United States: SEC Proposes to Amend Rule 701 and Form S-8 and Extend Rules to “Gig” Workers

Key takeaways

•  The proposed Rule 701 changes increase the value of eligible offerings, simplify the financial statement disclosure requirements for offerings with a value in excess of USD 10 million, and expand eligible award recipients to include certain former employees and consultant legal entities.
• Although generally moderate in scope, the proposed amendments to Form S-8 expand the eligible award recipients consistent with the proposed changes to Rule 701, while simplifying the rules for registering securities on Form S-8 and lowering compliance costs.
• The separately proposed temporary rules addressing platform workers expand the availability of Rule 701 and Form S-8 for a limited 5-year period for the grant of equity compensation to “platform workers” who may not currently be considered employees, consultants or advisers under Rule 701 or Form S-8.

Proposed Changes applicable to both Rule 701 and Form S-8 

• Expansion of Eligible Recipients. Two changes apply to both Rule 701 and Form S-8:

1. 1. Former Employees may receive grants of equity awards or other securities offers post-termination either: (i) as compensation for services rendered during a performance period ending within 12 months before their termination, or (ii) in substitution or exchange for equity awards granted to them while they were providing services to an entity that has been acquired by the issuer –  thereby allowing for the conversion of options or other awards held by former employees of a target company into awards over an acquiring company’s stock and other similar transactions.
   2. Consultants or advisors established as legal entities may receive equity awards or other securities provided that (i) substantially all of the activities of the entity involve the performance of services for the issuer (or eligible affiliate) not in connection with capital-raising or market promotion or maintenance, and (ii) substantially all of the ownership interests of the entity are held directly by no more than 25 natural persons, at least half of whom provide such services. In other words, availability of Rule 701 and Form S-8 would no longer be limited to consultants who are natural persons or their wholly-owned corporate alter-egos.

• A third change impacting eligible recipients seeks to harmonize Rule 701 with existing rules for Form S-8 by making Rule 701 available for offers to eligible recipients at all subsidiaries (as defined), rather than only those that are majority-owned.

Proposed Changes Specific to Rule 701

• Increase in Eligibility Caps. Two of the three caps on the aggregate value of offerings that may be made in reliance on Rule 701 in a 12-month period are proposed to be increased:

1. 1. The Asset Cap would be raised from 15% to 25% of the total assets of the issuer (or of the issuer’s parent if the issuer is a wholly-owned subsidiary and the securities represent obligations that the parent fully and unconditionally guarantees), measured at the issuer’s most recent balance sheet date (if no older than its last fiscal year end).
   2. The USD 1 Million Cap would be raised to USD 2 million.

• Liberalization of Disclosure Requirements for Offers over USD 10M. Several welcome changes are proposed to the financial statement and other disclosure requirements for offers with an aggregate sales value in excess of USD 10 million in a 12-month period, including, in particular:

1. 1. Application of USD 10M Threshold. Disclosures would need to be provided only for sales (e.g., option exercises, RSU grants) occurring after the USD 10 million threshold is exceeded, eliminating the current “trap for the unwary” that requires companies to anticipate prospectively whether their sales under Rule 701 will exceed the threshold and provide advance disclosures accordingly.
   2. Age of Financial Statements. The financial statements required for offers over USD 10 million would need to be made available only on a semi-annual basis and completed within three months after the end of the second and fourth quarters. In other words, companies would no longer be required to prepare financial statements quarterly in order for sales to be made continuously throughout the year pursuant to Rule 701.
   3. Reconciliation of Financial Statements to U.S. GAAP. Foreign private issuers who are exempt from Exchange Act registration under Rule 12g3-2(b) will be permitted to provide financial statements prepared in accordance with their home country accounting standards if they do not have financial statements prepared in accordance with U.S. GAAP or IFRS, and will no longer be required to provide a reconciliation to U.S. GAAP in such circumstances. Broadly, this exemption applies to non-U.S. companies with their primary trading market in a non-U.S. jurisdiction who make available in English on their websites all information required to be made public by applicable local law and stock exchange requirements. Other foreign private issuers remain subject to the U.S. GAAP reconciliation requirement (subject to the proposed alternative disclosures described below).
   4. Alternative to Financial Statements. The SEC proposes to dispense with the requirement to provide financial statements entirely, by allowing most issuers to instead use a valuation report prepared by an independent appraiser in accordance with the Code³ Section 409A tax rules for determining the fair market value of stock not readily tradable on an established securities market, provided that the valuation report is as of a date no more than six months before the sale of securities. Although foreign private issuers eligible for the Rule 12g3-2(b) exemption described above would not be eligible for this alternative, in view of the depth and liquidity of their foreign trading markets they would be permitted to simply disclose the fair market value of the stock on the most recent trading day preceding the date of sale in lieu of providing financial statements.
   5. Disclosure Date for Derivative Securities/Equity Awards. For securities such as options that involve a decision to exercise, issuers continue to be required to deliver required disclosures a reasonable period of time before the date of exercise. Although for securities such as restricted stock units (RSUs) that do not involve an exercise decision, issuers are still required to deliver disclosures a reasonable period of time before the grant of the awards, the proposed rules make an exception in the case of offers to new employees. In such circumstances, the disclosure may be provided within up to 14 calendar days after the date the person begins employment, even if an RSU (or similar award) was granted prior to such date.
   6. Acquisitions. Equity awards such as options assumed in a merger continue to qualify for Rule 701 for exercises post-merger as long as (i) the acquired entity complied with Rule 701 at the time it originally granted the awards and (ii) the acquirer complies with the Rule 701 disclosure requirements.

