[Federal Register Volume 63, Number 43 (Thursday, March 5, 1998)]
[Proposed Rules]
[Pages 10785-10792]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-5728]


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SECURITIES AND EXCHANGE COMMISSION

17 CFR Part 230

[Release No. 33-7511; File No. S7-5-98]
RIN 3235-AG21


Rule 701--Exempt Offerings Pursuant to Compensatory Arrangements

AGENCY: Securities and Exchange Commission.

ACTION: Proposed rule.

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SUMMARY: The current dollar limitations on the amount of securities 
that may be offered and sold under the Commission's Rule 701 under 
Securities Act of 1933 which provides an exemption from registration 
for such securities pursuant to compensatory benefit arrangements may 
be too restrictive. Therefore, we propose to amend these limitations to 
permit companies greater access to the exemption if certain disclosure 
requirements are satisfied.

DATES: Public comments should be received on or before May 4, 1998.

ADDRESSES: Please send three copies of the comment letter to Jonathan 
G. Katz, Secretary, Securities and Exchange Commission, 450 Fifth 
Street, N.W., Washington, D.C. 20549. You can send comments 
electronically to the following e-mail address: [email protected]. 
The comment letter should refer to File No. S7-5-98; if e-mail is used 
please include the file number in the subject line. Anyone can inspect 
and copy the comment letters at our Public Reference Room, 450 Fifth 
Street, N.W., Washington, D.C. 20549. We will post comment letters 
submitted electronically on our Internet site (http://www.sec.gov).

FOR FURTHER INFORMATION CONTACT: Richard K. Wulff (202-942-2950), 
Office of Small Business, Division of Corporation Finance, Securities 
and Exchange Commission, 450 Fifth Street, N.W., Washington, D.C. 
20549.

[[Page 10786]]

SUPPLEMENTARY INFORMATION:

I. Executive Summary

    Rule 701 1 under the Securities Act of 1933 
(``Securities Act'') 2 was adopted in 1988 to allow private 
companies to sell securities to their employees without the need to 
file a registration statement in the same manner as a public company. 
At that time we determined that it would be an unreasonable burden for 
these private companies, many of which are small businesses, to incur 
the expenses and disclosure obligations of public companies when their 
only public sales were to employees. This is especially true because 
these sales were for compensatory and incentive purposes, rather than 
capital-raising. To accommodate these companies, we used the maximum 
extent of our exemptive authority and exempted offers and sales of up 
to $5 million per year.
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    \1\ 17 CFR 230.701.
    \2\ 15 U.S.C. 77a et seq.
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    Over the years, the Commission staff monitored the use of the rule. 
Until mid-1993, Form 701 was required to be filed with us whenever an 
offering under the rule was made. On the basis of that data and 
feedback from practitioners, the staff has concluded that the rule has 
been popular for both small businesses and larger private companies 
(such as mutual insurance companies, foreign issuers, and engineering 
firms), but that the $5 million limit has been particularly restrictive 
in light of: the popularity of equity ownership by employees; 
inflation; and the growth of deferred compensation plans (which are 
eligible for the rule). In addition, the staff has concluded that the 
rule needs further simplification and clarification.
    In October 1996, Congress enacted the National Securities Markets 
Improvement Act of 1996 (``NSMIA'') 3 which, for the first 
time, gave us the authority to provide exemptive relief beyond $5 
million for transactions such as these. The legislative history of 
NSMIA suggested specifically that the $5 million ceiling on Rule 701 be 
lifted.4 As detailed below, we propose today to modify the 
ceilings and to further simplify and streamline the rule. To ensure 
continued investor protection along with the added flexibility, we 
propose to mandate that a company must give any purchaser specific 
types of disclosure.
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    \3\ Pub. L. 104-290, 110 Stat. 3416 (October 11, 1996).
    \4\ Both Committee Reports specifically highlighted the current 
$5 million limit contained in Rule 701 and seek prompt Commission 
action to raise that ceiling. H.R. Rep. No. 104-622 at 38; S. Rep. 
No. 104-293 at 16.
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    We seek to increase the flexibility and utility of Rule 701 by 
issuing proposals that would:
    (1) Remove the artificial $5 million ceiling and instead set the 
maximum amount of securities that may be sold in a year at the greatest 
of:

$1 million;
15% of the issuer's total assets; and
15% of the outstanding securities of that class

    (2) Not count offers for purposes of calculating the ceiling;
    (3) Require the issuer to disclose certain risk factors that may be 
associated with investment in securities pursuant to the plan or 
agreement, and deliver financial statements in accordance with Form 1-A 
of Regulation A 5 to each person to whom securities are 
sold;
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    \5\ 17 CFR 230.251-263.
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    (4) Amend Rule 701 to comport with current and more flexible 
interpretations; and
    (5) Simplify the Rule.
    Together, these changes will add greater flexibility for companies 
to sell securities to their employees and, at the same time, will 
provide that essential information be delivered to employees in a 
timely manner.

II. Background

    Rule 701 was adopted under section 3(b) of the Securities Act to 
provide an exemption from the registration requirements of that Act for 
offers and sales of securities pursuant to certain compensatory benefit 
plans or written agreements relating to compensation.6 The 
exemptive scope covers securities offered or sold pursuant to a plan or 
agreement established by a non-reporting (``private'') company, its 
parents or majority-owned subsidiaries, to their employees, directors, 
partners, trustees, consultants and advisors.
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    \6\ Release No. 33-6768 (April 14, 1988) [53 FR 12918].
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    Currently the rule provides that the amount of securities that may 
be subject to outstanding offers in reliance on Rule 701 plus the 
amount of securities offered or sold under the rule in the preceding 12 
months may not exceed the greater of $500,000, or an amount determined 
under one of two different formulas. One formula limits the amount to 
15% of the issuer's total assets measured at the end of the issuer's 
last fiscal year. The other formula restricts the amount to no more 
than 15% of the outstanding securities of the class being offered. 
Regardless of the measurement method elected, the Rule restricts the 
aggregate offering price of securities subject to outstanding offers 
and sold in the preceding 12 months to no more than $5 million.

