Equity Incentives: Securities Basics That Every Foreign-Based Company Should Know When Offering To Employees Based In The U.S. Or UK

Sunday, July 1, 2007 - 01:00
Ian G. Fraser

Foreign sponsors of equity incentive plans (stock option, restricted stock option plans, etc.) often assume that if their plans comply with local securities laws they will automatically meet the requirements of foreign jurisdictions. This is typically not true. Equity plans covering employees located in foreign jurisdictions usually must meet the securities requirements of these jurisdictions.

In this article we explore the general securities laws applicable where equity incentive plans of UK-headquartered groups are offered to employees located in the United States and the corresponding laws applicable where U.S.-headquartered groups offer incentives to employees located in the UK.

Offering UK Incentive Plans To Employees in the United States

Registration Of Securities In The United States - A General Overview

The sale or transfer of securities through incentive plans in the United States is governed by the Securities Act of 1933 (the 1933 Act) at the federal level, and "Blue Sky Laws" at the state level. In general, Blue Sky Laws supplement federal law.

The 1933 Act

The 1933 Act requires filing of a registration statement for any offer or sale of securities - unless a registration exemption exists - as a means of disclosure for potential investors. Proper disclosure enables potential investors (including employees participating in an equity plan) to make informed decisions about the security. Registration statements generally provide a description of the company's properties and business, information about the background and experience of the company's management team, certified financial statements and a clear description of the securities offered.

There are a number of exemptions available to companies offering equity through equity incentive plans. The most common is Rule 701, which provides a registration exemption for equity incentive plans, whether these arrangements are offered to employees, directors or consultants.

To qualify for the Rule 701 exemption, the following conditions must be met:

The shares must be provided under the terms of a written plan;

Each participant must receive a copy of the plan;

The aggregate amount sold during any consecutive 12-month period can not exceed the greater of:

w U.S. $1,000,000;

w 15 percent of the issuer's total assets, measured as of the most recent balance sheet date (if no older than its last fiscal year end); or

w 15 percent of the outstanding amount of the class of securities being offered and sold in reliance on Rule 701, measured at the issuer's most recent balance sheet date (if no older than its last fiscal year end).

If all of the Rule 701 requirements are met, the company's equity incentive plan securities offering will be exempt from the 1933 Act's registration requirements. The Rule 701 exemption is "self-executing;" that is, the company sponsoring the equity incentive plan is not required to file with the SEC or any other federal agency or organization to obtain the exemption.

State Blue Sky Laws

Every state has its own Blue Sky Laws designed to protect investors against fraudulent sales practices and activities. These laws vary from state to state, but, most typically require companies to register their securities before they can be sold.

Fortunately, most states recognize an exemption for securities offered through equity incentive plans when the awards are made to employees and/or the plan is Rule 701-compliant. Like the federal rule, this exemption is self-executing in most states. In states where exceptions exist, a filing is required to perfect the Rule 701 or state counterpart exemption.

In some states, the Rule 701 or state exemption is available if the incentive plan is available to employees only. While other exemptions may exist for plans covering consultants and non-employee directors, reliance on Rule 701 or state counterpart exception is unavailable. Some states also impose additional requirements.

Foreign companies offering equity through incentive plans to its U.S. employees should consult with counsel to determine whether the requirements of the 1933 Act (and other federal laws) apply to them. They should also be mindful that each U.S. state in which they offer individuals equity under an incentive plan will likely have its own Blue Sky Law. Care should be taken to ensure that either an exemption, such as Rule 701 or a state counterpart exists. If so, they should determine whether there are any additional requirements to gain the exemption, and whether it is self-executing.

Offering U.S. Incentive Plans To Employees In The UK

Where a U.S. company offers shares to employees of a UK subsidiary, UK securities laws may require a prospectus. These laws implement the European Union Prospectus Directive, which was introduced to harmonize the requirements for a prospectus across the European Union ("EU"), and make it unlawful for "transferable securities" (securities that are "negotiable on a capital market") to be offered to the public unless an approved prospectus is made available or a relevant exemption applies. A person who contravenes these rules is subject to imprisonment or a fine (or both).

