April 2018: Tapestry Alert: USA: Securities Law – Rule 701 – Enforcement

Last month, the Securities and Exchange Commission (SEC) brought an enforcement action against Credit Karma, Inc., for violating Rule 701 of the Securities Act 21933.

This enforcement action results from a broad SEC investigation in Rule 701 option-granting practices.

Summary of facts

  • Under the Securities Act, companies cannot offer or sell securities to the public without either registering the transaction with the SEC or having a valid exemption.
  • In the incentive plan context, companies rarely want to register a prospectus and so they need to find an exemption.
  • Rule 701 is a commonly used exemption for non-reporting issuers – such as US private companies or non US companies.
  • There are various value limits to the Rule 701 exemption. In particular, under Rule 701, if companies issue more than USD5million in securities during any 12-month period, they must deliver additional information to participants. This includes financial information, risk disclosures and a summary of the material terms of the plan. This information must be delivered within a reasonable period of time before the date of sale.
  • Credit Karma significantly exceeded the USD5million threshold in 2014. At that point Credit Karma should have given its employees the additional disclosure – but it failed to do so until 19 July 2016.
  • Credit Karma didn’t provide the disclosure until July 2016 because the company considered it to be commercially sensitive and confidential until that point.
  • The SEC found that Credit Karma had violated Rule 701 and ordered the company to cease and desist from committing or causing any further securities registration violations. Credit Karma consented to pay a civil penalty of USD160,000.

Tapestry Comment
This is a very clear reminder that US securities laws in general (not just Rule 701) are not something to be taken lightly! All companies (whether US or non-US and regardless of whether they are listed or private) should take advice when granting awards in the US. Many global companies do rely on Rule 701 and we recommend clients ensure they monitor their compliance during the life of their plan, not just at the point they first grant awards in the US.

The US is one of the most highly regulated countries in the world. In relation to both tax and regulatory issues the rules are complex. Enforcement can be strict and the penalties can be high. The US should always be considered high risk.

If you want to discuss any of the points above or want help with a US focused review of your share plans, please do contact us.

Thank you to our friends at Harter, Secrest & Emery LLP in the US for helping us with this update.

Bob, Sally and Jordan

Bob GraysonSally BlanchflowerJordan Levy

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