Dodd-Frank Reform Includes Notable Changes to Rule 701 of the Securities Act and Regulation A+

Kelley Drye Client Advisory


On May 24, 2018, President Trump signed into law the Economic Growth, Regulatory Relief, and Consumer Protection Act (the Relief Act”). The Relief Act significantly reforms the Dodd-Frank Wall Street Reform and Consumer Protection Act, adopted in 2010, by decreasing the regulatory burden on smaller banking institutions.  However, the Relief Act also directs the Securities and Exchange Commission (the SEC”) to adopt notable amendments to Rule 701 under the Securities Act of 1933, as amended (the Securities Act”), as well as Regulation A promulgated thereunder, also commonly known as Regulation A+.”

The change to Rule 701 increases, from $5 million to $10 million, the amount of securities that may be sold thereunder in a 12-month period without triggering certain enhanced disclosure requirements.  The changes to Regulation A+ include expanding its availability to public reporting companies, which had not been permitted to use this particular exemption for raising capital.

Rule 701

Rule 701 is an important exemption from the registration requirements under the Securities Act for the issuance of securities to employees, directors, and certain consultants.  Rule 701 is only available to private companies (i.e., companies that are not subject to the reporting obligations under the Securities Exchange Act of 1934, as amended (the Exchange Act”)), and requires that securities must be granted or sold pursuant to a written compensatory benefit plan (such as a stock option plan, equity incentive plan, or a written compensatory contract).  Rule 701 imposes a size limitation on the amount of securities that a company can sell or issue in reliance thereon in any 12-month period, at the greatest of:
  • $1 million;
  • 15% of total assets, as measured at the most recent balance sheet date (no older than its last fiscal year-end); or
  • 15% of the issued securities of the same class being offered, not including securities offered under Rule 701, as measured on at the most recent balance sheet date (no older than its last fiscal year-end).

These amounts are calculated using the sum of all cash and other consideration received by the issuer for the sale of such securities, so they include the exercise price of any stock options issued thereunder.  Note that Rule 701 does not preempt state blue sky” securities laws, so there may be additional requirements under state law based upon the state of residence of the recipients of issued securities.

Typically, Rule 701 only requires that companies provide recipients with a copy of the applicable compensatory plan.  However, there is an enhanced disclosure requirement for sales over $5 million in any 12-month period, which is being increased to $10 million under the Relief Act.  If the company meets or exceeds this threshold, it is required to provide recipients with the following, in addition to a copy of the compensatory plan, prior to the sale of securities (which, for a stock option, is the date of exercise):

  • A summary of the material terms of the compensatory plan (if it is subject to ERISA, this is a copy of the required summary plan description);
  • Information about the risks associated with the applicable securities; and
  • Financial statements of the company, prepared in accordance with GAAP, within 180 days of the date of issuance or sale of securities.

Note that the enhanced disclosure requirement is triggered for all securities sold in a 12-month period upon meeting or exceeding this threshold, even for those securities issued before the threshold is met.  Due to this lookback requirement and the fact that the disclosure must be made prior to the date of sale, a company may be required to provide the enhanced disclosure before meeting the threshold if it expects to meet it during a 12-month period, or else it may not be able to permitted to issue certain equity grants under Rule 701.

The Relief Act directs the SEC to amend Rule 701 to make this change within 60 days after its enactment, so the change is not in effect yet.  There had been prior interest in having the SEC make this particular change to Rule 701.  This amendment follows an enforcement action brought by the SEC earlier this year against Credit Karma, Inc., a privately-held fintech company. Credit Karma issued $13.8 million of stock options to employees in a 12-month period, but failed to provide the enhanced disclosure required under Rule 701, citing confidentiality concerns.  Credit Karma ultimately agreed to a settlement with the SEC and paid a civil penalty of $160,000.

As a practical matter, this change to Rule 701 will only apply to relatively large private companies that are issuing over $5 million in compensatory securities in a 12-month period, including those that may be approaching an IPO or that regularly issue equity compensation grants.  The increased threshold will help to prevent inadvertently triggering the enhanced disclosure requirements.

Regulation A+

Regulation A+ provides a significant exemption from the registration requirements under the Securities Act by allowing companies to raise up to $50 million in a 12-month period.  Instead of going through the traditional IPO process, including filing a full Form S-1 registration statement, companies can file a scaled Form 1-A with the SEC for these smaller offerings, and therefore, it is sometimes referred to as a mini-IPO.”  Regulation A+ offerings may be under Tier 1” (permitting up to $20 million to be raised in a 12 month period) or Tier 2” (permitting up to $50 million to be raised in a 12 month period).  Tier 2 offerings require audited financial statements and trigger ongoing periodic reporting obligations thereafter, but they have the distinct advantage of preempting” state blue sky laws, thereby not requiring the offering to be registered or qualified in each state where such securities will be offered (or be subject to a state securities law exemption).  Securities sold under Regulation A+ are not restricted” and therefore may be immediately resold, and such offerings are not limited to accredited investors” (those meeting certain standards under the Securities Act, including income or net worth).  Furthermore, certain testing the waters” communications are permitted under this rule, allowing a company to gauge interest from potential investors prior to actually filing the Form 1-A or subsequently commencing an offering.  Regulation A+, which was the result of the 2015 overhaul of Regulation A under the Jumpstart our Business Startups (JOBS) Act, previously had a $5 million limitation per 12-month period and was seldom used.

Regulation A+ has thus far only been available to non-public companies (i.e., companies not subject to the periodic reporting obligations under the Exchange Act).  However, the Relief Act directs the SEC to amend Regulation A+ to expand its availability to public reporting companies.  Furthermore, it states that the reporting requirements under the Exchange Act fulfill the reporting obligations under Tier 2 of Regulation A+, instead of having to file reports specified under both the Exchange Act and under Regulation A+.

The Relief Act does not specify when the SEC must amend Regulation A+.  Once in effect, it will create a new capital raising tool for public companies, which could prove to be particularly attractive for those issuers that are not already eligible to use the abbreviated Form S-3 registration statement.

For more information on this advisory, please contact:

Carol Sherman
(212) 808-5038

Hilary Krulc, a law clerk at Kelley Drye, contributed to this advisory.