A. Concerns With the Current Rule

    In the decade since adoption of Rule 701, equity ownership by 
employees has grown exponentially. Not only have employees benefited 
generally as the value of their stock has appreciated, but companies' 
managements have widely encouraged equity participation as a retention 
and incentive device for employees. In addition, companies have sought 
to provide tax benefits and possible investment opportunities by 
offering many of their senior and middle management personnel 
participation in deferred compensation plans. To the extent these plans 
involve an offer of securities, they are eligible to use Rule 701. The 
growth of these plans, coupled with the impact of inflation, has caused 
the $5 million annual limit to be impractical for many companies.
    In addition to concerns with the ceiling, a myriad of interpretive 
questions have arisen under the current rule. While every new rule 
needs routine interpretive gloss from the Commission staff, Rule 701 
has been the subject of an abundance of highly technical requests for 
clarification. Some of these issues include how to treat stock options, 
former employees, subsidiaries, consultants, advisors, and successor 
issuers, and when to integrate Rule 701 offerings with other exempt 
offerings under the federal securities laws. In summary, the rule needs 
to be both simplified and modernized.

B. National Securities Markets Improvement Act of 1996

    In October 1996, NSMIA was signed into law. Title I of that statute 
relating to ``Capital Markets'' adds section 28 to the Securities Act 
providing us with general exemptive authority from any provision of the 
Securities Act.7 During the legislative process, both the 
House Committee on Commerce 8 and the Senate Committee on 
Banking, Housing and Urban Affairs 9 noted, in

[[Page 10787]]

considering this provision, that we should take steps to increase the 
ceilings in our existing exemptions promulgated under section 3(b) of 
the Securities Act. The legislative history of NSMIA reflects a 
specific Congressional concern about the current $5 million aggregate 
offering price ceiling in Rule 701 having a negative impact for many 
issuers of securities in compensatory arrangements.
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    \7\ The Commission, by rule or regulation, may conditionally or 
unconditionally exempt any person, security, or transaction, or any 
class or classes of persons, securities, or transactions, from any 
provision or provisions of this title or of any rule or regulation 
issued under this title, to the extent that such exemption is 
necessary or appropriate in the public interest, and is consistent 
with the protection of investors. 15 U.S.C. 77bb. New section 2(b) 
of the Securities Act requires that when we engage in rulemaking and 
are required to consider the public interest as well as the 
protection of investors, we also must consider ``whether the action 
will promote efficiency, competition, and capital formation.''15 
U.S.C. 77b(b).
    \8\ H.R. Rep. No. 104-622 (June 17, 1996) at 38.
    \9\ S.Rep. No. 104-293 (June 26, 1996) at 15-16.
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III. Proposed Amendments to Rule 701

