TheCorporateCounsel.net

A tripleshot blog from our California law expert, Keith Bishop: I get many questions regarding the status of the proposed changes to the California Department of Corporations’ proposed stock option regulations. These were proposed last September and have been winding their way through the notice and comment process. Recently, this proposal has begun to move.

The proposal was filed with the California Office of Administrative Law (OAL) on May 30th. OAL is the office in California charged with reviewing regulations for compliance with California’s Administrative Procedure Act. Thus, OAL review is a technical review – not a policy review. OAL has 30 working days to review the proposed regulations. If OAL approves the regulations, it files the regulations with the Secretary of State.

Although regulations in most cases become effective 30 days after filing with the Secretary of State (Cal. Gov. Code Section 11343.4), I’ve been told that the Department has requested immediate effectiveness on filing with the Secretary of State. As a caveat, OAL does have the power to disapprove regulations. Although this is rare, it does happen occasionally. If OAL does so, the regulations go back to the department or an appeal is made to the Governor. I would be very surprised if OAL disapproves of these regulations; regardless, I think that many people are anxiously awaiting the effectiveness of these rules.

What is the California’s Proposal on Options?

More from Keith: The proposed regulations perform double duty. Originally, they served as guidelines for the exercise of the California Commissioner’s discretion in applying the fair, just and equitable standards for qualification purposes. Although they still perform this function, they began serving an additional purpose in 1996 when California enacted Corp. Code Section 25102(o).

That section exempted offers and sale of securities that, among other things, are exempt under Rule 701 and meet the Commissioner’s rules for qualification of stock option plans. While it was good to have a new exemption for stock option plans, the Commissioner’s rules were out of sync with many plans. In 1999, the Department proposed amendments to the rules.

However, these proposals went nowhere. In 2001, the legislature enacted SB 1837 to extend the statutory exemption to limited liability companies. Consequently, the Department amended its rules but only to account for options granted by limited liability companies. At the time, I had recommended that the amendments proposed by the Department in 1999 be included. However, the Department limited its amendments to the issue of limited liability company options. In 2002, the Department issued an invitation for comment on changing the rules. Although many comments were received, the Department took no action.

Now, at long last, the Department has finally addressed some of the issues that have been bedeviling issuers for the last ten years.

How Might the California Option Proposal Impact Public Companies?

I asked Keith: “If companies that have registered their plan on Form S-8 (which are just about all public companies), do they need to worry about these rules?”

Keith noted: These rules are of concern to many public companies. Smaller public companies with securities listed on a national securities exchange designated by the Commissioner (basically, the Nasdaq Global Market, NYSE, AMEX and Tier I of the Philadelphia Stock Exchange) are exempt because Cal. Corp. Code Section 25100(o) exempts both the listed securities and options to acquire listed securities.

Public companies whose securities are not listed on these exchanges cannot rely on the 25102(o) exemption because the exemption is conditioned on the availability of Rule 701 (for Rule 701 to be available, the company must not be subject to the reporting requirements of Section 13 or 15(d) of the Exchange Act). Thus, public companies whose securities are quoted in the OTCBB or Pink Sheets are cannot use the exemption. Also, it is not clear to me that companies with securities listed on the Nasdaq Capital Market are exempt because although the SEC has now designated the listed securities as “covered securities” under Section 18 of the Securities Act, their options are not covered securities.

Unless relying on some other exemption, options granted by these companies would be subject to qualification. In that case, the rules would perform their original function – standards for qualification. Sometimes, the stock option qualification issue can be a surprise and a problem for those companies that fall of the exchange. In those cases, the plan was not likely to have been drafted with the Commissioner’s standards in mind.

– Broc Romanek