SEC Issues C&DIs for Securities Act Rule 701 in the Merger Context
On June 23, 2016, the SEC Staff issued Compliance and Disclosure Interpretations (“C&DIs”) addressing the application of Rule 701 of the Securities Act of 1933 in the context of a merger.
Summary of Rule 701
Rule 701 provides to certain non-reporting issuers an exemption from registration for the issuance of compensatory securities under an employee benefit plan. There is no limit to the amount of securities an issuing company may offer under Rule 701(d), but the maximum amount it may sell during any consecutive 12-month period is the greater of:
(2) 15% of issuer’s total assets; or
(3) 15% of the outstanding securities of the class being sold. 
Under Rule 701(e), the issuer must provide investors with a copy of the employee benefit plan. Additionally, if the aggregate sales price or amount of securities sold during any 12-month period exceeds $5,000,000, the issuer must deliver to investors further disclosures within a reasonable period of time before the sale date. These disclosures include:
(1) if the plan is subject to ERISA, a copy of the summary plan description that ERISA requires;
(2) if the plan is not subject to ERISA, a summary of the material terms of the plan;
(3) information regarding the risks associated with investment in the securities; and
(4) financial statements that meet the Regulation A Form 1-A requirements as of a date no more than 180 days before the sale date.
Guidance for the Application of Rule 701 in the Context of a Merger
The new C&DIs provide guidance on how an acquirer can comply with Rule 701 in the context of a merger:
- An acquirer in a merger that assumes derivative securities of the target (such as employee stock options and warrants) does not need to claim an exemption from registration for the assumption if, at the date of grant by the target, the target’s employee benefit plan permitted this assumption without the consent of the holders.
- Under Rule 701, securities underlying derivative securities are deemed to be granted on the grant date of the derivative securities, without regard to when they become exercisable or convertible. Therefore, if the target complied with the provisions of Rule 701 on the grant date of the derivative securities, the exercise or conversion of the derivative securities assumed by the acquirer would be exempt, subject to compliance with disclosure requirements under Rule 701(e).
- Post-merger, an acquirer must count, for the purposes of determining the amount it can sell under Rule 701(d), the securities that the target sold in reliance on Rule 701 during any 12-month period for which the acquirer is making the determination.
- Post-merger, in calculating total assets and outstanding securities under Rule 701(d), an acquirer may use (a) a pro forma balance sheet as of its most recent balance sheet date that reflects the merger as if it occurred on that date or (b) a post-merger balance sheet date that reflects the combined entity’s total assets and outstanding securities.
- When the aggregate sales price or amount of securities sold during any 12-month period exceeds $5,000,000, the issuer may use financial statements that meet the requirements under either Tier 1 or Tier 2 of Regulation A offerings, whether or not the Tier 2 amount requirements were met.
- For assumed derivative securities requiring disclosure under Rule 701(e), the acquirer assumes the disclosure obligation and satisfies it by providing the necessary disclosures under Rule 701(e) in a reasonable period before the date of exercise or conversion.
- Post-merger, in determining whether the amount of securities the acquirer sold during any 12-month period exceeds $5,000,000, the acquirer must include the securities that the target sold during the same period.
The C&DIs are available at: https://www.sec.gov/divisions/corpfin/guidance/securitiesactrules-interps.htm
 Items (2) and (3) are measured at the issuer’s most recent balance sheet date (if no older than its last fiscal year end).
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