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Equity Awards - California
From 2009 Wilmer Hale Alert noted above:
California is one state in particular where careful attention must be paid to compliance with the rules governing option grants. An employee stock option plan under which grants are made to California residents must be qualified with the California Commissioner of Corporations or satisfy an exemption from the qualification requirement. If there are fewer than 35 plan participants, a company can rely on the general exempt securities offering exception in Section 25102(f) of the California Corporate Securities Law, provided the option recipients meet the business relationship or sophistication requirements of the exemption. However, most venture-backed companies rely on the compensatory benefit plan exemption under Section 25102(o) for convenience (one filing for the plan) and flexibility (no 35 participant limit).
Currently, Section 25102(o) has a number of requirements that apply to options granted to California residents, including (i) the grant of the option must be made in compliance with Rule 701, (ii) a maximum option term and plan term of 10 years, (iii) a prohibition on transferability of options except by will, laws of descent and distribution or as permitted under Rule 701, and (iv) a mandated post-employment termination exercise period of at least 30 days (or six months in the case of death or disability) unless such employment is terminated for “cause” (as defined by applicable law or the terms of the option, the plan or employment contract). These requirements are typically memorialized in the plan itself or in an addendum applicable to California grants. It is therefore critical for a venture-backed company to consult with California counsel before granting options to California employees.
California Corporation’s Code (relevant provisions as of July 2018):
§25102:
(o) An offer or sale of any security issued by a corporation or limited liability company pursuant to a purchase plan or agreement, or issued pursuant to an option plan or agreement, where the security at the time of issuance or grant is exempt from registration under the Securities Act of 1933, as amended, pursuant to Rule 701 adopted pursuant to that act ( 17 C.F.R. 230.701 ), the provisions of which are hereby incorporated by reference into this section, provided that (1) the terms of any purchase plan or agreement shall comply with Sections 260.140.42 , 260.140.45 , and 260.140.46 of Title 10 of the California Code of Regulations , (2) the terms of any option plan or agreement shall comply with Sections 260.140.41 , 260.140.45 , and 260.140.46 of Title 10 of the California Code of Regulations , and (3) the issuer files a notice of transaction in accordance with rules adopted by the commissioner no later than 30 days after the initial issuance of any security under that plan, accompanied by a filing fee as prescribed by subdivision (y) of Section 25608 .
§25608:
... (y) The fee for filing a notice of transaction under subdivision (o) of Section 25102 shall be the fee for filing an application for qualification of the sale of securities by permit under paragraph (1) of subdivision (b) of Section 25113 as set forth in subdivision (e) of this section.
§260.140.41: Compensatory Option Plans.
Options granted to employees [including insurance agents who are employees for purposes of Rule 701(c) under the Securities Act of 1933, as amended (17 C.F.R. 230.701(c)], officers, directors, general partners, trustees (where the issuer is a business trust), managers, advisors or consultants of the issuer, its parents, its majority-owned subsidiaries or majority-owned subsidiaries of the issuer's parent as part of a compensatory benefit plan shall be pursuant to a plan or agreement that provides for all of the following:
(a) The total number of securities (which may be expressed as a specific number of securities or as a percentage of the total number of securities outstanding from time to time) which may be issued and the persons eligible to receive options to purchase these securities.
(b) An exercise period of not more than 120 months from the date the option is granted.
(c) The non-transferability of the options, provided that the plan or agreement may permit transfer by will, by the laws of descent and distribution, to a revocable trust, or as permitted by Rule 701 of the Securities Act of 1933, as amended (17 C.F.R. 230.701).
(d) The proportionate adjustment of the number of securities purchasable and the exercise price thereof under the option in the event of a stock split, reverse stock split, stock dividend, recapitalization, combination, reclassification or other distribution of the issuer's equity securities without the receipt of consideration by the issuer, of or on the issuer's class or series of securities underlying the option.
(e) Unless employment is terminated for cause as defined by applicable law, the terms of the plan or option grant or a contract of employment, the right to exercise in the event of termination of employment, to the extent that the optionee is entitled to exercise on the date employment terminates, continues until the earlier of the option expiration date or:
(1) At least 6 months from the date of termination if termination was caused by death or disability.
(2) At least 30 days from the date of termination if termination was caused by other than death or disability.
(f) Options must be granted within 10 years from the date the plan or agreement is adopted or the date the plan or agreement is approved by the issuer's security holders, whichever is earlier.
(g) The plan or agreement must be approved by a majority of the outstanding securities entitled to vote by the later of (1) within 12 months before or after the date the plan is adopted or the date the agreement is entered into or (2) prior to or within 12 months of the granting of any option or issuance of any security under the plan or agreement in this state. Any option granted to any person in this state that is exercised before security holder approval is obtained must be rescinded if security holder approval is not obtained in the manner described in the preceding sentence. Such securities shall not be counted in determining whether such approval is obtained. A foreign private issuer, as defined by Rule 3b-4 of the Securities Exchange Act of 1934, as amended (17 C.F.R. 240.3b-4), shall not be required to comply with this subsection provided that the aggregate number of persons in this state granted options under all option plans and agreements and issued securities under all purchase and bonus plans and agreements does not exceed 35.
