Transferable Stock Options Create Estate Planning Opportunities
Form S-8 is the registration statement form that permits the fast and simple registration of securities issued under employee benefit plans. Form S-8 applies to sales of securities by employees, which has been defined to include consultants so long as they are not involved in the offer and sale of securities in capital-raising transactions. In addition, Form S-8 has only permitted the exercise of employee benefit plan stock options by the employee/optionee. The transfer of options has been prohibited. The new rules, which will become effective on April 7, 1999 and on May 10, 1999 for effective registration statements, make significant changes to the categories of persons eligible to use Form S-8.
Certain Consultants Ineligible to Use Form S-8
The SEC believes that Form S-8 has been abused through its use to register securities issued to consultants to hype the issuer’s stock or to distribute stock to the public on behalf of the issuer. The amendments are intended to address these abusive practices by limiting the use of Form S-8 to consultants who 1) are natural persons, 2) provide bona fide services to the issuer and 3) do not directly or indirectly promote or maintain a market for the issuer’s securities. The SEC has provided interpretive guidance as to the types of arrangements that will meet the new requirements by various categories of persons including brokers, finders, marketers, researchers, attorneys and insurance agents. In general, eligibility depends on whether the primary character of the services rendered are capital raising or promotional, in which cases Form S-8 may not be used.
At the same time, parallel language defining consultants’ eligibility under Rule 701 (for non-public companies) and Rule 405, which defines “employee benefit plan,” has been amended to conform to the new Form S-8 rules.
Transferable Options Now Eligible
Most existing employee benefit plans contain provisions consistent with the rules in effect when they were drafted, that prohibit the transfer of stock options. The new rule represents a substantial liberalization in the current scheme of regulation by permitting options to be transferred to relatives or family members through gift or a domestic relations order. Recipients of those options will be allowed to exercise them using Form S-8. The definition of family members includes any child, stepchild, grandchild, parent, stepparent, grandparent, spouse, sibling, mother-in-law, father-in-law, son-in-law, daughter-in-law, brother-in-law, sister-in-law and nieces and nephews. It also includes entities (for example, trusts) in which family members own more than 50% of the voting interests and in which family members have a more than 50% beneficial interest and persons (other than employees or tenants) who are sharing the employee’s household. A separate test is provided for foundations.
Regulation S-K’s Item 402(b) summary compensation table has also been revised to require disclosure of transferable options in the executive compensation disclosures.
The amendments to Form S-8 will apply to Forms S-8 filed initially on or after April 7, 1999. Currently effective registration statements on Form S-8 will also be required to comply with these requirements as of May 10, 1999. Thus, any securities issuances on or after May 10, 1999 under any currently effective Form S-8 must comply with these amendments.
The new rules represent a significant narrowing of the categories of consultants and advisers permitted to register securities under Form S-8. The new rules will have the greatest impact on emerging companies who have relied on Form S-8 as a way to provide registered shares to persons assisting the issuer in many ways, including activities that may not have been thought to fall within the prohibition applicable to capital-raising efforts. As a result of the SEC’s expanded interpretations, any proposed grants of securities to consultants or advisers will require careful analysis to make sure that they fall within the permissible categories.
The liberalization of Form S-8 that permits the assignment of options will create significant opportunities in estate tax planning through the use of option gifts and value reduction techniques. Executives will now have the ability to transfer vested options to family members who are in lower tax brackets. Parties to divorce proceedings will be able to allocate stock options without dealing with the complexities posed by the lack of an available registration mechanism.
To comply with and to take advantage of the new rules, issuers should take the following steps:
- Review all future proposed securities issuances to consultants and advisers to ensure that they meet the SEC’s interpretations of permissible arrangements.
- Implement procedures to review all issuances of securities made to consultants on or after May 10, 1999, pursuant to existing arrangements under effective Form S-8 registration statements to make sure they comply with the new restrictions.
- Amend existing employee benefit plans to permit transfers of options in accordance with the new rules.
The foregoing is only a summary of the SEC’s rules, which are lengthy and complex. We would be happy to discuss the impact of these rules in specific situations and to consult with you regarding potential changes to existing employee benefit plans. To discuss these questions further, please feel free to contact Thomas E. Dew.