

[Federal Register: December 7, 2007 (Volume 72, Number 235)]
[Rules and Regulations]               
[Page 69553-69567]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr07de07-16]                         


[[Page 69553]]

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Part V





Securities and Exchange Commission





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17 CFR Part 240



Exemption of Compensatory Employee Stock Options From Registration 
Under Section 12(G) of the Securities Exchange Act of 1934; Final Rule


[[Page 69554]]


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SECURITIES AND EXCHANGE COMMISSION

17 CFR Part 240

[Release No. 34-56887; International Series Release No. 1305; File No. 
S7-14-07]
RIN 3235-AJ91

 
Exemption of Compensatory Employee Stock Options From 
Registration Under Section 12(G) of the Securities Exchange Act of 1934

AGENCY: Securities and Exchange Commission.

ACTION: Final rule.

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SUMMARY: We are adopting two exemptions from the registration 
requirements of the Securities Exchange Act of 1934 for compensatory 
employee stock options. The first exemption will be available to 
issuers that are not required to file periodic reports under the 
Exchange Act. The second exemption will be available to issuers that 
are required to file those reports because they have registered under 
Exchange Act Section 12 a class of security or are required to file 
reports pursuant to Exchange Act Section 15(d). The exemptions will 
apply only to the issuer's compensatory employee stock options and will 
not extend to the class of securities underlying those options.

DATES: Effective Date: December 7, 2007.

FOR FURTHER INFORMATION CONTACT: Amy M. Starr, Senior Special Counsel 
to the Director, at (202) 551-3115, Division of Corporation Finance, 
U.S. Securities and Exchange Commission, 100 F Street, NE., Washington, 
DC 20549.

SUPPLEMENTARY INFORMATION: We are amending rule 12h-1 \1\ under the 
Securities Exchange Act of 1934.\2\
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    \1\ 17 CFR 240.12h-1.
    \2\ 15 U.S.C. 78a et seq.
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Table of Contents

I. Introduction and Background
    A. Proposing Release and Public Comment Letters
    B. Employee Stock Options and Exchange Act Section 12(g)
II. Discussion of Exemptions
    A. Exemption for Compensatory Employee Stock Options of Issuers 
That Are Not Exchange Act Reporting Issuers
    1. Eligible Issuers
    2. Eligible Compensatory Employee Stock Options
    3. Eligible Option Plan Participants
    4. Option Terms
    a. Compensatory Employee Stock Option Transferability 
Restrictions
    b. Permitted Exercisability of Compensatory Employee Stock 
Options
    5. Required Information
    6. Issuer Obligation To Impose the Conditions to the Exemption
    B. Exemption for Compensatory Employee Stock Options of Exchange 
Act Reporting Issuers
    C. Registering When No Longer Eligible for Exemption
III. Paperwork Reduction Act
    A. Background
    B. Summary of Collection of Information
    C. Summary of Comments
    D. Paperwork Reduction Act Burden Estimates
IV. Cost-Benefit Analysis
    A. Background
    B. Summary of Amendments
    1. Expected Benefits
    2. Expected Costs
V. Consideration of Burden on Competition and Promotion of 
Efficiency, Competition and Capital Formation Analysis
VI. Regulatory Flexibility Act Certification
VII. Administrative Procedure Act
VIII. Statutory Basis and Text of Rule Amendments

I. Introduction and Background

A. Proposing Release and Public Comment Letters

    On July 5, 2007, we proposed amendments to Exchange Act Rule 12h-1 
to provide two exemptions from Exchange Act Section 12(g) \3\ 
registration for compensatory employee stock options.\4\ The first 
proposed exemption applied to compensatory employee stock options of an 
issuer that did not have a class of security registered under Exchange 
Act Section 12 \5\ and was not subject to the reporting requirements of 
Exchange Act Section 15(d),\6\ provided certain conditions were met. 
The proposed exemption built on a line of no-action letters issued by 
the staff of the Division of Corporation Finance that granted relief 
from Exchange Act Section 12(g) registration to private, non-reporting 
issuers for their compensatory employee stock options.\7\ The second 
proposed exemption applied to compensatory employee stock options of 
issuers that were required to file periodic reports under the Exchange 
Act because they had registered under Section 12 the class of equity 
security underlying those options.
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    \3\ 15 U.S.C. 78l(g).
    \4\ Exemption of Compensatory Employee Stock Options from 
Registration Under Section 12(g) of the Securities Exchange Act of 
1934, Release No. 34-56010 (Jul. 10, 2007) [72 FR 37608] 
(``Proposing Release'').
    \5\ 15 U.S.C. 78l.
    \6\ 15 U.S.C. 78o(d).
    \7\ See, e.g., no-action letters to Starbucks Corporation 
(available Apr. 2, 1992); Kinko's, Inc. (available Nov. 30, 1999); 
Mitchell International Holding, Inc. (available Dec. 27, 2000) 
(``Mitchell International''); AMIS Holdings, Inc. (available Jul. 
30, 2001) (``AMIS Holdings''); Headstrong Corporation (available 
Feb. 28, 2003); and VG Holding Corporation (available Oct. 31, 2006) 
(``VG Holding'').
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    In response to our request for comment on the Proposing Release, we 
received twelve comment letters from various persons, all of whom 
expressed support for the need for the proposed exemptions.\8\ 
Commenters expressed differing concerns about the scope of the 
exemptions, and the transferability restrictions and information 
conditions of the proposed exemption for private, non-reporting 
issuers. After considering commenters' views, we are adopting 
amendments to Exchange Act Rule 12h-1, substantially as proposed, with 
some modifications including:
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    \8\ See letters from American Bar Association, Committee on 
Federal Regulation of Securities (``ABA''); America's Community 
Bankers (``ACB''); Center for Audit Quality (``CAQ''); Deloitte & 
Touche LLP (``D &T''); Drinker Biddle & Reath LLP (``Drinker''); 
Ernst & Young LLP (``E &Y''); Freescale Semiconductor 
(``Freescale''); KPMG LLP (``KPMG''); Andrew Ross, Partner, Loeb & 
Loeb (``Ross''); New York State Society of Certified Public 
Accountants (``NYSSCPA''); Pink Sheets LLC (``Pink Sheets''); and 
Simpson Thacher & Bartlett LLP (``Simpson'').
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     Exemption for private, non-reporting issuers:

--Elimination of transferability and ownership restrictions on holders 
of shares issued on exercise of compensatory employee stock options; 
and
--Elimination of an issuer's obligation to provide certain required 
information to holders of shares received on exercise of compensatory 
employee stock options.

     Exemption for public reporting issuers:

--Expansion of the category of issuers eligible to rely on the 
exemption to include any issuer required to file periodic reports under 
Exchange Act Section 13 \9\ or Section 15(d).
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    \9\ 15 U.S.C. 78m.
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B. Employee Stock Options and Exchange Act Section 12(g)

    In the 1980s, private, non-reporting issuers began using 
compensatory employee stock options \10\ to compensate a broader range 
of employees, including executive, middle, and lower-level employees, 
directors, and consultants.\11\ Compensatory

[[Page 69555]]

employee stock options provide a method to use non-cash compensation to 
attract, retain, and motivate company employees, directors, and 
consultants.\12\ Since the 1990s, a number of private, non-reporting 
issuers have granted compensatory employee stock options to 500 or more 
employees, directors, and consultants.\13\
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    \10\ Throughout this release, for purposes of the exemption for 
private, non-reporting issuers, we use the term ``compensatory 
employee stock options'' to refer to stock options issued to 
employees, directors, consultants, and advisors (to the extent 
permitted under Securities Act Rule 701 [17 CFR 230.701]). For 
reporting issuers, the phrase also refers to those persons described 
in General Instruction A.1(a) to Form S-8 [17 CFR 239.16b].
    \11\ The National Center for Employee Ownership surveyed 275 
venture capital-backed private businesses in the technology and 
telecommunications businesses. Of these firms, 77% provided options 
to all employees while 23% provided them only to select employees. 
``New Data Show Venture-Backed Companies Still Issue Options 
Broadly,'' http://www.nceo.org/library/option_venturebacked.html; 

see also J. Hand, 2005 ``Give Everyone a Prize? Employee Stock 
Options in Private Venture-Backed Firms,'' Working Paper, Kenan-
Flagler Business School, UNC Chapel Hill, available at http://ssrn.com/abstracts=599904
 (``Hand Paper'') (study investigating the 

