What is Rule 701 exemption for stock-based compensation?

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In general, stock-based compensation is a common and powerful way to incentivize and reward employees. As a way of promoting and creating a sense of ownership amongst employees, stock-based compensation is a way to motivate employees to work harder and achieve success. In this regard, securities laws require an entity to comply with registration requirements when issuing, granting, or selling its securities. However, the Rule 701 exemption allows an entity to issue its securities without registering them with the Securities and Exchange Commission (SEC). The Rule 701 exemptions are available only to private companies, as defined. To receive an exemption, the agreement providing for its securities issuance must qualify with certain conditions. In this article, we will look into the details of the Rule 701 exemption of securities.

Rule 701 for stock-based compensation

SEC Rule 701 for stock-based compensation is a rule that exempts private securities from the registration requirements under the Securities Act. If a company wants to receive an exemption under this rule, the issuer of the securities must make certain representations before granting an exemption. In effect, the exemption only applies to private companies, and the securities must be issued in connection with the company’s compensation of its employees, directors, or consultants.

The stock-based compensation includes the compensation in the form of shares issued by a private company. These are the common forms of stock-based compensation, from stock options and employee stock ownership plans to performance shares and restricted stock units. It is essential to note that the amount must not exceed a specified limit as prescribed by the SEC under Rule 701. Therefore, complying with the rule is essential to avoid legal issues.

What is the Rule 701?

According to Rule 701, a private company may issue securities with no registration requirement under the Securities Act. The rule was established by the SEC to facilitate private companies to have access to offering stock-based compensation without complicating the process of registration with the SEC. However, the rule requires private companies to represent that the securities were issued for the purpose of a compensatory benefit plan. As a result, these securities may be exempt from registration if the amount of compensation is less than the specified limit.

Additionally, the rules are designed to make things simple for a private company’s operations. This ensures that companies have the ability to pay their employees and still remain compliant with SEC rules. Thus, employee benefits rule 701 is based on the idea of offering compensatory packages to employees without going through the burden of registering with the SEC.

Importance of Rule 701

Rule 701 is important because it allows companies to grant options, restricted stock awards, and other forms of stock compensation without being subject to the registration requirements of the Securities Act. Here are a few points stating the importance of Rule 701:

1. Companies can easily grant their employees these types of stock-based compensation and remain compliant with federal securities laws. This ensures that companies can be more flexible with their employee benefits plans.

2. Rule 701 is specifically framed to encourage companies to offer stock-based compensation packages to their employees under the specified compensation limits. It allows companies to offer their employees equity without the hassle of registration.

3. Rule 701 helps private companies to retain their competitive edge against public companies. This is because most of the time, private companies are competing for top talent with their counterparts in the public market. Offering equity to employees can help a private company win the battle for talent because it is a powerful way to motivate employees.

Safe harbor exemption of Rule 701

The Rule 701 exemption has certain conditions and requirements. Some of these involve the safe harbor provisions, which are a basic aspect of the rule. Safe harbor protects companies interested in complying with SEC regulations on offering and selling their securities. In this regard, the total sales price or value of securities sold or options granted in compliance with the rule during any consecutive 12-month period should not exceed the specified limit. Following are the important safe harbors of the rule:

  • The maximum value of $10,000,000 can be raised in any 12 months in order to maintain the safe harbor. As such, the value of the securities sold or options granted can be calculated by multiplying the option exercise price by the number of options granted.
  • Total assets of 15% of the issuers cannot exceed the recent balance sheet. It is important to note that the value of the company’s assets must be calculated in regard to the main asset of the company.
  • Exceeding the 15% of the outstanding amount of the class of securities is not permitted. This ensures that a private company remains compliant with the rule.

Rule 701 for employee benefits

Benefiting employees is a primary purpose of issuing stock-based compensation. Typically, a private company can issue securities under the Rule 701 exemption as long as it complies with the requirements. The direct benefit from the issuance of securities should be towards the employees of the company. Rule 701 aims at providing such employee benefits by exempting companies from the tedious process of registering with the SEC.

As an employee of a private company, you may receive stock compensation in the form of options, restricted stock, or other kinds of stock benefits. With Rule 701 in place, you can be sure that you are receiving your benefits in compliance with U.S. federal securities laws. Thus, the Rule 701 exemption is essential for private companies and their employees.

Rule 701 for companies

Issuing stock-based compensation for employees is important for a private company as it is a fundamental way of motivating employees. Rule 701 helps private companies to save the time and expense of registration with the SEC. To fall under the Rule 701 exemption, the companies can issue securities according to a written compensatory benefit plan. In addition, companies may hire experts to advise them about the process of issuing securities to comply with Rule 701.

Disclosure requirements for Rule 701

The SEC requires companies to disclose information about the offered securities to ensure transparency. Disclosing information is a key aspect of complying with the rule. Some of the information that should be made available includes:

1. The summary of the employee benefit plan must disclose the terms and its material provisions. It should include legal agreements, purpose, scope of the plan, and basic terms and conditions of the plan. A well-defined summary and disclosure of the employee benefit plan should aid the issuer in maintaining its compliance with Rule 701.

2. In addition to the summary of the employee benefit plan, it is important to provide accurate and complete information about the risks associated with the plan. Stating the risks involved with the plan is necessary to help SEC monitor the company’s capital adequacy.

3. As per Generally Accepted Accounting Principles (GAAP), the financial statements are to be prepared in accordance with the accounting standards applicable to the specific industry. This includes the recent balance sheet, income statements, and cash flows for the previous two fiscal years.

What happens if you cannot maintain Rule 701?

Failure to maintain Rule 701 can result in a variety of consequences, including negative publicity, increased SEC scrutiny, and potentially leading to contractual changes or termination of the stock-based compensation plan. As a company dealing with stock-based compensation and considering the Rule 701 exemption, it is essential to work with expert consultants who can help you to be compliant with the law.

How can you solve the problem?

Following the limit of $10,000,000 for up to a period of 12 consecutive months can help the company maintain a safe harbor. Moreover, the disclosure should be accurate and complete to ensure that the SEC has access to all relevant details. As per SEC, the summary of the employee benefit plan, risks involved in the plan, and GAAP financial statements should be discussed thoroughly with the company.

While in extreme situations where you cannot maintain the requirements of Rule 701, you must consider terminating the plan or modifying the terms. As such, appointing an experienced legal counsel to help you handle your problems is a great start to ensuring compliance with all aspects of the rule. Adhering to the rules and regulations of the SEC is imperative for your company.


Approving Rule 701 as an exemption for stock-based compensation plans is an important step for private companies. As a responsible company, it is essential to ensure that there are no violations with the exemption. The SEC requires detailed information to be disclosed and accounted for. This helps them to ensure compliance with the rule and maintain transparency in the company. Therefore, opting for Rule 701 as an exemption is a great way to avoid the time and costs of registering with the SEC.

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