HOGAN & HARTSON L.L.P. MEMORANDUM. January 23, Ellen Lieberman, Esq. Chair of the Committee on State Regulation of Securities

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1 HOGAN & HARTSON L.L.P. COLUMBIA SQUARE 555 THIRTEENTH STREET, NW MICHELE A. KULERMAN WASHINGTON, DC COUNSEL TEL (202) (202) FAX (202) MEMORANDUM January 23, 2007 TO: Ellen Lieberman, Esq. Chair of the Committee on State Regulation of Securities Debevoise & Plimpton LLP 919 Third Avenue New York, N.Y FROM: RE: Michele A. Kulerman, Esq. / Hogan & Hartson LLP Peter G. Danias, Esq. / Kaye Scholer LLP Report of the Subcommittee on Employee Benefit Plans and Other Exempt Transactions Dear Ellen: The Subcommittee is scheduled to meet in Washington, D.C. at the Spring Meeting of the ABA and to discuss current developments in the state securities regulation of employee plans and other exempt transactions. The Subcommittee has been working on several projects and we look forward to discussing the contents in greater detail at the upcoming Spring meeting. During this past year we have worked on the following projects: 1. California Proposal on Rule 701 Exemption - The State Regulation of Securities Committee (the Committee ) of the Section of Business Law (the Section ) of the American Bar Association (the ABA ) submitted a comment letter dated December 7, 2006, to Karen Fong, California Office of Laws and Legislation, in support of the amendments proposed in PRO 27/06 (the Proposal ) by the California Corporations Commissioner (the Commissioner ) to modify , , , , and of Title 10 of the California Code of Regulations (the CCR ), adopted under the California Corporate Securities Law of 1968 (the CSL ) relating to compensatory benefit plans. In addition to our support for the Proposal, we made several additional comments or proposed revisions primarily relating to Rule 701 plans or agreements; the requirements for qualified plans are subject to the Commissioner s discretion rather than the specific language of the Proposal by virtue of being incorporated in CSL 25102(o). A copy of the letter is attached as Attachment A. ABA/Jan2007EmpComteReport/Letterhead

2 HOGAN & HARTSON L.L.P. It is our understanding that Colleen Monahan, Sr. Corporations Counsel at the California Department of Corporations, is handling the Proposal. Ms. Monahan told us that she received eight comment letters, all of which supported the proposed changes. The Committee's letter and the California State Bar Corporations Committee letter (copy also attached as Attachment B.) were the most comprehensive. The Los Angeles County Bar Association also wrote to generally support the proposal, but apparently did not make detailed comments. All letters are public record. The Commissioner is currently considering all of the comments received and is planning to reissue the Proposal incorporating some of the comments. We understand that the Commissioner will keep all of the flexibility proposed in the original Release, but that changes will likely be made in the definitions to conform with the SEC Rule 701. There were also comments on conforming the definitions with the California Family Code (for example, to include Registered Domestic Partners as permitted transferees). No action has been taken by the Commissioner at this time. The revised Proposal will be issued by early February and will be subject to 15 days additional comment period. They still anticipate the final rules will be adopted by the end of the first quarter of In the mean time, the Commissioner issued a Release (No. 118-C, available here: indicating that relief from the old rules would be granted on a case by case basis through February 28, 2007 under conditions stated in that Release. The Release states that a variance may be considered if "the variance request accompanies an application for qualification filed on or before February 28, 2007" and that the variance may not be requested for a notice of exemption under 25102(o) Coordinating Exemption in the States - Continues to maintain an up-to-date survey regarding state adoption of a Rule 701 coordinating exemption. (Survey attached as Attachment C.) 2

3 HOGAN & HARTSON L.L.P. 3. Merger/Reorganization Exemption Survey - In the process of undertaking a merger/reorganization survey. The objective of this project is to create an updated chart showing state exemptions for issuers of non-covered securities in connection with share exchanges, mergers, reorganizations and similar transactions. The Subcommittee also plans to develop a related survey of practitioners and other participants. The purpose of the survey is, in part, to highlight aspects such as the different uses for these exemptions, the related filing requirements, situations where there may be a need to seek a no-action/interpretive ruling, particular state information, forms or requirements that are unusual or unclear, use of overlapping exemptions and status of issuer "dealer" registration requirements. 4. Submitted comments to: The SEC on 12/20/06, commenting on a proposed amendment to SEC Rule 146 under the Securities Act of Very truly yours, /s/ Michele A. Kulerman /s/ Peter G. Danias Attachments BEIJING BRUSSELS BUDAPEST LONDON MOSCOW PARIS PRAGUE TOKYO WARSAW BALTIMORE, MD BOULDER, CO COLORADO SPRINGS, CO DENVER, CO IRVINE, CA LOS ANGELES, CA McLEAN, VA NEW YORK, NY Affiliated Office 3

4 ATTACHMENT A. AMERICAN BAR ASSOCIATION SECTION OF BUSINESS LAW STATE REGULATION OF SECURITIES COMMITTEE 321 NORTH CLARK STREET CHICAGO, ILLINOIS December 7, 2006 Ms. Karen Fong Office of Laws and Legislation California Department of Corporations 1515 K Street, Suite 200 Sacramento, California address: regulations@corp.ca.gov Re: PRO 27/06 Rule Changes under California Corporate Securities Law of 1968 California Code of Regulations, Title 10, , , , , and Dear Ms. Fong: The State Regulation of Securities Committee (the "Committee") of the Section of Business Law (the "Section") of the American Bar Association (the "ABA") writes in support of the amendments proposed in PRO 27/06 (the "Proposal") by the California Corporations Commissioner (the "Commissioner") to modify Sections , , , , and of Title 10 of the California Code of Regulations (the "CCR"), adopted under the California Corporate Securities Law of 1968, as amended (the "CSL"), relating to compensatory benefit plans. 1. The Committee. The Committee is comprised of over 390 ABA members, a part of whose practice (in many cases, a principal or substantial part) involves the regulation of securities by state authorities (so-called "Blue Sky" law). The Committee is comprised of attorneys practicing in both the public and private sectors, including private interest groups and self-regulatory organizations (SROs). A draft of this letter was reviewed by members of the Committee, 4

