Rule 701 – Exemption for Offers and Sales to Employees of Non-Reporting Entities
While the issuance of small numbers of shares as prizes or awards to employees may be made without Securities Act Registration, if such awards are tied to the achievement of specific goals (eg. sales goals) by individual employees, an offer or sale requiring registration may be involved. When tied to the achievement of specific goals, the share awards may constitute compensation for services performed or to be performed by the employees that would amount to a disposition of the shares for value and a “sale” of the shares to employees requiring either registration or an exemption from registration under the Securities Act of 1933.
Although many exemptions may be available for the issuance of securities to employees, Rule 701 provides an excellent exemption for non-reporting entities. In particular, Rule 701 is only available to issuers that are not subject to the reporting requirements of the Securities Exchange Act 1934. The beauty of Rule 701 is that ninety days after the
A Comprehensive Analysis of Section 5
Section 5 of the Securities Act of 1933, as amended, contains the basic registration requirements for all offerings and rules of securities. Section 5(a) provides that “unless a registration statement is in effect as to a security, it shall be unlawful for any person, directly or indirectly:
- …to sell such security through the use or medium of any prospectus or otherwise; or
- …to transmit through the mails or in interstate commerce any such security for the purpose of sale or for delivery after sale”
Section 5(b) provides that “it shall be unlawful for any person directly or indirectly:
- …to transmit through the mails or in interstate commerce, any prospectus relating to a security with respect to which a registration has been filed…., unless such prospectus meets the requirements of Section 10; or
- …to transmit through the mails or in interstate commerce any such security for the purpose of sale or for delivery after sale, unless accompanied or preceded by a
Section 3(a)(9) Exchanges Evaluated
Section 3(a)(9) of the Securities Act of 1933, provides an exemption from the registration requirements for “[E]xcept with respect to a security exchanged in a case under title 11 of the United States Code, any security exchanged by the issuer with its existing security holders exclusively where no commission or other remuneration is paid or given directly or indirectly for soliciting such exchange.” Generally, in an exchange offer, the issuer offers to exchange new debt or equity securities for its outstanding debt or equity securities.
Since Section 3(a)(9) is a transactional exemption, the new securities issued are subject to the same restrictions on transferability, if any, of the old securities, and any subsequent transfer of the newly issued securities will require registration or another exemption from registration. However, since the new securities take on the character of the old securities, tacking of a holding period is generally permitted allowing for subsequent resales under Rule 144 (assuming all other conditions have
When Can Separate Issuer Offerings That Occur Within a Short Time Be Integrated?
The integration doctrine prevents issuers from circumventing the registration requirements of the Securities Act of 1934 by determining whether two or more securities offerings are really one offering that does not qualify as an exempt offering, or an exempt offering is really part of a registered public offering.
Securities Act Release No. 33-4552 (November 6, 1962) sets forth a five factor test that is used as a guideline in determining whether the separate offerings of an issuer that occur within a short time of one another will be integrated. These same factors are set forth in the Note to Rule 502(a) of Regulation D, which factors address whether the offerings:
- are part of a single plan of financing;
- involve the issuance of the same class of securities (convertible securities, warrants, and other
- derivative instruments generally are deemed to be the same class as the underlying security unless the terms of the primary security prohibit exercises until at least the one
Regulation A and Rule 504
Section 3(b) of the Securities Act gives the SEC authority to exempt from registration certain offerings where the securities to be offered involve relatively small dollar amounts. Under this provision, the SEC has adopted Regulation A, a conditional ex-emption for certain public offerings not exceeding $5 million in any 12-month period. An offering statement (consisting of a notification, offering circular, and exhibits) must be filed with the SEC Regional Office in the region where the company’s principal business activities are conducted. Although Regulation A is technically an exemption from the registration requirements of the Securities Act, it is often referred to as a “short form” of registration since the offering circular (similar in content to a prospectus) must be sup-plied to each purchaser and the securities issued are freely tradeable in an aftermarket.