A. Exemptive Limits

    The current rule limits the dollar amount of securities offered to 
employees, regardless of how many securities are sold to employees. 
Calculations based on offers for this purpose are problematic, 
especially in determining how to treat options, warrants, rights and 
other exercisable or convertible securities (which represent offers to 
sell the underlying securities). In light of our new exemptive 
authority, we propose eliminating the restriction in the dollar amount 
of securities that may be offered pursuant to the rule since limiting 
the amount of offers is not necessary to assure that these transactions 
are not so large as to necessitate registration. Instead, a test that 
focuses on the amount of sales in each 12-month period should serve 
that purpose.
    Changing the focus to sales means that issuers no longer will have 
to calculate and regularly monitor the amount of options, warrants, 
rights or other exercisable or convertible securities, but rather can 
focus solely on the amount of securities sold. This change also reduces 
the likelihood that companies will restrict eligibility or 
participation in a compensatory benefit plan solely to meet an offering 
limit. This proposal would make the exemption more usable to a greater 
number of companies, including those that maintain deferred 
compensation plans, but are not reporting companies under the Exchange 
Act and therefore do not qualify to utilize Form S-8.10 
Commenters are asked to address whether removing offers from the 
calculation is appropriate or whether we should limit the amount of 
securities being offered as well as, or instead of, a limit on the 
amount of securities sold.
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    \10\ 17 CFR 239.16b. Form S-8 is a simplified form for 
registering securities for sale to employees but is limited to 
public companies which file reports pursuant to the reporting 
requirements of the Exchange Act.
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    As part of eliminating the ceiling on the amount of offers of 
securities that may be made pursuant to the rule, we propose 
eliminating outstanding offers from the calculation under the two 
formulas for determining the aggregate sales price or number of 
securities that may be sold in a 12-month period. By only measuring the 
amount of securities sold against the 15% of assets formula or the 15% 
of outstanding securities formula, some issuers will be given more 
flexibility and an increase in the limit on the amount of securities 
that they may sell. The proposal also will greatly simplify a highly 
technical calculation and the resulting need for incremental 
interpretation. We believe no investor protection concerns are 
presented by this added flexibility, but solicit comment as to whether 
there might be unanticipated abuses.
    Rule 701 has become increasingly of limited utility to larger 
companies due to the $5 million limitation. We believe that this would 
be the case even if we re-focus the limitation on sales. Moreover, the 
more appropriate focus is not the absolute dollar amount sold, but 
rather how the amount compares to the size of the company and its 
capital base. Therefore, we propose to eliminate the $5 million 
aggregate offering price ceiling and rely on the three-part calculation 
of the amount of securities that may be sold in a 12-month period to 
set a more appropriate dollar limit. In addition, we propose to amend 
Rule 701 so that the issuer's most recent balance sheet date would be 
used for purposes of that calculation. This would make the measurement 
consistent and avoid confusion as to the date to be used when 
performing the calculation.11 Comment is solicited as to 
whether a specific aggregate offering price ceiling, such as $10 
million, $15 million or $20 million, is preferable to no ceiling, and 
whether we should change the measurement periods as we propose. We also 
solicit comment as to whether non-reporting foreign issuers should be 
subject to an annual limit, such as $10 million, because the 
application of the calculation to large foreign private companies could 
result in the sale of a large amount of securities to a large number of 
employees without such companies ever being required to register under 
either the Securities Act or the Exchange Act.12
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    \11\ Under the current rule, assets are calculated as of the end 
of its last fiscal year. The rule is silent as to when outstanding 
securities are calculated.
    \12\ Domestic issuers that acquire more than 500 shareholders 
and have assets exceeding $10 million must register under Section 
12(g) of the Exchange Act. Foreign private issuers crossing those 
thresholds may instead rely on the exemption from Section 12(g) 
provided by Rule 12g3-2(b). 17 CFR 240.12g3-2(b). The rule exempts 
from Exchange Act registration securities of a foreign private 
issuer if the issuer furnishes to us annual and other reports and 
other materials that are publicly available in its home market.
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    Comment is solicited as to whether Rule 12g3-2(b) should be amended 
so that foreign private issuers that either sell securities under Rule 
701 or sell more than some annual threshold amount under the rule, such 
as $10 million, would be ineligible for the Rule 12g3-2(b) exemption 
since that exemptive relief from reporting under Section 12(g) is 
predicated on the foreign issuer not taking any steps to enter the U.S. 
market voluntarily.
    It is not only the $5 million ceiling that has an obvious limiting 
effect; the $500,000 level used in the calculation also has such an 
effect. We are particularly concerned that many small businesses are 
unnecessarily constrained by this limit. We therefore propose setting 
this level of the amount of securities sold in reliance on the rule 
during a 12-month period at $1 million. The proposed $1 million limit 
should ensure issuers adequate flexibility. Thus, regardless of total 
assets or outstanding securities, a private company could always sell 
up to $1 million in securities to its employees in a 12-month period. 
We note that this level would be consistent with the $1 million 
offering exemption in Rule 504 of Regulation D.13 (Unlike 
Rule 504, however, securities sold under Rule 701 are ``restricted'' 
securities and cannot be freely resold.) We request comment on whether 
the alternative level allowed under Rule 701 should be limited to $1 
million, as proposed, or alternatively whether the amount should be 
retained at $500,000 or raised to $750,000, $1.5 million or $2 million.
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    \13\ 17 CFR 230.504.
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    We propose that the changes in the Rule 701 ceilings would apply to 
plans and agreements currently covered by the rule, including those 
with consultants and advisors. We do not propose to change the status 
of securities sold under the rule, so that the securities would 
continue to be ``restricted'' and subject to resale restrictions. We do 
not anticipate that the same types of abuses that are associated with 
Form S-8, with issuers selling securities to consultants and advisors, 
who are in effect underwriters in reselling the securities to the 
public, would arise because the securities would be restricted. 
However, we solicit comment as to whether Rule 701 should retain 
consultants and advisors as eligible participants pursuant to the rule, 
whether the current offer and sale ceilings should be retained for 
consultants and advisors, and whether the definition of consultant

[[Page 10788]]

and advisor should be narrowed to the definition used with Form S-8.

B. Disclosure to Persons Covered by Rule 701

    Similar to some private placements, there is no requirement in Rule 
701 to deliver a specific disclosure document to buyers other than a 
copy of the relevant compensation plan or agreement. However, because 
these transactions are subject to the antifraud provisions of the 
federal securities laws,14 we understand that many companies 
prepare an offering document to provide information to employee 
investors.15 While we are not aware of any widespread 
abuses, we are concerned that the increased flexibility added by 
today's proposals could lead to a series of larger transactions and 
consequently a broader impact on U.S. investors. While it may be 
burdensome to impose specific disclosure requirements on small 
transactions by small businesses, the cost-benefit balance may shift 
because the amended rule would facilitate larger transactions to 
potentially unsophisticated employees.
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    \14\ See 15 U.S.C. 77q(a) and 15 U.S.C. 78j(b).
    \15\ Issuers are reminded of the preliminary note to Rule 701 
which reaffirms the obligations of issuers and persons acting on 
their behalf to provide disclosure to employees or other persons 
within the scope of the rule adequate to satisfy the antifraud 
provisions of the federal securities laws.
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    We propose that sales of securities under Rule 701 would require 
that the employees and other persons covered by the rule be supplied 
with recent financial and other information a reasonable period of time 
prior to the sale of such securities. We propose that this disclosure 
include the risk factors associated with investment in the securities 
pursuant to the plan or agreement and the financial statements required 
in an offering statement pursuant to Form 1-A of Regulation A under the 
Securities Act.16 Regulation A allows for simpler unaudited 
financial statements. We also propose that the financial statements be 
as of a date no more than 180 days prior to the sale of such 
securities.17
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    \16\ Form 1-A [17 CFR 239.90] under Regulation A sets forth the 
financial and non-financial information required in an offering 
statement.
    \17\ Proposed Rule 701(g) would provide that the disclosure 
delivery obligation would apply a reasonable period of time prior to 
the date of sale, but not necessarily at the time offers are first 
made. For example, for stock options, disclosure would be required a 
reasonable period of time prior to the date of exercise, rather than 
at the time of grant or when the option becomes exercisable, and 
deferred compensation plans would have a disclosure delivery 
obligation a reasonable period of time prior to the date the 
employee makes the irrevocable election to defer.
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    We do not believe that this limited disclosure would be unduly 
burdensome to private companies. In proposing such requirements, we 
note that issuers with deferred compensation plans would be required to 
disclose the material risks that may be associated with such plans, 
such as the risks arising from the unsecured nature of the companies' 
obligations.
    Commenters are asked to address whether any specific disclosure 
requirements should be adopted. In this regard, commenters may want to 
address any differences between a disclosure regime for compensatory 
purposes and one for capital-raising purposes. Comment also solicited 
comment as to whether additional disclosure, such as the other 
requirements of Form 1-A, should be required. Commenters should address 
whether these disclosure requirements should apply to all Rule 701 
sales, or only to those sales that exceed a specified minimum amount 
per 12-month period, such as $1 million. That approach would harmonize 
Rule 701 with Rule 504.

