on
the exemption. There is no mandatory retention period for the
information disclosed and the information disclosed is not required to
be filed with the Commission.
B. Summary of Collection of Information
Our proposed amendments to Exchange Act Rule 12h-1 would provide an
exemption for private, non-reporting issuers from Exchange Act Section
12(g) registration for compensatory employee stock options issued under
employee stock option plans. The proposed amendments also would provide
an exemption from Exchange Act Section 12(g) registration for
compensatory employee stock options of issuers that have registered
under Exchange Act Section 12 the class of equity security underlying
those options.
The proposed requirements regarding notice of information
availability, Internet availability of information, and, for certain
issuers, the preparation of information related to the proposed
exemption from Exchange Act Section 12(g) for compensatory employee
stock options of private, non-reporting issuers would, if adopted,
constitute a new collection of information under the Exchange Act. The
proposed information provision in the proposed exemption for private,
non-reporting issuers would not be a new collection of information for
those private, non-reporting issuers that also are required to provide
such information to optionholders pursuant to Securities Act Rule 701
\75\ or that already prepare and provide such information to their
shareholders.
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\75\ 17 CFR 230.701.
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The collection of information would be required for those private,
non-reporting issuers that rely on the proposed exemption because they
had 500 or more optionholders and more than $10 million in assets at
the end of their fiscal year. The issuers likely to use the proposed
exemption would be those private, non-reporting issuers that had more
than $10 million in assets and had used stock options to compensate
employees, directors, consultants, and advisors on a broad basis. The
proposed exemption from Section 12(g) registration for compensatory
employee stock options of reporting issuers that have registered under
Exchange Act Section 12(g) the class of equity security underlying such
options does not impose any new collection of information on these
reporting issuers.
C. Paperwork Reduction Act Burden Estimates
If the proposed exemption for private, non-reporting issuers is
adopted, we estimate that the annual burden for responding to the
collection of information in the proposed exemption would not increase
significantly for most private, non-reporting issuers, due to the
current disclosure provisions of Securities Act Rule 701 and the
probability that such issuers already prepare such information for
other purposes. The costs may increase for those private, non-reporting
issuers who are not relying on Securities Act Rule 701 when they grant
compensatory employee stock options or who do not prepare the
information for other purposes. The cost of providing such information
may increase because of the requirement in the proposed exemption for
private, non-reporting issuers to provide the required information. We
seek comment on the number of private, non-reporting issuers that would
rely on the proposed exemption that already prepare the information
required by the proposed exemption for other purposes.
Our estimates represent the burden for private, non-reporting
issuers eligible to rely on the proposed exemption. Because the
registration provisions of Section 12(g) apply only to an issuer with
500 or more holders of record of a class of equity security and assets
in excess of $10 million at the end of its most recently ended fiscal
year, only those private, non-reporting issuers satisfying those
thresholds would be subject to the collection of information. The
Division of Corporation Finance has granted no-action relief from
registration of compensatory employee stock options to 30 private, non-
reporting issuers during the period 1992 through 2006. If we assume
that approximately 3 new private, non-reporting issuers would be
relying on the proposed exemption each year and that a certain number
of private, non-reporting issuers will no longer be relying on the
exemption because they have become reporting issuers, have been
acquired, or have terminated business, we estimate that approximately
40 private, non-reporting issuers each year may be relying on the
exemption. The proposed exemption for private, non-reporting issuers
would terminate once such issuer became subject to the reporting
requirements of the Exchange Act. Thus, the number of private, non-
reporting issuers that may rely on the proposed exemption may vary from
year to year.
For purposes of the PRA, we estimate the annual paperwork burden
for private, non-reporting issuers desiring to rely on the proposed
exemption and to comply with our proposed collection of information
requirements to be approximately 20 hours of in-house issuer personnel
time and to be approximately $24,000 for the services of outside
professionals.\76\ These estimates include the time and the cost of
preparing and reviewing the information and making the information
available to optionholders and holders of shares received on exercise
of the options. We assume that the same number of private, non-
reporting issuers would rely on the proposed exemption each year.
---------------------------------------------------------------------------
\76\ For administrative convenience, the presentation of the
totals related to the paperwork burden hours have been rounded to
the nearest whole number and the cost totals have been rounded to
the nearest hundred.
