January 30, 2018

Rule 701 Refresher and Updates

The Securities and Exchange Commission (SEC) issued additional guidance in late 2017 to assist companies in complying with the heightened disclosure requirements under Rule 701 of the Securities Act of 1933, as amended (the Securities Act). We wanted to make our clients aware of this guidance and also thought it was a good time to provide a brief overview of the key requirements of Rule 701.


The Securities Act requires that any offer or sale of securities (including stock options, restricted stock units (RSUs) and other equity compensation awards) be registered with the SEC unless an exemption from registration applies. Rule 701 of the Securities Act (Rule 701) is the federal securities exemption most frequently relied upon by private companies to grant or sell compensatory equity awards to their employees and other service providers. The purpose of Rule 701 is to allow private companies to offer equity-based compensation without the expense of registering offers and sales of these securities with the SEC. Under Rule 701, the issuer of such securities does not need to file any forms with the SEC; the exemption applies as long as the grant or issuance complies with the rule’s requirements.

What to Know

Eligibility for Rule 701 Exemption. Rule 701 exempts offers and sales of securities by an “eligible issuer” to an “eligible recipient” pursuant to a “compensatory plan.”

  • Eligible Issuers. Companies that are neither subject to the reporting requirements of the Securities Exchange Act of 1934, as amended, nor investment companies registered or required to be registered under the Investment Company Act of 1940, are eligible to rely on Rule 701. Generally, this means that a company that is neither a public company nor a mutual fund can qualify as an eligible issuer for purposes of Rule 701.
  • Eligible Recipients. Those eligible to receive securities pursuant to Rule 701 include employees, officers and directors of the issuer (or the issuer’s parent or majority-owned subsidiaries or the majority-owned subsidiaries of the issuer’s parent, each an “issuer related entity”). Consultants and advisors may also receive securities under Rule 701 so long as the consultant or advisor is a natural person, providing bona fide services to the issuer or an issuer related entity and such services are not in connection with the offer or sale of securities in a capital-raising transaction and do not directly or indirectly promote or maintain a market for the issuer’s securities. Rule 701 is not available for equity awards to entities (including, for example, entity consultants). Rule 701 only applies if the eligible recipient was employed by, or providing services to, the issuer or an issuer related entity at the time the grant was made or the securities were offered.
  • Compensatory Plan. Securities issued under Rule 701 must be granted or sold pursuant to a written compensatory benefit plan. A compensatory benefit plan would include a stock option plan, equity incentive plan, or the like, as well as a written compensatory contract such as a restricted stock agreement.

Offering Size Limitations. The SEC places limits on the amount of securities that a company can sell in reliance on Rule 701 in any 12-month period. This 12-month period may be measured either on a fixed annual basis or on a rolling 12-month basis, provided that the measurement period is applied consistently and not changed. The aggregate sales price, or amount, of securities that can be sold under Rule 701 in the applicable 12-month period must be less than one of the following three limits:

  • $1,000,000;
  • 15% of the total assets of the issuer, measured at the issuer’s most recent balance sheet (no older than its last fiscal year-end); or
  • 15% of the issuer’s total outstanding securities of the same class being offered in reliance on Rule 701, measured at the issuer’s most recent balance sheet (no older than its last fiscal year-end).

The aggregate sales price of stock sold in reliance on Rule 701 is calculated as the sum of all cash and other consideration received by the issuer for the sale of such stock. For stock options, the “sales price” is the aggregate exercise price to be paid for such options. The date of sale, for purposes of calculating the aggregate sales price, is the date on which the stock is sold or, with respect to stock options and RSUs, the date the stock option or RSU is granted without regard as to when the stock option becomes vested and exercised or the RSU becomes vested or settled.

General Disclosure Requirements. Companies relying on Rule 701 must provide a copy of the relevant compensatory plan (e.g., the stock option plan) to all eligible recipients a reasonable time prior to the sale of securities (e.g., for stock options, prior to the date of exercise). This is typically accomplished by providing the eligible recipients with a copy of the equity plan and related award agreements prior to, or at the time of, an equity grant being made.

