Howard Berkenblit is the head of the Capital Markets Group at Sullivan & Worcester, the international law firm of some 200 attorneys who focus on supporting private and public companies as they raise and deploy capital.
As Berkenblit tells PLANADVISER, the firm helps its clients manage all ongoing Securities and Exchange Commission (SEC) reporting matters—from preparing quarterly financial disclosures to helping with shareholder meetings and earnings releases, “all that fun stuff.”
“Our firm is a full-service firm, so we work hand-in-hand with equity compensation folks and attorneys working on labor issues, tax issues, ERISA, etc.,” he adds. “We all overlap and all our clients are issuing equity in some capacity. Generally speaking, all of our clients are relying on Rule 701 to do this, if they are private entities. If they are public, they are going to have an S8 on file.”
According to Berkenblit, the SEC’s move this week to amend Securities Act Rule 701 as mandated by the Economic Growth, Regulatory Relief, and Consumer Protection Act, is an important one. The rule change increases from $5 million to $10 million the threshold in excess of which the issuer is required to deliver additional disclosures to investors. In addition, the SEC solicited comment on “possible ways to modernize rules related to compensatory arrangements in light of the significant evolution in both the types of compensatory offerings and the composition of the workforce since the Commission last substantively amended these rules in 1999.”
“While the rule change was mandated by Congress, it goes to the SEC’s credit that they acted so quickly on getting this change in place,” Berkenblit says. “It’s a fairly modest change, but I do think it will help companies and that this is a positive development.”
As Berkenblit breaks it down, this $10 million amount is “only the threshold above which private companies need to give equity grantees some key financial and operational information.”
“As you can imagine, a lot of private companies don’t want their financial statements widely disseminated, even among employees,” he explains. “As a general matter they want to keep this stuff as close to the vest as possible, for as long as they can. Facebook and Google are good examples of this—they really fought sharing information of this nature until they absolutely had to.”
With the change to Rule 701, companies can grant up to $10 million worth of equity securities in any rolling 12-month period without having to provide any detailed level of financial disclosures.
“It is important to understand this is an ongoing aggregate limit,” Berkenblit says. “It’s a limit in any rolling 12-month period—not tied to the calendar year. If the award was given as an equity option grant, the count is based on the exercise price. If it is a stock grant, the count is based on the share value as of the date of grant.”
One of the more complex issues addressed by the SEC’s open call for industry comment is what happens when an employer makes an honest mistake and blows this newly expanded limit. Currently, if this happens, the violation entirely negates the Rule 701 exemption for the entire preceding 12-month period.
“So if you make a mistake and go beyond the limit, you could potentially find yourself distributing sensitive financial information to many more people than just the last grantee,” Berkenblit warns. “This seems pretty harsh, a lot of people believe, so we are interested to see what the commentary is on this from the marketplace. The SEC seems open to making for a less-onerous penalty for blowing the limit on accident. We expect some might even urge the SEC to do away with these reporting requirements entirely, or to simplify them.”
As Berkenblit sees it, the main idea behind the current regulatory paradigm around private companies issuing equity compensation is that, the larger the amount of equity issued by a private company without disclosure, generally the larger the risk.
“In the eyes of the SEC, having access to financial information gives equity grantees some sense of the stability of the company and its prospects,” he explains. “They will get to see things like two years’ worth of cash balances, net income, revenues and other trends. This would theoretically allow people to make a more informed decision about how to manage and access their equity awards. Why the SEC doesn’t require these disclosures now for everyone is the counter-concern that it can be onerous and expensive to furnish this information. It’s a balancing act, because you can argue that everyone should get this information, but on the other hand you can argue that employers have a right to privacy and that employees can make up their minds based on many other factors.”
Looking ahead, Berkenblit concludes it is still hard to tell at this juncture what the ultimate impact of doubling the Rule 701 limit could be.
“I don’t expect it will dramatically change behavior,” he says. “I’ve heard some arguments that companies are likely to make more grants to more people—and some more cynical arguments that companies are likely to give more equity to the same people. I think we will just have to wait and see. Time will tell. One other item to mention is the call for discussion of ‘gig workers’ and their access to equity stock. I don’t know how realistic this is, personally. I haven’t seen a big outcry among gig workers demanding equity, or much interest among owners in granting equity to this group.”