Publications

The SEC Proposes Rules to Implement the JOBS Act Amendments

January 20, 2015
Harter Secrest & Emery

On December 17, 2014, the SEC proposed long-awaited rule amendments to update the mechanics with respect to registration, termination of registration and suspension of reporting requirements under the Exchange Act. The Jumpstart Our Business Startups Act, known as the JOBS Act, previously amended Sections 12(g) and 15(d) of the Exchange Act of 1934 to revise the thresholds for registration, termination of registration and suspension of reporting requirements under the Exchange Act as follows:

  • The registration threshold for shareholders of record increased from 500 to either (i) 2,000 or (ii) 500 who are not accredited investors.
  • A bank or bank holding company must register a class of equity securities if its total assets exceed $10 million and the class of equity securities is held of record by 2,000 or more persons.
  • A bank or bank holding company may deregister and suspend reporting requirements if it has less than 1,200 shareholders of record, an increase from 300 shareholders of record.
  • The definition of “held of record” was amended to exclude shareholders who receive securities under an employee compensation plan if the issuance was exempt from the requirements of Section 5 of the Securities Act of 1933, such as under Rule 701 of the Securities Act.

Prior to the signing of the JOBS Act in 2012, a private company with a growing shareholder base and/or widespread employee stock ownership was at greater risk of becoming subject to the reporting requirements and associated compliance costs of the Securities Exchange Act of 1934 before it was ready to become public due to the lower shareholder of record standard.

The Proposed Rule Amendments

Although the proposed amendments serve primarily to harmonize the Exchange Act rules with the already-effective JOBS Act amendments, the proposed amendments also:

  • Revise the rules so that savings and loan holding companies, which were not covered by the JOBS Act, are treated in a similar manner to banks and bank holding companies.
  • Clarify that the definition of “accredited investor” in Regulation D of the Securities Act will apply in determining which shareholders of record are accredited investors for purposes of Exchange Act registration. A company must determine the accredited investor status of its shareholders of record as of fiscal year-end.
  • Amend the definition of “held of record” to exclude shareholders who receive securities under an employee compensation plan if the issuance was exempt from Securities Act registration or did not involve a sale within the meaning of Section 2(a)(3) of the Securities Act.
  • Create a non-exclusive safe harbor, under which a person will be deemed to have received securities under an employee compensation plan. The safe harbor follows the conditions of Securities Act Rule 701(c).

The proposed amendments to the Exchange Act rules would smooth some procedural kinks that have existed since the JOBS Act amended the corresponding Exchange Act sections. For instance, post-JOBS Act, banks and bank holding companies can deregister and suspend reporting requirements after falling below the new threshold of 1,200 shareholders of record. However, since the corresponding Exchange Act rules still reflect the old threshold, some of these companies cannot take advantage of the Exchange Act rules, which would otherwise allow issuers falling below the thresholds to suspend reporting requirements immediately rather than waiting for 90 days after providing certification to the SEC. The proposed rule revisions would revise the thresholds to allow banks and bank holding companies to suspend reporting requirements immediately upon reaching the updated threshold levels.

Accredited Investor Status

The SEC’s proposed rule revisions confirm that the definition of accredited investor that is used for Securities Act registration under Regulation D would be used when determining the threshold for Exchange Act registration purposes. Issuers must consider accredited investor status as of ­fiscal year-end for purposes of evaluating Exchange Act registration requirements, whereas the Securities Act requires the evaluation to occur at the time of a securities offering. Thus, to ensure compliance with the Exchange Act registration requirements, private companies that have or are approaching 500 or more shareholders of record would need to monitor the accredited investor status of their shareholders on an ongoing basis. The SEC made clear that issuers would not be able to rely on information previously provided by shareholders in connection with the purchase of securities under the Securities Act for an indefinite period of time. Without additional guidance from the SEC, issuers would need to make determinations at fiscal year-end based on the procedures they would use when relying on Rule 506 of Regulation D for a securities offering. In recognition of the practical difficulties of using such an approach, the SEC is soliciting comment from the public regarding the appropriate structure and criteria for a safe harbor or other method of determining accredited investor status at fiscal year-end.

Shareholders of Record

The JOBS Act amendments to the Exchange Act changed the definition of “held of record” to exclude securities held by persons who received them pursuant to an “employee compensation plan” in transactions exempted from the registration requirements of the Securities Act. As proposed, the SEC’s rule revisions will change the definition of “held of record” and establish a non-exclusive safe harbor that relies on the definition of “compensatory benefit plan” in Rule 701 and the conditions in Rule 701(c) of the Securities Act. As proposed, the definition of “held of record” would exclude securities that are either:

  • held by persons who received the securities pursuant to an employee compensation plan in transactions exempt from the registration requirements of the Securities Act or that did not involve a sale within the meaning of Section 2(a)(3) of the Securities Act or
  • held by persons eligible to receive securities from the issuer pursuant to Securities Act Rule 701(c) who received the securities in a transaction exempt from the registration requirements of the Securities Act in exchange for securities excludable under the proposed “held of record” definition; the proposed exclusion would allow the issuer to conduct restructurings, business combinations and similar transactions that are exempt from Securities Act registration while ensuring that the securities acquired by shareholders in exchange for securities that would not have been counted under the proposed definition will also not be counted.

Persons who could be excluded as shareholders of record under the new definition include employees, directors, general partners, trustees, officers or consultants and advisors, and their family members who subsequently acquire the securities through gifts or domestic relations orders. Shareholders who are former employees, directors, general partners, trustees, officers, consultants and advisors may be excluded as long as they were employed or providing services to the issuer at the time the securities were offered. The SEC’s proposed definition for “held of record” also takes into account that issuers sometimes issue securities to employees involving “no sale” under Section 2(a)(3), and that the employees who receive such securities should not be counted as shareholders of record for purposes of the Exchange Act registration requirements. No sale issuances may include the issuance of securities pursuant to a noncontributory pension plan. The non-exclusive safe harbor allows issuers to exclude persons who receive securities received in other employee compensation plan transactions that are exempted from or not subject to registration under Securities Act if the conditions of Rule 701(c) are met.

Looking Ahead

By increasing the threshold for the number of shareholders of record of an issuer’s equity securities that would be required to trigger Exchange Act reporting requirements, while at the same time altering the definition of “held of record” to exclude securities issued pursuant to employee compensation plans, the JOBS Act and the SEC’s proposed rule amendments will allow smaller, private companies to grow a shareholder base and grant securities pursuant to compensatory benefit plans without becoming prematurely subject to the Exchange Act’s reporting requirements and related compliance costs. Although the SEC’s proposed rule amendments clarify certain issues left open by the JOBS Act amendments, it remains to be seen how companies that meet or are approaching the 500 shareholder of record threshold would be expected to monitor accredited investor status on an annual basis.

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