5 Things Important Pieces of the Proposed Rule 701 changes

On November 24, 2020, the SEC published proposed long-anticipated changes to Rule 701. As a reminder, Rule 701 allows companies to provide offers and sales of securities with an exemption from Rule 144. Basically, it makes it easier to grant equity or sell shares to employees. No need to go into the legalese here, since there are a ton of other places that cover it in detail.

The proposed rules cover some esoteric stuff like REITS and Foreign Issuers and also cover things that every pre-IPO company (or long-term private company) should be aware of.

1. They are proposing changing the crazy 12-month / $10M threshold. The current process essentially requires you to be psychic. The new rule would require disclosure of the additional financial and other information mandated by Rule 701(e) only concerning those sales that exceed the rule’s $10 million threshold in a 12-month period.
2. Rule 701 would cover some equity for consultants or advisers if substantially all of the activities of the entity involve the performance of services, and substantially all of the ownership interests of the entity are held directly by not more than 25 natural persons, of whom at least 50% perform such services for the issuer through the entity. Under the current rule, entities can receive grants under Rule 701 only if they are the wholly-owned “alter ego” of the service provider.
3. Extend the coverage of former employees receiving post-termination grants as compensation for services rendered within 12 months preceding the termination. Also covers terminated employees of an acquired entity where the securities are issued in exchange for securities of the acquired entity issued as compensation during the person’s employment with the acquired entity.
4. Increase the value of securities covered by Rule 701 from $1M to $2M during a consecutive 12-month period. Also, increases coverage from 15% up to 25% of the total assets of the issuer (or up to 15% of the outstanding amount of the class of securities being offered).
5. Companies can delay required grant date financial statement disclosures to 14 days after hire for new employees. This allows companies to grant equity for an upcoming hire, without needing to disclose the grant before the individual’s start date.

Rule 701 is one of those things that most compensation people don’t give much thought to. With the recent swell in IPO and SPAC activity, it is a good plan to refamiliarize yourself with the rule if you work at a company that may: 1) go public in the future or; 2) have a valuation that is high enough to trigger disclosure requirements long before going public is even a consideration. Well, that’s it for the boring, but important updates.  Back to pithy metaphors and stories in my next post!

Dan Walter is a CECP, CEP, and Fellow of Global Equity (FGE). He works as Managing Consultant for FutureSense. Dan is also a leading expert on incentive plans and equity compensation issues. He has written several industry resources including the only resource dedicated to Performance-Based Equity Compensation. He has co-authored ”Everything You Do In Compensation is Communication”, “The Decision Makers Guide to Equity Compensation”, “Equity Alternatives” and other books. Connect with Dan on LinkedIn. Or, follow him on Twitter at @DanFutureSense.