At its open meeting held on November 15, 2007, the Securities and Exchange Commission ("SEC") adopted several rule amendments that are designed to facilitate the capital raising process and to ease the burden of certain reporting requirements, particularly for smaller companies. In particular, the SEC adopted several important changes to Rules 144 and 145 under the Securities Act of 1933, as amended (the "Securities Act"), and adopted a rule that exempts compensatory stock options from the registration requirements under Section 12(g) of the Securities Exchange Act of 1934 (the "Exchange Act"). The SEC's press release announcing these changes is available at http://www.sec.gov/news/press/2007/2007-233.htm.
At yesterday's meeting, the SEC also adopted an important rule change for foreign private issuers that is intended to facilitate the cross-border capital raising process. The revision adopted by the SEC allows foreign private issuers to file their financial statements included with Form 20-F without complying with the U.S. GAAP reconciliation requirement if the financial statements are prepared in accordance with International Financial Reporting Standards ("IFRS"), as issued by the International Accounting Standards Board ("IASB"). The SEC's press release announcing this development is available at http://www.sec.gov/news/press/2007/2007-235.htm.
A summary of the new rules is set forth below. This summary is based on information provided at the SEC's open meeting, and therefore may not reflect nuances that will appear in the SEC's adopting releases, which are expected to be issued shortly.
Amendments to Rules 144 and 145
The amendments to Rules 144 and 145 are intended to decrease the cost of capital for public and private issuers by providing increased liquidity to investors who acquire restricted securities from public and private issuers.
Restricted securities are securities that have been acquired in transactions exempt from the registration requirements of Section 5 of the Securities Act. Rule 144 under the Securities Act permits the resale of restricted securities, subject to certain conditions, without registration under Section 5 of the Securities Act. Purchasers of restricted securities sold in compliance with Rule 144 will receive freely tradable shares. Prior to the amendments adopted by the SEC, in order to sell securities in compliance with Rule 144, sellers of restricted securities were generally required to have held the securities for a minimum period of one year. Following expiration of the one-year holding period, security holders were permitted to resell restricted securities in broker transactions subject to various volume and other limitations. Security holders who are unaffiliated with the issuer and who have held the securities for a minimum period of two years could sell the securities under Rule 144 without complying with the volume, manner of sale and other restrictions.
The amendments adopted at yesterday's meeting reduce the holding period required before restricted securities issued by a "reporting company" may be sold under Rule 144 from one year to six months. The amendments also eliminate all volume limitations and manner of sale and other restrictions on sales under Rule 144 by security holders unaffiliated with the reporting company, other than the Rule 144(c) public information requirement until the securities have been held for one year. Security holders that are affiliates of the reporting company will still be required to comply with the volume limitations and manner of sale and other restrictions required under Rule 144.
Under the amendments, restricted securities issued by a non-reporting company may be sold under Rule 144 after they have been held for one year. After the one-year holding period has expired, security holders unaffiliated with a non-reporting company will be able to sell restricted securities under Rule 144 without complying with any of the other current Rule 144 requirements; security holders that are affiliates of the non-reporting company will be required to comply with all of the current Rule 144 requirements.
The final revisions to Rule 144 did not incorporate the proposal that the holding period for restricted securities issued by reporting companies be tolled (but would not be extended for longer than one year) for any period while the security holder's position in the restricted securities was hedged.
The SEC also adopted a number of revisions to Rule 144 in order to streamline the regulatory process and reduce filing and other costs, including:
- increasing the thresholds for sales by affiliates of the issuer that trigger Form 144 filing requirements from 500 shares or $10,000 to 5,000 shares or $50,000;
- eliminating the manner of sale limitations applicable to sales of debt securities by affiliates of the issuer; and
- codifying certain staff interpretations relating to Rule 144.