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[[Page 37619]]
We estimate that 25% of the burden of preparation and provision of
the information required by the proposed exemption is carried by the
issuer internally and that 75% of the burden is carried by outside
professionals retained by the issuer at an average cost of $400 per
hour.\77\ The portion of the burden carried by outside professionals is
reflected as a cost, while the portion of the burden carried by the
issuer internally is reflected in hours. We request comment and
supporting empirical data on the number of private, non-reporting
issuers that would rely on the proposed exemption and the burden and
cost of preparing and providing the information required by the
proposed exemption.
---------------------------------------------------------------------------
\77\ In connection with other recent rulemakings, we have had
discussions with several private law firms to estimate an hourly
rate of $400 as the average cost of outside professionals that
assist issuers in preparing disclosures for offerings.
---------------------------------------------------------------------------
D. Request for Comment
We request comment in order to evaluate the accuracy of our
estimate of the burden of the collections of information.\78\ Any
member of the public may direct to us any comments concerning the
accuracy of these burden estimates. Persons who desire to submit
comments on the collection of information requirements should direct
their comments to the OMB, Attention: Desk Officer for the Securities
and Exchange Commission, Office of Information and Regulatory Affairs,
Washington, DC 20503, and should send a copy of the comments to Nancy
M. Morris, Secretary, Securities and Exchange Commission, 100 F Street,
NE., Washington, DC 20549-1090, with reference to File No. S7-14-07.
Requests for materials submitted to the OMB by us with regard to this
collection of information should be in writing, refer to File No. S7-
14-07, and be submitted to the Securities and Exchange Commission,
Office of Filings and Information Services, Branch of Records
Management, 6432 General Green Way, Alexandria, VA 22312. Because the
OMB is required to make a decision concerning the collections of
information between 30 and 60 days after publication, your comments are
best assured of having their full effect if the OMB receives them
within 30 days of publication.
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\78\ Comments are requested pursuant to 44 U.S.C. 3506(c)(2)(B).
---------------------------------------------------------------------------
IV. Cost-Benefit Analysis
A. Background
Compensatory stock options provide a method to use non-cash
compensation to attract, retain, and motivate issuer employees,
directors and consultants. Since the 1990s, a number of private, non-
reporting issuers have granted compensatory employee stock options to
500 or more employees, directors, and consultants. Compensatory
employee stock options also are used routinely by issuers required to
report under the Exchange Act.
Stock options, including stock options issued to employees under
stock option plans, are a separate class of equity security for
purposes of the Exchange Act. Under Section 12(g) of the Exchange Act,
an issuer with 500 or more holders of record of a class of equity
security and assets in excess of $10 million at the end of its most
recently ended fiscal year must register that class of equity security,
unless there is an available exemption from registration. While there
is an exemption from Exchange Act Section 12(g) registration for
interests and participations in certain other types of employee
compensation plans involving securities, currently there is no
exemption for compensatory employee stock options.
B. Summary of Proposed Amendments
We are proposing two exemptions from the registration provisions of
Exchange Act Section 12(g) for compensatory employee stock options
issued under employee stock option plans that are limited to employees,
directors, consultants, and advisors of the issuer.
One proposed amendment to Rule 12h-1 would provide an exemption
from Exchange Act Section 12(g) registration for compensatory employee
stock options of an issuer that does not have a class of securities
registered under Section 12 and is not subject to the reporting
requirements of Exchange Act Section 15(d), where the following
conditions are present:
Eligible optionholders are limited to employees,
directors, consultants, and advisors of the issuer;
Transferability by optionholders and holders of shares
received on exercise of the options of compensatory employee stock
options, the shares received, or to be received, on exercise of those
options, and shares of the same class as those underlying those options
is restricted; and
Risk and financial information is provided to
optionholders and holders of shares received on exercise of those
options that is of the type that would be required under Rule 701 if
securities sold in reliance on Rule 701 exceeded $5 million in a 12-
month period.
The second proposed amendment to Exchange Act Rule 12h-1 would
provide an exemption for compensatory employee stock options of issuers
that are required to file reports under the Exchange Act because they
have registered under Exchange Act Section 12 the class of equity
security underlying those options.
1. Expected Benefits
Benefits of the proposed exemption for private, non-reporting
issuers are likely to include the following: (1) Lower costs to, and
reduced uncertainty for, private, non-reporting issuers desiring relief
from registration under Section 12(g) for compensatory employee stock
options issued to employees, directors, consultants, and advisors for
compensatory purposes; (2) benefits to private, non-reporting issuers
in designing and implementing employee stock option plans without
regard to concerns arising from Exchange Section 12(g) registration of
the compensatory employee stock options; (3) benefits to private, non-
reporting issuers arising from the use of electronic or Internet-based
methods of providing the information necessary to satisfy the
information requirement of the proposed exemption; and (4) benefits to
optionholders and holders of shares received on exercise of options of
private, non-reporting issuers arising from the required provision of
information under the proposed exemption.
