Jones, Day, Reavis & Pogue
3 Queen Victoria Street
London EC4N 8NA, England
May 1, 1998
Securities and Exchange Commission
450 Fifth Street, N.W.
Attention: Mr. Jonathan G. Katz
Re: File No. S7-5-98
Ladies and Gentlemen:
This letter responds to the request of the Securities and Exchange Commission (the "Commission") in Release No. 33-7511 (the "Release") for comments on its proposal to revise Rule 701 promulgated under the Securities Act of 1933 (the "Securities Act").
In general we wish to express our support for the efforts of the Commission and its staff to simply and clarify this area of the law and we strongly endorse the overall relaxation of the volume and value restrictions of Rule 701, which will make the rule much more useful for many of our clients.
The principal purpose of this letter is to reflect the concerns that have been expressed to us by our clients, particularly foreign clients with operations in the United States. These concerns are: first, the proposed information requirements, especially those relating to US GAAP financial statements; and second, the suggestion that the availability of Rule 12g3-2(b) promulgated under the Securities Exchange Act of 1934 (the "Exchange Act") may be withdrawn for foreign private issuers that have sold shares under Rule 701. Each of these subjects is addressed separately below. Finally, we will address some specific questions in the Release.
1. US GAAP Financial Statements
The Release proposes new disclosure requirements for issuers using Rule 701. In particular, the proposed amendments to the Rule would require issuers to deliver to participants the financial statements required in an offering statement pursuant to Form 1-A of Regulation A under the Securities Act. These are financial statements prepared in accordance with generally accepted accounting principles as in effect in the United States ("US GAAP").
A significant number of our clients that use Rule 701 are British companies or other foreign issuers. In Britain, substantially all companies are required to prepare annual audited, and semi-annual unaudited, financial statements in accordance with U.K. accounting standards ("UK GAAP"). The added cost of preparing US GAAP financial statements would make compliance with Rule 701 too expensive for a large number of these issuers. This is especially true of companies having only a few U.S. employees.
Many of our British clients have been extremely eager to extend the share ownership benefits currently enjoyed by their British employees to their employees in other countries, including the U.S. High-tech companies, especially, believe that share option plans are essential to recruiting qualified personnel in the United States, who have come to expect such plans as part of their compensation package. Discussions with our clients and other foreign issuers indicate that it would not be economically feasible for many foreign companies to offer share options to their U.S. employees if Rule 701 is amended as proposed. This would not only deprive U.S. employees of these foreign companies of share option benefits that they otherwise would have received, but would also put foreign companies at an unfair competitive disadvantage when recruiting U.S. personnel.
The Release indicates that the Commission believes that additional disclosure may be desirable if the amended rule results in an increase in offerings to potentially unsophisticated employees. At least for companies incorporated in countries, such as Britain, that already require financial disclosure prepared to an internationally recognized standard, perhaps this concern could be addressed by having issuers deliver their home country financial statements to plan participants.
Another concern that has been expressed is how the proposed disclosure requirements would affect sales of shares upon exercise of options granted prior to the amendment of the rule. Specifically, will issuers that currently have options outstanding be required to deliver US GAAP financial statements to employees who exercise their options after Rule 701 is amended? This would certainly be an unfair financial burden on issuers that granted options in reliance on Rule 701 as it currently stands.
2. Rule 12g3-2(b)
The Commission has solicited comment as to whether Rule 12g3-2(b) should be amended so that foreign private issuers that sell securities under Rule 701 (or sell more than a certain threshold), would be ineligible for the Rule 12g3-2(b) exemption. The basis for this suggestion is that Rule 12g3-2(b) is predicated on the foreign issuer not taking any steps to enter the U.S. market.
Although offers and sales under Rule 701 are made to persons within the U.S., they can be distinguished from "taking steps to enter the U.S. market." Shares sold under Rule 701 are "restricted securities" and cannot be freely re-sold by U.S. employees within the U.S. Moreover, sales of shares to employees under Rule 701 are not likely to create a U.S. market for the foreign issuer's shares. By its terms, Rule 701 is only available for compensatory purposes and is not available for "plans or schemes to circumvent this purpose, such as to raise capital". Without some other securities offering or selling activities in the U.S., the issuers home country will remain the real market for sales of its shares, including re-sales by U.S. employees.