C. Other Disclosure Approaches

    We considered information requirements other than Regulation A, 
such as those reflected in Rule 502 of Regulation D.\18\ We decided 
however, not to use the Rule 502 requirements because, among other 
things, they require audited financial statements and more non-
financial information. They would therefore be more burdensome on these 
companies, many of which are small businesses. At the same time, it 
does not appear that this level of information should be necessary for 
all persons participating in compensatory benefit plans. We also 
considered requiring the information requirements of Form SB-1, \19\ 
which allows small business issuers to offer and sell up to $10 million 
worth of securities in any 12-month period under a Regulation-A-type 
format, and Form SB-2 \20\ which uses the simplified Regulation S-B 
\21\ rules. However, both of those forms also require audited financial 
statements as well as more non-financial information than what we 
propose. We request comment as to whether other informational 
requirements should be utilized rather than the proposed risk factor 
and financial, such as those in Rule 502, Form SB-1 or Form SB-2.
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    \18\ 17 CFR 230.502.
    \19\ 17 CFR 239.9.
    \20\ 17 CFR 239.10.
    \21\ 17 CFR 228.10 et seq.
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    As an alternative, should the level of disclosure to employees 
depend on their level of sophistication? For example, executive 
officers (as defined by Rule 3b-7 under the Exchange Act), directors 
and general partners are very knowledgeable about the company/
partnership and may not benefit significantly from a mandated 
disclosure document. ``Officers'' as defined by Rule 3b-2 can be 
presumed to be somewhat knowledgeable about the company but may have 
less access to company information than executive officers. For this 
group, the proposed financial statements and risk factor disclosure may 
be appropriate. For more junior employees, former employees, 
consultants, advisors, disclosure substantially similar to Form 1-A may 
be appropriate.\22\ Would this approach be practical and better protect 
those employees who may not have the requisite knowledge about the 
company?
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    \22\ If this regime were adopted, the private nature of these 
companies may justify less disclosure about executive compensation 
than you would expect from a public company.
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D. Plain-English Technical and Clarifying Revisions

    We also propose to recast Rule 701 by making various non-
substantive technical and clarifying revisions in plain English to make 
it more concise, readable and understandable. In this regard, we 
propose changes to make it clear that an issuer may combine several 
different exemptions under the Securities Act (such as Rule 701 and 
Rule 506 \23\), and that Rule 701 is available to plans and agreements 
encompassing consultants and advisors that are natural persons without 
regard to exclusivity of representation of the issuer, as long as they 
render bona fide services that are not in connection with capital-
raising. Comment is solicited on to whether there should be other 
changes to make the rule more understandable. Comment also is solicited 
as to whether the proposed modifications would be helpful.
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    \23\ 17 CFR 230.506.
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E. Other Interpretive Revisions

    We would amend the rule in several ways to address a variety of 
questions that have arisen since its adoption.\24\ This section 
describes each of these proposed changes.
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    \24\ Not all staff interpretations need specific changes in Rule 
701. For example, although the ability to make offerings to 
employees through a trust is not specifically stated in the rule, 
the staff has interpreted the rule to allow for such offerings.
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1. Treatment of Affiliates
    In the past few years, it has become increasingly commonplace to 
sell stock of a private subsidiary to employees of

[[Page 10789]]

