SEC Committee Approve Recommendation to Permit Employees of Private Companies and Small Public Companies to More Easily Monetize their Holdings - Codification of Unofficial Rule 4(a) (1 1/2)

4th June 2015

The Security and Exchange Commission’s (the “SEC”) Advisory Committee on Small and Emerging Companies (the “Committee”) stated in a draft statement recommending the action that "making equity compensation more attractive to prospective employees will facilitate job creation and startup growth."

The Committee unanimously approved on Wednesday, June 3, 2015 a recommendation whose objective is make it easier for employees of privately held companies to monetize at least part of their equity compensation.

The Committee formalized the exemption commonly known as “Section 4(a) (1 1/2)” that enables security holders to sell privately-issued securities when conditions of Securities Act Rule 144, a commonly used safe harbor from registration requirements, are not met.

The Committee's recommendation stated that since enactment of the Jumpstart Our Business Startups Act of 2012, known as the JOBS Act, private companies have greater flexibility to defer an initial public offering and many are choosing to remain private longer. This action, according to the Committee, can result in shareholders and employees longer wait times public liquidity, negatively affecting private company capital formation and job creation.

Securities Act Rule 144 allows selling security holders to sell privately issued securities exempt from registration requirements subject to conditions of the rule. The Committee stated that in some situations under which the employees and affiliates of the issuer may not be able to meet the conditions of Rule 144, such as when an option holder seeks a "cashless" exercise of employee options.

When Rule 144 conditions are not met, selling security holders often rely on the so-called "4(a) (1 1/2) exemption, a legal construct that incorporates elements of exemptions available under Securities Act Section 4(a) (1) and 4(a)(2),  according to Committee.

The expenses involved in a 4(a)(1) transaction can often be significant, the Committee stated, requiring the securityholder to hire legal counsel to provide a legal opinion confirming that the shares were sold pursuant to a valid exemption from registration.

While bills have been introduced in Congress to formalize 4(a) (1 1/2), the Committee stated that the SEC also has the authority to formalize the exemption through rulemaking.