impacts on the equity values of private venture-backed firms of the 
organizational depth to which they grant employee stock options).
    Securities Act Rule 701, which provides an exemption from 
Securities Act registration for non-reporting issuers for offerings 
of securities to employees, directors, consultants and advisors, and 
specified others, pursuant to written compensatory benefit plans or 
agreements, has given private issuers great flexibility in granting 
compensatory employee stock options to employees (and other eligible 
persons) at all levels. See Rule 701(c) [17 CFR 230.701(c)]; and 
Rule 701 Exempt Offerings Pursuant to Compensatory Arrangements, 
Release No. 33-7645 (Mar. 8, 1999) [64 FR 11095] (``Rule 701 
Release''). See also Compensatory Benefit Plans and Contracts, 
Release No. 33-6768 (Apr. 14, 1988) [53 FR 12918].
    \12\ See Hand Paper, note 11 supra.
    \13\ See no-action letters cited at note 7 supra.
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    Under Exchange Act Section 12(g), an issuer with 500 or more 
holders of record of a class of equity security and assets in excess of 
$10 million at the end of its most recently ended fiscal year must 
register that class of equity security, unless there is an available 
exemption from registration.\14\ Stock options, including stock options 
issued to employees under stock option plans, are a separate class of 
equity security for purposes of the Exchange Act.\15\ Accordingly, an 
issuer with 500 or more optionholders and more than $10 million in 
assets is required to register that class of options under the Exchange 
Act, absent an available exemption. While there is an exemption from 
Exchange Act Section 12(g) registration for interests and 
participations in certain other types of employee compensation plans 
involving securities,\16\ currently there is no exemption for 
compensatory employee stock options.
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    \14\ The asset threshold was set originally at $1 million in 
Section 12(g). Pursuant to its authority under Section 12(h) of the 
Exchange Act, the Commission has increased the amount three times; 
from $1 million to $3 million in 1982 (System of Classification for 
Purposes of Exempting Smaller Issuers From Certain Reporting and 
Other Requirements, Release No. 34-18647 (Apr. 13, 1982)[47 FR 
17046]), from $3 million to $5 million in 1986 (Reporting by Small 
Issuers, Release No. 34-23406 (Jul. 8, 1986) [51 FR 253601]), and 
from $5 million to $10 million in 1996 (Relief from Reporting by 
Small Issuers, Release No. 34-37157 (May 1, 1996) [61 FR 21353]).
    \15\ Exchange Act Section 3(a)(11) [15 U.S.C. 78c(a)(11)] 
defines equity security to include any right to purchase a security 
(such as options) and Exchange Act Rule 3a11-1 [17 CFR 240.3a11-1] 
explicitly includes options in the definition of equity security for 
purposes of Exchange Act Sections 12(g) and 16 [15 U.S.C. 78l(g) and 
78p]. Exchange Act Section 12(g)(5) [15 U.S.C. 78l(g)(5)] defines 
class to include ``all securities of an issuer which are of 
substantially similar character and the holders of which enjoy 
substantially similar rights and privileges.''
    \16\ The exemption from registration under Exchange Act Section 
12(g) which is contained in Exchange Act Rule 12h-1(a), was adopted 
in 1965, for ``[a]ny interest or participation in an employee stock 
bonus, stock purchase, profit sharing, pension, retirement, 
incentive, thrift, savings or similar plan which is not transferable 
by the holder except in the event of death or mental incompetency, 
or any security issued solely to fund such plans.'' Rule 12h-1 is 
intended to exempt from Section 12(g) registration the same types of 
employee benefit plan interests as Section 3(a)(2) [15 U.S.C. 
77c(a)(2)] of the Securities Act of 1933 [15 U.S.C. 77a et seq.] 
exempts from Securities Act registration and, thus, does not cover 
stock options. See, e.g., L. Loss and J. Seligman, Securities 
Regulations, 3d., at Sec.  6-A-4.
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    The addition of Section 12(g) to the Exchange Act in 1964 was 
intended ``to extend to investors in certain over-the-counter 
securities the same protection now afforded to those in listed 
securities by providing that the issuers of certain securities now 
traded over the counter shall be subject to the same requirements that 
now apply to issuers of securities listed on an exchange.'' \17\ 
Further, Exchange Act Section 12(g) extended the disclosure and other 
Exchange Act safeguards to unlisted securities as a means to prevent 
fraud.\18\
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    \17\ House of Representatives Report No. 1418 (1964), 88th 
Cong., 2d Sess., HR 679, p.1. See also Section 3(c) of the 
Securities Act Amendments of 1964, Pub. L. 88-467; 78 Stat. 565.
    \18\ Senate Committee Report, No. 379 (1963), 88th Cong., 1st 
Sess., p. 63.
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    A number of private, non-reporting issuers faced with registration 
under Exchange Act Section 12(g) due solely to their compensatory 
employee stock options being held by 500 or more holders of record (as 
well as having more than $10 million in assets) at the end of their 
fiscal year have requested registration relief from our Division of 
Corporation Finance.\19\ Since 1992, the Division has provided relief 
through no-action letters \20\ to these private issuers when specified 
conditions were present. More recently, the Advisory Committee on 
Smaller Public Companies, in its Final Report, recommended that we 
provide Exchange Act Section 12(g) registration relief for compensatory 
employee stock options.\21\
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    \19\ The Division has delegated authority to grant (but not 
deny) applications for exemption under Exchange Act Section 12(h). 
See Rule 200.30-1(e)(7) [17 CFR 200.30-1(e)(7)].
    \20\ For the conditions necessary to receive relief under these 
letters and orders see, e.g., the no-action letter to Mitchell 
International, note 7 supra (for the pre-2001 relief) and the no-
action letters to AMIS Holdings, note 7 supra; ISE Labs, Inc. 
(available Jun. 2, 2003); Jazz Semiconductor, Inc. (available Nov. 
21, 2005) (``Jazz Semiconductor''); and VG Holding, note 7 supra 
(for the expanded relief beginning in 2001).
    \21\ Final Report of the Advisory Committee on Smaller Public 
Companies to the Securities and Exchange Commission, Apr. 23, 2006 
at 87 (``Final Report of the Advisory Committee'').
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    As we discussed further in the Proposing Release, we believe that 
it is appropriate at this time to adopt two new exemptions from the 
registration provisions of Exchange Act Section 12(g) for compensatory 
employee stock options issued under employee stock option plans that 
are limited to employees, directors, consultants, and advisors of the 
issuer, its parents, and majority-owned subsidiaries of the issuer or 
its parents.\22\
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    \22\ The exemption for private, non-reporting issuers allows 
compensatory employee stock options to be held only by those persons 
described in Securities Act Rule 701(c) [17 CFR 230.701(c)] 
(including permitted transferees), while the exemption for reporting 
issuers also allows options to be held by those persons described in 
General Instruction A.1(a) to Form S-8. Securities Act Rule 701(c) 
lists the categories of persons to whom offers and sales of 
securities under written compensatory benefit plans or contracts may 
be made in reliance on Securities Act Rule 701 by an issuer, its 
parents, and majority-owned subsidiaries of the issuer or its 
parents. The categories of persons are: employees (including 
specified insurance agents); directors; general partners; trustees 
(where the issuer is a business trust); officers; consultants and 
advisors (under certain conditions); family members who acquire 
their securities from such persons through gifts or domestic 
relations orders; and former employees, directors, general partners, 
trustees, officers, consultants and advisors only if such persons 
were employed by or providing services to the issuer at the time the 
securities were offered. The exemption also allows options to be 
transferred to (and held by) family members (as described in 
Securities Act Rule 701) through gifts or domestic relations orders, 
or to an executor or guardian of the optionholder upon the death or 
disability of the optionholder. For ease of discussion, in this 
release we use the phrase ``employees, directors, consultants and 
advisors of the issuer'' to refer to those persons described in 
Securities Act Rule 701(c) and transferees permitted by the 
exemption. For reporting issuers, the exemption will cover grants of 
options made prior to and after the issuer becomes subject to the 
Exchange Act reporting requirements.
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II. Discussion of Exemptions

    We are adopting two amendments to Exchange Act Rule 12h-1 as 
proposed, with some modifications. These amendments will:
     Provide an exemption for private, non-reporting issuers 
from Exchange Act Section 12(g) registration for compensatory employee 
stock options issued under employee stock option plans; and
     Provide an exemption from Exchange Act Section 12(g) 
registration for compensatory employee stock

[[Page 69556]]

options of issuers that have registered under Exchange Act Section 12 a 
class of security or are required to file reports pursuant to Exchange 
Act Section 15(d).
    Given the differences between issuers that are required to file 
periodic reports under the Exchange Act and those issuers that do not 
have such an obligation, including the nature of the trading markets 
and the amount of publicly available information, we believe that it is 
appropriate to adopt separate exemptions for these different types of 
issuers.

A. Exemption for Compensatory Employee Stock Options of Issuers That 
Are Not Exchange Act Reporting Issuers

    We believe it is appropriate to provide an exemption from Exchange 
Act registration, based on the factors identified in Exchange Act 
Section 12(h),\23\ for compensatory employee stock options of issuers 
that are not required to file reports under the Exchange Act.\24\ We 
believe that an exemption from Exchange Act registration of 
compensatory employee stock options for private, non-reporting issuers 
will provide useful certainty to those issuers in their compensation 
decisions and will help them avoid becoming subject to the registration 
and reporting requirements of the Exchange Act prior to the time they 
have public shareholders. The availability of this exemption is subject 
to specified limitations, including limitations concerning permitted 
optionholders, transferability, and provision of information. We 
believe that the conditions to the exemption and the existing statutory 
provisions and rules provide holders of compensatory employee stock 
options in private, non-reporting issuers appropriate disclosure and 
investor protections under the federal securities laws, given the 
compensatory circumstances of the securities issuance and the 
restrictions on transferability of the compensatory employee stock 
options. As such, we believe that the exemption is in the public 
interest, in that it would clarify and routinize the basis for an 
exemption from Exchange Act Section 12(g) registration for compensatory 
employee stock options so private, non-reporting issuers would be able 
to continue to use compensatory employee stock options and would 
provide appropriate investor protections for optionholders.
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    \23\ Exchange Act Section 12(h) provides for exemptive authority 
with regard to certain provisions of the Exchange Act. Included in 
Exchange Act Section 12(h) is the authority to create appropriate 
exemptions from the Exchange Act registration requirements. Under 
Exchange Act Section 12(h), the Commission may exempt a class of 
securities by rules and regulations or by order if it ``finds, by 
reason of the number of public investors, amount of trading interest 
in the securities, the number and extent of the activities of the 
issuer, income or assets of the issuer, or otherwise, that such 
action is not inconsistent with the public interest or the 
protection of investors.'' Exchange Act Section 12(h) [15 U.S.C. 
78l(h)].
    \24\ We believe that the exemption is consistent with the 
exemption provided for other employee benefit plans in Exchange Act 
Rule 12h-1, which is not available for stock option plans, the 
compensatory employee stock options issued pursuant to such plans, 
or the securities issued on exercise of such compensatory employee 
stock options. We believe that the characteristics of many employee 
benefit plans, which are by their own terms limited to employees, 
not available to the general public, and subject to transfer 
restrictions, obviate the need for applicability of all the rules 
and regulations aimed at public trading markets. In addition, 
because many of the conditions in the exemption refer to certain 
Securities Act Rule 701 definitions and requirements, we believe 
that the exemption from Exchange Act Section 12(g) registration will 
allow non-reporting issuers to continue to rely on Securities Act 
Rule 701 in offering and selling compensatory employee stock options 
and the shares issued on exercise of those options.
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1. Eligible Issuers
    The amendment we are adopting today will provide an exemption from 
Exchange Act Section 12(g) registration for compensatory employee stock 
options of the following types of issuers:
     Issuers that do not have a class of securities registered 
under Exchange Act Section 12; and
     Issuers that are not subject to the reporting requirements 
of Exchange Act Section 15(d).\25\
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    \25\ Under Exchange Act Section 15(d), an issuer's ``duty to 
file [reports under Section 15(d) is] automatically suspended if and 
so long as any issue of securities of such issuer is registered 
pursuant to section 12 of this title.'' [15 U.S.C. 78o(d)].
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    The exemption will be available only to those issuers that are not 
required to report under the Exchange Act. As such, the exemption will 
terminate once the issuer becomes subject to the reporting requirements 
of the Exchange Act. The exemption also will terminate if the issuer no 
longer satisfies the conditions to the exemption.\26\
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    \26\ The exemption under Exchange Act Section 12 will allow 
issuers 120 calendar days to register the class of options once an 
issuer no longer is able to rely on the exemption. Currently, the 
no-action letter relief terminates once an issuer becomes subject to 
the Exchange Act reporting requirements. See, e.g., no-action letter 
to VG Holding, note 7 supra. Moreover, the exemption will not be 
available if the issuer was required, but failed, to register 
another class of equity security under the Exchange Act.
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2. Eligible Compensatory Employee Stock Options
    The exemption for compensatory employee stock options will:
     Apply only to compensatory employee stock options that are 
issued under a written compensatory stock option plan \27\ that is 
limited to employees, directors, consultants, and advisors of the 
issuer, its parents, or majority-owned subsidiaries of the issuer or 
its parents; \28\
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    \27\ Securities Act Rule 701 is available only for offers and 
sales of compensatory employee stock options and the shares issuable 
upon exercise of those options that are issued under written 
compensatory employee benefit plans of an issuer, its parents, or 
majority-owned subsidiaries of the issuer or its parents. See 
Securities Act Rule 701(c) [17 CFR 230.701(c)]. Thus, the 
requirement that the options be issued under written compensatory 
stock option plans will not impose a new obligation on issuers 
relying on Securities Act Rule 701 in offering and selling 
compensatory employee stock options or the shares issued on exercise 
of those options.
    \28\ The exemption for the compensatory employee stock options 
will not extend to other rights issued in connection with the 
compensatory employee stock options, such as stock appreciation 
rights. Any such other rights will be evaluated separately for 
purposes of Exchange Act Section 12(g) registration. Some commenters 
had requested that the exemption apply to all compensation 
arrangements involving securities, including restricted stock units, 
stock appreciation rights, and other rights or securities. See 
letters from ABA and Freescale. Consistent with the scope of the 
staff no-action letters granting Section 12(g) registration relief 
for compensatory employee stock options, at this time we believe the 
exemption should address only compensatory employee stock options. 
We, therefore, are not expanding the scope of the exemption beyond 
compensatory employee stock options.
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     Apply to all compensatory employee stock options issued 
under all written compensatory stock option plans on a combined basis 
where the securities underlying the compensatory employee stock options 
are of the same class of securities of the issuer, with the exemptive 
conditions applying to the compensatory employee stock options issued 
under each option plan; and
     Not extend to any class of securities received or to be 
received on exercise of the compensatory employee stock options.
    The exemption covers all compensatory employee stock options 
meeting the conditions of the exemption, even if the compensatory 
employee stock options are issued under separate written option plans 
of the issuer, its parents, or majority-owned subsidiaries of the 
issuer or its parents.\29\ For the purpose of the exemption, the 
compensatory employee stock options will be considered to belong to the 
same class of equity security of the issuer if the same class of 
securities of the issuer will be issuable on exercise of the 
compensatory employee stock options.\30\ While one commenter