The SEC also approved amendments to Rule 145 that eliminate the "presumptive underwriter doctrine" under Rule 145(c), except for transactions involving blank check or shell companies. Under this doctrine, persons who are parties to, or affiliates of parties to, a Rule 145(a) business combination transaction (other than the issuer) are deemed to be underwriters with respect to public sales of shares received in a Rule 145(a) transaction. As a result, even if the acquiring company in a Rule 145(a) transaction registers the issuance of its shares, affiliates of the target company will not be able to publicly sell the shares they receive unless they are sold pursuant to a resale registration statement or in compliance with certain provisions of Rule 144. Once the amendments to Rule 145 become effective, affiliates of the target company will generally no longer be subject to these resale restrictions. The amendments also conform the Rule 145(d) resale restrictions to certain of the approved amendments to Rule 144 discussed above.
The amendments to Rule 144 will increase the liquidity of restricted securities by significantly reducing the restrictions on resales, shortening the holding periods and eliminating manner of sale requirements, such as the volume limitations. As a result, the amendments will likely decrease the cost of capital for issuers of restricted securities by reducing the liquidity discount typically imposed on such securities, and by reducing the need for issuers to agree to file and maintain the effectiveness of resale registration statements for the benefit of investors who purchase restricted securities. The amendments to Rules 144 and 145 and the resulting greater access to capital are also likely to enhance the attractiveness of restricted securities as a form of acquisition currency.
Another point to consider is that registration rights agreements entered into with purchasers of restricted securities often require that the issuer maintain the effectiveness of a resale registration statement until the restricted securities may be resold without restriction under Rule 144(k). Companies that are currently maintaining the effectiveness of, or that have agreed to file, resale registration statements for the benefit of holders of restricted securities should check the terms of any related registration rights agreements. Once the amendments to Rule 144 become effective, as a result of the shorter holding period, an issuer may no longer be obligated to keep the resale registration statement effective, or to file a resale registration statement, if the applicable securities may be resold without restriction under Rule 144.
These amendments will be effective 60 days after they are published in the Federal Register.
Exemption from Registration Requirements for Compensatory Stock Options
The SEC also voted unanimously to adopt a rule creating two exemptions for compensatory stock options from the registration requirements under Section 12(g) of the Exchange Act. The first exemption applies to private companies that are not required to file periodic reports under the Exchange Act. The second exemption is available to issuers that are required to file such periodic reports.
Under Section 12(g) of the Exchange Act, a company is required to register a class of securities if there are 500 or greater holders of that class and the company has assets in excess of $10 million as of its last fiscal year end. For purposes of the Exchange Act, options are a separate class of security. The SEC staff's position, articulated in no-action letters, has been that non-reporting companies that have options issued to more than 500 holders are exempt from the Section 12(g) registration requirements with respect to such options if they meet certain conditions. The first exemption essentially codifies this no-action practice and is intended to provide non-reporting companies with comfort that decisions to issue compensatory employee stock options will not subject them to additional registration and reporting requirements of the Exchange Act.
The first exemption provides that, for an issuer that does not have a class of securities registered under Section 12 of the Exchange Act and that is not subject to the Section 15(d) reporting requirements, compensatory stock options issued pursuant to a written plan are exempt from registration under Section 12(g) if the following conditions are present:
- the class of eligible optionholders is restricted to employees, directors, consultants and advisors of the non-reporting company;
- transferability of the options and shares received upon exercise is restricted; and
- optionholders are provided with risk and financial information of the type that would be required under Rule 701 for the sale of greater than $5 million worth of securities in a 12-month period.
The second exemption may be relied on by public companies that have registered a class of securities under Section 12 of the Exchange Act. This exemption has been viewed as somewhat controversial because until the proposing release, it had not been clear that stock options were even subject to the Section 12(g) registration requirements where the underlying security had already been registered under Section 12. At yesterday's open meeting, the conditions that a public company will need to satisfy in order to rely on this new exemption were not discussed in detail, so the final adopting release will need to be examined to identify the specific conditions. As proposed, however, an issuer would not be required to also register under Section 12 a class of compensatory employee stock options if (i) the stock options were issued pursuant to the written plan, (ii) the securities underlying the options have been registered under Section 12 and (iii) the class of eligible optionholders is restricted to employees, directors, consultants and advisors of the issuer.