Is A Prospectus Required For An Offer Of Employee Incentives In The UK?

Any share incentive award that constitutes an offer for Prospectus Directive purposes will require a prospectus unless an exemption applies. The main exemptions apply where:

The total "consideration" for the securities being offered is less than 2.5 million.

The issuing company has securities listed on an EU-regulated market (in which case a prospectus is not required for offers to employees and directors of a group company, but an information document must be issued to the employees/directors setting out various details in relation to the offer).

The offer of securities is made to fewer than 100 persons in each EU member state.

Practical Implications

In the UK, the Financial Services Authority (FSA - the UK securities regulator) considers that the grant and exercise of employee share options does not constitute the offer of transferable securities and, therefore, does not require a prospectus as long as the options are not themselves transferable or assignable. The same should be true of restricted stock units that are capable of being settled in shares.

Similarly, the award of restricted stock for no consideration should be exempt as an offer under which the aggregate consideration is less than 2.5 million. The 2.5 million limit is tested by reference to the total consideration payable for all offers of the same securities made by the offeror throughout the EU over the preceding year.

Where a U.S. company already has securities listed in the EU, the UK interprets the exemption for offers made to employees/directors as being applicable as long as the company has any class of securities listed on any EEA-regulated market (so that, for example, if a U.S. company has debt securities listed on an EEA-regulated market the exemption would apply in the UK in respect of an offer of company shares to group employees).

The exemption for offers to under 100 employees is not cumulative. If an offer is made to 99 employees on one date, an additional offer to 99 employees can be made on a later date.

The main concern for U.S. companies making incentive awards in the UK involves share purchase arrangements where the aggregate consideration across the EU will be in excess of 2.5 million. For example, the offer of ESPP rights to more than 100 employees could require a prospectus. This applies even where the ESPP is structured as a short-term share option, because it is unclear whether EU securities regulators will accept that the grant and exercise of a short-term share option should be treated as a non-transferable security as discussed above.

While it would appear that an offer of private company shares is not an offer of shares that are "negotiable on a capital market," the lack of definitive guidance on this point from either the FSA or the European authorities makes it safest to assume that all private company shares are subject to the Prospectus Directive rules. Shares listed on the Alternative Investment Market (AIM) are not treated as listed on an EU-regulated market and are also subject to these rules.

The Prospectus Directive rules require a non-EU issuer to have a "home member state" for the purposes of EU securities regulation and a prospectus approved by the local regulator in the home member state can then be used in any other EU member state. For a short period in 2005, non-EU issuer companies with securities listed on EU-regulated markets could choose their home member state. Otherwise, the state in which a company makes its first public offer of securities after December 31, 2003 normally becomes its home member state. As the meaning of an offer to the public is broad, there is some concern that a home member state can be fixed whenever an offer is made in the EU - even when the offer falls within one of the exemptions from the Prospectus Directive mentioned above.

When a home member state is fixed, it is fixed permanently. Many companies making a first offer of securities that relies on a Prospectus Directive-exemption will therefore offer the securities first in the jurisdiction they would prefer as their home member state. This can be useful in the event there is any requirement to issue a prospectus at any time in the future.

While the UK has generally adopted a permissive interpretation of these EU Prospectus Directive rules, other EU states have different interpretations. It is essential to check the position in all EU member states where incentives awards will be made.


Companies considering whether to offer equity incentives outside their home jurisdiction should consider whether and to what extent the securities offering may be subject to local regulation. Proper steps should be taken to ensure that the securities requirements are met in the local jurisdiction. This often means careful review of various laws that are not necessarily designed to complement each other or that are subject to differing interpretation by local regulatory authorities.

Ian Fraser and Peter Marathas are Executive Compensation lawyers with K&L Gates. Mr. Fraser is a Partner in the firm's London office, and Mr. Marathas is a Partner in the firm's Boston office.

Please email the authors at ian.fraser@klgates.com or peter.marathas@klgates.com with questions about this article.