[[Page 69557]]

requested that we allow companies to determine whether a particular 
group of compensatory employee stock options was the same class as 
other compensatory employee stock options for purposes of determining 
whether it had met the 500 holder threshold,\31\ we are adopting the 
exemption as proposed in this regard.\32\ We believe that, solely for 
purposes of determining whether the Rule 12h-1 exemption is available, 
it is important to establish uniformity in evaluating whether there are 
500 or more holders of compensatory employee stock options and so that 
issuers appropriately analyze when Exchange Act Section 12(g) applies 
to their compensatory employee stock options.\33\
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    \29\ In response to comment (see letter from ABA), we have 
clarified that the options may be granted under plans of the issuer, 
its parents, and majority-owned subsidiaries of the issuer or its 
parents.
    \30\ See Exchange Act Section 12(g)(5) [15 U.S.C. 78l(g)(5)].
    \31\ See letter from ABA.
    \32\ One commenter suggested that the class of options should 
only include those options issued after the effective date of the 
exemption that satisfied the conditions of the exemption. See letter 
from Drinker. We are not adopting such a provision. Under the 
Exchange Act, the class of equity security is not determined based 
on when the securities are issued. The exemption provides that the 
class of compensatory employee stock options for purposes of the 
exemption includes all compensatory employee stock options on the 
same class of the issuer's securities regardless of whether the plan 
is a plan of the issuer, its parents, or majority-owned subsidiaries 
of the issuer or its parents. No distinction is made in the 
exemption as to when those options are issued.
    \33\ This provision will not affect the separate class analysis 
under Exchange Act Section 12(g)(5) for other purposes.
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    The exemption, as adopted, applies to the compensatory employee 
stock options only and not to the securities issued (or to be issued) 
on exercise of the compensatory employee stock options. Thus, the 
issuer will have to apply the registration requirements of Exchange Act 
Section 12 to the class of equity security underlying the compensatory 
employee stock options without regard to the exemption.\34\
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    \34\ For example, if an issuer had more than $10 million in 
assets and 500 or more holders of a class of equity security 
underlying the compensatory employee stock options as of the end of 
its fiscal year, it would have to register under Exchange Act 
Section 12 that class of equity security.
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3. Eligible Option Plan Participants
    The exemption is available only where the class of persons eligible 
to receive compensatory employee stock options under the stock option 
plans is limited to those persons described in the exemption. These 
eligible optionholders are the same as those participants permitted 
under Securities Act Rule 701 and include: \35\
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    \35\ See the discussion at note 22 supra.
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     Employees of the issuer, its parents, or majority-owned, 
direct or indirect, subsidiaries of the issuer or its parents;
     Directors of the issuer, its parents, or majority-owned, 
direct or indirect, subsidiaries of the issuer or its parents; and
     Consultants and advisors of the issuer, its parents, or 
majority-owned, direct or indirect, subsidiaries of the issuer or its 
parents.
    As adopted, the exemption is limited to those situations where 
compensatory employee stock options may be held only by those persons 
who are permitted to hold or be granted compensatory employee stock 
options under Securities Act Rule 701 and their permitted 
transferees.\36\ We believe that the experience of issuers and their 
counsels with Securities Act Rule 701 will ease compliance with and 
limit uncertainty regarding the exemption.\37\
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    \36\ In this regard, we note that this category of eligible 
optionholders is broader than the category of persons to whom 
employee benefit securities, including compensatory employee stock 
options, may be offered and sold by reporting issuers using a Form 
S-8 registration statement. See General Instruction A.1(a) to Form 
S-8. As we note below, the exemption for reporting issuers will 
allow eligible optionholders to satisfy the definitions contained in 
either Securities Act Rule 701 or Form S-8 because an issuer may 
grant options both prior to and after it becomes subject to the 
periodic reporting requirements of the Exchange Act.
    \37\ Some commenters were concerned that the terms of 
outstanding options may not contain all the restrictive provisions 
of the exemption. (See letters from Drinker and Ross). We believe 
that our elimination of the restrictions on holders of shares 
received on exercise of an option and the modification of the 
transferability conditions affecting optionholders should address 
these concerns.
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    Just as Securities Act Rule 701 was designed specifically not to be 
available for capital-raising transactions, the exemption will apply 
only to employee stock options issued for compensatory purposes. The 
restrictions on the eligible participants in the stock option plans are 
intended to assure that the exemption is limited to employee stock 
options issued solely for compensatory purposes.\38\
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    \38\ All option grants and exercises must, of course, comply 
with the requirements of the Securities Act.
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4. Option Terms
a. Compensatory Employee Stock Option Transferability Restrictions
    The exemption is available only where there are certain 
restrictions on the transferability by an optionholder of those options 
and, prior to the exercise of the options, the shares issuable on 
exercise of those options.\39\ Specifically, the exemption is available 
only if:
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    \39\ The exemption does not impose any limitations on the 
ability of current or former employees, directors, consultants, or 
advisors of an issuer to retain or exercise their compensatory 
employee stock options.
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     The compensatory employee stock options and, prior to 
exercise, the shares to be received on exercise of those options cannot 
be transferred except, as permitted by the exemption: \40\
---------------------------------------------------------------------------

    \40\ The transferability restrictions are not intended to 
supersede other transferability restrictions imposed for other 
reasons, including under the Internal Revenue Code of 1986, as 
amended [26 U.S.C. 422(b)(5)].

--To family members (as defined in Securities Act Rule 701) by gift or 
pursuant to domestic relations orders; and
--On death or disability of the optionholder; \41\
---------------------------------------------------------------------------

    \41\ These permitted transferees are intended to be the same as 
those permitted under Securities Act Rule 701(c) as well as 
executors or guardians of an optionholder on the death or disability 
of the optionholder. See note 22 supra.

     There can be no other permitted pledges, gifts, 
hypothecations, or other transfers of the compensatory employee stock 
options, or shares issuable on exercise of those options, prior to 
exercise, until the issuer becomes subject to the reporting 
requirements of the Exchange Act or is no longer relying on the 
---------------------------------------------------------------------------
exemption; provided that there may be:

--Transfers back to the issuer; or
--Transfers in connection with a change of control or other acquisition 
transactions involving the issuer if, following such transaction, the 
options no longer will be outstanding and the issuer no longer will be 
relying on the exemption; \42\ and

    \42\ After an issuer becomes subject to the reporting 
requirements of the Exchange Act, the issuer will be able to rely on 
the exemption for Exchange Act reporting issuers only if it becomes 
subject to Exchange Act reporting as a result of its Exchange Act 
Section 12 registration of a class of security or pursuant to 
Exchange Act Section 15(d).
---------------------------------------------------------------------------

     The compensatory employee stock options or the securities 
issuable upon exercise of those options cannot be the subject of a 
short position, a ``put equivalent position'' \43\ or a ``call 
equivalent position'' \44\ by the optionholder, prior to exercise, 
until the issuer becomes subject to the reporting requirements of the 
Exchange Act or is no longer relying on the exemption; provided that 
the options may be subject to repurchase rights of the issuer or the 
optionholder may participate in a change of control or other 
acquisition transaction involving the issuer.
---------------------------------------------------------------------------

    \43\ 17 CFR 240.16a-1(h). Rule 16a-1(h) defines a ``put 
equivalent position'' as a derivative security position that 
increases in value as the value of the underlying equity decreases, 
including, but not limited to, a long put option and a short call 
option position.
    \44\ 17 CFR 240.16a-1(b). Rule 16a-1(b) defines a ``call 
equivalent position'' as a derivative security position that 
increases in value as the value of the underlying equity increases, 
including, but not limited to, a long convertible security, a long 
call option, and a short put option position.
---------------------------------------------------------------------------

    As adopted, the conditions provide that, except with regard to the 
limited

[[Page 69558]]

permitted transfers specified in the conditions, an optionholder cannot 
be permitted, prior to exercise, to pledge, hypothecate, or otherwise 
transfer the compensatory employee stock options or the shares 
underlying those options, including through a short position, a ``put 
equivalent position,'' or a ``call equivalent position,'' until the 
issuer becomes subject to the reporting requirements of the Exchange 
Act or is no longer relying on the exemption.\45\ For the exemption to 
be available, these transfer restrictions will have to apply to options 
outstanding at the time that the issuer is relying on the exemption.
---------------------------------------------------------------------------

    \45\ The current no-action letters contain similar conditions on 
transferability of the options, although the rule as adopted 
clarifies the limitations on the ability of optionholders to engage 
in certain derivative transactions prior to exercise, such as 
restrictions on an optionholder from entering into a ``put 
equivalent position'' or ``call equivalent position'' until the 
issuer becomes subject to the reporting requirements of the Exchange 
Act, or is no longer relying on the exemption. See, e.g., no-action 
letter to VG Holding, note 7 supra. In addition, the amendment as 
adopted does not restrict holders of shares following exercise of 
compensatory employee stock options.
---------------------------------------------------------------------------

    The restrictions on transfer of the compensatory employee stock 
options and the shares underlying those options, prior to exercise, are 
intended to limit the possibility for a trading market to develop for 
the compensatory employee stock options while the issuer is relying on 
the exemption. These restrictions also are intended to assure that an 
optionholder is not able to profit from the compensatory employee stock 
options or the securities to be received on exercise of those options 
(except from permitted payments or transfers as described in the 
exemption), until the issuer becomes subject to the reporting 
requirements of the Exchange Act or is no longer relying on the 
exemption.
    In response to comments, we have modified the transferability 
condition to permit optionholders to receive compensation for their 
options from the issuer or arising from a change of control or other 
acquisition transaction after which the options no longer will be 
outstanding and the issuer no longer will be relying on the 
exemption.\46\
---------------------------------------------------------------------------

    \46\ See letters from ABA, Ross, and Simpson.
---------------------------------------------------------------------------

    Commenters also were concerned that a requirement for an issuer to 
repurchase the shares or options due to state law limitations on 
transfer restrictions could have adverse accounting consequences to 
companies.\47\ As a result, we have modified the transferability 
conditions to eliminate a requirement for an issuer to repurchase 
options if an express prohibition on transfer of options is not 
permitted under applicable state law. Instead, the condition permits 
the issuer to provide that it may repurchase the options in the event 
of an impermissible transfer. Issuers also may provide that the options 
terminate in such an event. We note that compensatory employee stock 
option plans or written stock option agreements generally restrict the 
persons who may exercise the options, so providing for a termination of 
an option in the event of an impermissible transfer would, in many 
cases, already be contemplated by the terms of the written stock option 
agreement or plan.
---------------------------------------------------------------------------

    \47\ See letters from CAQ, D&T, E&Y, and KPMG.
---------------------------------------------------------------------------

