California Private Company Equity Compensation Plan Rules Liberalized

August 20, 2007

In a long-awaited and positive development, on July 9, 2007, the California Corporations Commissioner liberalized the compensatory benefit plan rules under the California Corporate Securities Law of 1968. The regulations were amended because the existing regulations were inconsistent with the regulatory approach taken by other states and the federal securities laws. In addition, they imposed a burden on businesses seeking to create jobs and expand operations in California, and they restricted the opportunity for California residents to participate in compensatory benefit plans without providing significant investor protection in return. These regulations generally are relevant only to private companies, as most public companies are exempted from the qualification requirements under the California Securities Law.


The offer and sale of securities in California is regulated by the Commissioner under the California Securities Law. Securities may not be offered or sold in California unless the sale has been qualified by the Commissioner (under Section 25110 of the California Securities Law) or the security or transaction is exempt or not subject to such qualification. Most issuers of stock options in California rely on exemption under Section 25102(o) of the California Securities Law (Section 25102(o)) for the grant of such stock options. In order to rely on the exemption under Section 25102(o), the stock option plan must satisfy all of the requirements of Rule 701 of the Securities Act of 1933, as amended (Rule 701); the issuer must file a notice with the Department of Corporations; and the stock option plan must satisfy very detailed and exhaustive requirements established by regulation under the California Securities Law.

Summary of the Amended Regulations

The amendments released by the Commissioner on July 9, 2007, significantly liberalize many of the requirements under the California Securities Law.

Specifically, the new amendments:

  • Revise the definition of the persons eligible to receive awards of stock options so it is consistent with Rule 701. Previously, the eligible recipients were limited to employees, directors, managers, and consultants. This has been expanded to include officers, advisors, general partners, trustees (where the issuer is a business trust), and insurance agents who are employees.
  • Eliminate the requirement that the total number of securities issuable under a plan is limited to no more than 30 percent of the then-outstanding securities of a company (unless a higher percentage is approved by two-thirds of the outstanding securities entitled to vote), so long as the plan complies with Rule 701.
  • Eliminate the requirement that the exercise price or purchase price of securities be at least 85 percent of the fair value at the time of grant or issuance.
  • Revise the transferability limitations to permit transfer to a revocable trust, as well as by will, by the laws of descent and distribution or as permitted by Rule 701.
  • Eliminate the requirement that stock options vest at a minimum rate of 20 percent per year over five years.
  • Clarify that a stock option may terminate upon its expiration date, even if the minimum post-termination exercise period requirements for stock options have yet to be satisfied. The regulations generally require that optionees be permitted to exercise their stock options following their termination (unless employment is terminated for cause) for at least six months from the date of termination if the termination is due to death or disability, or for at least 30 days in the event of other terminations.
  • Permit stockholder approval to occur prior to the grant of stock options or rights to acquire securities in California, rather than within 12 months before or after a plan is adopted. This change will permit out-of-state issuers to grant stock options and rights to acquire securities under plans that were adopted more than a year prior to making grants in California. Additionally, foreign private issuers may utilize Section 25102(o) to issue stock options or rights to acquire securities to up to 35 individuals in California without obtaining stockholder approval of the plan or agreement.
  • Eliminate restrictions on repurchase rights for plans that comply with all of the conditions of Rule 701, although plans or agreements submitted to the Commissioner for qualification will remain subject to certain restrictions.
  • Eliminate the requirement that shares of common stock issuable under plans relying on Section 25102(o) must carry equal voting rights on all matters where such a vote is permitted by applicable law.
  • Eliminate the requirement that companies provide financial statements to compensatory benefit plan participants at least annually, provided the plan complies with Rule 701.
  • Clarify that the authority to grant stock options or rights to acquire securities under a plan or agreement expires within 10 years from the date the plan or agreement is adopted or approved by the issuer's stockholders, whichever is earlier, and that the plan itself does not need to terminate after 10 years.

Expanded Types of Equity Awards

Eliminating the requirement that the purchase price of securities be at least 85 percent of the fair value at the time of grant in the corresponding regulation exempting compensatory purchase or bonus plans greatly expands the types of equity awards that can be granted under compensatory benefit plans by private companies in California. However, before companies begin utilizing other types of equity awards—including, for example, stock appreciation rights, restricted stock, and restricted stock units—companies should consider the tax and accounting consequences associated with such awards.

Effective Date of the Amended Regulations

The amended regulations were effective as of July 9, 2007. Companies adopting new stock option plans or stock purchase plans that are able to satisfy all of the requirements of Rule 701 will be able to take advantage of the amended regulations and their newly relaxed requirements immediately.

Effect of the Amended Regulations on Private Companies

The amendment to the compensatory benefit plan regulations means that satisfying the rules for exemption of offers and sales of securities in California will be much easier. Many of the difficult requirements that private companies previously were required to satisfy for exemption under Section 25102(o) have been removed, and the regulations have been expanded to include other award types that previously were not covered by Section 25102(o). As a result, the amended regulations now more closely align the California blue-sky laws to Rule 701, which will allow private companies to have a global equity incentive plan that will not need to satisfy the previously stringent Section 25102(o) requirements.

Action Items

As a result of the amendment to the compensatory benefit plan regulations, we recommend that all private companies with existing stock option and stock purchase plans that were designed to comply with the Section 25102(o) requirements consider adopting an amended and restated plan that removes or modifies the provisions that satisfied the previous Section 25102(o) requirements but which have been eliminated or revised by the amended regulations.

For More Information

This Client Alert is intended only as a general summary of the amended regulations regarding compensatory benefit plans in California. We strongly advise you to seek professional assistance with respect to your specific questions or concerns regarding the amended regulations.

If you have any questions regarding this Client Alert, please contact John Aguirre, Ralph Barry, Roger Stern, or any other member of the Employee Benefits & Compensation practice at Wilson Sonsini Goodrich & Rosati:

Name Phone E-mail
John Aguirre (650) 565-3603
Heather Aune (858) 350-2213
Michael Baker (650) 565-3902
Melody Barker (415) 947-2029
Ralph Barry (858) 350-2344
Jessica Bliss (650) 849-3470
Madeleine Boshart (415) 947-2057
Jason Flaherty (650) 849-3268
Jessica Janov (858) 350-2351
Sriram Krishnamurthy (650) 849-3309
Thuy Le (650) 849-3329
Scott McCall (650) 320-4547
Michael Montfort (202) 973-8815
Cisco Palao-Ricketts (650) 565-3617
Roger Stern (650) 320-4818
David Thomas (650) 849-3261
Jackie Tokuda (650) 565-3904
Michelle Wallin (650) 565-3620
Michael Yang (650) 461-6013

Circular 230 Compliance: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this memorandum is not intended or written to be used, and cannot be used, for the purpose of (a) avoiding penalties under the Internal Revenue Code, or (b) promoting, marketing, or recommending to another party any transaction or matter addressed herein.