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SEC Proposes Updates to Rule 701

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December 22, 2020 | Barbara Baksa

SEC Proposes Updates to Rule 701

As I noted a couple of weeks ago (“SEC Proposes Updates to Form S-8”), the SEC has issued two proposals to update Form S-8 and Rule 701. The first proposal would modernize Form S-8 and Rule 701. The second proposal would allow companies to temporarily rely on Form S-8 and Rule 701 to issue equity awards to gig workers.

In today’s blog entry, I summarize the modernizations proposed for Rule 701; I’ll get to gig workers in a future entry.

Rule 701 Maximums Could Increase

Currently, the maximum amount of securities private companies can issue in reliance on Rule 701 for any 12-month period is the greater of three amounts: 1) a flat dollar’s worth of shares, 2) shares having a value equal to a percentage of the company’s total assets, or 3) shares equal to a percentage of the company’s total outstanding common stock. The proposed rule would increase two of these amounts: the flat dollar amount and the percentage of assets (the percentage of outstanding common stock would remain unchanged).

The table below indicates the current and proposed maximums.

Maximum Current Rule Proposed Rule
Flat $ Amount $1 million $2 million
% of Assets 15% 25%
% of Common Stock Outstanding 15% 15%



Compliance with Rule 701 Disclosures Could Get Easier

Currently, Rule 701 requires private companies that issue more than $10 million worth of securities (updated from $5 million in 2018—see “Rule 701 Gets an Update”) during any 12-month period to provide additional disclosures, including financial statements, to the employees that receive the securities. Many private companies balk at providing financial statements to their employees because of the confidential nature of this information.

The time of the disclosures is also problematic. They must be provided in advance of the sale of securities (exercise for stock options, grant for unit awards) and must be provided for all securities issued during the 12-month period, not just those issued in excess of $10 million. This requires private companies to predict when they will exceed the $10 million threshold a year in advance.

The proposed rules would make the following changes to the additional disclosure requirements:

  • The additional disclosures will only need to be provided for those sales of securities that exceed $10 million. In addition, for unit awards issued upon hire, companies would be permitted up to 14 days after the date of hire to provide the disclosures.
  • The requirements as to the age of the financial statements will be relaxed, so that private companies who have exceeded the $10 million threshold will no longer need to prepare financial statements quarterly to rely on Rule 701.
  • Private companies could choose to disclose the 409A valuation of their stock in lieu of providing financial statements to their employees, provided that the valuation was obtained no more than six months prior to the sale for which it is relied on and the valuation is performed by an independent appraiser.

Rule 701 Could be Expanded to Cover Additional Entities

The proposal would also expand the individuals that would be covered under Rule 701, so that it could be relied on for grants and issuances to the following entities:

  • Business entities providing consulting or advisory services, provided specified conditions are met.
  • Former employees (and executors, administrators, and beneficiaries of the estates of deceased employees, as well as guardians for incompetent former employees) in circumstances not already covered under Rule 701, provided specified conditions are met.
  • Employees of non-majority-owned subsidiaries (employees of majority-owned subsidiaries are already covered under Rule 701).

Implementing an ESPP upon IPO Could Get Easier

The proposal asks for comments on how the SEC could make it easier for companies to implement an ESPP at the time they go public. Currently, companies cannot communicate to employees about the ESPP until they file the Form S-8 registering the plan, which generally can’t be filed until after the Form S-1 for the IPO is effective.

Thus, the company can’t communicate to employees about the ESPP until the IPO—a challenge if the company would like the first offering to begin on the IPO date (to lock in the IPO price). To accomplish this, companies automatically enroll all employees without their consent. After the IPO (and the Form S-8 is filed), they announce the ESPP and allow employees to withdraw or change their contribution rate. This process is cumbersome and can have accounting implications for the company.

Thanks in part to the NASPP’s comment letter on the original concept release, the SEC requests comments on how they might bridge “the IPO gap” for ESPPs. Their suggestions include allowing companies to rely on Rule 701 for the initial enrollment or allowing companies to communicate the plan to employees in advance of the Form S-8 filing.


Comments on the proposed rules can be submitted to the SEC on or before February 9, 2021.

- Barbara

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