    We proposed that the transferability restrictions apply to holders 
of shares issued on exercise of the options. In response to 
comments,\48\ we have not adopted this condition of the exemption. We 
understand from commenters that private, non-reporting issuers normally 
already have shareholder agreements and other mechanisms to restrict 
the transfer of shares received on exercise of options prior to the 
time the issuer becomes subject to the reporting requirements of the 
Exchange Act or is involved in a change of control or other acquisition 
transaction involving the issuer.\49\ We also understand that private, 
non-reporting issuers do not anticipate that optionholders will 
exercise their options prior to a liquidity event, such as an initial 
public offering or sale of the company, or prior to termination of the 
options.\50\
---------------------------------------------------------------------------

    \48\ See letters from ABA, Drinker, Ross, and Simpson.
    \49\ See letters from ABA, Freescale, Ross, and Simpson.
    \50\ In expressing their views that the proposed transferability 
restrictions should not be expected to affect a private company's 
ability to value the compensatory employee stock options under 
Financial Accounting Standards Board Statement of Financial 
Accounting Standards No. 123R (revised 2004) Share-Based Payment 
(FAS 123R), some commenters noted that in valuing employee stock 
options for purposes of FAS 123R, private, non-reporting issuers use 
an expected term assumption that does not anticipate early exercise 
of the options. See letters from CAQ, E&Y, and KPMG. These 
commenters noted that employees of non-public companies normally do 
not have an incentive to exercise a vested option early due to the 
lack of a market for the underlying shares. These commenters 
observed that non-public company employees typically hold their 
options until they have incentive to exercise such as at the end of 
their terms, termination of employment, or until a liquidity event, 
such as an initial public offering or sale of the company occurs.
---------------------------------------------------------------------------

    We are not adopting as a condition to the exemption separate 
transferability restrictions on holders of the shares received on 
exercise of the compensatory employee stock options. While we 
acknowledged in the Proposing Release the existence of company-imposed 
and securities law transferability restrictions, we are persuaded to 
modify the exemption in light of the additional concerns that 
commenters believed the proposed transferability restrictions would 
raise. In modifying the exemption, we have considered the treatment of 
compensatory employee stock options under Securities Act Rule 701 as 
restricted securities as defined in Securities Act Rule 144,\51\ the 
fact that optionholders typically do not exercise their options prior 
to their termination or a liquidity event and the fact that, if 
exercised, most private companies take steps to restrict 
transferability of shares received on exercise of compensatory employee 
stock options, so that there is a limited possibility of a market 
developing in the securities issued on exercise of immediately 
exercisable compensatory employee stock options. In addition, we have 
considered a commenter's view that imposing separate transferability 
restrictions on the holders of shares received on exercise of 
compensatory employee stock options may affect a company's decision to 
use stock options for compensatory purposes.\52\ We also note that the 
exemptions we are adopting today do not impact the continued potential 
applicability of Exchange Act Section 12(g) to the securities issued on 
exercise of the options.
---------------------------------------------------------------------------

    \51\ 17 CFR 230.144. See, e.g., Securities Act Rule 701(g).
    \52\ See letter from ABA. See also, letter from Ross.
---------------------------------------------------------------------------

    We also are not adopting the proposed restriction on other shares 
of the same class of equity security as those underlying the options. 
We believe that this restriction is no longer necessary because we have 
not adopted transferability restrictions on holders of securities 
received on exercise of compensatory employee stock options. In 
addition, we have taken into account one commenter's concern that the 
transferability restrictions on the optionholder with respect to shares 
of the same class as those issuable on exercise of the options would 
affect an optionholder's ability to dispose of other securities of the 
issuer that the optionholder owned.\53\
---------------------------------------------------------------------------

    \53\ See letter from Ross.
---------------------------------------------------------------------------

    As proposed, the exemption would have provided that there could be 
no market, process, or methodology that would permit optionholders, 
prior to exercise, to receive compensation or consideration for their 
options, the shares issuable on exercise of the options, or shares of 
the same class of equity security as those underlying those options. 
Commenters noted that generally there is no market for the securities 
underlying the options while

[[Page 69559]]

the issuer is a private, non-reporting entity.\54\ Commenters were 
concerned that optionholders should not be disadvantaged from receiving 
payments from an issuer or in connection with a change of control or 
other corporate transaction involving an issuer, either with respect to 
their options or shares of the issuer they already own.\55\ In light of 
these comments, we do not believe the exemption should impair an 
optionholder's ability to participate in transactions involving the 
issuer's securities they already own and we do not believe the 
exemption should restrict an issuer or other shareholders from engaging 
in particular transactions due to the issuer's reliance on the 
exemption.
---------------------------------------------------------------------------

    \54\ See letters from ABA, Freescale, Ross, and Simpson.
    \55\ See letters from ABA, Freescale, Ross, and Simpson.
---------------------------------------------------------------------------

b. Permitted Exercisability of Compensatory Employee Stock Options
    The exemption will not require that there be any restriction on the 
timing of the exercise of the compensatory employee stock options:
     By the optionholder (regardless of whether the 
optionholder continues to be an employee, director, consultant or 
advisor of the issuer);
     In the event of the death or disability of the 
optionholder, by the estate or guardian of the optionholder; or
     By a family member (as defined in Securities Act Rule 701) 
who acquired the options through a gift or domestic relations order.
5. Required Information
    We are adopting the proposed requirement that the issuer provide 
information to optionholders with certain modifications. In response to 
comment, we are not adopting a requirement for issuers to provide 
information to holders of shares received on exercise of compensatory 
employee stock options after exercise or for issuers to provide 
optionholders access to their books and records.\56\
---------------------------------------------------------------------------

    \56\ See letter from ABA.
---------------------------------------------------------------------------

    As adopted, the information condition will require the issuer, for 
purposes of the exemption, to periodically provide the following 
information to optionholders: \57\
---------------------------------------------------------------------------

    \57\ In response to comment (see letters from ABA and Ross), we 
are clarifying that the information conditions may commence once a 
company has 500 or more optionholders and may terminate once the 
company becomes subject to the reporting requirements of the 
Exchange Act or is no longer relying on the exemption.
---------------------------------------------------------------------------

     The same risk and financial information that would be 
required to be provided under Securities Act Rule 701 if securities 
sold in reliance on Securities Act Rule 701 in a 12-month period 
exceeded $5 million (as such provision may be modified \58\), with the 
optionholders being provided every six months required information, 
including financial statements that are not more than 180 days old.\59\
---------------------------------------------------------------------------

    \58\ One commenter suggested that the exemption take into 
account changes in the dollar threshold in Securities Act Rule 701. 
See letter from ABA. The rule text, as proposed and adopted, refers 
only to the relevant paragraph of Securities Act Rule 701 and does 
not include a separate dollar threshold. Therefore, any change in 
the dollar threshold in Securities Act Rule 701 would apply to the 
exemption.
    \59\ See Securities Act Rule 701(e) [17 CFR 230.701(e)] for a 
description of the risk factor and financial statement requirements. 
The required information will have to be provided under the terms of 
the exemption, once an issuer is relying on the exemption regardless 
of whether the issuer would be required to provide the information 
under Securities Act Rule 701 (for example, because the issuer did 
not sell $5 million in securities in a 12-month period in reliance 
on Securities Act Rule 701). The financial statement requirements 
under Securities Act Rule 701 refers to financial statements of Part 
F/S of Form 1-A [17 CFR 239.90]. Part F/S of Form 1-A does not 
require audited financial statements unless an issuer has prepared 
them for other purposes. Otherwise, Part F/S of Form 1-A permits an 
issuer to provide two years of unaudited financial statements.
---------------------------------------------------------------------------

    The issuer will be permitted to provide the required information to 
the optionholders either by:
     Physical or electronic \60\ delivery of the information; 
or
---------------------------------------------------------------------------

    \60\ Electronic delivery of such information will have to be 
made in compliance with the Commission's interpretations regarding 
the electronic delivery of information. See, e.g., ``Use of 
Electronic Media,'' Release No. 34-42728 (Apr. 28, 2000) [65 FR 
25843].
---------------------------------------------------------------------------

     Notice to the optionholders of:

--The availability of the information on an Internet site that may be 
password-protected; \61\ and
---------------------------------------------------------------------------

    \61\ A password-protected closed-system intranet site accessible 
to employees also would be a permitted method to provide the 
required information to those persons having access to such site.
---------------------------------------------------------------------------

--Any password needed to access the information.

    In Securities Act Rule 701, we established the type of information 
that employees holding compensatory employee stock options must be 
provided before the exercise of those options.\62\ The Securities Act 
Rule 701 information provisions provide optionholders and other persons 
who purchase securities without registration under Securities Act Rule 
701 with important information. While one commenter objected to the 
provision of information condition,\63\ we believe that the ongoing 
provision of the same information is necessary and appropriate for 
purposes of the exemption from Exchange Act registration.\64\ While 
requiring private, non-reporting issuers to provide information, as 
adopted, the exemption will allow flexibility in the means of providing 
the information by permitting physical, electronic, or Internet-based 
delivery.
---------------------------------------------------------------------------

    \62\ See Rule 701 Release, note 11 supra. ``The type and amount 
of disclosure needed in a compensatory securities transaction 
differs from that needed in a capital-raising transaction. In a bona 
fide compensatory arrangement, the issuer is concerned primarily 
with compensating the employee-investor rather than maximizing its 
proceeds from the sale. Because the compensated individual has some 
business relationship, perhaps extending over a long period of time, 
with the securities issuer, that person will have acquired some, and 
in many cases, a substantial amount of knowledge about the 
enterprise. The amount and type of disclosure required for this 
person is not the same as for the typical investor with no 
particular connection with the issuer.'' Id.
    \63\ See letter from ABA.
    \64\ As the Commission reminded issuers when it adopted the 
amendments to Securities Act Rule 701 in 1999, issuers should be 
aware that compliance with the minimum disclosure standards for 
Securities Act Rule 701 may not necessarily satisfy the antifraud 
standards of the securities laws. See Rule 701 Release, note 11 
supra. (Preliminary Note 1 to Rule 701 states that issuers and other 
persons acting on their behalf have an obligation to provide 
investors with disclosure adequate to satisfy the antifraud 
provisions of the federal securities laws.) We recognize that the 
Advisory Committee has recommended modifications to Securities Act 
Rule 701 that would affect the thresholds that would trigger the 
disclosure provisions of that rule. Our amendments do not address 
the Advisory Committee's recommendations regarding Securities Act 
Rule 701. See Final Report of the Advisory Committee, note 21 supra, 
at p. 92-93.
---------------------------------------------------------------------------

    Securities Act Rule 701 provides that the required information must 
be provided to an optionholder a reasonable period of time before the 
date of exercise of the compensatory employee stock options. Securities 
Act Rule 701 also requires that the required financial statements be as 
of a date no more than 180 days before the sale of the securities 
(which in the case of compensatory employee stock options is the date 
of exercise of the options). We believe that the exemption from 
Exchange Act registration presents the need for ongoing information to 
be provided to optionholders. As such, the exemption requires that, 
once an issuer has 500 or more optionholders, the optionholders must be 
provided every six months the required information, including financial 
statements that are not more than 180 days old.
    We believe that our experience with Securities Act Rule 701 and the 
combined conditions of the exemption, including the eligibility and 
transferability provisions, make it appropriate to require the same 
risk and financial information as required under Securities Act Rule 
701, as noted above, rather than essentially the same

[[Page 69560]]

Exchange Act information and reports as if it was subject to the 
Exchange Act reporting requirements in the context of an ongoing 
reporting exemption relating to compensatory employee stock 
options.\65\ As such, we believe that the scope of information that the 
optionholders will be provided under the exemption is not inconsistent 
with investor protection and the public interest.\66\
---------------------------------------------------------------------------

