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Change to Rule 701 Increases Disclosure Threshold

Rule 701, issued under the Securities Act of 1933, provides a broad exemption from federal registration requirements for issuances of stock compensation by private companies. Compliance with Rule 701 also provides an exemption from regulation under many state securities laws. One of the (sometimes overlooked) requirements of Rule 701 is that an issuing company must provide certain disclosures to employees and other grantees of stock awards if the company issues more than $5 million worth of stock in any 12-month period. The required disclosures include financial statements, risks related to investment in the company’s stock and a summary of the material terms of the applicable plan. The $5 million disclosure threshold has been in place since 1999, and has increasingly become a trap for the unwary as stock prices generally have appreciated.  For example, in March of this year, the SEC imposed a fine on Credit Karma for failing to comply with Rule 701’s disclosure requirements in connection with stock option grants made by the company over a 12-month period in 2014 through 2015.

In accordance with a provision of the Economic Growth, Regulatory Relief, and Consumer Protection Act, the SEC recently amended Rule 701 to double the disclosure threshold from $5 million to $10 million. While this change provides welcome relief to issuing companies, taking advantage of Rule 701’s exemption entails more than just determining whether disclosures are necessary. The Rule requires the issuance of stock to be made under a written compensatory plan and exempt issuances are subject to certain dollar limits that are different than the disclosure threshold. Also, certain state securities laws, such as California, may require financial statement or other types of disclosures or regulatory filings for private company equity grants, regardless of Rule 701’s requirements. Private companies that issued or are contemplating issuing stock compensation should closely review compliance with all requirements of Rule 701 and state securities regulations.

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