a parent or affiliate subsidiary. Given that these transactions appear 
to retain the envisioned compensatory aspect, the proposed amendments 
would expand coverage to sales to employees of majority-owned 
subsidiaries of the issuer's parent (i.e., brother-sister 
subsidiaries).
    We also understand that some subsidiaries, particularly those 
intending to use the rule for deferred compensation arrangements, may 
not be able to utilize to great effect the two formulas in the 
calculation of the maximum sales per 12-month period. They may not have 
sufficient assets or independent business operations to make the ``15% 
of assets'' formula meaningful or enough securities to make the ``15% 
of outstanding securities'' formula meaningful. Therefore, we propose 
to provide that if a parent (whether or not a reporting company) of a 
wholly-owned subsidiary fully and unconditionally guarantees the 
obligations of the subsidiary, and if such guarantee does not exceed 
15% of the parent's assets, the subsidiary can use the 15% of assets 
formula with respect to its parent. In that situation, the parent would 
deliver its financial statements to satisfy the disclosure 
obligations.\25\ Comment is requested as to whether employees of 
related companies would be sufficiently informed about their affiliates 
such that the information provided would suffice to protect them?
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    \25\ Rule 701 would provide that, in limited situations, the 
guarantee also would be exempt from the registration requirements of 
the Securities Act even though the guarantee may be issued by a 
reporting company.
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2. Treatment of Former Employees, Advisors and Consultants
    The proposed amendments also would clarify an interpretive question 
relating to former employees by specifying that sales may be made to 
former employees under the rule. A condition to this treatment would be 
that at the time the offer of those securities was originally made the 
employee must have been a current employee. Comment is solicited as to 
whether companies similarly should be allowed to use the rule to sell 
securities to former directors, consultants and advisors.
    Historically, the staff has interpreted broadly the definition of 
``employee'' and ``consultant'' for purposes of Rule 701.\26\ This 
interpretation does not appear to have resulted in any significant 
abuses. However, comment is solicited as to whether consultants and 
advisors should be restricted from using Rule 701 if they are directly 
or indirectly promoting the company's securities. Comment also is 
solicited as to whether sales to consultants and advisors who sell the 
company's products or services should be limited to those who derive a 
certain minimum percentage of their income from sales on behalf of the 
issuer, such as 20 percent.
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    \26\ See Exceptional Producers Holding Company (August 17, 
1989), agents who serve as independent sales representatives for an 
affiliate of an insurance company are considered ``consultants and 
advisors'' under Rule 701; Golfpro, Inc. (October 3, 1989), golf 
pros who serve as independent agents for the distribution of golf 
products through their pro shops considered consultants and 
advisors; Herff Jones, Inc. (November 13, 1990), Microship 
Technology, Inc. (November 4, 1992) and Optika Imaging Systems, Inc. 
(October 1, 1996), independent sales representatives for the 
distribution of the issuer's products considered consultants and 
advisors within the meaning of Rule 701; US Web Corporation 
(November 7, 1996), non-employee franchisees considered consultants 
and advisors within the meaning of Rule 701; and The Morgan Health 
Group, Inc. (December 18, 1995), Princeton Medical Management 
Resources, Inc. (September 12, 1997), PHM Management, Inc. 
(September 12, 1997) and Talbert Medical Corporation (September 12, 
1997), participating physicians who contract to provide medical 
services pursuant to various managed care arrangements considered 
consultants and advisors within the meaning of Rule 701.
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3. Valuation of Services
    The proposed amendments also would simplify the determination of 
value of consultant services for purposes of calculating aggregate 
sales limit. Rather than retaining different rules for employees and 
consultants, such as currently not counting employee services while 
counting consultants' and advisors' services, proposed Rule 701 would 
treat employee services the same as consultant/advisor services so that 
in both cases they would count for determining aggregate sales.
4. Transfers to Family Members
    As senior and mid-management personnel receive an increasing 
proportion of their compensation in the form of securities, these 
investments assume greater significance in the context of estate 
planning transactions and other intra-family transfers, such as 
property settlements in connection with divorce. Given the common 
economic interest of family members evidenced by estate planning 
transactions and the non-capital raising nature of these transactions, 
we believe that Rule 701 should be available for sales to family donees 
of such securities and transferees who receive these securities in 
divorce proceedings. Therefore, we propose to amend Rule 701 so that it 
is available for immediate family members who have acquired such 
securities through a gift or a domestic relations order. For this 
purpose ``immediate family'' would be defined as in Form S-8 to include 
any child, stepchild, grandchild, parent, stepparent, grandparent, 
spouse, siblings, aunt, uncle, mother-in-law, father-in-law, son-in-
law, daughter-in-law, brother-in-law or sister-in-law, including 
adoptive relationships, trusts for the exclusive benefit of these 
persons, and other entities owned solely by these persons. This 
proposal would be consistent with the treatment of transferable 
securities pursuant to the pending proposals for Form S-8.\27\
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    \27\ See Release No. 33-7506.
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5. Form 701
    Should Form 701, a notice filing required to be filed when Rule 701 
was first adopted, be reinstituted completely or substantially? How 
would this type of information be useful to investors? Should the form, 
if reinstituted, be required to be filed electronically on EDGAR? 
Should we require that copies of any consultant or advisor agreements 
be filed along with or described in Form 701? Would public disclosure 
help ensure that only bona fide consultants and advisors purchase 
securities from the company under the Rule?

IV. General Request for Comment

    Any interested person wishing to submit written comments on the 
proposed rule amendments or suggest additional changes or comments on 
other matters that might have an impact on the proposals set forth in 
this release are invited to do so by submitting them in triplicate to 
Jonathan G. Katz, Secretary, Securities and Exchange Commission, 450 
Fifth Street, N.W., Washington, D.C. 20549. We request comment as to 
the impact of the proposals from the point of view of the public, as 
well as the entities required to make available information to persons 
covered by Rule 701. We will consider comments on this inquiry in 
complying with our responsibilities under section 19(a) of the 
Securities Act.\28\ We further request comment on any competitive 
burdens that may result from adoption of the proposals. We will 
consider comments on this inquiry in complying with our 
responsibilities under section 23(a) of the Exchange Act.\29\ Comment 
letters should refer to File No. S7-5-98. All comments received will be 
available for public inspection and copying in the Commission's Public 
Reference Room, 450 Fifth Street, N.W., Washington, D.C. 20549.
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    \28\ 15 U.S.C. 77s(a).
    \29\ 15 U.S.C. 78w(a).

