Unexpected (but welcome) changes to Rule 701

As noted in our earlier post Pre-IPO Companies can have disclosure obligations too, a recent Rule 701 enforcement action by the SEC has served as a reminder of the pitfalls that exist for private companies with increasing valuations and robust equity compensation programs. Happily, some relief is on the way based on a provision included in the recently enacted Economic Growth, Regulatory Relief, and Consumer Protection Act. The Act directs the SEC to increase the Rule 701(e) disclosure threshold from $5 million to $10 million.

As a reminder, Rule 701 is the exemption from registration most commonly used by companies to grant equity to employees under compensatory benefit plans. Although companies can generally stay below the limitations on the aggregate amounts that may be sold under Rule 701 during any twelve-month period, a company with an increasing valuation can quickly bump up against the existing requirement to provide disclosure to plan recipients if more than $5 million of awards are granted in reliance on the rule during a twelve-month period. The increased threshold for disclosure will provide much needed additional flexibility to companies as they compete for talent and structure equity compensation programs.

The SEC is required to take action, not later than July 23, 2018, to implement this change. (Don’t hold your breath; the SEC doesn’t always meet rulemaking deadlines established by Congress.) We expect that the Staff will also provide some transition guidance regarding how the new threshold will be applied to current plan periods (e.g., solely with respect to twelve-month periods starting on or after the amendment effective date).

Although the increased threshold should provide comfort to many companies that they will be able to stay below the Rule 701 disclosure threshold, companies should continue to monitor compliance with the rule and update their procedures to reflect these changes once effective.

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