In addition, the submission requirements of Rule 12g3-2(b) already make a substantial amount of information about foreign issuers available in the U.S. Companies listed on an internationally recognized stock exchange, such as the London Stock Exchange, are required to submit a considerable amount of information to the relevant exchange. For issuers relying on Rule 12g3-2(b), this information is also submitted to the Commission.
Obviously, foreign companies that once would have used Rule 12g3-2(b) would be faced with the significant burden and expense of registering under the Exchange Act. The likely outcome is that foreign issuers will decide to stop granting share options to U.S. employees rather than register.
3. Other Issues.
Limitations on Offers. The Release also solicits comment on whether the volume and value limitations should apply to offers as well as sales under Rule 701. A limitation on offers does not seem to be necessary in the context of share option plans. Limiting the volume and value of sales in any twelve-month period will effectively limit the amount of offers that can be made under the rule. Issuers will need to restrict the number of offers they make in respect of granting options so that the Rule 701 limitations on sales are not exceeded when the options are exercised. Nevertheless, removing the restrictions on offers will give issuers more flexibility in terms of making offers and granting options because they can, to a certain extent, rely on historical data on how many employees will take up the options or exercise them. Removing the limitations on offers is an important step in simplifying calculations under Rule 701.
Disclosure. The Release also solicits comment on whether the level of disclosure to employees should depend on their level of sophistication. Although there is superficial logic to this suggestion, it would substantially increase the administrative burden for issuers. First, categorizing employees according to their level of sophistication, or even knowledge of the issuer, will be an extremely difficult process. For example, would an executive officer of a US subsidiary of a foreign issuer be likely to have knowledge of the issuer itself that one would normally expect from an executive officer of the issuer? Or would it be more appropriate to treat such a person as a mere "officer?" Second, maintaining separate sets of disclosure material for different categories and employees will multiply the expense and effort required of an issuer in complying with Rule 701. The likely result is that, practically speaking, issuers would prepare disclosure materials for the lowest level of sophistication and would distribute these materials to all employees. This would, to a large extent, negate the other steps taken by the Commission to simplify compliance with Rule 701 and would discourage issuers that want to be able to grant options to a small number of US employees.
Similarly, for foreign issuers, the suggestion that additional disclosure (such as the other disclosure requirements of Form 1-A) should be required would also add to the administrative burden and expense of compliance with the rule. If the Commission believes that additional disclosure is appropriate, perhaps this requirement could be met by supplying participants with the foreign issuer's home country annual reports (which, in Britain, are required even for privately held companies).
Form 701. The Release also queries whether Form 701 should be reinstated or whether some other form should be required. It is not clear what benefits would result from requiring such a form to be filed, other than to ensure that issuers have not exceeded the number of U.S. shareholders that would require them to register under the Exchange Act or comply with the exemption provided by Rule 12g3-2(b).
The proposal to relax the volume and value restrictions of Rule 701 will enhance the ability of issuers, both foreign and domestic, to provide compensatory share options to their employees.
The proposed increased disclosure requirements, particularly those relating to US GAAP financial statements, will, however, severely increase the cost and administrative burden to foreign issuers in complying with the rule. In many cases, the extra cost and burden will be prohibitive to foreign issuers, especially those with few U.S. employees. Similarly, eliminating the availability of Rule 12g3-2(b) for issuers using Rule 701 will discourage those foreign issuers having a large number of U.S. employees from offering share options generally to their U.S. employees.
If foreign issuers are unable to grant share options to their U.S. employees, they will be placed at an unfair disadvantage in respect of recruiting personnel in the United States, particularly in certain fields (such as the high tech industry) in which share options are a major component of standard compensation packages. In addition, U.S. employees of foreign companies (or their U.S. subsidiaries) will be deprived of a compensatory benefit that is more and more frequently made available to employees of American companies. Without a compelling benefit to U.S. investors, it seems that these disadvantages for foreign issuers and their employees are not justified.
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We hope that the Commission will find these comments useful. Naturally, we would be happy to discuss any aspects of our comments in further detail. Please contact David Curtin in our London office for this purpose. His telephone number is (44 171) 634-9216. Thank you for your consideration.
Jones, Day, Reavis & Pogue