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[[Page 10790]]

V. Summary of Initial Regulatory Flexibility Analysis

    In accordance with 5 U.S.C. 603 we have prepared an initial 
Regulatory Flexibility Analysis (``IRFA'') regarding the proposed 
amendments.
    The analysis notes that we are proposing the amendments to Rule 701 
as a result of:
    (i) Concerns expressed to us by practitioners;
    (ii) Feedback that the current dollar limitations unduly constrain 
the ability of many eligible issuers to utilize Rule 701; and
    (iii) The specific Congressional mandate expressed in the 
legislative history of NSMIA. The purpose of the revisions is to remove 
unnecessary constraints. We have determined that the proposed 
amendments will not impair investor protection.
    As the IRFA describes, we are aware of approximately 1100 Exchange 
Act reporting companies that currently satisfy the definition of 
``small business'' under Rule 157 of the Securities Act.\30\ The 
proposals do not impose any new recordkeeping requirements or require 
reporting of additional information. Thus, we believe that the 
proposals will not increase reporting, recordkeeping or compliance 
burdens, and may reduce those burdens for smaller businesses.
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    \30\ 17 CFR 230.157.
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    As discussed more fully in the IRFA, several possible significant 
alternatives to the proposals were considered. These included 
establishing different compliance or reporting requirements for small 
entities, exempting them from all or part of the proposed requirements, 
or requiring them to provide more disclosure, such as more Form 1-A 
items, more information pursuant to Rule 502 of Regulation D or the 
full disclosure requirements of Form SB-1 or SB-2. The IRFA also 
indicates that no current federal rules duplicate, overlap, or conflict 
with the proposed rule amendments.
    We encourage written comments on any aspect of the IRFA. In 
particular, we seek comment on:
    (i) The number of small entities that would be affected by the 
proposed rule amendments; and
    (ii) The determination that the proposed rule amendments would not 
increase (and in some cases may reduce) reporting, recordkeeping and 
other compliance requirements for small entities. If you believe the 
proposals will significantly impact a substantial number of small 
entities, please describe the nature of the impact and estimate the 
extent of the impact. For purposes of making determinations required by 
the Small Business Regulatory Enforcement Fairness Act of 1996 
(``SBREFA''),\31\ we are also requesting data regarding the potential 
impact of the proposed amendments on the economy on an annual basis. 
Your comments will be considered in the preparation of the Final 
Regulatory Flexibility Analysis if the proposed amendments are adopted. 
A copy of the Initial Regulatory Flexibility Act Analysis may be 
obtained from Twanna M. Young, Office of Small Business, Division of 
Corporation Finance, Securities and Exchange Commission, 450 Fifth 
Street, N.W., Washington, D.C. 20549.
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    \31\ Pub. L. No. 104-121, 110 Stat. 857 (1996)(codified in 
scattered sections of 5 U.S.C., 15 U.S.C., and as a note to 5 U.S.C. 
601).
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VI. Cost-Benefit Analysis

    As an aid in the evaluation of the costs and benefits of these 
proposals, we request the views and other supporting information of the 
public. We believe that the proposed rule amendments, if adopted, would 
result in significant cost savings for issuers without compromising 
investor protection. We believe that the expanded use of Rule 701 may 
provide significant savings to small issuers and considerable benefits 
to compensated persons who in the past may have been deprived of the 
opportunity to receive securities as an incentive or in payment for 
their services. We note that during the period from mid-1988 through 
mid-1993, when persons relying upon the exemption were required to file 
a report with us concerning reliance on the exemption, that 1,294 
filings were made covering approximately $2.28 billion worth of 
securities.
    We request your comment on whether the proposed rule amendments 
would be a ``major rule'' for purposes of the SBREFA. We have concluded 
preliminarily that the proposed rule amendments would not result in a 
major increase in costs or prices for consumers or individual 
industries, or significant adverse effects on competition, employment, 
investment, productivity, innovation or small business. We believe that 
those persons who will rely on the rule will not have significantly 
increased costs for providing the proposed information since many of 
these persons either provide to or have such information readily 
available for their employees and other persons covered by the rule 
now. We request comments on whether the proposed rule amendments are 
likely to have an annual effect on the economy of $100 million or more. 
Your comments should provide empirical data to support your views.

VII. Paperwork Reduction Act

    Our staff has consulted with the Office of Management and Budget 
(``OMB'') and has submitted the proposals for review in accordance with 
the Paperwork Reduction Act of 1995 (``the Act'').\32\ The title to the 
affected information collection is: ``Rule 701.'' The specific 
information that must be included is explained in the rule itself, and 
relates to the issuer and the risk factors that may be associated with 
investment in securities under the plan or agreement. The information 
is needed by prospective purchasers to make informed investment 
decisions.
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    \32\ 44 U.S.C. 3501 et seq.
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    The proposed amendments, if adopted, would increase the flexibility 
and utility of Rule 701 for private companies using securities to 
compensate their employees.
    The collection of information in Rule 701 will be required in order 
for companies to use the rule for sales of their securities to their 
employees and other persons covered by the rule. The likely respondents 
to the rule are those companies that have heretofore utilized the rule, 
but were being constrained by its limits and those private companies 
who could not utilize the two formulas. While we cannot estimate the 
number of respondents that may use expanded Rule 701, there were 1,294 
Form 701 filings during the period from mid-1988 through mid-1993, when 
persons relying upon the exemption were required to file a report with 
us concerning reliance on the exemption. We expect that approximately 
300 companies each year will be relying on the exemption. If expanded 
Rule 701 is adopted, the estimated burden for responding to the 
collection of information in Rule 701 would not increase for most 
companies due to the current disclosure requirements in Rule 701, but 
may increase slightly for other companies who may not be currently 
providing risk factor information and financial statements to employee 
purchasers. We estimate that the burden hours per respondent each year 
will be two. Therefore, we estimate an aggregate of 600 burden hours 
per year.
    The information collection requirements imposed by Rule 701 are 
mandatory to the extent that a company elects to utilize the Rule 701 
exemption. The information will be disclosed to third parties or the 
public. We may not require a response to the collection of