Neither of the two exemptions extend to the securities received upon exercise of the options or to any stock appreciation rights.
The SEC will promulgate amendments to Exchange Act Rule 12h-1 in order to establish these two exemptions. The new rules will become effective upon publication in the Federal Register.
Foreign Private Issuers--Ability to File Financial Statements Prepared in Accordance with IFRS Without U.S. GAAP Reconciliation Requirement
The SEC voted unanimously to allow foreign private issuers to file their financial statements in accordance with the English language version of the IFRS as issued by the IASB, and where such financial statements are filed to eliminate the U.S. GAAP reconciliation requirement. Foreign private issuers reporting under Sections 13(a) and 15(d) of the Exchange Act have historically been required to reconcile their financial statements with U.S. GAAP if the statements were prepared under an accounting standard other than U.S. GAAP. In order to reconcile their financial statements with U.S. GAAP, these issuers had to provide a narrative description of accounting differences, along with a quantitative reconciliation of specific financial statement line items. The reconciliation requirement was intended by the SEC to balance two policy concerns: (1) investors' need for comparable basic information when making investment decisions; and (2) the public interest served by the opportunity to diversify in foreign securities.
Because some viewed the reconciliation process as too burdensome for foreign private issuers, the elimination of this requirement for those foreign private issuers who prepare their financial statements in accordance with IFRS is designed, in part, to encourage foreign private issuers to offer securities in the U.S. market. The SEC also noted that the rule is a step on the path towards formulating convergence of international accounting standards.
The rule will only apply to those foreign private issuers that prepare their financial statements in accordance with the English language version of the IFRS as published by the IASB. Issuers who rely upon other accounting standards must continue to reconcile their financial statements with U.S. GAAP. Also, under the final rule, the SEC said that foreign private issuers that prepare their financial statements in accordance with IFRS will be able to omit a U.S. GAAP reconciliation from their unaudited interim period financial statements, to the extent such interim financials are required in an SEC filing (such as a registration statement on Form 20-F). In addition, the SEC said that the final rule will include a carve-out from the IFRS requirement for situations where a foreign private issuer follows the European Commission's November 2004 exception to International Accounting Standard 39, which eliminated the fair value and hedge accounting restrictions from that standard. The SEC said, however, that this limited carve-out will apply only for a two-year transition period, after which foreign private issuers that want to take advantage of the exemption from the U.S. GAAP reconciliation requirement will have to file financial statements that comply with IFRS in its entirety.
To implement the rule, the SEC will amend Form 20-F and make conforming changes to Regulation S-X, Forms F-4 and S-4, and Section 701 of the Securities Act. This rule will become effective 60 days after publication in the Federal Register, but will apply to financial statements covering fiscal years ended after November 15, 2007.
Gibson, Dunn & Crutcher lawyers are available to assist in addressing any questions you may have regarding these issues. Please contact the Gibson Dunn attorney with whom you work, or John F. Olson (202-955-8522, firstname.lastname@example.org), Ronald O. Mueller (202-955-8671, email@example.com), Brian J. Lane (202-887-3646, firstname.lastname@example.org), Stephen I. Glover (202-955-8593, email@example.com), Amy L. Goodman (202-955-8653, firstname.lastname@example.org), Michael Scanlon (202-887-3668, email@example.com), or Alisa Babitz (202-887-3720, firstname.lastname@example.org) in the firm's Washington, D.C. office.
 An issuer must have been subject to the reporting requirements under the Exchange Act for at least 90 days prior to the date of issuance to qualify as a "reporting company" for purposes of Rule 144.
 Stephen I. Glover & Alisa Babitz, Proposed Amendments to Rule 145 & Rule 144 Could Make Stock Deals More Attractive, The M&A Lawyer (Sept. 2007).
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