Rule 701 – Exemption for Offers and Sales to Employees of Non-Reporting Entities

by Laura Anthony, Esq. on January 01, 2010 in SEC Guidance

While the issuance of small numbers of shares as prizes or awards to employees may be made without Securities Act Registration, if such awards are tied to the achievement of specific goals (eg. sales goals) by individual employees, an offer or sale requiring registration may be involved. When tied to the achievement of specific goals, the share awards may constitute compensation for services performed or to be performed by the employees that would amount to a disposition of the shares for value and a “sale” of the shares to employees requiring either registration or an exemption from registration under the Securities Act of 1933.

Although many exemptions may be available for the issuance of securities to employees, Rule 701 provides an excellent exemption for non-reporting entities. In particular, Rule 701 is only available to issuers that are not subject to the reporting requirements of the Securities Exchange Act 1934. The beauty of Rule 701 is that ninety days after the Issuer becomes subject to the reporting requirements of the Exchange Act, securities issued under this Rule may be resold by persons who are not affiliates under Rule 144 without compliance with the current public information, holding period, amount or Form 144 requirements. That is, generally speaking, ninety days after an Issuer becomes reporting, Rule 701 issued securities may be freely sold. Regardless of whether an Issuer becomes reporting, resales may be made under any available exemption, or pursuant to registration.

Compliance with Rule 701

To comply with Rule 701, an Issuer must have a written compensatory benefit plan for the participation of its employees, director, general partners, trustees, officers, or consultants and advisors. Rule 701 is only available for consultants and advisors if: (i) they are natural persons; (ii) they provide bona fide services to the issuer; and (iii) the services are not in connection with the offer or sale of securities in a capital raising transaction, and do not directly or indirectly promote or maintain a market for the issuer’s securities. A copy of the plan must be delivered to all individuals receiving stock under the plan.

The amount of securities sold in reliance on Rule 701 may not exceed, in any 12 month period, the greater of: (i) $1,000,000; (ii) 15% of the total assets of the issuer; or (iii) 15% of the outstanding amount of the class of securities being offered and sold in reliance on the exemption. Rule 701 issuances do not integrate with the offer and sales of any other securities under the Act whether registered or exempt.

Antifraud Provisions Still Apply

As with all other Securities Act registration exemptions, the issuer is still subject to the antifraud, civil liability and other provisions of the federal securities laws. Issuers and persons acting on their behalf have an obligation to provide all investors, including employees, with disclosure adequate to satisfy the antifraud provisions of the federal securities laws. In addition, Rule 701 is not available for plans or schemes to circumvent the purpose of the Rule, which is for compensatory purposes, and not to raise capital. Moreover, Rule 701 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 Securities Act. Finally, in addition to complying with Rule 701, the Issuer also must comply with any applicable state law relating to the issuance.

Securities attorney Laura Anthony provides expert legal advice and ongoing corporate counsel to small public Companies as well as private Companies seeking to go public on the Over the Counter Bulletin Board Exchange (OTCBB). Ms. Anthony counsels private and small public Companies nationwide regarding reverse mergers, due diligence on public shells, corporate transactions and all aspects of securities law.

Ms. Anthony is the Founding Partner of Legal & Compliance, LLC, a national corporate, securities and civil litigation law firm based in West Palm Beach, Florida. The firm’s corporate and securities attorneys provide technical legal services to small and mid-size private and public (OTCBB) Companies, entrepreneurs, and business professionals nationwide. Contact us today for a FREE consultation!


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