California Scales Back Restrictions on Equity Compensation Plan Rules - 26 Jan 2009

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California Scales Back Restrictions on Equity Compensation Plan Rules

January 26, 2009

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The State of California heavily regulates equity
compensation grants and awards. Employers located or having employees,
advisers or consultants in California have wrestled with the choice of
either conforming their equity compensation plans to California’s
mandated terms or maintaining separate plans for employees and service
providers located inside California from those located outside
California. The result has been that many of the terms mandated by
California law have become the status quo in equity plans nationwide.

Recently, the California Corporations Commissioner
approved changes to regulations underlying Section 25102(o) of the
California Securities Law1 which removed many of these restrictive
requirements.2 In particular, California has eliminated many of the
more onerous substantive restrictions on compensatory benefit plans
that are exempt from registration under the Securities Act of 1933
pursuant to Rule 701.

Companies may want to consult with legal counsel to
determine whether their existing equity compensation plans were drafted
to comply with the old California regulations and whether they would
benefit by amending these plans to remove any now unnecessary
restrictions.

KEY CHANGES

The key changes for California Section 25102(o)
offerings that otherwise comply with Rule 701 and the Internal Revenue
Code are as follows:

• 
  

  The restrictions on option exercise price have been eliminated3

  
  
  
  
  • 
    

    Previously, the exercise price was not permitted to be
    less than 85% of the fair value of the underlying security on the grant
    date

    
    
  
  
  
  


• 
  

  The restrictions on vesting requirements have been eliminated

  
  
  
  
  • 
    

    Previously, options were required to vest at the rate of at least 20% per year over five years

    
    
  
  
  
  


• 
  

  The list of employees, officers, directors, consultants
  and other advisors eligible to participate under a compensatory benefit
  plan has been expanded to conform to the eligibility requirements of
  Rule 701

  
  


• 
  

  The restriction limiting the total number of shares reserved for issuance under equity compensation plans has been eliminated

  
  
  
  
  • 
    

    Previously, the number of securities issuable under the
    plan could not exceed 30% of the then outstanding number of shares,
    unless approved by a two-thirds shareholder vote

    
    
  
  
  
  


• 
  

  The restrictions on stock repurchase rights have been eliminated

  
  
  
  
  • 
    

    Previously, any repurchase was generally required to be
    either for cash or cancellation of indebtedness within 90 days of
    termination of employment (or with respect to options exercised by an
    employee after termination, within 90 days of exercise) and the
    repurchase had to be at (1) not less than fair market value on the date
    of termination or (2) the original purchase price provided that the
    repurchase rights lapsed at the rate of at least 20% per year over five
    years

    
    
  
  
  
  


• 
  

  The restrictions on required voting rights have been eliminated

  
  
  
  
  • 
    

    Previously, common stock and similar equity was
    generally required to have voting rights equal to those held by the
    issuer’s other common stock

    
    
  
  
  
  


• 
  

  The requirement that annual financial information be provided to security holders has been eliminated

  
  

SHAREHOLDER APPROVAL

For most plans, California will still require
shareholder approval by a majority of the outstanding securities
entitled to vote by the later of (1) 12 months after the date the plan
is adopted or the agreement is entered into or (2) within 12 months of
the date options or shares are granted under the plan or agreement or
the issuance of any securities under the plan or agreement in
California.

A foreign private issuer4 may grant options, shares or
other securities to up to 35 persons in California without seeking
shareholder approval.

CONTINUING REQUIREMENTS

California kept in place several substantive requirements for Section 25102(o) plans, including the following: 1697917v3

• 
  

  The plan or agreement must have a termination date of
  (and options must be granted within) no more than 10 years from the
  earlier of the adoption date or the shareholder approval date

  
  


• 
  

  The exercise period of an option must not exceed 120 months from the date each option is granted

  
  


• 
  

  Options and rights must not be transferable, except by
  will, the laws of descent or distribution, or limited transfers to
  family members by gift or domestic relations orders permitted by Rule
  701

  
  


• 
  

  Options for terminated employees (other than those
  terminated for cause) that are exercisable on the date of termination
  may not terminate prior to the earlier to occur of the option
  expiration date or 30 days from termination (six months if termination
  is due to death or disability)

  
  


• 
  

  An issuer is still required to make a Section 25102(o)
  filing with the California Secretary of State no later than 30 days
  after the first issuance of securities in California in reliance on
  Section 25102(0). However, late filing or failure to file will not
  result in the loss of the Section 25102(o) exemption.

  
  

It should be noted that, to be eligible for these less
restrictive California requirements, plans must still comply with the
requirements of Rule 701, including certain limits on the number of
shares that may be granted under the exemption and specific information
disclosure requirements. Also, all grants of incentive stock options
must comply with the ISO rules of the IRS. Finally, public

more...http://www.troutmansanders.com/pe03/