On March 12, 2018, the Securities and Exchange Commission (“SEC”) ordered a pre-IPO internet-based financial technology company to pay a $160,000 civil money penalty for not complying with the disclosure requirements prescribed in Rule 701(e) of the Securities Act. SEC also ordered the company to cease and desist from committing or causing any violations of the Securities Act.

As a general rule, a company cannot offer or sell securities to the public unless the offering is registered or is exempt from registration. Most private companies rely on Rule 701 for issuance of securities to employees pursuant to stock-based compensation plans, provided that the issuer, among other things, does not offer more than $5 million in securities over a 12-month period. If the offer exceeds this threshold amount, Rule 701(e) of the Securities Act mandates that the company provide its employees certain disclosures, including risk disclosures, within a reasonable time before the Rule 701 issuances.

Credit Karma issued approximately $13.8 million in unregistered stock options to its employees during a twelve-month period from October 1, 2014 to September 30, 2015. According to the SEC, the company violated Rule 701(e) when it failed to deliver financial statements and risk disclosures associated with the securities to its employees within a reasonable time before the employees exercised their stock options.  Given the utility of Rule 701 and the reliance by so many companies, especially companies choosing to remain private longer, on Rule 701 issuances, this enforcement action is notable.  A copy of the cease and desist order is available here.  Various bills have been introduced during this session of Congress that would raise the dollar threshold at which disclosure requirements are triggered; however, to date, these measures have failed to garner sufficient bipartisan approval.