On December 17, 2014, the SEC proposed amendments to revise the rules that govern the thresholds for registration and deregistration under Exchange Act Section 12(g). These amendments would change Exchange Act Rules 3b-4, 12g-1, 12g-2, 12g-3, 12g-4, 12g5-1 and 12h-3, as well as Securities Act Rule 405, to further implement the JOBS Act mandate that was partially reflected in the text of Exchange Act Section 12(g) upon the JOBS Act’s passage.
Exchange Act Section 12(g) requires an issuer to register its securities under the Exchange Act (and consequently requires an issuer to file periodic Exchange Act reports) upon crossing certain asset and shareholder base thresholds. This prospective regulatory burden limits privately-held companies’ practical ability to raise capital. The JOBS Act liberalized Exchange Act Section 12(g)’s requirements to permit private companies to build larger shareholder bases without triggering the Exchange Act’s registration and reporting requirements.
Before the JOBS Act, Exchange Act Section 12(g)(1) and the SEC’s rules pursuant thereto required an issuer to register a class of equity security if, at the end of the issuer’s fiscal year, the issuer had total assets exceeding $10 million and the class of equity security was held of record by 500 or more persons. The issuer could later deregister the class of equity security once (A) held by less than 300 persons or (B) held by less than 500 persons if the issuer’s total assets were no greater than $10 million at the end of each of its last three fiscal years.
Since adoption of the JOBS Act, Exchange Act Section 12(g)(1) has required an issuer to register a class of equity security if, at the end of the issuer’s fiscal year, the issuer had total assets exceeding $10 million and the class of equity security was held of record by either (A) 2,000 or more persons or (B) 500 or more persons who are not accredited investors. The issuer can later deregister the equity security once held of record by less than 300 persons. The post-JOBS Act Section 12(g)(1) provides a separate standard for banks and bank holding companies: Such an issuer must register a class of equity security if, at the end of the issuer’s fiscal year, the issuer had total assets exceeding $10 million and the class of equity security was held of record by 2,000 or more persons. A bank or bank holding company may deregister the class of equity security once held of record by less than 1,200 persons.
In both its pre- and post- JOBS Act formulations, the Exchange Act Section 12(g) shareholder base threshold turns on the number of holders “of record”—that is, the number of persons or entities reflected in the share register maintained by the company or its transfer agent. This number does not necessarily equal the number of beneficial owners, as one broker may be the holder of record of shares held in street name for several clients. However, a private company may nevertheless amass a large number of holders of record: In addition to issuing shares to investors, privately-held companies often issue shares (including pursuant to compensation arrangements) to employees, consultants and agents, each of whom may appear on the share register as a separate holder of record. This can cause a company to trip the Exchange Act Section 12(g) registration requirement quickly and inadvertently. The JOBS Act responded to this concern in part by raising the numerical thresholds as discussed above and in part by amending Exchange Act Section 12(g)(5) to provide that, for purposes of Exchange Act Section 12(g)(1), “the definition of ‘held of record’ shall not include securities held by persons who received the securities pursuant to an employee compensation plan in transactions exempted from the registration requirements of Section 5 of the Securities Act of 1933.” The JOBS Act further directed the Commission to “adopt safe harbor provisions that issuers can follow when determining whether holders of their securities received the securities pursuant to an employee compensation plan in transactions that were exempt from the registration requirements of Section 5 of the Securities Act of 1933.”
The SEC’s newly proposed amendments endeavor to fulfill this JOBS Act requirement. The amendments would harmonize the text of the Exchange Act rules with the JOBS Act’s registration and deregistration thresholds already reflected in the Exchange Act text. Further, the amendments would change the definition of “held of record” so as to exclude certain securities issued as compensation. Specifically, issuers would be permitted to exclude securities (A) held by persons who received the securities pursuant to an employee compensation plan in transactions exempt from the registration requirements of Securities Act Section 5 or that did not involve a sale within the meaning of Securities Act Section 2(a)(3) or (B) held by persons who received them in exchange for securities received under an employee compensation plan (subject to certain requirements). Further, the proposed amendments would establish a non-exclusive safe harbor: Securities held by a person who received them pursuant to a compensatory benefit plan in transactions that met the conditions of Securities Act Rule 701(c) would be deemed to be received pursuant to an employee compensation plan. (Rule 701(c) covers offers and sales of securities under a written compensatory benefit plan or written compensation contract established by an issuer or certain of its affiliates, for the participation of their employees, directors, general partners, trustees (where the issuer is a business trust), officers, or consultants and advisors, and their family members who acquire such securities through gifts or domestic relations orders, but covers offers and sales to former employees, directors, general partners, trustees, officers, consultants and advisors only if they were employed by or providing services to the issuer at the time the securities were offered.) The safe harbor would depend only on these transaction conditions of Rule 701(c); Rule 701’s issuer eligibility, volume limitation and disclosure delivery conditions would not apply. Thus, the safe harbor would be available for holders of securities received in employee compensation plan transactions exempted from, or not subject to, the registration requirements of Securities Act Section 5, such as securities issued in reliance on Securities Act Section 4(a)(2), Regulation D or Regulation S, so long as the transactions met the Rule 701(c) conditions.
The proposed amendments also would revise the Exchange Act rules so as to apply Section 12(g)(1)’s registration and deregistration thresholds for banks and bank holding companies to savings and loan holding companies as well.
In addition, the proposed amendments would clarify that the Securities Act Rule 501(a) definition of “accredited investor” applies to the Exchange Act Section 12(g)(1) registration requirement.
The SEC has solicited comments on the proposed amendments; the comment period will run through 60 days after publication of the proposing release in the federal register.
Prepared by Glenn Pollner, Andrew Fabens & John Lawrence