February 05, 2015
Securities Law Alert
The Securities and Exchange Commission (the “SEC”) is continuing its rule-making efforts to give effect to the JOBS Act which was passed in 2012. This Securities Law Alert discusses rule amendments proposed by the SEC to give effect to new shareholding thresholds for registration as a public company, deregistration and suspension of registration for banks and bank holding companies. The SEC has also proposed a safe harbor to enable issuers to exclude certain employee compensation securities from the new threshold, and a framework for excluding “accredited investors” from the new threshold.
The Jumpstart Our Business Startups Act, or JOBS Act, was signed into law in April 2012. The Securities and Exchange Commission (the “SEC”) has since come out with regulations effecting various provisions of the JOBS Act, including final regulations on the easing of restrictions on general solicitation and proposed regulations on crowdfunding. On December 18, the SEC issued a release (the “Release”), to give effect to Titles V and VI of the JOBS Act, to:
The SEC is seeking public comment on the rule amendments proposed in the Release through March 2, 2015.
Prior to the JOBS Act, Section 12(g) of the Securities Exchange Act of 1934 (the “Exchange Act”) required an issuer to register its securities if, at the end of its prior fiscal year, the securities were “held of record” by more than 500 persons and the issuer had assets in excess of $10 million. The JOBS Act revised the holders of record threshold requirement for registration to (i) 2,000 persons, or (ii) 500 persons who are not accredited investors.
Further, specifically as to banks and bank holding companies, the JOBS Act revised the thresholds for registration, termination of registration and suspension of reporting. The holders of record threshold for registration of a class of securities, which was the same as that for all other issuers, was increased for banks and bank holding companies to 2,000 or more persons. Unlike with other issuers, however, the thresholds for termination of registration and suspension of reporting for banks and bank holding companies were increased to 1,200 persons. The JOBS Act left the thresholds relating to the termination of registration and suspension of reporting unchanged for issuers other than banks and bank holding companies.
The changes to the registration, termination of registration and suspension of reporting obligations for issuers, including those for banks and bank holding companies, came into effect immediately when the JOBS Act was passed. The Release proposes amendments to existing rules under the Exchange Act to reflect the new JOBS Act thresholds. Specifically, the Release proposes to reflect the new thresholds in provisions establishing mechanisms for termination of registration and suspension of reporting, such as filing of certifications on Form 15, and time periods for effectiveness of the termination or suspension. If adopted, the amendments would allow banks and bank holding companies to utilize procedural accommodations available to other issuers regarding termination of registration and suspension of reporting. They would also allow banks and bank holding companies to automatically suspend reporting with respect to any class of equity security held of record by less than 1,200 persons at the beginning of its fiscal year, so long as the issuer did not have a registration statement under the Securities Act of 1933 (the “Securities Act”) that became effective during the prior year.
According to the SEC’s estimates, as of June 30, 2014, more than 90 banks and bank holding companies had utilized the new JOBS Act thresholds to terminate registration or suspend reporting. With the clarity that the proposed amendments are expected to bring to the mechanism for deregistration and suspension of reporting, we expect to see additional deregistrations and suspensions after the adoption of the proposed amendments.
Because of the definition of “bank” and “bank holding companies” under relevant legislations, the benefits of the new thresholds for registration, termination of registration and suspension of reporting obligations introduced by the JOBS Act for banks and bank holding companies do not apply to savings and loan holding companies. In light of the equivalent regulatory oversight over these entities, the SEC has also proposed to extend the benefit of the higher thresholds to savings and loan holding companies, which were not explicitly covered by the JOBS Act. This proposed change is expected to extend the benefits of increased registration and deregistration thresholds to approximately an additional 90 reporting companies.
As discussed above, the JOBS Act increased the holder of record threshold that triggers the registration requirement for an issuer that is not a bank or bank holding company to 2,000 persons, or 500 persons who are not “accredited investors.”
The most common usage of the concept of “accredited investor” is in the context of a private placement under Regulation D of Rule 506, which allows a private placement of an unlimited dollar amount of securities so long as 35 or fewer purchasers are not accredited investors who fulfill certain income and net worth criteria, and there is compliance with the other requirements of Rule 506. Although the JOBS Act left it to the SEC to define “accredited investor” for the purposes of triggering the registration requirements under Section 12(g), the SEC has proposed using the definition in Regulation D. We find this to be an appropriate approach, since an issuer typically goes through one or more rounds of private placements prior to becoming a reporting issuer, whether through an initial public offering or by triggering the Section 12(g) thresholds. An issuer that is not yet subject to the registration requirements of the Securities Act and is thus required to monitor its holders of record, including their status as accredited investors, will likely have a working understanding of the Regulation D definition and the measures used to verify accredited investor status for purposes of Regulation D.