(h) Compliance with Section 260.140.46 of these rules regarding the information required to be received by security holders.
§260.140.42: Compensatory Purchase or Bonus Plans Excluding Option Plans
Securities (other than options) distributed or sold to employees [including insurance agents who are employees for purposes of Rule 701(c) under the Securities Act of 1933, as amended (17 C.F.R. 230.701)], officers, directors, general partners, trustees (where the issuer is a business trust), managers, advisors or consultants of the issuer, its parents, its majority-owned subsidiaries or majority-owned subsidiaries of the issuer's parents as part of a compensatory benefit plan shall be pursuant to a plan or agreement that provides for all of the following:
(a) The total number of securities (which may be expressed as a specific number of securities or as a percentage of the total number of securities outstanding from time to time) which may be issued and the persons eligible to purchase securities under the plan or agreement.
(b) The nontransferablity of the rights of any eligible person to acquire securities under the plan or agreement, provided that the plan or agreement may permit transfer of the rights to purchase securities by will, by the laws of descent and distribution, to a revocable trust, or as permitted by Rule 701 of the Securities Act of 1933, as amended (17 C.F.R. 230.701).
(c) The proportionate adjustment of the number of securities allocated to any eligible person under the plan or agreement in the event of a stock split, reverse stock split, stock dividend, recapitalization, combination, reclassification or other distribution of the issuer's equity securities without the receipt of consideration by the issuer, of or on the issuer's class of securities subject to the purchase right.
(d) Securities must be issued within 10 years from the date the plan or agreement is adopted or the plan or agreement is approved by the issuer's security holders, whichever is earlier.
(e) The plan or agreement must be approved by a majority of the outstanding securities entitled to vote by the later of (1) within 12 months before or after the plan is adopted or the date the agreement is entered into or (2) prior to or within 12 months of the issuance of any security under the plan or agreement in this state. Any issuance of securities before security holder approval is obtained must be rescinded if security holder approval is not obtained in the manner described in the preceding sentence. Such securities shall not be counted in determining whether such approval is obtained. A foreign private issuer, as defined by Rule 3b-4 of the Securities Exchange Act of 1934, as amended (17 C.F.R. 240.3b-4), shall not be required to comply with this subsection provided that the aggregate number of persons in this state granted options under all option plans and agreements and issued securities under all purchases and bonus plans and agreements does not exceed 35.
(f) Compliance with Section 260.140.46 of these rules regarding the information required to be received by security holders.
§260.140.45: Limitation on Number of Securities.
(a) The total number of securities issuable upon exercise of all outstanding options [exclusive of rights described in Section 260.140.40 and warrants described in Sections 260.140.43 and 260.140.44 of these rules, and any purchase plan or agreement as described in Section 260.140.42 of these rules (provided that the purchase plan or agreement provides that all securities will have a purchase price of 100% of the fair value (Section 260.140.50) of the security either at the time the person is granted the right to purchase securities under the plan or agreement or at the time the purchase is consummated)], and the total number of securities called for under any bonus or similar plan or agreement shall not exceed a number of securities which is equal to 30% of the then outstanding securities of the issuer (convertible preferred or convertible senior common shares of stock will be counted on an as if converted basis), exclusive of securities subject to promotional waivers under Section 260.141, unless a percentage higher than 30% is approved by at least two-thirds of the outstanding securities entitled to vote.
(b) The 30% limitation set forth in this Rule, or such other percentage limitation as may be approved pursuant to this Rule, shall be deemed satisfied if the plan or agreement provides that at no time shall the total number of securities issuable upon exercise of all outstanding options and the total number of shares provided for under any stock bonus or similar plan or agreement of the issuer exceed the applicable percentage as calculated in accordance with the conditions and exclusions of this Rule, based on the securities of the issuer which are outstanding at the time the calculation is made.
(c) This section shall not apply to any plan or agreement that complies with all conditions of Rule 701 of the Securities Act of 1933, as amended (17 C.F.R. 230.701); provided that for purposes of determining such compliance, any registered domestic partner shall be considered a “family member” as that term is defined in Rule 701.
§260.140.46: Information to Security Holders
Plans or agreements pursuant to which securities are to be issued to employees, officers, directors, managers, advisors or consultants (including option, purchase and bonus plans) shall provide that the security holder(s) will receive financial statements at least annually. This section does not require the use of financial statements in accordance with Section 260.613 of these rules. This section shall not apply when issuance is limited to key persons whose duties in connection with the issuer assure them access to equivalent information. This section shall not apply to any plan or agreement that complies with all conditions of Rule 701 of the Securities Act of 1933, as amended (17 C.F.R. 230.701); provided that for purposes of determining such compliance, any registered domestic partner shall be considered a “family member” as that term is defined in Rule 701.
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