The principal advantages of Regulation A offerings, as opposed to full registration on Form S-1, SB-1 or SB-2, are:
- Required financial statements are simpler and need not
SEC Stock Buyback Rules Examined
SEC Rule 10b-18 provides issuers with a safe harbor from liability for market manipulation under Sections 9(a)(2) and 10(b) of the Exchange Act and Rule 10b-5 under the Exchange Act when issuers bid for or repurchase their common stock in the market in accordance with the Rule’s manner, timing, price and volume conditions. Each of the conditions of Rule 10b-18 must be satisfied on each day that a repurchase is made.
Rule 10b-18
The material portions of Rule 10b-18 are as follows:
Definition. A “Rule 10b-18 purchase” is generally defined as a purchase or any bid or limit order of an issuer’s common stock by or for the issuer or any of the issuer’s affiliated purchasers.
To be able to rely on Rule 10b-18 in make repurchases, the following four (4) conditions must be met.
- Time of Purchase. The Rule restricts issuers from making repurchases that constitute the opening transaction in the security on a trading day, or
Transparency in the Financial Markets and the Materiality Standards
The disclosure requirements at the heart of the federal securities laws involve a delicate and complex balancing act. Too little information provides an inadequate basis for investment decisions; too much can muddle and diffuse disclosure and thereby lessen its usefulness. The legal concept of materiality provides the dividing line between what information companies must disclose, and must disclose correctly, and everything else. Materiality, however, is a highly judgmental standard, often colored by a variety of factual presumptions.
Transparency in Financial Markets
The guiding purpose of the many and complex disclosure provisions of the federal securities laws is to promote “transparency” in the financial markets. However, the task of winnowing out the irrelevant, redundant and trivial from the potentially meaningful material falls on corporate executives and their professional advisors in the creation of corporate disclosure, and on investment advisors, stock analysts and individual investors in its interpretation. The concept of materiality represents the dividing line between information reasonably likely to influence
10b5-1 Trading Plans and Material Non-Public Information
As a safe harbor from insider trading liability, Rule 10b5-1 provides that a purchase or sale of securities will not be deemed to be on the basis of material nonpublic information if it is pursuant to a contract, instruction or plan that (i) was entered into before the person became aware of the information; (ii) specifies the amounts, prices, and dates for transactions under the plan (or includes a formula for determining them); and (iii) does not later allow the person to influence how, when or whether transactions will occur.
Good Faith Practices When Establishing Trading Plans
In addition, the plan must be entered into in good faith and not as part of a scheme to evade the insider trading laws. Particular care should be taken to avoid adopting or amending trading plans when in possession of material nonpublic information. On June 4, 2009, The SEC filed an insider trading complaint against Angelo Mozilo, the former CEO of Countrywide Financial
Proper Use of S-8 Registration Statements
A Form S-8 registration statement is popular with small business issuers because it becomes effective immediately upon filing and allows for incorporation by reference, two benefits not always available to smaller public companies. A Form S-8 registration statement can be used by Issuers to register securities to be offered to employees under certain employee benefit plans.
To qualify to use an S-8 registration statement the Issuer must: (i) be subject to the reporting requirements of the Securities Exchange Act of 1934, as amended; (ii) have filed all reports required to be filed during the preceding 12 months, or such shorter period of time that the Issuer has been subject to the reporting requirements; (iii) is not a shell company and has not been a shell company for at least 60 calendar days previously; and (iv) if it has been a shell company at any time previously, has filed current Form 10 information with the Securities and Exchange Commission (SEC) at
Rule 144 and Pink Sheet Shells; Selling Shares Post Merger
One of the most common inquiries received by securities attorneys today involves Issuers wanting to know when they and their shareholders can sell their shares on the open market following a merger with a Pink Sheet shell. In many cases, the answer they get is not the answer they want; twelve months after the Pink Sheet Company becomes a fully reporting entity.
If a private entity has merged with a Pink Sheet shell under the assumption that they can avoid the Securities and Exchange Commission (SEC) reporting requirements, this revelation is devastating. As a result of the amendments to Rule 144 and Rule 145, enacted in February, 2009, private companies that wish to go public on the Pink Sheets are advised to do so directly, and not through a reverse merger with a shell company.
Rule 144
Technically Rule 144 provides a safe harbor from the definition of the term “underwriter” such that a selling shareholder may utilize the exemption