Timing is a key difference between the evaluation of accredited investors for purposes of Regulation D and for purposes of determining Exchange Act registration thresholds. While under Regulation D accredited investor status is determined at the time of sale, for purposes of Section 12(g) of the Exchange Act the determination of accredited investor status would need to be made on the last day of each fiscal year. While the SEC has recognized that a safe harbor or other guidance may be required to aid compliance by issuers, it has not proposed a safe harbor. Instead, the SEC has sought comments on various approaches that it may take in its final rule-making in this regard, including:
SEC has not proposed a framework for the determination of holders who are accredited investors, and, therefore, the eventual form taken by the guidance or safe harbor, if any, may vary significantly and may be impacted by the comments received by the SEC in response to the Release. Whether the guidance or safe harbor would emphasize investor protection or burden reduction on issuers may also depend on data regarding usage of the alternative means to verify a person’s status as an accredited investor per new Rule 506(c), which permits fundraising by general advertising and general solicitation under Regulation D. Early data showed a weak usage of the new rule—almost 900 new offerings were conducted in reliance on the new exemption by March 2014, raising approximately $10 billion, whereas 9,200 offerings under the old Rule 506 exemption (now Rule 506(b)), resulted in the sale of over $233 billion in securities in the same period of time. The form of the final guidance or safe harbor will also be impacted by expected SEC rulemaking to revisit the accredited investor definition, as mandated by the Dodd-Frank Act.
The Exchange Act, as amended by the JOBS Act, asserts that the definition of “held of record” for purposes of triggering the registration requirement under Section 12(g) excludes securities held by persons who received them under an “employee compensation plan” in transactions exempt from the registration requirements of Section 5 of the Securities Act. Existing rules under the Exchange Act provide issuers with an exemption from Section 12(g) for stock options issued under written compensatory stock option plans. The JOBS Act directed the SEC to establish a safe harbor for issuers determining whether securities held by persons were received under an “employee compensation plan” in an exempt transaction, which is significantly broader than the existing Exchange Act rules.
Citing a comment letter from the American Bar Association, the SEC proposed broadening the JOBS Act safe harbor to cover not only securities in an exempt transaction, but also those issued in reliance of a “no sale” theory. Issuers regularly take the position that issuance of compensatory grants to broad groups of employees, where no consideration is received by the issuer, is not an “offer or sale” of securities under Section 2(a)(3) of the Securities Act.
Instead of proposing a new definition, the safe harbor offered in the Release relies on the definition of “compensatory benefit plan” in Securities Act Rule 701, which contains an exemption from Securities Act registration requirements for offers and sales of securities pursuant to certain compensatory benefit plans and contracts relating to compensation. The SEC has proposed a non-exclusive safe harbor; an issuer can, in the alternate, rely on the safe harbor as well as the words of the legislation. The safe harbor would apply to plan participants enumerated in Rule 701(c), which include employees, directors, general partners, trustees, officers and certain advisors and consultants, and their family members acquiring such securities from these persons through gifts or domestic relations orders.
The Release also proposes permitting an issuer to exclude holders (i) who are eligible plan participants under Rule 701(c), and (ii) who acquired the securities in exchange for securities excludable under the proposed definition. Securities would typically be issued in exchange in the context of restructurings, business combinations and similar transactions, and the proposal seeks to exclude from the count securities surrendered in such a transaction if the transaction is exempt from Securities Act registration.
Therefore, as proposed, the definition of “held of record,” when determining whether the requirement to register securities has been triggered under Section 12(g), would be amended such that an issuer may exclude securities that are either:
However, the safe harbor disappears and the securities would need to be counted as “held of record” if the holders specified in Rule 701(c) were to transfer the securities. We note that the safe harbor is limited to calculating holders of record for purposes of triggering the registration requirement and is not available for calculating the holders of record for purposes of termination of the registration requirement.
By and large, the SEC has taken an issuer-friendly approach in its rule-making mandate under Titles V and VI of the JOBS Act. The proposals around calculating the holders of record and accredited investors for purposes of triggering the Section 12(g) registration requirements appear to lean toward providing safe harbors and guidance, which typically provide clarity and enable a broader uptake of the proposed changes. The proposals also engender clarity and facilitate compliance by piggybacking on existing definitions, as issuers are already familiar with existing concepts.
Less clear is the rulemaking around issuers making a determination of their holders’ accredited investor status. SEC rulemaking that permits easing of general solicitation requirements has been criticized by some as being complicated and costly to use. It is to be hoped that the SEC’s proposal, when finalized, provides clear and easy-to-follow guidance on determining the accredited investor status of holders of records for purposes of requiring registration of a class of securities.
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