    \65\ As the Commission also recognized when it adopted the 
Securities Act Rule 701 amendments in 1999, and because many issuers 
that have 500 or more optionholders and more than $10 million in 
assets are likely to have received venture capital financing (see 
for example the data in the Hand Paper, note 11 supra), we believe 
that many of these issuers already have prepared the type of 
disclosure required in their normal course of business, either for 
using other exemptions, such as Regulation D, or for other purposes. 
As a result, the disclosure requirement generally will be less 
burdensome for them. In adopting the amendments to Securities Act 
Rule 701, we stated that a minimum level of disclosure was essential 
to meet even the reduced level of information needed to inform 
compensatory-type investors such as employees and consultants. See 
Rule 701 Release, note 11 supra.
    \66\ For a private, non-reporting issuer with a significant 
number of optionholders (and with more than $10 million in assets at 
the end of its fiscal year), we believe it is likely that such 
issuer either already is obligated to provide the same information 
to optionholders due to sales of securities in reliance on 
Securities Act Rule 701 or already prepares and, as such, provides 
such information to its shareholders. One commenter also stated that 
many private, non-reporting issuers prepare financial statements, 
including audited financial statements, for other purposes. See 
letter from E&Y. Moreover, because of the transferability 
restrictions on the compensatory employee stock options and, prior 
to exercise, the shares to be received on exercise of those options, 
optionholders will have limited investment decisions to make, until 
the issuer becomes subject to the reporting requirements of the 
Exchange Act or is engaged in an acquisition transaction affecting 
the options. Consequently, we believe that the disclosure required 
under the exemption is the appropriate level of disclosure to be 
provided optionholders until the issuer becomes subject to the 
reporting requirements of the Exchange Act or is no longer relying 
on the exemption.
---------------------------------------------------------------------------

    One commenter objected to the proposed condition that the issuer 
make its books and records available for inspection by the optionholder 
and holders of shares received on exercise of compensatory employee 
stock options to the same extent that they are available to other 
shareholders of the issuer.\67\ This commenter stated that such a 
requirement may go beyond or be inconsistent with state law 
requirements. We are not adopting the books and records element of the 
information condition. We believe that holders of such shares can 
exercise their state law rights to inspect corporate books and records. 
Moreover, because optionholders, as such, are not shareholders, we 
agree with the commenter that it is not necessary to extend the books 
and records inspection right to them if it is not already provided for 
under applicable state law.
---------------------------------------------------------------------------

    \67\ See letter from ABA.
---------------------------------------------------------------------------

    To permit issuers to safeguard proprietary or confidential 
information that may be contained in the information to be provided, 
the exemption will permit provision of the disclosure to be conditioned 
on the optionholder agreeing to maintain the confidentiality of the 
information.\68\ In response to a commenter,\69\ we are not adopting 
the proposed provision that would have required an issuer to allow 
inspection of the documents at one of the described issuer offices if 
an optionholder chooses not to enter into such a confidentiality 
agreement. Under the exemption, as adopted, the issuer is not required 
to provide the information to a particular optionholder if the holder 
does not agree to keep the information to be provided pursuant to the 
exemption confidential.\70\ Therefore, the exemption, as adopted, 
permits an issuer to take steps to protect the confidentiality of its 
information.
---------------------------------------------------------------------------

    \68\ This provision is consistent with the related information 
provision under Securities Act Rule 701.
    \69\ See letter from ABA.
    \70\ This provision does not affect an issuer's information 
delivery obligation under Securities Act Rule 701.
---------------------------------------------------------------------------

    The proposal also would have required that the issuer provide the 
required information to holders of shares received on exercise of 
options. We have revised the information condition to apply only to 
optionholders in light of concern regarding the potential misuse of 
information by non-employees or former employees of a company.\71\ The 
amendments, as adopted, do not condition the exemption on 
transferability restrictions on the underlying shares similar to those 
applicable to the compensatory employee stock options. One commenter 
expressed concern that the information delivery conditions would treat 
these company shareholders differently than other company 
shareholders.\72\ Since the exemption applies only to the compensatory 
employee stock options and not to the shares received on exercise of 
the compensatory employee stock options, we believe our revisions 
should address concerns in this regard and provide companies 
flexibility in addressing confidentiality and share transferability 
issues.
---------------------------------------------------------------------------

    \71\ See letter from ABA.
    \72\ See letter from ABA.
---------------------------------------------------------------------------

6. Issuer Obligation To Impose the Conditions to the Exemption
    We are adopting essentially as proposed the requirement that, for 
the exemption to be available, a private, non-reporting issuer must 
include the necessary limitations and conditions in the written stock 
option plans, within the terms of the individual written option 
agreements, or in another enforceable written agreement. Some 
commenters were concerned about the need to include the conditions and 
obligations in option plans or option agreements and one commenter 
suggested that the conditions and restrictions should only have to be 
satisfied in practice.\73\ We believe that the nature of the exemption 
necessitates the inclusion of the conditions to the exemption in an 
enforceable written agreement or agreements between the issuer and the 
optionholders, or in the issuer's by-laws or certificate of 
incorporation. By allowing the conditions and obligations to be 
included in any enforceable written agreement or in the issuer's 
certificate of incorporation or by-laws, we also believe that the 
modified condition will provide issuers necessary flexibility in where 
to include the conditions in their agreements with optionholders.
---------------------------------------------------------------------------

    \73\ See, e.g., letters from ABA, Drinker, and Ross. While one 
commenter suggested eliminating any requirement for the conditions 
to be embodied in an agreement (see letter from ABA), we believe 
that the condition must be enforceable by the optionholder. Further, 
we believe the issuer must have written evidence that it satisfies 
this condition.
---------------------------------------------------------------------------

B. Exemption for Compensatory Employee Stock Options of Exchange Act 
Reporting Issuers

    To provide certainty regarding the obligations of issuers that 
already have registered securities under the Exchange Act or are 
required to file reports under the Exchange Act pursuant to Exchange 
Act Section 15(d), we are adopting an exemption from Exchange Act 
registration for compensatory employee stock options of these reporting 
issuers.\74\ While the proposed exemption would have been available 
only for an issuer that had registered under Exchange Act Section 12 
the class of equity security underlying the compensatory employee stock 
options, in response to comment,\75\ we are expanding the eligibility 
for this exemption to all issuers required to file periodic reports 
pursuant to Exchange

[[Page 69561]]

Act Section 13 or Exchange Act Section 15(d). The filing of Exchange 
Act reports pursuant to Exchange Act Sections 13 or 15(d) will provide 
the appropriate information to optionholders.
---------------------------------------------------------------------------

    \74\ We believe the exemption will provide important guidance 
regarding, and an appropriate exemption to, eligible issuers from 
the Exchange Act registration requirement for compensatory employee 
stock options.
    \75\ See letter from ABA.
---------------------------------------------------------------------------

    As with the exemption for private, non-reporting issuers, the 
exemption for issuers subject to the reporting requirements of the 
Exchange Act will be available only where the options are issued 
pursuant to a written compensatory stock option plan. We have revised 
the exemption, in response to comment,\76\ to provide that the class of 
persons eligible to receive or hold compensatory employee stock options 
under the stock option plans includes those participants permitted to 
be granted options under an issuer's Form S-8, as well as to those 
participants permitted under Securities Act Rule 701.\77\ We have made 
this change to take into account the fact that, for a reporting issuer, 
compensatory employee stock options may have been granted before, and 
may be granted after, the issuer becomes subject to the Exchange Act 
reporting requirements.
---------------------------------------------------------------------------

    \76\ See letter from ABA.
    \77\ This expansion will make the categories of eligible 
optionholders consistent under both exemptions. See the discussion 
under ``Eligible Option Plan Participants,'' above, for a 
description of the eligible optionholders.
---------------------------------------------------------------------------

    We also have modified the optionholder eligibility condition to 
address the concerns of some commenters that the exemption still should 
be available to reporting issuers even where a small number of 
optionholders may not necessarily fall within the permitted categories 
of optionholders.\78\ We are adopting a provision that will permit the 
exemption to continue to be available even if there is an insignificant 
deviation from satisfying the eligibility conditions of the 
exemption.\79\ This provision will allow reporting issuers to rely on 
the exemption if the number of optionholders that do not meet the 
eligibility condition are insignificant both as to the aggregate number 
of optionholders and number of outstanding options. Further, following 
the effective date of the exemption, to be able to rely on the 
exemption, including the insignificant deviation provision, the issuer 
must have made a good faith and reasonable attempt to comply with the 
conditions of the exemption.
---------------------------------------------------------------------------

    \78\ See letters from ABA, Drinker, and Ross. Commenters noted 
that options could be held by persons that previously had been 
granted options by the issuer, or by another entity acquired by the 
issuer. One commenter also was concerned about options held by 
former employees of an acquired entity who would not be considered 
eligible optionholders under Form S-8.
    \79\ While we are allowing the exemption to be available to 
reporting issuers that have insignificant deviations from the 
eligibility conditions, we are not adopting a similar provision for 
private, non-reporting issuers. We believe this distinction is 
appropriate because reporting issuers are subject to all of the 
disclosure requirements under the periodic reporting rules of the 
Exchange Act and also are subject to staff review. The concept of 
allowing an insignificant deviation from required conditions also is 
included in Regulation D and Regulation A under the Securities Act 
[17 CFR 230.260 and 17 CFR 230.508]. We believe that issuers are 
familiar with the concept under the Securities Act and applying a 
similar concept to the exemption under the Exchange Act will assist 
issuers in avoiding unintentional failures to satisfy the exemption 
conditions.
---------------------------------------------------------------------------

    The exemption from Section 12(g) registration for compensatory 
employee stock options of Exchange Act reporting issuers does not 
include any information conditions, other than those arising from the 
registration of a class of security under the Exchange Act or arising 
under Exchange Act Section 15(d).
    We are not conditioning the availability of the exemption on the 
issuer being current in its Exchange Act reporting. As we noted in the 
proposing release, we believe it would seem inappropriate for the 
issuer to lose the exemption, and be required to register a class of 
compensatory employee stock options under Exchange Act Section 12(g), 
because it was late in filing a required Exchange Act report and, for 
the days before that report was filed, was not ``current'' in its 
Exchange Act reporting. One commenter agreed with this approach.\80\
---------------------------------------------------------------------------

    \80\ See letter from ABA.
---------------------------------------------------------------------------

    While we had proposed that the exemption apply only where the 
issuers had registered the class of equity security underlying the 
compensatory employee stock options, which would provide optionholders 
the protections of Exchange Act Sections 13(e) \81\ and 14(e),\82\ we 
agree with one commenter that the exemption should be available to all 
issuers required to file periodic reports under the Exchange Act.\83\ 
For those issuers required to file periodic reports pursuant to 
Exchange Act Section 15(d), the exemption will no longer be available 
once their obligation to file reports under Exchange Act Section 15(d) 
is suspended. In that case, to maintain the exemption, the issuer would 
have to register a class of security under Exchange Act Section 12.
---------------------------------------------------------------------------

    \81\ 15 U.S.C. 78m(e).
    \82\ 15 U.S.C. 78n(e).
    \83\ See letter from ABA. Exchange Act Section 14(e) would, of 
course, continue to apply regardless of whether the issuer had 
registered the class of equity security underlying the compensatory 
employee stock options.
---------------------------------------------------------------------------

    We believe that once an issuer has 500 or more optionholders it is 
more likely that it will have 500 or more holders of the shares 
underlying the options and therefore will be required to register that 
class under Exchange Act Section 12 if it also has more than $10 
million in assets. In addition, if the issuer becomes a private, non-
reporting issuer due to the suspension or termination of its reporting 
obligation, it may rely on the exemption for the compensatory employee 
stock options of private, non-reporting issuers if the conditions to 
that exemption are satisfied.

