Recently, the Securities and Exchange Commission (“SEC”) adopted final rules regarding the thresholds for registration, termination of registration and suspension of reporting under Section 12(g) of the Securities Exchange Act of 1934, as amended (“Exchange Act”).
Exchange Act Reporting Thresholds Amendments
The SEC amended Rules 12g‑1 through 12g‑4 and 12h‑3, which govern the procedures relating to registration and termination of registration under Section 12(g) of the Exchange Act. For non‑bank issuers, in addition to having in excess of $10 million in total assets, the threshold number of holders of any class of equity securities necessary to trigger Section 12(g) reporting obligations was increased from 500 holders of record to 2,000 holders of record, or 500 holders of record who are not “accredited investors”. In the case of a foreign private issuer, in addition to these thresholds, Section 12(g) reporting is not required unless 300 or more of the holders of record are U.S. residents.
“Accredited Investor” Definition Amendments
The rules amend Rule 12g‑1 to clarify that the definition of “accredited investor” found in Rule 501(a) under the Securities Act of 1933, as amended (“Securities Act”) applies to determinations for purposes of Section 12(g)(1), with the determination made as of the last day of each fiscal year rather than at the time of a securities issuance (as under Rule 501(a)). This includes the notion found within Rule 501(a) that an accredited investor includes a person that comes within one of the categories of the definition or that the issuer “reasonably believes” comes within any such category. Accordingly, an investor must determine, based on then‑current facts and circumstances, whether prior information possessed by the issuer provides a basis for a reasonable belief that a holder continues to be an accredited investor. The SEC declined to establish a safe harbour that would allow an issuer to conclusively establish that a security holder is an accredited investor. Instead, issuers are directed to consider “their particular facts and circumstances in establishing a reasonable basis for their determination”. Factors that an issuer can take into account include such things as information obtained during a securities issuance, third‑party certifications and annual confirmations from investors, although none of these is considered conclusive.
Given that the ability to determine accredited investor status on a timely basis may be critical to companies that are close to the 500‑holder threshold, companies should consider what steps might be appropriate to facilitate this determination.
Definition of “Held of Record” Amendments in Exchange Act Rule 12g5‑1
The SEC also finalized amendments to the definition of “held of record” in Rule 12g5‑1 to provide that, when determining whether registration is required under Section 12(g)(1), an issuer may exclude securities held by persons who received them under an employee compensation plan in transactions exempt from, or not subject to, the registration requirements of Section 5 of the Securities Act and, in certain circumstances, held by persons who received them in exchange for securities received under an employee compensation plan. This is an important change because excluding such securities significantly reduces the risk of a private company inadvertently becoming subject to the reporting requirements of the Exchange Act.
As part of this change, the SEC established a non‑exclusive safe harbour for determining holders of record which provides that:
- An issuer may deem a person to have received the securities under an employee compensation plan if the plan and the person who received the securities under the plan met the enumerated conditions of Securities Act Rule 701(c). (Family members who receive equity securities as a result of the employee’s (or former employee’s) gift, domestic relations order, or death are also considered to be persons who “received [the] securities pursuant to an employee compensation plan” for purposes of Rule 12g5‑1).
- An issuer may, solely for the purposes of Section 12(g), deem the securities to have been issued in a transaction exempt from, or not subject to, the registration requirements of Section 5 of the Securities Act if the issuer reasonably believed at the time of the issuance that the securities were issued in a transaction meeting the requirements of Rule 701(c). Consistent with Rule 701(c), securities held of record by former employees would be excluded when determining the securities held of record only if the employees were employed by or providing services to the surviving issuer at the time the exchange securities were offered.
It should be noted that this exception for securities received under an employee compensation plan applies only while the shares are held by the person who received them under the plan. Once these persons transfer the securities to holders not specified in Rule 701(c), the securities must be counted as held of record for purposes of determining registration and reporting requirements of Section 12(g)(1). Private companies that have issued securities pursuant to an employee compensation plan should ensure that their record‑keeping procedures allow them to track when and to whom a person that received securities under an employee compensation plan transfers such securities.
Foreign private issuers are able to exclude securities received pursuant to an employee compensation plan when making their determination of the number of U.S. resident holders under Rule 12g3‑2 (to determine if they reach the 300‑U.S. holder reporting threshold), however securities held by employees continue to be counted for purposes of determining the percentage of the issuer’s outstanding securities held by U.S. residents when assessing foreign private issuer status under the Securities Act.
The foregoing is a general discussion of certain legal and related developments and should not be relied upon as legal advice. If you require legal advice, please contact the author who would be pleased to discuss the issues above with you, in the context of your particular circumstances.
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