Private, non-reporting issuers would benefit from cost savings as a
result of the proposed exemption from Section 12(g) registration of
their compensatory employee stock options. A number of private, non-
reporting issuers that have 500 or more optionholders and assets in
excess of $10 million have hired attorneys and requested no-action
relief from the Division of Corporation Finance with regard to the
registration of the options. The conditions to no-action relief from
the Division include information provision conditions that are more
extensive than in the proposed exemption. The proposed exemption, which
would be self-executing if the provisions of the exemption were
satisfied, would reduce the legal and other costs to a private, non-
reporting issuer arising from the no-action request and relief. Such
cost savings include reduced legal and accounting fees arising from
both the request for no-action relief and for preparation of reports
equivalent to Exchange Act reports of a reporting issuer on an ongoing
basis. Because we expect that a number of the issuers that may take
advantage of the proposed exemption may be smaller issuers, these cost
[[Page 37620]]
savings could be significant relative to revenues.
The proposed amendments would require the same information that the
issuer otherwise would be required to provide if securities sold in
reliance on Securities Act Rule 701 exceeded $5 million during any
consecutive 12-month period. Thus, for private, non-reporting issuers
with a significant number of optionholders (and with more than $10
million in assets at the end of its fiscal year), it is likely that
such issuer either already is obligated to provide the same information
to optionholders due to sales of securities in reliance on Securities
Act Rule 701, or already prepares and, as such, provides such
information to its shareholders. Further, any private, non-reporting
issuer that has received no-action relief regarding registration of its
compensatory employee stock options will face reduced disclosure costs
under the proposed exemption.
The proposed amendment also would benefit private, non-reporting
issuers by providing the less expensive alternative of electronic or
Internet-based methods of providing the information necessary to
satisfy the information requirement of the proposed exemption.
Private, non-reporting issuers also would benefit from the
certainty that the proposed exemption would provide in designing and
implementing compensation programs and employee stock option plans. The
proposed amendments would identify the eligibility provisions and
transfer restrictions that would need to be contained in compensatory
stock option plans or agreements, thereby lessening the need for
issuers, at the time that Section 12(g) registration relief is needed
for the compensatory employee stock options, to amend their stock
option plans and outstanding options to include provisions that would
be necessary to obtain no-action relief. The proposed exemption would
help private, non-reporting issuers avoid becoming subject to the
registration and reporting requirements of the Exchange Act prior to
the time they have public shareholders.
Optionholders and holders of shares received on exercise of options
also would benefit from the proposed exemption. The proposed exemption
assures the provision of the information, including financial
information that is not more than 180 days old, to optionholders and
holders of shares received on exercise of options. Employees,
directors, consultants, and advisors would benefit from the proposed
exemption because private, non-reporting issuers would be able to use
options for compensatory purposes without concern that the option
grants would subject the issuer to Exchange Act registration.
The proposed exemption for reporting issuers also would benefit
optionholders and holders of shares received on exercise of options.
Optionholders and holders of shares received on exercise of options
would have access to the issuer's publicly filed Exchange Act reports.
Further, certain provisions of Sections 13, 14, and 16 would apply to
the options and the securities issuable on exercise of the options.
Holders of shares issued on exercise of those options would have the
same rights as other shareholders of the issuer. Thus, the proposed
exemption eliminates a possible disincentive for issuers to use certain
compensatory employee stock options. This may be a benefit if this type
of compensation is useful in attracting and retaining qualified
employees that increase the issuer's competitiveness.
2. Expected Costs
Issuers would be required to satisfy the provisions of the proposed
amendments, if adopted, to avoid registering under Section 12(g) their
compensatory employee stock options if the registration thresholds are
met at the end of the issuer's fiscal year. Private, non-reporting
issuers may incur certain costs to rely on the proposed exemption
including (1) costs to amend their existing employee stock option plans
if the plans and option grants do not contain the restrictive and
information provisions of the proposed exemption; (2) costs arising
from preparing and providing the information required by the proposed
exemption to the extent that the issuer does not already prepare or
provide such information for other purposes; and (3) costs of
maintaining an Internet site on which the information may be available
if the issuer chooses to use that method to provide the required
information to optionholders and holders of shares received on exercise
of options.
