Compensation Committee Corner : Executive Compensation Lawyer & Attorney : Winstead Law Firm : Director Liability, Employee Benefit Arrangements

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The purpose of this post is to describe how stock options and restricted stock units ("RSUs") are counted when analyzing the SEC registration mandate for privately-held issuers with 500 or more holders of a class of equity securities and assets in excess of $10mm.  The following is a quick analysis and compilation of the applicable legal support.

•  Stock Options.  Stock Options are treated as a separate class of equity securities for purposes of the 500 limit.  See Section 3(a)(11) and Rule 3a11-1; and Section 12(g)(5) (defining "class" to include "all securities of an issuer which are of a substantially similar character and the holders of which enjoy substantially similar rights and privileges.").  This means a company could have 499 shareholders and 499 option holders (PROVIDED NO OPTIONEES EXERCISE) without triggering the foregoing registration requirement.  Stated another way, this means an issuer with 500 or more option holders and more than $10mm in assets is required to register that class of options under the Exchange Act UNLESS AN EXEMPTION APPLIES.  See Release No 34-56887.
• Exemption for Retirement-Type of Plans.  An exemption from the 500 limit for certain employee compensation plans (such as retirement plans) is contained in Rule 12h-1(a).  This means the securities held by such plans are NOT counted towards the applicable 500 limit.
• Exemption for Certain Stock Options.  Effective December 7, 2007, the SEC adopted an exemption from the above registration requirement for certain compensatory stock options.  See Release No. 34-56887 (provided the conditions and limitations contained therein are satisfied).  This means stock options that comply with the requirements and mandates set forth under Release No. 34-56887 are NOT counted towards the applicable 500 limit.  Keep in mind there are certain disclosure requirements that must be contained within the granting documentation in order to gain protection under Release No. 34-56887.  Another important note to keep in mind is that the exemption does not apply to the class of securities underlying stock options to the extent such are exercised.  Therefore, if a privately-held issuer has a shareholder count close to the 500 limit, it may want to consider adding exercise pre-conditions to ensure such stock options cannot be exercised until a liquidity event (e.g., the stock option cannot be exercised until the earlier of an IPO or a change-in-control).
• Application to RSUs.  On February 13, 2012, the SEC essentially incorporated the above analysis and applied it to stock and cash-settled RSUs.  See SEC No-Action Letter.  Private issuers should be able to rely upon this SEC no-action letter because the relief was addressed to a law firm in response to their request (Requesting Letter Found Here); whereas previous SEC no-action letters on the topic were provided to specific issuers.  See No-Action Relief to Twitter on August 23, 2011 (SEC Response Found Here and Requesting Letter Found Here), and Facebook on October 13, 2008 (SEC Response Found Here and Requesting Letter Found Here).
• Increase in 500 Limit?  There is a bill in the House to increase the above shareholder limit from 500 to 1,000.  The status of this bill is uncertain at this time.

The above is not a frequent topic in the life of most private issuers, but when the topic does arise, it is usually a topic of high importance.