C. Registering When No Longer Eligible for Exemption

    If a private, non-reporting issuer becomes ineligible to rely on 
the exemption, the issuer will be permitted up to 120 calendar days 
from the date it became ineligible to rely on the exemption to file a 
registration statement to register under Exchange Act Section 12(g) the 
class of compensatory employee stock options. For a reporting issuer 
that becomes ineligible to rely on the exemption, the issuer will be 
permitted up to 60 calendar days from the date it became ineligible to 
rely on the exemption to file a registration statement to register 
under Exchange Act Section 12(g) the class of compensatory employee 
stock options or a class of security. We have revised the transition 
provision for private, non-reporting issuers in response to a 
commenter's concern that 60 days would not be sufficient for private, 
non-reporting issuers to prepare a Form 10 registration statement 
including audited financial statements.\84\ We have retained the 60 day 
time period for reporting issuers because they already would have been 
required to prepare and file periodic reports under the Exchange Act, 
including audited financial statements.
---------------------------------------------------------------------------

    \84\ See letter from ABA.
---------------------------------------------------------------------------

III. Paperwork Reduction Act

A. Background

    Certain provisions of the amendments to Exchange Act Rule 12h-1 
\85\ contain ``collection of information'' requirements within the 
meaning of the Paperwork Reduction Act of 1995 (``PRA'').\86\ We 
published a notice requesting comment on the collection of information 
requirements in the Proposing Release and submitted these to the Office 
of Management and Budget (``OMB'') for review and approval in 
accordance with the PRA.\87\ OMB approved the collection and the 
control number is 3235-0632. An agency may not conduct or sponsor, and 
a person is

[[Page 69562]]

not required to respond to, a collection of information unless it 
displays a currently valid OMB control number. The title for this 
information is:
---------------------------------------------------------------------------

    \85\ 17 CFR 240.12h-1.
    \86\ 44 U.S.C. 3501 et seq.
    \87\ 44 U.S.C. 3507(d) and 5 CFR 1320.11.
---------------------------------------------------------------------------

     Exchange Act Rule 12h-1.
    The hours and costs associated with preparation of notices, 
maintaining Internet sites, and preparation of information to be 
disclosed to optionholders for private, non-reporting issuers relying 
on the exemption from Exchange Act Section 12(g) \88\ registration 
constitute cost burdens imposed by the collection of information. The 
exemption available to reporting issuers will not constitute new 
collections of information. The amendments will not affect existing 
collections of information.
---------------------------------------------------------------------------

    \88\ 15 U.S.C. 78l(g).
---------------------------------------------------------------------------

    The exemptions from Exchange Act Section 12(g) registration are 
being adopted pursuant to the Exchange Act. The information collection 
requirements related to the exemption for private, non-reporting 
issuers are a condition to reliance on the exemption. There is no 
mandatory retention period for the information disclosed and the 
information disclosed is not required to be filed with the Commission.

B. Summary of Collection of Information

    Our amendments to Exchange Act Rule 12h-1 will provide an exemption 
for private, non-reporting issuers from Exchange Act Section 12(g) 
registration for compensatory employee stock options issued under 
employee stock option plans. The amendments also will provide an 
exemption from Exchange Act Section 12(g) registration for compensatory 
employee stock options of issuers that are subject to the periodic 
reporting requirements of the Exchange Act pursuant to Exchange Act 
Section 13 or Section 15(d).
    The requirements regarding notice of information availability, 
Internet availability of information, and, for certain issuers, the 
preparation of information related to the exemption from Exchange Act 
Section 12(g) for compensatory employee stock options of private, non-
reporting issuers constitute a new collection of information under the 
Exchange Act. The information provision in the exemption for private, 
non-reporting issuers is not a new collection of information for those 
private, non-reporting issuers that also are required to provide such 
information to optionholders pursuant to Securities Act Rule 701 \89\ 
or that already prepare and provide such information to their 
shareholders.
---------------------------------------------------------------------------

    \89\ 17 CFR 230.701.
---------------------------------------------------------------------------

    The collection of information is required for those private, non-
reporting issuers that rely on the exemption because they had 500 or 
more optionholders and more than $10 million in assets at the end of 
their fiscal year. The issuers likely to use the exemption are those 
private, non-reporting issuers that had more than $10 million in assets 
and had used stock options to compensate employees, directors, 
consultants, and advisors on a broad basis. The exemption from Section 
12(g) registration for compensatory employee stock options of reporting 
issuers that are subject to the periodic reporting requirements of the 
Exchange Act pursuant to Exchange Act Section 13 or Section 15(d) does 
not impose any new collection of information on these reporting 
issuers.

C. Summary of Comments

    None of the commenters addressed our request for comment on the PRA 
analysis and, accordingly, we have not revised our PRA estimates.

D. Paperwork Reduction Act Burden Estimates

    For purposes of the PRA, we estimate that the annual burden for 
responding to the collection of information in the exemption will not 
increase significantly for most private, non-reporting issuers, due to 
the current disclosure provisions of Securities Act Rule 701 and the 
probability that such issuers already prepare such information for 
other purposes. The costs may increase for those private, non-reporting 
issuers who are not relying on Securities Act Rule 701 when they grant 
compensatory employee stock options or who do not prepare the 
information for other purposes. The cost of providing such information 
may increase because of the requirement in the exemption for private, 
non-reporting issuers to provide the required information.
    Our estimates represent the burden for private, non-reporting 
issuers eligible to rely on the exemption. Because the registration 
provisions of Exchange Act Section 12(g) apply only to an issuer with 
500 or more holders of record of a class of equity security and assets 
in excess of $10 million at the end of its most recently ended fiscal 
year, only those private, non-reporting issuers satisfying those 
thresholds will be subject to the collection of information. The 
Division of Corporation Finance has granted no-action relief from 
registration of compensatory employee stock options to 30 private, non-
reporting issuers during the period 1992 through 2006. If we assume 
that approximately 3 new private, non-reporting issuers will be relying 
on the exemption each year and that a certain number of private, non-
reporting issuers will no longer be relying on the exemption because 
they have become reporting issuers, have been acquired, or have 
terminated business, we estimate that approximately 40 private, non-
reporting issuers each year may be relying on the exemption. The 
exemption for private, non-reporting issuers would terminate once such 
issuer became subject to the reporting requirements of the Exchange Act 
or was no longer relying on the exemption. Thus, the number of private, 
non-reporting issuers that may rely on the exemption may vary from year 
to year.
    For purposes of the PRA, we estimate the annual paperwork burden 
for private, non-reporting issuers desiring to rely on the exemption 
and to comply with our collection of information requirements to be 
approximately 20 hours of in-house issuer personnel time and to be 
approximately $24,000 for the services of outside professionals.\90\ 
These estimates include the time and the cost of preparing and 
reviewing the information and making the information available to 
optionholders. We assume that the same number of private, non-reporting 
issuers will rely on the exemption each year.
---------------------------------------------------------------------------

    \90\ For administrative convenience, the presentation of the 
totals related to the paperwork burden hours have been rounded to 
the nearest whole number and the cost totals have been rounded to 
the nearest hundred.
---------------------------------------------------------------------------

    We estimate that 25% of the burden of preparation and provision of 
the information required by the exemption is carried by the issuer 
internally and that 75% of the burden is carried by outside 
professionals retained by the issuer at an average cost of $400 per 
hour.\91\ The portion of the burden carried by outside professionals is 
reflected as a cost, while the portion of the burden carried by the 
issuer internally is reflected in hours.
---------------------------------------------------------------------------

    \91\ In connection with other recent rulemakings, we have had 
discussions with several private law firms to estimate an hourly 
rate of $400 as the average cost of outside professionals that 
assist issuers in preparing disclosures for offerings.
---------------------------------------------------------------------------

IV. Cost-Benefit Analysis

A. Background

    Compensatory stock options provide a method to use non-cash 
compensation to attract, retain, and motivate issuer employees, 
directors and consultants. Since the 1990s, a number of private, non-
reporting issuers have granted

[[Page 69563]]

compensatory employee stock options to 500 or more employees, 
directors, and consultants. Compensatory employee stock options also 
are used routinely by issuers required to report under the Exchange 
Act.
    Stock options, including stock options issued to employees under 
stock option plans, are a separate class of equity security for 
purposes of the Exchange Act. Under Exchange Act Section 12(g), an 
issuer with 500 or more holders of record of a class of equity security 
and assets in excess of $10 million at the end of its most recently 
ended fiscal year must register that class of equity security, unless 
there is an available exemption from registration. While there is an 
exemption from Exchange Act Section 12(g) registration for interests 
and participations in certain other types of employee compensation 
plans involving securities, currently there is no exemption for 
compensatory employee stock options.

B. Summary of Amendments

    We are adopting two exemptions from the registration provisions of 
Exchange Act Section 12(g) for compensatory employee stock options 
issued under employee stock option plans that are limited to employees, 
directors, consultants, and advisors of the issuer.
    One amendment to Exchange Act Rule 12h-1 will provide an exemption 
from Exchange Act Section 12(g) registration for compensatory employee 
stock options of an issuer that does not have a class of securities 
registered under Exchange Act Section 12 and is not subject to the 
reporting requirements of Exchange Act Section 15(d), where the 
following conditions are present:
     Eligible optionholders are limited to employees, 
directors, consultants, and advisors of the issuer, its parents, or 
majority-owned subsidiaries of the issuer or its parents and permitted 
transferees;
     Transferability by optionholders of compensatory employee 
stock options and, prior to exercise, the shares to be received on 
exercise of those options is restricted; and
     Risk and financial information is provided to 
optionholders that is of the type that would be required under 
Securities Act Rule 701 if securities sold in reliance on Securities 
Act Rule 701 exceeded $5 million in a 12-month period.
    The second amendment to Exchange Act Rule 12h-1 will provide an 
exemption for compensatory employee stock options of issuers that are 
required to file reports under the Exchange Act pursuant to Exchange 
Act Section 13 or Exchange Act Section 15(d).
1. Expected Benefits
    Benefits of the exemption for private, non-reporting issuers are 
likely to include the following: (1) Lower costs to, and reduced 
uncertainty for, private, non-reporting issuers desiring relief from 
registration under Section 12(g) for compensatory employee stock 
options issued to employees, directors, consultants, and advisors for 
compensatory purposes; (2) benefits to private, non-reporting issuers 
in designing and implementing employee stock option plans without 
regard to concerns arising from Exchange Section 12(g) registration of 
the compensatory employee stock options; (3) benefits to private, non-
reporting issuers arising from the use of electronic or Internet-based 
methods of providing the information necessary to satisfy the 
information requirement of the exemption; and (4) benefits to 
optionholders of private, non-reporting issuers arising from the 
required provision of information under the exemption.
    Private, non-reporting issuers would benefit from cost savings as a 
result of the exemption from Section 12(g) registration of their 
compensatory employee stock options. A number of private, non-reporting 
issuers that have 500 or more optionholders and assets in excess of $10 
million have hired attorneys and requested no-action relief from the 
Division of Corporation Finance with regard to the registration of the 
options. The conditions to no-action relief from the Division include 
information provision conditions that are more extensive than in the 
exemption. The exemption, which is available if the provisions of the 
exemption are satisfied, will reduce the legal and other costs to a 
private, non-reporting issuer arising from the no-action request and 
relief. Such cost savings include reduced legal and accounting fees 
arising from both the request for no-action relief and for preparation 
of reports equivalent to Exchange Act reports of a reporting issuer on 
an ongoing basis. Because we expect that a number of the issuers that 
may take advantage of the exemption may be smaller issuers, these cost 
savings could be significant relative to revenues.
    The amendments require the same information that the issuer 
otherwise would be required to provide if securities sold in reliance 
on Securities Act Rule 701 exceeded $5 million during any consecutive 
12-month period. Thus, for private, non-reporting issuers with a 
significant number of optionholders (and with more than $10 million in 
assets at the end of its fiscal year), it is likely that such issuer 
either already is obligated to provide the same information to 
optionholders due to sales of securities in reliance on Securities Act 
Rule 701, or already prepares and, as such, provides such information 
to its shareholders.\92\ Further, any private, non-reporting issuer 
that has received no-action relief regarding registration of its 
compensatory employee stock options will face reduced disclosure costs 
under the exemption.
---------------------------------------------------------------------------

