Baker & McKenzie - Japan Expands Securities Law Exemption for Equity Grants to Second Tier KKs

Baker & McKenzie - Global Equity Services

Japan Expands Securities Law Exemption for Equity Grants to Second Tier KKs

Introduction

On April 6, 2011, the Financial Services Agency released amendments (the "Amendments") to the Cabinet Office Ordinance on Disclosure of Corporate Affairs, etc. (Ministry of Finance Ordinance, 1973 No. 3, as amended) (the "Ordinance") expanding the scope of the so-called "Employee Plan Exemption" (the "Exemption") prescribed by the Order for Enforcement of the Financial Instruments and Exchange Law (Cabinet Order, 1965 No. 321, as amended). Under the Exemption companies granting stock options [1] to officers and/or employees in Japan are exempt from the duty to file a Securities Registration Statement (Forms 7 and 7-2) (and a Securities Notice (Form 6)) under the Financial Instruments and Exchange Law (Law, 1948 No. 25, as amended). The Amendments became effective on the day of release.

Prior to the Amendments, the Exemption was applicable only to a company (an "Issuing Company") that granted stock options to (i) its own officers and/or employees and/or (ii) those of a company whose shares are 100% directly owned by the Issuing Company (a "100% Direct Subsidiary"). So long as the stock options were issued only to such officers and/or employees, Issuing Companies were exempt from the duty to file a Securities Registration Statement upon granting the stock options.

The Amendments: Expansion of the Scope of the Exemption

Cases Specified by the Ordinance

Under the Amendments, in addition to the cases in which the Exemption had previously been applicable, an Issuing Company is now not required to file a Securities Registration Statement when it grants stock options to officers and/or employees of the following companies:

· a company whose shares are 100% directly owned by a 100% Direct Subsidiary of the Issuing Company; and

· a company whose shares are collectively 100% owned by both (a) the Issuing Company itself (say, 60%) and (b) a 100% Direct Subsidiary(ies) of the Issuing Company (say, 40%).

Cases Considered to Fall within the Amended Exemption:

Company 100% Owned by Several 100% Direct Subsidiaries

Although not explicitly specified by the Amendments, it can safely be interpreted that the Amendments are applicable to a case in which stock options are granted to officers and/or employees of a company whose shares are collectively 100% directly owned by several 100% Direct Subsidiaries of the Issuing Company (and, thus, not directly owned by the Issuing Company itself in any percentage). Our Tokyo office has confirmed this interpretation with the Kanto Local Finance Bureau ("KLFB").

Cases Falling Outside the Amendments

The Amendments are applicable to stock option grants to officers and/or employees of subsidiaries down to the tier two (i.e., "grandchild") level. Stock option grants to officers and/or employees of subsidiaries in tier three (i.e., "great-grandchild") or lower level subsidiaries are still outside the scope of the Exemption even after the Amendments. Therefore, even if the shares are ultimately 100% owned by the Issuing Company though its group companies, the Exemption is not applied to a stock option grant to officers and/ or employees of a subsidiary in tier three or a lower level.

In addition, the Exemption is strictly focused only on cases involving stock companies ("kabushiki-kaisha" or "KKs"). Cases involving a company other than a stock company (such as a membership company, LLC or limited liability company ("godo-kaisha") under the Japanese Companies Act (Japanese LLC)) fall outside the scope of the Exemption. For example, when an Issuing Company issues stock options to officers and/or employees of a Japanese LLC that is 100% directly owned by a 100% Direct Subsidiary of the Issuing Company, the Exemption cannot be applied. Likewise, if the 100% Direct Subsidiary (tier one) between the Japanese subsidiary (tier two) and the Issuing Company is not a stock company but rather an LLC-type entity incorporated outside Japan, the Exemption cannot not be applied[2][3]. We reached these conclusions through our Tokyo office's discussions with KLFB officials.

Effect on the Duty of Continuous Disclosure

The Amendments are applied only to the exemption from filing a Securities Registration Statement when stock options are granted to officers and/or employees in Japan. The Amendments are irrelevant to the duty of continuous disclosure (e.g., the duty to file Annual Securities Reports (Form 8), Semi-annual Securities Reports (Form 10) and Extraordinary Securities Reports (Form 10-2).

Accordingly, the Amendments do not affect a duty of continuous disclosure that had already applied before the Amendments as a result of filing a Securities Registration Statement for a stock option grant to officers and/or employees of a Japanese company that is a 100% direct subsidiary of a 100% Direct Subsidiary of the Issuing Company. In other words, although ongoing stock option grants to such officers and/or employees of the Japanese company may be free from the duty to file a Securities Registration Statement under the Amendments, the duty of continuous disclosure still continues to exist unless certain prescribed conditions (such as where the number of holders of the securities (i.e., stock options or shares, as the case may be) in Japan drops below 25) are satisfied and approval from the KLFB is obtained.

This alert was provided by the following members of our GES team in Tokyo:

Tadashi Ishii
+81 3 5157 2714
tadashi.ishii@bakermckenzie.com

Tsugihiro Okada
+81 3 5157 4332
tsugihiro.okada@bakermckenzie.com

Takeshi Shimizu
+81 3 5157 4335
takeshi.shimizu@bakemckenzie.com

[1] In this alert, reference to stock options will include stock purchase rights under ESPPs.

[2] The 100% Direct Subsidiary (tier one) does not have to be a stock company ("kabushiki-kaisha") incorporated in Japan. It can be a foreign corporation incorporated outside Japan so long as it is equivalent to a Japanese stock company. Whether a foreign corporation would be considered equivalent to a Japanese stock company would be determined on a case-by-case basis through consultation with the KLFB as necessary.

[3] The Japanese subsidiary (tier two) must always be a stock company ("kabushiki-kaisha"). A legal entity other than a stock company, such as a Japanese LLC ("godo-kaisha"), is not sufficient.