[[Page 10791]]

information if the rule does not display a current valid OMB control 
number.
    In accordance with the Act,\33\ we solicit comment on the 
following: whether the proposed changes in the collection of 
information is necessary; on the accuracy of our estimate of the burden 
of the proposed changes to the collection of information; on the 
quality, utility and clarity of the information to be collected; and 
whether the burden of collection of information on those who are to 
respond; including through the use of automated collection techniques 
or other forms of information technology, may be minimized.
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    \33\ 44 U.S.C. 3506(c)(2)(B).
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    Persons desiring to submit comments on the collection of 
information requirement should direct them to: Office of Management and 
Budget, Attention: Desk Officer for the Securities and Exchange 
Commission, Office of Information and Regulatory Affairs, Washington, 
D.C. 20503, and should also send a copy of their comments to Jonathan 
G. Katz, Secretary, Securities and Exchange Commission, 450 Fifth 
Street, N.W., Washington, D.C. 20549, with reference to File No. S7-5 -
98. OMB is required to make a decision concerning the collection of 
information between 30 and 60 days after publication, so a comment to 
OMB is best assured of having its full effect if OMB receives it within 
30 days of publication.

VIII. Statutory Basis, Text of Proposals and Authority

    The amendments to our rules and forms are being proposed pursuant 
to sections 2, 3(b), 6, 7, 8, 10, 19(a) and 28 of the Securities Act.

List of Subjects in 17 CFR Part 230

    Reporting and recordkeeping requirements, Securities.
    For the reasons set out in the preamble, title 17, chapter II of 
the Code of Federal Regulations is proposed to be amended as follows:

PART 230--GENERAL RULES AND REGULATIONS, SECURITIES ACT OF 1933

    1. The general authority citation for part 230 is revised to read 
in part as follows:

    Authority: 15 U.S.C. 77b, 77f, 77g, 77h, 77j, 77r, 77s, 7sss, 
78c, 78d, 78l, 78m, 78n, 78o, 78w, 78ll(d), 79t, 80a-8, 80a-24, 80a-
29, 80a-30, and 80a-37, unless otherwise noted.
* * * * *
    2. Section 230.701 is revised to read as follows:


Sec. 230.701  Exemption for offers and sales of securities pursuant to 
certain compensatory benefit plans and contracts relating to 
compensation.

Preliminary Notes

    1. This section relates to transactions exempted from the 
registration requirements of section 5 of the Act (15 U.S.C. 77e). 
These transactions are not exempt from the antifraud, civil liability, 
or other provisions of the federal securities laws. Issuers have an 
obligation to provide investors with any additional material 
information as may be necessary to make the information required under 
this regulation, in light of the circumstances under which it is 
furnished, not misleading.
    2. In addition to complying with this section, the issuer also must 
comply with any applicable state law relating to the offer and sale of 
securities.
    3. An issuer that attempts to comply with this section, but fails 
to do so, may claim any other exemption that is available.
    4. This section is available only to the issuer of the securities. 
Affiliates of the issuer may not use this section to offer or sell 
securities. This section also does not cover resales of securities by 
any person. This section provides an exemption only for the 
transactions in which the securities are offered or sold by the issuer, 
not for the securities themselves.
    5. The purpose of this section is to provide an exemption from the 
registration requirements of the Act for securities issued in 
compensatory circumstances. This section is not available for plans or 
schemes to circumvent this purpose, such as to raise capital. This 
section also is not available to exempt any transaction that is in 
technical compliance with this section but is part of a plan or scheme 
to evade the registration provisions of the Act. In any of these cases, 
registration under the Act is required unless any other exemption is 
available.
    (a) Exemption. Offers and sales made in compliance with all of the 
conditions of this section are exempt from section 5 of the Act (15 
U.S.C. 77e).
    (b) Issuers eligible to use the rule--(1) General. This section is 
available to any issuer that is not subject to the reporting 
requirements of section 13 or 15(d) of the Securities Exchange Act of 
1934 (the ``Exchange Act'') (15 U.S.C. 78m or 78o(d)) and is not an 
investment company registered or required to be registered under the 
Investment Company Act of 1940 (15 U.S.C. 80a-1 et seq.).
    (2) Issuers that become subject to reporting. If an issuer becomes 
subject to the reporting requirements of section 13 or 15(d) of the 
Exchange Act (15 U.S.C. 78m or 78o(d)) after it has made offers 
complying with this section, it may nevertheless rely on this section 
to sell the securities previously offered to the persons to whom those 
offers were made.
    (3) Guarantees by reporting companies. An issuer subject to the 
reporting requirements of section 13 or 15(d) of the Exchange Act (15 
U.S.C. 78m, 78o(d)) may rely on this section if it is merely 
guaranteeing the repayment of a subsidiary's securities that are sold 
under this rule.
    (c) Transactions exempted by the rule. This section exempts offers 
and sales of securities (including plan interests and guarantees 
pursuant to Sec. 230.701(d)(1)(ii)) under a written compensatory 
benefit plan (or written compensation contract) established by the 
issuer, its parents, its majority-owned subsidiaries or majority-owned 
subsidiaries of the issuer's parent, for the participation of their 
employees, former employees, directors, general partners, trustees 
(where the issuer is a business trust), or consultants and advisors, 
and their immediate family who acquire such securities from such 
persons through gifts or domestic relations orders. In the case of a 
former employee, this section exempts offers and sales only if the 
former employee was employed by the issuer at the time the securities 
were offered to the employee.
    (1) Special requirements for consultants and advisors. This section 
is only available if bona fide services are provided by the consultants 
or advisors that are natural persons and the services are not provided 
in connection with the offer and sale of securities in a capital-
raising transaction.
    (2) Definition of ``Compensatory benefit plan''. For purposes of 
this section, a compensatory benefit plan is any purchase, savings, 
option, bonus, stock appreciation, profit sharing, thrift, incentive, 
deferred compensation, pension or similar plan.
    (d) Amounts that may be sold--(1) Offers. Any amount may be offered 
in reliance on this section.
    (2) Sales. The aggregate sales price or amount of securities sold 
in reliance on this section in any consecutive 12-month period, shall 
not exceed the greatest of the following:
    (i) $1,000,000;
    (ii) 15% 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