We believe that the provisions of the proposed exemption are
consistent in many respects with the restrictive provisions of other
laws and rules governing option grants and, thus, the costs to private,
non-reporting issuers should not be increased. The proposed exemption
provisions also are consistent with or are more flexible than the
existing conditions for obtaining no-action relief from the Division of
Corporation Finance. Therefore, the costs to private, non-reporting
issuers to prepare the information required by the proposed exemption
may be the same or less than the current costs to the issuer relying on
registration relief provided in a no-action letter issued by the
Division of Corporation Finance.
Those private, non-reporting issuers who do not already prepare the
required information will face costs if they desire to avail themselves
of the proposed exemption. In addition to the costs discussed in the
Paperwork Reduction Act Analysis,\79\ as described below, issuers may
face costs in maintaining the confidentiality of the information
required to be provided, including preparation and enforcement of
confidentiality agreements entered into with optionholders and holders
of shares received on exercise of options. It should be noted, however,
that these increased costs would be borne voluntarily, as it is within
the issuer's control as to the number of optionholders it may have.
Issuers would be able to perform their own cost-benefit analysis to
determine whether to comply with the conditions to the exemption or
avoid issuing options to 500 or more optionholders.
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\79\ See discussion under ``PAPERWORK REDUCTION ACT ANALYSIS,''
above.
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Private, non-reporting issuers may incur costs in providing the
information required under the exemption. These costs may include
printing and sending the information or making the information
available on an Internet site. We request comment on the magnitude of
these potential costs and whether there are any other additional
potential costs.
The Division of Corporation Finance has granted no-action relief
from registration of compensatory employee stock options to 30 private,
non-reporting issuers during the period 1992 through 2006. If we assume
that approximately 3 new private, non-reporting issuers would be
relying on the proposed exemption each year and that a certain number
of private, non-reporting issuers will no longer be relying on the
exemption because they have become reporting issuers, have been
acquired, or have terminated business, we estimate that approximately
40 private, non-reporting issuers each year may be relying on the
exemption. The proposed exemption for private, non-reporting issuers
would terminate once such issuer became subject to the reporting
requirements of the Exchange Act. Thus, the number of private, non-
reporting issuers that may rely on the proposed exemption may vary from
year to year.
For purposes of the Paperwork Reduction Act, the Commission staff
has estimated that the annual paperwork
[[Page 37621]]
burden for private, non-reporting issuers desiring to rely on the
proposed exemption and to comply with our proposed collection of
information requirements to be approximately 20 hours of in-house
issuer personnel time, which is equivalent to $3,500, and to be
approximately $24,000 for the services of outside professionals, for a
total paperwork burden cost of $27,500.\80\ These estimates include the
time and the cost of preparing and reviewing the information and making
the information available to optionholders and holders of shares
received on exercise of the options. The Commission staff assumed that
the same number of private, non-reporting issuers would rely on the
proposed exemption each year. The Commission staff estimated that 25%
of the burden of preparation and provision of the information required
by the proposed exemption would be carried by the private, non-
reporting issuer internally and that 75% of the burden would be carried
by outside professionals retained by the private, non-reporting issuer
at an average cost of $400 per hour.\81\
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\80\ For administrative convenience, the presentation of the
totals related to the paperwork burden hours have been rounded to
the nearest whole number and the cost totals have been rounded to
the nearest hundred.
\81\ In connection with other recent rulemakings, we have had
discussions with several private law firms to estimate an hourly
rate of $400 as the average cost of outside professionals that
assist issuers in preparing disclosures and conducting registered
offerings. Consistent with recent rulemaking releases, we estimate
the value of work performed by the company internally at a cost of
$175 per hour.
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Although a private, non-reporting issuer relying on the proposed
exemption would benefit from cost savings associated with not having to
register the compensatory employee stock options as a separate class of
equity security under the Exchange Act, or obtaining no-action relief,
by not doing so, an optionholder or holder of shares received on
exercise of an option would not have the benefit of the disclosures
contained in Exchange Act reports that the issuer otherwise would be
obligated to file with us, including audited financial statements, or
the disclosures required to be provided under the terms of the no-
action relief.