Proposed Changes Specific to Form S-8

• • Addition of Plans and Securities to Existing Form S-8. Issuers may add additional plans or securities of the same class or an additional class to an existing Form S-8 by filing an automatically effective post-effective amendment to a previously filed Form S-8, rather than filing a new Form S-8 as is currently required.
  • Use of a Single Form S-8 for Multiple Incentive Plans. Issuers may use a single Form S-8 for multiple incentive plans without having to allocate the registered securities among the incentive plans.
  • Fee Calculation and Fee Payments on Form S-8 for Defined Contribution Plans. To simplify share counting for securities registered under a defined contribution plan (e.g., when employees elect to invest in company stock under a 401(k) plan), the Form S-8 registration would cover an aggregate offering value of securities and the registration fee for sales made during an issuer’s fiscal year would be paid within 90 days after the issuer’s fiscal year end, rather than when the Form S-8 is filed.
  • Conforming Form S-8 Instructions with Current IRS Plan Review Practices. For plans that are subject to ERISA⁴, the proposed rules eliminate the requirement that issuers submit plan amendments to the IRS and file a copy of the IRS determination letter regarding the plan’s qualified status, and instead permit issuers to provide an undertaking that the issuer will maintain the plan’s compliance with ERISA and make all changes required to maintain such compliance in a timely manner.
  • Elimination of Description of Tax Effects of Plan Participation on the Issuer. The current requirement under Form S-8 to include a description of the tax effects, if any, on the issuer would be eliminated. The requirement to disclose the tax consequences to employees and state whether the plan is qualified under Section 401(a) of the Code would remain in effect.

Proposed Temporary Rules Addressing Availability of Rule 701 and Form S-8 to “Gig” Workers

For a limited 5-year period from the date the proposed rules become effective, Rule 701 and Form S-8 would be available for the grant of equity awards to “platform workers,” if several conditions, including the following, are satisfied:

• • “Platform Worker.” The “platform worker” must be a service provider who is unaffiliated with the issuer and provides bona fide services through the use of an internet-based or other widespread, technology-based platform or system that is operated and controlled by the issuer. The issuer must have the ability to establish the terms of service of use of the platform and the terms and conditions by which platform workers receive compensation for services and may be approved or removed from the platform. These requirements are intended to demonstrate that the issuance of securities is for compensatory purposes rather than primarily for capital raising purposes. The proposed rules do not extend the availability of Rule 701 and Form S-8 to the grant of securities to workers who engage in the sale or transfer of discrete tangible goods.
  • Written Compensatory Plan. The securities issuable to platform workers must be offered pursuant to a written compensatory arrangement between the issuer and the platform worker.
  • Annual/3-Year Limitations. Securities issued to a platform worker pursuant to Rule 701 or Form S-8 cannot exceed 15% of the platform worker’s “value” of compensation received from the issuer during a 12-month period, and cannot exceed USD 75,000 in total during any 36-month period (valued as of the grant date).
  • No Individual Bargaining. The securities compensation arrangement with the platform worker cannot be subject to individual bargaining, including that the platform worker could not be permitted to elect between payment of securities or cash.
  • Transferability Restrictions. For offerings under Rule 701 only, issuers must take reasonable steps to prohibit the transfer of the securities issued to platform workers, other than transfers to the issuer or by operation of law, such as upon death or divorce.

Information Requirements. While it would not be a condition to the availability of the Rule 701 exemption or Form S-8 registration, the proposed rules impose a requirement on issuers taking advantage of the rules to grant equity awards to platform workers to provide certain information to the SEC at six-month intervals, including: (i) the criteria used for granting awards to platform workers, (ii) the type and terms of securities issued to platform workers; (iii) steps taken to prevent the transfer of shares issued pursuant to Rule 701; (iv) the percentage of overall outstanding securities allocated to platform workers; (v) the issuer’s number of platform workers versus regular workers and number of each group who received equity awards under Rule 701 or Form S-8 in the six-month period; and (vi) details of the number and value of securities issued to platform workers. This information is intended to assist the SEC in determining whether to implement the rule on a permanent basis.

1. Securities Exchange Act of 1934, as amended (the “Exchange Act”)

2. Rule 701 provides an exemption from registration under the Securities Act of 1933, as amended

3. Internal Revenue Code of 1986, as amended

4. Employee Retirement Income Security Act of 1974.