[[Page 10792]]

guarantees), measured at the issuer's most recent balance sheet date; 
or
    (iii) 15% of the outstanding amount of the class of securities 
being offered and sold in reliance on this section, measured at the 
issuer's most recent balance sheet date.
    (3) Rules for calculating prices and amounts--(i) Aggregate sales 
price. The term aggregate sales price means the sum of all cash, 
property, notes, cancellation of debt or other consideration received 
or to be received by the issuer for the sale of the securities. Non-
cash consideration must be valued by reference to bona fide sales of 
that consideration made within a reasonable time or, in the absence of 
such sales, on the fair value as determined by an accepted standard. 
The value of services exchanged for securities issued to employees, as 
well as to consultants and advisors, should be included in the 
aggregate sales price.
    (ii) Derivative securities. In calculating outstanding securities 
for purposes of paragraph (d)(2)(iii) of this section, treat the 
securities underlying all currently exercisable or convertible options, 
warrants, rights or other securities, other than those issued under 
this section, as outstanding. In calculating the amount of securities 
sold for purposes of paragraph (d)(1) of this section, count the amount 
of securities that would be acquired upon exercise or conversion in 
connection with sales of options, warrants, rights or other exercisable 
or convertible securities.
    (iii) Other exemptions. Amounts of securities sold in reliance on 
this section do not affect amounts that may be sold in reliance on 
other exemptions, and amounts of securities sold in reliance on other 
exemptions do not affect amounts that may be sold in reliance on this 
section.
    (e) Disclosure that must be provided--The issuer must deliver the 
following disclosure to investors a reasonable period of time prior to 
the date of sale:
    (1) A copy of the compensatory benefit plan or the contract, as 
applicable;
    (2) If the plan is subject to the Employee Retirement
    Income Security Act of 1974 (``ERISA'') (29 U.S.C. 1104-1107), a 
copy of the summary plan description required by ERISA;
    (3) If the plan is not subject to ERISA, a summary of the material 
terms of the plan;
    (4) Information about the risks associated with investment in the 
securities sold pursuant to the compensatory benefit plan or 
compensation contract; and
    (5) Financial statements required to be furnished by Part F/S of 
Form 1-A (Regulation A Offering Statement) (Sec. 239.90 of this 
chapter). Such financial statements must be as of a date no more than 
180 days prior to the sale of securities in reliance on this section. 
If the issuer is relying on Sec. 230.701(d)(2)(ii) to use its parent's 
total assets to determine the amount of securities that may be sold, 
the parent's financial statements must be delivered. If the parent is 
subject to the reporting requirements of section 13 or 15(d) of the 
Exchange Act (15 U.S.C. 78m or 78o(d)), the financial statements of the 
parent required by Rule 10-01 of Regulation S-X (Sec. 210.10-01 of this 
chapter) and Item 310 of Regulation S-B (Sec. 228.310 of this chapter), 
as applicable, must be delivered.
    (6) If the sale involves a stock option or other exercisable or 
convertible security, the issuer must deliver disclosure a reasonable 
period of time prior to the date of exercise or conversion. For 
deferred compensation or similar plans, the issuer must deliver 
disclosure to investors a reasonable period of time prior to the date 
the irrevocable election to defer is made.
    (f) No integration with other offerings. Offers and sales exempt 
under this section are deemed to be a part of a single, discrete 
offering and are not subject to integration with any other offers or 
sales, whether registered under the Act or otherwise exempt from the 
registration requirements of the Act.
    (g) Resale limitations--(1) Securities issued pursuant to this 
section are deemed to be ``restricted securities'' as defined in 
Sec. 230.144.
    (2) Resales of securities issued pursuant to this section must be 
in compliance with the registration requirements of the Act or an 
exemption therefrom.
    (3) Ninety days after the issuer becomes subject to the reporting 
requirements of section 13 or 15(d) of the Exchange Act (15 U.S.C. 78m 
or 78o(d)), securities issued pursuant to this section may be resold by 
persons who are not affiliates (as defined in Sec. 230.144) in reliance 
on Sec. 230.144 without compliance with paragraphs (c), (d), (e) and 
(h) of Sec. 230.144, and by affiliates without compliance with 
paragraph (d) of Sec. 230.144.

    By the Commission.

    Dated: February 27, 1998.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 98-5728 Filed 3-4-98; 8:45 am]
BILLING CODE 8010-01-P