    \92\ One commenter noted that ``they expect that most non-public 
companies with the number of compensatory optionholders necessary to 
benefit from the proposed exemption are likely to already be 
obtaining audited financial statements for other business and 
financial purposes.'' Letter from E&Y.
---------------------------------------------------------------------------

    The amendment also will benefit private, non-reporting issuers by 
providing the less expensive alternative of electronic or Internet-
based methods of providing the information necessary to satisfy the 
information requirement of the exemption.
    Private, non-reporting issuers also will benefit from the certainty 
that the exemption will provide in designing and implementing 
compensation programs and employee stock option plans. The amendments 
identify the eligibility provisions and transfer restrictions that need 
to be contained in compensatory stock option plans or other written 
agreements, thereby lessening the need for issuers, at the time that 
Section 12(g) registration relief is needed for the compensatory 
employee stock options, to amend their stock option plans and 
outstanding options to include provisions that would be necessary to 
obtain no-action relief. The exemption will help private, non-reporting 
issuers avoid becoming subject to the registration and reporting 
requirements of the Exchange Act prior to the time they have public 
shareholders.
    Optionholders also will benefit from the exemption. The exemption 
assures the provision of the information every six months, including 
financial information that is not more than 180 days old, to 
optionholders. Employees, directors, consultants, and advisors would 
benefit from the exemption because private, non-reporting issuers will 
be able to use options for compensatory purposes without concern that 
the option grants will subject the issuer to Exchange Act registration.
    The exemption for reporting issuers also will benefit optionholders 
and holders of shares received on exercise of

[[Page 69564]]

options. Optionholders and holders of shares received on exercise of 
options will have access to the issuer's publicly filed Exchange Act 
reports. Further, if the issuer has registered under Exchange Act 
Section 12 the class of equity security underlying the compensatory 
employee stock options, certain provisions of Exchange Act Sections 13 
and 14 would apply to the options and the securities issuable on 
exercise of the options. Holders of shares issued on exercise of those 
options would have the same rights as other shareholders of the issuer. 
Thus, the exemption eliminates a possible disincentive for issuers to 
use certain compensatory employee stock options. This may be a benefit 
if this type of compensation is useful in attracting and retaining 
qualified employees that increase the issuer's competitiveness.
2. Expected Costs
    Issuers will be required to satisfy the provisions of the 
amendments to avoid registering under Exchange Act Section 12(g) their 
compensatory employee stock options if the registration thresholds are 
met at the end of the issuer's fiscal year. Private, non-reporting 
issuers may incur certain costs to rely on the exemption including (1) 
costs to amend their existing employee stock option plans if the plans 
and option grants do not contain the restrictive and information 
provisions of the exemption; (2) costs arising from preparing and 
providing the information required by the exemption to the extent that 
the issuer does not already prepare or provide such information for 
other purposes; and (3) costs of maintaining an Internet site on which 
the information may be available if the issuer chooses to use that 
method to provide the required information to optionholders.
    We believe that the provisions of the exemption are consistent in 
many respects with the restrictive provisions of other laws and rules 
governing option grants and, thus, the costs to private, non-reporting 
issuers should not be increased. The exemption provisions also are 
consistent with or are more flexible than the existing conditions for 
obtaining no-action relief from the Division of Corporation Finance. 
Therefore, the costs to private, non-reporting issuers to prepare the 
information required by the exemption may be the same or less than the 
current costs to the issuer relying on registration relief provided in 
a no-action letter issued by the Division of Corporation Finance.
    Those private, non-reporting issuers who do not already prepare the 
required information will face costs if they desire to avail themselves 
of the exemption. In addition to the costs discussed in the Paperwork 
Reduction Act analysis,\93\ as described below, issuers may face costs 
in maintaining the confidentiality of the information required to be 
provided, including preparation and enforcement of confidentiality 
agreements entered into with optionholders. It should be noted, 
however, that these increased costs will be borne voluntarily, as it is 
within the issuer's control as to the number of optionholders it may 
have. Issuers are able to perform their own cost-benefit analysis to 
determine whether to comply with the conditions to the exemption or 
avoid issuing options to 500 or more optionholders.
---------------------------------------------------------------------------

    \93\ See discussion under ``PAPERWORK REDUCTION ACT,'' above.
---------------------------------------------------------------------------

    Private, non-reporting issuers may incur costs in providing the 
information required under the exemption. These costs may include 
printing and sending the information or making the information 
available on an Internet site.
    The Division of Corporation Finance has granted no-action relief 
from registration of compensatory employee stock options to 30 private, 
non-reporting issuers during the period 1992 through 2006. If we assume 
that approximately 3 new private, non-reporting issuers will be relying 
on the exemption each year and that a certain number of private, non-
reporting issuers will no longer be relying on the exemption because 
they have become reporting issuers, have been acquired, or have 
terminated business, we estimate that approximately 40 private, non-
reporting issuers each year may be relying on the exemption. The 
exemption for private, non-reporting issuers will terminate once such 
issuer becomes subject to the reporting requirements of the Exchange 
Act or is no longer relying on the exemption. Thus, the number of 
private, non-reporting issuers that may rely on the exemption may vary 
from year to year.
    For purposes of the Paperwork Reduction Act, we have estimated that 
the annual paperwork burden for private, non-reporting issuers desiring 
to rely on the exemption and to comply with our collection of 
information requirements to be approximately 20 hours of in-house 
issuer personnel time, which is equivalent to $3,500, and to be 
approximately $24,000 for the services of outside professionals, for a 
total paperwork burden cost of $27,500.\94\ These estimates include the 
time and the cost of preparing and reviewing the information and making 
the information available to optionholders. We have assumed that the 
same number of private, non-reporting issuers would rely on the 
exemption each year. We have estimated that 25% of the burden of 
preparation and provision of the information required by the exemption 
would be carried by the private, non-reporting issuer internally and 
that 75% of the burden would be carried by outside professionals 
retained by the private, non-reporting issuer at an average cost of 
$400 per hour.\95\
---------------------------------------------------------------------------

    \94\ For administrative convenience, the presentation of the 
totals related to the paperwork burden hours have been rounded to 
the nearest whole number and the cost totals have been rounded to 
the nearest hundred.
    \95\ In connection with other recent rulemakings, we have had 
discussions with several private law firms to estimate an hourly 
rate of $400 as the average cost of outside professionals that 
assist issuers in preparing disclosures and conducting registered 
offerings. Consistent with recent rulemaking releases, we estimate 
the value of work performed by the company internally at a cost of 
$175 per hour.
---------------------------------------------------------------------------

    Although a private, non-reporting issuer relying on the exemption 
will benefit from cost savings associated with not having to register 
the compensatory employee stock options as a separate class of equity 
security under the Exchange Act, or obtaining no-action relief, by not 
doing so, an optionholder will not have the benefit of the disclosures 
contained in Exchange Act reports that the issuer otherwise would be 
obligated to file with us, including audited financial statements, or 
the disclosures required to be provided under the terms of the no-
action relief.
    Optionholders also will not be able to freely sell their options 
while the private, non-reporting issuer is relying on the exemption. 
Optionholders will not be able realize value from the options or, prior 
to exercise of the options, the shares to be issued on exercise of the 
options until after the private, non-reporting issuer becomes subject 
to the reporting requirements of the Exchange Act or is not relying on 
the exemption, other than as a result of certain permitted transfers. 
Many private, non-reporting issuers that grant options, however, 
currently restrict the transfer of securities held by holders of shares 
received on exercise of options, in most cases until after the issuer 
becomes subject to the reporting requirements of the Exchange Act or 
unless the issuer is acquired by another entity. In some cases, 
private, non-reporting issuers retain the right to repurchase options 
or shares received on exercise of an option. Any exercise of such 
repurchase right by the issuer would be a cost to such issuer.

[[Page 69565]]

V. Consideration of Burden on Competition and Promotion of Efficiency, 
Competition and Capital Formation Analysis

    Section 23(a)(2) \96\ of the Exchange Act requires us, when 
adopting rules under the Exchange Act, to consider the impact that any 
new rule would have on competition. In addition, Section 23(a)(2) 
prohibits us from adopting any rule that would impose a burden on 
competition not necessary or appropriate in furtherance of the purposes 
of the Exchange Act. We are adopting an exemption for private, non-
reporting issuers from Exchange Act Section 12(g) registration for 
compensatory employee stock options issued under employee stock option 
plans. We also are adopting an exemption from Exchange Act Section 
12(g) registration for compensatory employee stock options of issuers 
that are subject to the reporting requirements of the Exchange Act 
pursuant to Exchange Act Section 13 or Exchange Act Section 15(d).
---------------------------------------------------------------------------

    \96\ 15 U.S.C. 78w(a)(2).
---------------------------------------------------------------------------

    We expect that the exemption for private, non-reporting issuers 
from Exchange Act registration of compensatory employee stock options 
will provide necessary certainty to those issuers in their compensation 
decisions and will help them avoid becoming subject to the registration 
and reporting requirements of the Exchange Act prior to the time they 
have public shareholders. We anticipate that the exemption would save 
such private, non-reporting issuers costs and will not require that 
companies make their confidential issuer information public prior to 
the issuer voluntarily determining to become a public reporting issuer 
or being required to register a class of equity security under the 
Exchange Act. Further, we anticipate that the exemption will continue 
to provide private, non-reporting issuers freedom to determine 
appropriate methods of compensating their employees, directors, 
consultants, and advisors without concern that they will be required to 
register their compensatory employee stock options as a class of equity 
security under Exchange Act Section 12. Thus, the exemption eliminates 
a possible disincentive for issuers to use certain compensatory 
employee stock options. This may be a benefit if this type of 
compensation is useful in attracting and retaining qualified employees 
that increase the private, non-reporting issuer's competitiveness.
    The exemption for reporting issuers will provide certainty 
regarding the obligations of issuers that already are subject to the 
reporting requirements of the Exchange Act pursuant to Exchange Act 
Section 13 or Exchange Act Section 15(d) to register their compensatory 
employee stock options under the Exchange Act. In addition, in the case 
of these reporting issuers, the optionholders would have access to the 
issuer's publicly filed Exchange Act reports and, if the issuer has 
registered under Exchange Act Section 12 the class of equity security 
underlying the options, the appropriate provisions of Sections 13 and 
14 would apply to the compensatory employee stock options and the 
equity securities issuable on exercise of those options.
    Section 3(f) \97\ of the Exchange Act requires us, when engaging in 
rulemaking that requires us to consider or determine whether an action 
is necessary or appropriate in the public interest, to consider, in 
addition to the protection of investors, whether the action will 
promote efficiency, competition, and capital formation.
---------------------------------------------------------------------------

    \97\ 15 U.S.C. 78c(f).
---------------------------------------------------------------------------

    We believe that the exemption from Exchange Act registration for 
the compensatory stock options may beneficially affect the issuer's 
ability to compete for employees because it will allow such issuers to 
continue to use employee stock options in their compensation programs, 
thus enabling them to compete for such employees with both private, 
non-reporting issuers and public reporting issuers. The exemption also 
will provide an eligible issuer a more efficient, available exemption 
from Exchange Act Section 12(g) registration of compensatory employee 
stock options, instead of such issuer having to seek no-action relief 
or an exemptive order under Exchange Act Section 12(h).
    The exemptions do not relate to or affect capital formation, as the 
compensatory employee stock options covered by the exemptions are 
issued for compensatory and not capital raising purposes.
    The exemptions will allow eligible issuers to continue to have 
freedom to determine appropriate methods of compensating their 
employees, directors, consultants, and advisors. For private, non-
reporting issuers, these compensation decisions could be made without 
concern that the issuer will become subject to the Exchange Act 
reporting requirements before they have public shareholders.