Optionholders and holders of shares received on exercise of options
also would not be able to freely sell their options or shares received
on exercise of such options while the private, non-reporting issuer is
relying on the proposed exemption. Optionholders and holders of shares
received on exercise of such options would not be able to realize value
from the options or shares until after the private, non-reporting
issuer becomes subject to the reporting requirements of the Exchange
Act. Many private, non-reporting issuers that grant options, however,
currently restrict the transfer of securities held by holders of shares
received on exercise of options, in most cases until after the issuer
becomes subject to the reporting requirements of the Exchange Act or
unless the issuer is acquired by another entity. In some cases,
private, non-reporting issuers retain the right to repurchase options
or shares received on exercise of an option. Any exercise of such
repurchase right by the issuer would be a cost to such issuer.
Request for Comment
We request comment on the costs and benefits to optionholders,
holders of shares received on exercise of compensatory employee stock
options, private, non-reporting issuers, reporting issuers, and others
who may be affected by the proposed exemptions in Rule 12h-1. We
request your views on the costs and benefits described above as well as
on any other costs and benefits that could result from adoption of the
proposed exemptions. We also request data to quantify the costs and
value of the benefits identified.
V. Consideration of Impact on the Economy, Burden on Competition and
Promotion of Efficiency, Competition and Capital Formation Analysis
Section 23(a)(2) \82\ of the Exchange Act requires us, when
adopting rules under the Exchange Act, to consider the impact that any
new rule would have on competition. In addition, Section 23(a)(2)
prohibits us from adopting any rule that would impose a burden on
competition not necessary or appropriate in furtherance of the purposes
of the Exchange Act. We are proposing an exemption for private, non-
reporting issuers from Exchange Act Section 12(g) registration for
compensatory employee stock options issued under employee stock option
plans. We also are proposing an exemption from Exchange Act Section
12(g) registration for compensatory employee stock options of issuers
that have registered under Exchange Act Section 12 the class of equity
security underlying those options.
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\82\ 15 U.S.C. 78w(a)(2).
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We expect that the proposed exemption for private, non-reporting
issuers from Exchange Act registration of compensatory employee stock
options will provide necessary certainty to those issuers in their
compensation decisions and will help them avoid becoming subject to the
registration and reporting requirements of the Exchange Act prior to
the time they have public shareholders. We anticipate that the
exemption would save such private, non-reporting issuers significant
costs and would not require that their confidential issuer information
become public prior to the issuer voluntarily determining to become a
public reporting issuer. Further, we anticipate that the proposed
exemption would continue to provide private, non-reporting issuers
freedom to determine appropriate methods of compensating their
employees, directors, consultants, and advisors without concern that
they would be required to register their compensatory employee stock
options as a class of equity security under Exchange Act Section 12.
Thus, the proposed exemption eliminates a possible disincentive for
issuers to use certain compensatory employee stock options. This may be
a benefit if this type of compensation is useful in attracting and
retaining qualified employees that increase the private, non-reporting
issuer's competitiveness.
The proposed exemption for reporting issuers will provide certainty
regarding the obligations of issuers that already have registered under
the Exchange Act the securities underlying compensatory employee stock
options to register those options under the Exchange Act. In addition,
in the case of these reporting issuers, the optionholders would have
access to the issuer's publicly filed Exchange Act reports and the
appropriate provisions of Sections 13, 14, and 16 would apply to the
compensatory employee stock options and the equity securities issuable
on exercise of those options.
Section 3(f) \83\ of the Exchange Act requires us, when engaging in
rulemaking that requires us to consider or determine whether an action
is necessary or appropriate in the public interest, to consider, in
addition to the protection of investors, whether the action will
promote efficiency, competition, and capital formation.
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\83\ 15 U.S.C. 78c(f).
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We anticipate that the proposed amendments, if adopted, would allow
private, non-reporting issuers to continue to maintain the
confidentiality of information regarding their business and operations
through the use of confidentiality agreements with optionholders and
holders of shares received on exercise of the options. For issuers that
are voluntarily reporting under the Exchange Act or those reporting
issuers that are subject to Exchange Act reporting under Section
[[Page 37622]]
15(d), the proposed exemption from Section 12(g) for compensatory
employee stock options would be unavailable and such issuers would be
required to register under Exchange Act Section 12 the class of equity
security underlying the options in order to take advantage of the
proposed exemption.
We believe that the proposed exemption from Exchange Act
registration for the compensatory stock options may beneficially affect
the issuer's ability to compete for employees because it will allow
such issuers to continue to use employee stock options in their
compensation programs, thus enabling them to compete for such employees
with both private, non-reporting issuers and public reporting issuers.
The proposed exemption also will provide an eligible issuer a more
efficient, self-executing exemption from Exchange Act Section 12(g)
registration of compensatory employee stock options, instead of such
issuer having to seek no-action relief.