Heightened Disclosure Requirements for Sales Over $5 Million1 in any 12-Month Period. If the aggregate sales price of securities sold by the issuer in reliance on Rule 701 exceeds $5 million in a 12-month period (calculated as described above), then, in addition to providing recipients with a copy of the compensatory plan, the issuer must also provide additional disclosure to all eligible recipients, including:

  • A summary of the material terms of the compensatory plan or compensatory contract;
  • A list of risk factors associated with investing in the issuer’s securities; and
  • Financial statements of the issuer prepared in accordance with U.S. GAAP dated not more than 180 days before the sale.

Timing of Disclosure. The additional disclosures described above must be provided within a reasonable time before the date of sale of stock, the date of grant of RSUs or the date of exercise of stock options. In addition, if the aggregate sales price of securities sold pursuant to Rule 701 exceeds $5 million in a 12-month period, this heightened disclosure requirement applies retroactively to all of the sales made during the entire 12-month period (i.e., up to the full preceding 12 months). Rule 701 is not available if the additional disclosures are not provided with respect to sales made during the entire 12-month period. The most recent SEC guidance points out that this disclosure must be provided prior to the date of grant of RSUs. Therefore, companies that grant RSUs should carefully monitor their aggregate sales to ensure that any required disclosure is provided in advance with respect to all RSU grants made in an applicable 12-month period, if necessary. For example, a company may be required to provide the additional disclosures prior to the date on which it actually exceeds the $5 million threshold during a 12-month period.

Method of Disclosure. Companies may deliver the required disclosures in hard copy or electronically in accordance with SEC guidance. For companies that choose to provide disclosure electronically (e.g., by email or by access to a website), the most recent SEC guidance clarifies that it is permissible to impose standard electronic safeguards, such as user-specific login requirements like those required to access documents via a virtual data room. The use of other safeguards, such as a dedicated physical disclosure room, is permissible as long as the safeguards do not prevent recipients from effectively accessing the required disclosures. For example, a designated physical disclosure room should be accessible during regular business hours upon reasonable notice and, once access is provided, recipients should be allowed to either retain the information or have ongoing access that is substantially equivalent to personal retention.

State Securities Law Issues. Rule 701 does not exempt an issuer from complying with state securities laws (i.e., “blue sky” laws). Although most states have securities law exemptions that mirror Rule 701, several states have different requirements. California in particular imposes additional requirements for certain equity compensation plans. In addition, certain states require separate state filings or fees, some of which must be made up to 30 days before any offers or grants of plan securities to residents of such state. Companies should monitor whether they are subject to any state securities laws and consult with us if there are questions about state law compliance.

Other Considerations. Rule 701 is not the exclusive exemption available for equity incentive awards. Under appropriate circumstances, companies may rely on any other available exemption (for example, a private placement exemption may be available for issuances to accredited investors that meet certain requirements).

Key Takeaways

The SEC has been known to audit companies for their compliance with Rule 701, and failure to meet the requirements to rely on Rule 701 or any other available exemption to make equity incentive awards or sales can have serious consequences. Accordingly, we recommend that companies put in place controls in order to monitor compliance with the Rule 701 requirements, sales limits and the disclosure obligations. If a company believes that it may exceed the $5 million threshold during any 12-month period, it should contact a Goodwin attorney promptly to discuss these disclosure requirements.

Equity incentives are a very important compensation tool for many of our clients. Rule 701 is a helpful exemption that can enable private companies to offer equity-based compensation. The Goodwin team recognizes that Rule 701 can be a highly technical rule. We are happy to help our clients navigate the Rule 701 requirements, including the impact of the most recent SEC guidance on this topic.

1 In 2017, each of the U.S. House of Representatives and the U.S. Senate passed a version of a bill that would require the SEC to increase this threshold from $5 million to $10 million.


This informational piece, which may be considered advertising under the ethical rules of certain jurisdictions, is provided on the understanding that it does not constitute the rendering of legal advice or other professional advice by Goodwin or its lawyers. Prior results do not guarantee a similar outcome.