VI. Regulatory Flexibility Act Certification

    The Commission hereby certifies pursuant to 5 U.S.C. 605(b) that 
the two exemptions from the registration provisions of Exchange Act 
Section 12(g) for compensatory employee stock options issued under 
employee stock option plans that are limited to employees, directors, 
consultants, and advisors of the issuer, its parents, and the majority-
owned subsidiaries of the issuer or its parents will not have a 
significant economic impact on a substantial number of small entities. 
We prepared an Initial Regulatory Flexibility Act Analysis in which we 
stated that the proposed exemption would not affect issuers that are 
small entities because small entities do not satisfy the asset 
threshold of Section 12(g) and therefore the exemptions would not be 
needed by such entities until their asset size increased to more than 
$10 million at the end of a fiscal year. We stated, therefore, that 
there may not be a large number of small entities that may be impacted. 
Because we received no comment disagreeing with that conclusion we are 
certifying that the two exemptions will not have a significant economic 
impact on a substantial number of small entities.

VII. Administrative Procedure Act

    Section 553(d) of the Administrative Procedure Act generally 
provides that, unless an exception applies, a substantive rule may not 
be made effective less than 30 days after notice of the rule has been 
published in the Federal Register. One exception to the 30-day 
requirement is if such rule grants or recognizes an exemption or 
relieves a restriction. We are adopting two exemptions designed to 
relieve issuers from the registration requirements of Section 12(g) for 
compensatory employee stock options. The rules only affect issuers that 
issue stock options as compensation to their employees, directors, 
consultants, and advisors. Even after the rules are effective, issuers 
may still register the compensatory employee stock options under 
Exchange Act Section 12(g) as before; however, the new amendments to 
Exchange Act Rule 12h-1 grant exemptions to the requirement, relieving 
eligible issuers of the Exchange Act registration obligations, subject 
to certain conditions. Immediate effectiveness will provide certainty 
to issuers that provide compensatory employee stock options to their 
current or future employees, directors, consultants, and advisors as a 
form of compensation. Eligible issuers that satisfy the conditions to 
the

[[Page 69566]]

exemptions can make compensation decisions without having to register 
under Exchange Act Section 12(g) the compensatory employee stock 
options or seek a no-action letter from the staff of the Commission or 
an exemption under Section 12(h) from the Commission for such 
registration relief.

VIII. Statutory Basis and Text of Rule Amendments

    We are amending Exchange Act Rule 12h-1 under the authority in 
Sections 12, 23, and 36 of the Exchange Act, as amended.

List of Subjects in 17 CFR Part 240

    Reporting and recordkeeping requirements, Securities.

Text of Rule

0
For the reasons set out in the preamble, we are amending Title 17, 
Chapter II of the Code of Federal Regulations as follows:

PART 240--GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE ACT OF 
1934

0
1. The authority citation for part 240 continues to read in part as 
follows:

    Authority: 15 U.S.C. 77c, 77d, 77g, 77j, 77s, 77z-2, 77z-3, 
77eee, 77ggg, 77nnn, 77sss, 77ttt, 78c, 78d, 78e, 78f, 78g, 78i, 
78j, 78j-1, 78k, 78k-1, 78l, 78m, 78n, 78o, 78p, 78q, 78s, 78u-5, 
78w, 78x, 78ll, 78mm, 80a-20, 80a-23, 80a-29, 80a-37, 80b-3, 80b-4, 
80b-11, and 7201 et seq.; and 18 U.S.C. 1350, unless otherwise 
noted.
* * * * *

0
2. Amend Sec.  240.12h-1 to remove ``and'' at the end of paragraph (d), 
and add paragraphs (f) and (g) to read as follows:


Sec.  240.12h-1  Exemptions from registration under section 12(g) of 
the Act.

* * * * *
    (f)(1) Stock options issued under written compensatory stock option 
plans under the following conditions:
    (i) The issuer of the equity security underlying the stock options 
does not have a class of security registered under section 12 of the 
Act and is not required to file reports pursuant to section 15(d) of 
the Act;
    (ii) The stock options have been issued pursuant to one or more 
written compensatory stock option plans established by the issuer, its 
parents, its majority-owned subsidiaries or majority-owned subsidiaries 
of the issuer's parents;

    Note to paragraph (f)(1)(ii): All stock options issued under all 
written compensatory stock option plans on the same class of equity 
security of the issuer will be considered part of the same class of 
equity security for purposes of the provisions of paragraph (f) of 
this section.

    (iii) The stock options are held only by those persons described in 
Rule 701(c) under the Securities Act (17 CFR 230.701(c)) or their 
permitted transferees as provided in paragraph (f)(1)(iv) of this 
section;
    (iv) The stock options and, prior to exercise, the shares to be 
issued on exercise of the stock options are restricted as to transfer 
by the optionholder other than to persons who are family members (as 
defined in Rule 701(c)(3) under the Securities Act (17 CFR 
230.701(c)(3)) through gifts or domestic relations orders, or to an 
executor or guardian of the optionholder upon the death or disability 
of the optionholder until the issuer becomes subject to the reporting 
requirements of section 13 or 15(d) of the Act or is no longer relying 
on the exemption pursuant to this section; provided that the 
optionholder may transfer the stock options to the issuer, or in 
connection with a change of control or other acquisition transaction 
involving the issuer, if after such transaction the stock options no 
longer will be outstanding and the issuer no longer will be relying on 
the exemption pursuant to this section;

    Note to paragraph (f)(1)(iv): For purposes of this section, 
optionholders may include any permitted transferee under paragraph 
(f)(1)(iv) of this section; provided that such permitted transferees 
may not further transfer the stock options..

    (v) The stock options and the shares issuable upon exercise of such 
stock options are restricted as to any pledge, hypothecation, or other 
transfer, including any short position, any ``put equivalent position'' 
(as defined in Sec.  240.16a-1(h) of this chapter), or any ``call 
equivalent position'' (as defined in Sec.  240.16a-1(b) of this 
chapter) by the optionholder prior to exercise of an option, except in 
the circumstances permitted in paragraph (f)(1)(iv) of this section, 
until the issuer becomes subject to the reporting requirements of 
section 13 or 15(d) of the Act or is no longer relying on the exemption 
pursuant paragraph (f)(1) of this section; and

    Note to paragraphs (f)(1)(iv) and (f)(1)(v): The transferability 
restrictions in paragraphs (f)(1)(iv) and (f)(1)(v) of this section 
must be contained in a written compensatory stock option plan, 
individual written compensatory stock option agreement, other stock 
purchase or stockholder agreement to which the issuer and the 
optionholder are a signatory or party, other enforceable agreement 
by or against the issuer and the optionholder, or in the issuer's 
by-laws or certificate or articles of incorporation.

    (vi) The issuer has agreed in the written compensatory stock option 
plan, the individual written compensatory stock option agreement, or 
another agreement enforceable against the issuer to provide the 
following information to optionholders once the issuer is relying on 
the exemption pursuant to paragraph (f)(1) of this section until the 
issuer becomes subject to the reporting requirements of section 13 or 
15(d) of the Act or is no longer relying on the exemption pursuant 
paragraph (f)(1) of this section:
    The information described in Rules 701(e)(3), (4), and (5) under 
the Securities Act (17 CFR 230.701(e)(3), (4), and (5)), every six 
months with the financial statements being not more than 180 days old 
and with such information provided either by physical or electronic 
delivery to the optionholders or by written notice to the optionholders 
of the availability of the information on an Internet site that may be 
password-protected and of any password needed to access the 
information.

    Note to paragraph (f)(1)(vi): The issuer may request that the 
optionholder agree to keep the information to be provided pursuant 
to this section confidential. If an optionholder does not agree to 
keep the information to be provided pursuant to this section 
confidential, then the issuer is not required to provide the 
information.

    (2) If the exemption provided by paragraph (f)(1) of this section 
ceases to be available, the issuer of the stock options that is relying 
on the exemption provided by this section must file a registration 
statement to register the class of stock options under section 12 of 
the Act within 120 calendar days after the exemption provided by 
paragraph (f)(1) of this section ceases to be available; and
    (g)(1) Stock options issued under written compensatory stock option 
plans under the following conditions:
    (i) The issuer of the equity security underlying the stock options 
has registered a class of security under section 12 of the Act or is 
required to file periodic reports pursuant to section 15(d) of the Act;
    (ii) The stock options have been issued pursuant to one or more 
written compensatory stock option plans established by the issuer, its 
parents, its majority-owned subsidiaries or majority-owned subsidiaries 
of the issuer's parents;

    Note to paragraph (g)(1)(ii): All stock options issued under all 
of the written compensatory stock option plans on the same class of 
equity security of the issuer will be considered part of the same 
class of equity

[[Page 69567]]

security of the issuer for purposes of the provisions of paragraph 
(g) of this section.

    (iii) The stock options are held only by those persons described in 
Rule 701(c) under the Securities Act (17 CFR 230.701(c)) or those 
persons specified in General Instruction A.1(a) of Form S-8 (17 CFR 
239.16b); provided that an issuer can still rely on this exemption if 
there is an insignificant deviation from satisfaction of the condition 
in this paragraph (g)(1)(iii) and after December 7, 2007 the issuer has 
made a good faith and reasonable attempt to comply with the conditions 
of this paragraph (g)(1)(iii). For purposes of this paragraph 
(g)(1)(iii), an insignificant deviation exists if the number of 
optionholders that do not meet the condition in this paragraph 
(g)(1)(iii) are insignificant both as to the aggregate number of 
optionholders and number of outstanding stock options.
    (2) If the exemption provided by paragraph (g)(1) of this section 
ceases to be available, the issuer of the stock options that is relying 
on the exemption provided by this section must file a registration 
statement to register the class of stock options or a class of security 
under section 12 of the Act within 60 calendar days after the exemption 
provided in paragraph (g)(1) of this section ceases to be available.

    By the Commission.

    Dated: December 3, 2007.
Nancy M. Morris,
Secretary.
 [FR Doc. E7-23756 Filed 12-6-07; 8:45 am]

BILLING CODE 8011-01-P
