Client Alerts


Relief for Equity Incentive Plans Subject to California State Securities Regulations

Recently, the California Commissioner of Corporations (the “Commissioner”) proposed to amend the current regulations imposed on securities offered or sold in California pursuant to certain compensatory benefit plans.[1] These rules apply primarily to (i) privately-held companies that offer or sell securities in the state of California (which occurs when either the company is located in California or the recipient is a resident of California), and (ii) public companies not listed on a major stock exchange. The proposed amendment would relax a number of substantive requirements contained in those regulations. Although the proposed amended regulations are expected to become effective in 2007, the Commissioner has also announced that it will consider granting permits for arrangements that comply with the proposed regulations, provided the permit applications are filed no later than February 28, 2007. Companies intending to grant compensatory equity awards to California residents will find the additional flexibility provided by the proposed amendments to be welcomed relief.


Section 25110 of the California Corporate Securities Law of 1968, as amended (the “California Securities Law”) generally prohibits the offer or sale of any security in California pursuant to a compensatory benefit plan unless either (i) the offer or sale has been qualified by the Commissioner, or (ii) an exemption is available. Issuers rely primarily on Section 25102(o) of the California Securities Law (“Section 25102(o)”) for the grant of compensatory stock options and stock issuances. The regulations promulgated by the Commissioner under Section 25102(o) impose a number of substantive requirements on the provisions of stock options and stock issuances. The Commissioner has recognized that these substantive requirements are inconsistent with the rules imposed by other states[2] and the federal securities laws, and impose an undue burden on businesses creating jobs and expanding their operations in California.

Proposed amendment to compensatory benefit plan regulations

The Commissioner has proposed to make the following changes to the Section 25102(o) regulations applicable to stock options and stock issuances:[3]

  • Allow the total number of securities that may be issued under a plan to be specified as either (i) a fixed number, or (ii) a percentage of securities outstanding from time to time[4];
  • Eliminate the minimum exercise price of options and the minimum purchase price for securities;
  • Eliminate the minimum 20% annual vesting rule (i.e., permitting targeted incentives and performance-based vesting for non-management employees);
  • Permit necessary stockholder approval to occur prior to the grant of options or issuance of securities in California, rather than within 12 months before or after a plan is adopted (i.e., permitting out-of-state issuers to grant options and issue securities under plans that were adopted more than a year prior to making grants in California);
  • Permit “foreign private issuers”[5] to use the Section 25102(o) exemption for up to 35 individuals in California without stockholder approval;
  • Eliminate certain restrictions on the ability to repurchase securities upon termination of employment;
  • Eliminate the restriction to grant only voting stock (e.g., “drag-along” rights and classes of non-voting common stock no longer prohibited);
  • Eliminate the two-thirds super-majority vote required to approve shares issued under compensatory benefit plans in an amount greater than 30% of the outstanding number of shares on a fully-converted basis; and
  • Eliminate the requirement that companies provide financial statements to compensatory benefit plan participants at least annually.
Note that eligibility for the Section 25102(o) exemption continues to require that all arrangements thereunder be exempt under and comply with Rule 701, promulgated under the Securities Act of 1933 (“Rule 701”).

Surviving substantive requirements

Following adoption of the proposed amendments to the Section 25102(o) regulations, the following substantive requirements will remain:[6]

  • The plan must specify the total number of securities that may be issued and the class of individuals eligible to receive options and purchase securities under the plan;
  • The exercise period of an option must not exceed 120 months from the date of grant;
  • Options and the right to acquire securities under the plan must be non-transferable, except as permitted by Rule 701;
  • The number of securities and the exercise price subject to equity awards must be proportionately adjusted in the event of stock splits and similar transactions effected without the receipt of consideration by the issuer;
  • Optionees must be permitted to exercise their options until the earlier of (i) the option expiration date, or (ii)(A) at least 6 months from a termination due to death or disability, and (B) at least 30 days from a termination due to any other reason except for cause;
  • Equity awards must be granted within 10 years from the earlier of (i) the date the plan is adopted, or (ii) the date the plan is approved by the issuer’s security holders; and
  • The plan must be approved by a majority of the outstanding securities entitled to vote within 12 months before or after the date the plan is adopted[7] or, if later, prior to the grant of any equity award in California.
Interim relief available through permit application

On or before February 28, 2007, the Commissioner will consider requests for variances from the existing Section 25102(o) regulations on a case-by-case basis pursuant to a permit application,[8] provided that:

  • The permit application is filed on or before February 28, 2007 (a variance is not available on a standard Notice of Issuance filed under Section 25102(o));
  • The applicant has not violated any California securities laws or regulations within the past four years;
  • The variance request is limited to those regulations that the Commissioner has proposed to amend (i.e., no variance permitted from the proposed amended regulations); and
  • The grant of options pursuant to the plan conforms with applicable corporate documents, and the grant dates of options are accurately reflected in the applicant’s books, records and financial statements.
What companies should do

Companies that have previously granted options and stock issuances under the Section 25102(o) exemption should continue complying with the current regulations. Companies that desire to take advantage of the proposed regulations for new option grants and stock issuances may consider applying for a permit with the Commissioner on or before February 28, 2007.

It is not clear whether issuers may apply the relief offered by the new proposed regulations to existing options and stock issuances (e.g., relief from the requirement to provide financial statements to participants at least annually). We have alerted the Commissioner’s office about this issue, and we hope that the Commissioner will provide appropriate transition relief in the final rules.

Once the amended regulations are adopted, companies that wish to take advantage of the new relaxed requirements for future grants (e.g., to permit performance-based vesting for non-management employees, impose drag-along rights, etc.) should review their plans carefully to determine whether any amendments are necessary.

If you have questions about this Alert, please contact one of the following attorneys:

Mark Bradford Palo Alto, CA
Wendy Davis Palo Alto, CA
Michelle Lara San Diego, CA
Buff Miller Palo Alto, CA
Amy Muecke San Diego, CA
Tom Reicher San Francisco, CA
Soo Kim San Francisco, CA
Thomas Welk San Diego, CA


[1] See

[2] In its rationale for the proposed amendment, the Commissioner stated that it was unaware of any other state that imposes such substantive requirements on compensatory stock options and stock issuances. See

[3] We have been informed that the Commissioner is considering making minor technical changes to the proposed amendments in response to public comments.

[4] Note that incentive stock options may not be granted pursuant to a plan in which the maximum aggregate number of shares that may be issued under the plan is specified as a percentage of securities outstanding from time to time. Treas. Reg. §1.422-2(b)(3).

[5] Generally defined by Rule 3b-4, promulgated under the Securities Exchange Act of 1934, as an issuer incorporated or organized under the laws of any foreign country, except an issuer meeting the following conditions: (a) more than 50% of the issuer’s outstanding voting securities are directly or indirectly held of record by residents of the United States; and (b) any one of the following: (i) the majority of the executive officers or directors are United States citizens or residents; or (ii) more than 50% of the assets of the issuer are located in the United States; or (iii) the business of the issuer is administered principally in the United States.


[7] If security holder approval is not obtained within the requisite time period, any option exercises or security issuances must be rescinded.


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