Credit Karma, a San Francisco fintech company, recently agreed to pay a $160,000 penalty to settle charges from the Securities and Exchange Commission that it issued stock options to employees without giving them access to financial statements or risk disclosures required under Securities Act Rule 701. The action demonstrates the SEC’s continued interest in whether private companies are providing employees the disclosures that are required under the rule and highlights the potential consequences of a violation, which greatly outweighs the cost of compliance.
Rule 701 is an exemption from SEC registration requirements for equity compensation that is issued to employees, consultants and directors under compensatory benefits plans or compensation agreements. The rule is only available to private companies; public companies cannot participate.
Rule 701 limits the sales price or amount of securities that can be sold during any consecutive 12-month period to the greater of:
- $1 million;
- 15 percent of the total assets of the company; or
- 15 percent of the outstanding amount of the class of securities being offered or sold.
If the total amount of securities sold during a 12-month period exceeds $5 million, the company is required to provide additional disclosures to investors. These disclosures, which includes the risks associated with the investment, must be delivered a reasonable amount of time before the exercise of any stock options. (Note: the Economic Growth, Regulatory Relief and Consumer Protection Act, which was signed into law in May, directs the SEC to amend the rule and increase to this cap to $10 million).
The SEC in a March order alleged that Credit Karma issued approximately $13.8 million in stock options to its employees from October 2014 to September 2015. Credit Karma sought to rely on Rule 701 to exempt the offering from registration. But over the next several months, various employees exercised options granted in the offering, without receiving Credit Karma’s risk disclosures or financial information. The order noted the information was available and provided by Credit Karma to potential investors. Credit Karma agreed to a $160,000 penalty without admitting or denying the SEC’s allegations.