The SEC’s Streamlined S-8 Securities Registration Scheme, Demystified

This Article is Outdated and Should Not Be Relied Upon as Current Law

Without doubt, S-8 is a powerful tool: it empowers fully reporting companies to register shares quickly and easily–without automatic SEC examiner review. S-8 registration allows issuers to compensate employees and some outside consultants with registered shares in lieu of cash. Issuers and their management remain confused, however, by the types of services for which S-8 compensation can be issued. Actually, the SEC’s pronouncements on S-8-set forth in a recent Final Rule Release (see below for link)-are as clear as day.

Who Can Issue Stock on Form S-8

Form S-8 requires the disclosure of very little information on an issuer. Form S-8 relies upon an issuer’s existing SEC filings to ensure that adequate public information is available regarding an issuer. Thus, S-8 is only available to fully reporting companies that have met their 1934 Act filing obligations (10-Ks, 10-Qs, etc.) for the twelve-month period preceding the S-8 Filing. A company’s annual and quarterly reports are simply incorporated by reference into the S-8, and need not even be included in the S-8 registration filing.

The Form S-8 Process

A typical Form S-8 registration statement is rarely more than twenty pages long, and is often ten pages or less. It requires none of the typical registration statement disclosures such as risk factors, MD&A, and financial statements. A copy of the consultation contract or employee benefit plan must be attached to the S-8 filing as an exhibit.

S-8 registrations enjoy two immeasurable benefits: S-8 registration statements are not subject to automatic review by SEC examiners, and become effective immediately upon filing. Once the Form S-8 is filed, the S-8 shares are registered, free trading stock. Company counsel can then issue an opinion letter to the company’s transfer agent asking that unrestricted shares be issued in the name of the employees under either the consultation contract or employee benefit plan.

A History of Abuse

The SEC’s literature on S-8 routinely notes two primary areas of abuse that are strictly forbidden. First, companies fraudulently issue S-8 stock to nominal employees or consultants, who then sell the shares at the direction of (and for the benefit of) the issuer. Second, Form S-8 has been misused to register securities issued to compensate advisors who then use the shares to hype and/or promote the issuer’s securities. These two specific misuses have routinely led to SEC investigations and prosecutions by SEC staff. See http://www.sec.gov/litigation/admin/3-9597.htm, for a sample case.

When S-8 Cannot Be Used

As discussed, the SEC’s prohibitions on the use of S-8 fall ultimately into two areas: a prohibition on the use of S-8 to raise capital, and a prohibition on the use of S-8 to promote the issuer’s stock. In practice, these prohibitions are necessarily expanded to, for example, forbid S-8 shares to compensate persons who arrange reverse mergers. The SEC’s position is that reverse mergers too often deteriorate into pump and dump schemes. Similarly, S-8 shares cannot be used to compensate anyone if the issuer or a promoter directs the resale of the shares, or the issuer receives any of the proceeds.

Also, S-8 shares must be issued to an individual person who provides bona fide services, not an entity such as a partnership or corporation. The SEC reasons that they wish to prevent “the use of consultant entities as underwriters.” Note, however, that the consulting contract underlying the S-8 issuance can be between the issuer and an entity, “as long the securities registered are issued to the natural persons working for the consulting entity.”

Thus, the following five rules summarize S-8’s explicit prohibitions:

* S-8 shares cannot be issued in connection with promotion of the company’s shares.
* S-8 shares cannot be used if the issuer or a promoter controls or directs the resale of the shares.
* S-8 shares cannot be part of a capital raising-scheme or if the issuer receives a share of the proceeds of resales.
* S-8 shares cannot be issued to persons who arrange reverse mergers.
* S-8 share must be issued to natural persons for bona fide services.

Services for Which S-8 May Be Issued, and a Warning

As long as the S-8 prohibitions are avoided, S-8 can be issued in exchange for a wide range of services. Of course, because Form S-8 is not subject to automatic SEC examiner review, the SEC will never advise that S-8 is or is not appropriate. The only way an issuer will ever learn that an S-8 issuance was improper will be if the matter comes to the attention of the Division of Enforcement. Thus, caution is obviously warranted. If an issuer ever doubts the appropriateness of S-8 shares in a particular circumstance, the best course is to postpone the S-8 filing and secure a no-action letter from the SEC.

The SEC has offered a substantial degree of welcome guidance by outlining specific types of compensation for which S-8 share may be issued. Of course, individual circumstances can render these examples worthless. The following services have been explicitly outlined by the SEC as examples of services for which S-8 stock may be issued:

* Consultants who provide traditional product or corporate image advertising (except when done to promote a company’s stock).
* Business development consultants retained to identify another company as a potential partner for technology development.
* Consultants who advise the issuer on business strategy or compensation policies.
* A consultant who arranges a bank credit line.
* Attorneys who represent an issuer in matters not relation to its securities, such as litigation defense, securing U.S. Food and Drug Administration approval, or obtaining a patent.
* Attorneys who prepare the issuer’s Exchange Act reports and proxy statements.
* Attorneys and other consultants who assist an issuer in identifying acquisition targets, or in structuring mergers or other acquisitions in which securities are issued as consideration, unless the acquisition is a typical reverse merger.

Where To Go for More Information

The Securities Lawyer’s Deskbook, at www.law.uc.edu/CCL/intro.html, contains the full text of the basic U.S. securities laws and regulations, as well as SEC forms. For the last word on S-8, the SEC’s Final Rule Release No. 33-7646, issued in early 1999, noted S-8’s various abuses, and directed strict rules for the issuance of S-8 shares. You can find this release at www.sec.gov, and it is an invaluable resource for a company researching S-8 shares.

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Michael Spadaccini

Michael Spadaccini is the author of 8 books on self-help legal matters such as, Ultimate LLC Compliance Guide: Covers All 50 States (Ultimate Series), Ultimate Book of Forming Corps, LLCs, Partnerships & Sole Proprietorships, and Ultimate Guide to Forming an LLC in Any State, Second Edition (Ultimate Series).

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