The proposed exemptions do not relate to or affect capital
formation, as the compensatory employee stock options covered by the
proposed exemptions are issued for compensatory and not capital raising
purposes.
The proposed exemptions would allow eligible issuers to continue to
have freedom to determine appropriate methods of compensating their
employees, directors, consultants, and advisors. For private, non-
reporting issuers, these compensation decisions could be made without
concern that the issuer would become subject to the Exchange Act
reporting requirements before they had public shareholders.
Request for Comment
We request comment on whether the proposed rule would impose a
burden on competition or whether it would promote efficiency,
competition, and capital formation. Commenters are requested to provide
empirical data and other factual support for their views if possible.
VI. Initial Regulatory Flexibility Analysis
This Initial Regulatory Flexibility Analysis has been prepared in
accordance with 5 U.S.C. 603. It relates to proposed amendments to Rule
12h-1 that would provide two exemptions from the registration
provisions of Exchange Act Section 12(g) for compensatory employee
stock options issued under employee stock option plans that are limited
to employees, directors, consultants, and advisors of the issuer, its
parents, and the majority-owned subsidiaries of the issuer or its
parents.
A. Reasons for the Proposed Action
Compensatory stock options provide a method to use non-cash
compensation to attract, retain, and motivate issuer employees,
directors and consultants. Since the 1990s, a number of private, non-
reporting issuers have granted compensatory employee stock options to
500 or more employees, directors, and consultants. Compensatory
employee stock options routinely are used by issuers required to report
under the Exchange Act as well.
Stock options, including stock options issued to employees under
stock option plans, are a separate class of equity security for
purposes of the Exchange Act. Under Section 12(g) of the Exchange Act,
an issuer with 500 or more holders of record of a class of equity
security and assets in excess of $10 million at the end of its most
recently ended fiscal year must register that class of equity security,
unless there is an available exemption from registration. While there
is an exemption from Section 12(g) registration for interests and
participations in certain other types of employee compensation plans
involving securities, currently there is no exemption for compensatory
employee stock options.
B. Objectives
The primary objective of the proposed amendments is to provide two
exemptions from Exchange Act Section 12(g) registration for
compensatory employee stock options. One proposed exemption would be
for compensatory employee stock options of issuers that do not have a
class of securities registered under Section 12 and are not subject to
the reporting requirements of Exchange Act Section 15(d). The second
proposed exemption would be for compensatory employee stock options of
issuers that are required to file reports under the Exchange Act
because they have registered under Exchange Act Section 12 the class of
equity security underlying those options.
Codifying an exemption from registration for compensatory employee
stock options will provide necessary certainty to issuers in their
compensation decisions and will help private non-reporting issuers
avoid becoming subject to the registration and reporting requirements
of the Exchange Act prior to the time they have public shareholders.
For reporting issuers that have registered under Section 12 the class
of security underlying the compensatory employee stock options, we
believe the proposed exemption of compensatory employee stock options
from Exchange Act registration is appropriate because the optionholders
would have access to the issuer's publicly filed Exchange Act reports
and the appropriate provisions of Sections 13, 14, and 16 would apply
to the compensatory employee stock options and the equity securities
issuable on exercise of those options. The proposed exemptions would
allow private, non-reporting issuers, as well as reporting issuers, to
continue to reward and retain employees with the issuers' securities.
C. Legal Basis
We are proposing the amendments to Rule 12h-1 under the authority
set forth in Sections 12,\84\ 23,\85\ and 36 \86\ of the Securities
Exchange Act of 1934, as amended.
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\84\ 15 U.S.C. 78l.
\85\ 15 U.S.C. 78w.
\86\ 15 U.S.C. 78mm.
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D. Small Entities Subject to the Proposed Rules
The proposed exemptions would not affect issuers that are small
entities. Exchange Act Rule 0-10(a) \87\ defines an issuer to be a
``small business'' or ``small organization'' for purposes of the
Regulatory Flexibility Act if it had total assets of $5 million or less
on the last day of its most recent fiscal year. The registration
requirements of Section 12(g) arise only if an issuer has more than $10
million in assets and has 500 or more holders of a class of equity
security at the end of its most recently ended fiscal year. Small
entities do not satisfy the asset threshold of Section 12(g) and
therefore the proposed exemptions would not be needed by such entities
until their asset size increased to more than $10 million at the end of
a fiscal year.
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\87\ 17 CFR 240.0-10(a).
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