Our Voices

Amendments to Rule 701 of the Securities Act of 1933

By Parth S. Munshi, Esq.

On July 18, 2018, as mandated by the Economic Growth, Regulatory Relief, and Consumer Protection Act, the Securities and Exchange Commission (the “SEC”) adopted an amendment to Rule 701 of the Securities Act of 1933, as amended (the “Securities Act”), which provides an exemption from registration for securities issued by non-reporting companies pursuant to compensatory arrangements. Amended Rule 701(e) increases from $5 million to $10 million the aggregate sales price or amount of securities issued during any consecutive 12-month period in excess of which an issuer is required to deliver to employees (and other covered persons) certain disclosures, including financial statements. The rule amendment became effective on July 23, 2018.

Issuers that have commenced an issuance of securities covered by Rule 701 in the current 12-month period will be able to apply the new $10 million disclosure threshold immediately.

The Securities Act requires that any offer or sale of securities (including equity-based compensation such as stock options, restricted stock units and other equity compensation awards) be registered with the SEC unless either the security or the transaction is exempt.

For eligible companies, Rule 701 permits such private companies to make compensatory equity awards to their employees without registering the offering.  However, these transactions are not exempt from the antifraud, civil liability, or other provisions of the federal securities laws. 

Issuers eligible to rely on Rule 701 are those that are not required to file periodic and other reports under Section 13 or 15(d) of the Securities Exchange Act of 1934 and are not investment companies registered or required to be registered under the Investment Company Act of 1940.

Under Rule 701, eligible companies can issue securities to employees and other covered persons (e.g., directors, officers and certain consultants and advisers [1]) without SEC registration if the securities are granted or issued pursuant to a written compensatory benefit plan, which would include an employment agreement, and the aggregate sales price or amount of securities (the value of the securities, or for options the exercise price) sold under Rule 701 does not exceed the greatest of the following in any consecutive 12-month period:

  • $1 million;
  • 15 percent of the total assets of the issuer, measured as of the date of the issuer’s most recent balance sheet; or
  • 15 percent of the outstanding amount of the class of securities being issued in reliance on Rule 701, measured as of the date of the issuer’s most recent balance sheet.

The 12-month period may be measured either on a fixed annual basis or on a rolling 12-month basis, provided that the measurement period is applied consistently and not changed.

In order to qualify for the exemption, an issuer must provide a copy of the applicable compensatory plan to all eligible recipients a reasonable time prior to the sale of securities (i.e., for stock options, prior to the date of exercise; for all other equity awards, prior to the date of grant).

As the rule is amended, if the aggregate sales price or amount of securities issued by the issuer in reliance on Rule 701 exceeded $10 million in a 12-month period (calculated as described above), then, the issuer must also provide enhanced disclosures to all eligible recipients, including:

  • A summary of the material terms of the compensatory plan or compensatory contract;
  • A list of risk factors associated with investing in the issuer’s securities; and
  • Financial statements of the issuer for the two most recently completed fiscal years or the period during which it has been in existence, if shorter, prepared in accordance with the U.S. generally accepted accounting principles (GAAP) and dated not more than 180 days before the issuance. Interim financial statements may be required to make sure that the date of the most recent financial statements is never more than 180 days before the securities are sold or issued.

These financial statements must include consolidated balance sheets and statements of income, cash flows and changes in stockholders’ equity.

The other provisions of Rule 701 were not changed by the amendment.

If issuances under Rule 701 exceed $10 million in a 12-month period, and the required enhanced disclosures have not been provided to all investors before issuance, the issuer will lose the exemption for all of the issuances. To avoid the risk of retroactive loss of the exemption, issuers should maintain robust controls to track the volume and expected timing of sales or grants under their equity compensation plans. An issuer that has a reasonable possibility of issuances in excess of $10 million in a 12-month period generally should consider providing the enhanced disclosures prior to all grant activity.

Securities issued under Rule 701 are deemed to be “restricted securities” as defined in Rule 144 under the Securities Act, and resales of such securities must be in compliance with the registration requirements of the Securities Act or an exemption from those requirements.  Ninety days after the issuer becomes subject to the reporting requirements of Section 13 or 15(d) of the Securities Exchange Act, securities issued under Rule 701 may be resold in reliance on Rule 144, by persons who are not affiliates of the issuer without compliance with the current public information and holding period requirements of Rule 144, and by affiliates without compliance with the holding period requirements.

Our View

While the ability of non-reporting companies to more easily issue equity awards with greater value in lieu of cash compensation is a step in the right direction, the level of the increase to $10 million before enhanced disclosure is required will not have a significant impact for companies wanting to utilize the Rule 701 exemptions.

This memorandum is provided by CKR Law LLP and its affiliates for educational and informational purposes only and is not intended and should not be construed as legal advice. This memorandum is considered advertising under applicable state laws.


[1] Such consultants and advisers must be natural persons and must provide bona fide services to the issuer or its affiliated entities, and the services are not in connection with the offer or sale of securities in a capital-raising transaction, and do not directly or indirectly promote or maintain a market for the issuer's securities.