5 and the views expressed herein are generally consistent with those of the majority of such members. The views expressed herein have not, however, 5

6 Ms. Karen Fong Office of Laws and Legislation California Department of Corporations December 7, 2006 Page 6 been approved by the House of Delegates or the Board of Governors of the ABA, and they should not be construed as representing the policy of the ABA. In addition, this letter does not represent the official position of the Section, nor does it necessarily reflect the views of all members of the Committee or the member's respective clients. 2. The Existing Law and Regulations. The Commissioner has adopted rules in connection with the exercise of its discretionary authority in qualifying the issuance of securities, including the rules being modified in the Proposal. CSL 25102(o) currently provides a transactional exemption for the issuance of securities pursuant to a purchase plan or option plan where the securities are exempt under Rule 701 ("Rule 701") promulgated under the Securities Act of 1933, as amended (the "Securities Act"), by the U.S. Securities and Exchange Committee (the "SEC"), subject to compliance with CCR , and for a purchase plan, and CCR , and for an option plan. A notice filing with the Commissioner within 30 days after the initial grant of securities under such a plan is required (although failure to file this notice does not affect the exemption). It is our opinion and experience that the provisions of CCR through (the "Regulations") unnecessarily restrict the interest of the general public and the ability of companies, especially start-up and foreign companies, to provide their employees, directors and service providers (each, a "Participant") with a proprietary interest in, and commitment to, the issuer by unnecessarily inhibiting the availability of the Rule 701 exemption. This is important to the growth of companies and business and we agree with the Commissioner's decision to amend these Regulations. 3. We Support The Proposal. As the Commissioner identified in the Initial Statement of Reasons for Rule Changes, compensatory plans are an important and positive tool for newer and emerging companies without the current ability to pay large amounts of cash compensation. Such plans also help align the interests of employees and other eligible persons who receive such non-cash compensation with the interests of the owners of the business. In recent years equity compensatory plans have been an important tool assisting business start-ups in attracting qualified workers, and most jobs are created by smaller businesses. Under the existing regulatory structure in California, issuers with California Participants must adopt a plan that includes the provisions of the Regulations. Restrictions similar to these Regulations are not required in any other jurisdiction in the United States with a similar benefit plan exemption. As a result, California Participants may not be offered the same opportunities which the employer grants to its non-california Participants. It is common practice for private companies to exclude California Participants from their equity compensation plans in order to avoid difficulties in complying with California Blue Sky restrictions. Further, the provisions of the Regulations may not match the ABA/Jan2007EmpComteReport/Letterhead

7 Ms. Karen Fong Office of Laws and Legislation California Department of Corporations December 7, 2006 Page 7 issuer's general compensation policy or business goals with respect to all of its Participants. We believe the Proposal brings California into line with other US jurisdictions and levels the playing field for businesses with employees and other eligible persons located in California. The Proposals will allow issuers to have a single, uniform compensatory program available for all Participants, and not one that prohibits the issuance of securities in California. The current Regulations, by forcing complying issuers to adopt different plans solely for California Participants, also result in additional costs to such issuers. These additional costs vary, depending upon the specific situation, but a minimal stock option plan can cost from $5,000 to as much as $10,000 to establish, plus the on-going costs of administering such separate plans. These additional costs clearly reduce the incentive for companies to locate employees, to add new employees, or to offer the benefit of plans to employees, in California. The current Regulations do not provide additional protections to California Participants that would justify the increased compliance costs. For these reasons, we strongly support the Proposal. 4. Additional Comments. While we generally support the Proposal, we have several additional comments on the proposed revisions, primarily relating to Rule 701 plans or agreements. A. Bonus Stock. In many instances the grant of bonus stock by an employer would not constitute a "sale" within the meaning of Section 2(a)(3) of the Securities Act. In SEC Release No (Feb. 1, 1980), according to the SEC: Stock bonus plans are plans under which an employer awards shares of its stock to covered employees at no direct cost to the employees.... While the stock awarded to employees under the above types of plans is a security, the staff generally has not required it to be registered. The basis for this position generally has been that there is no "sale" in the 1933 Act sense to employees, since such persons do not individually bargain to contribute cash or other tangible or definable consideration to such plans. It also is justified by the fact that registration would serve little purpose in the context of a bonus plan, since employees in almost all instances would decide to participate if given the opportunity. Similarly, the interests of employees in bonus plans have not been subjected to registration. In an accompanying footnote, the SEC further stated that: The staffs position generally is applicable only in the context of bonus plans which are made available to a relatively broad class of employees. With respect to stock awarded to, or acquired by, employees pursuant to 7

8 Ms. Karen Fong Office of Laws and Legislation California Department of Corporations December 7, 2006 Page 8 individual employment arrangements, the staff generally has concluded that such arrangements involve separately bargained consideration, and that a sale of the stock has occurred. The rationale expressed by the SEC, that there is no need for federal securities registration where employees do not individually bargain for bonus stock that they would wish to accept in almost all instances, should have equal applicability to the CSL. As the Commissioner has noted in the Statement of Reasons issued in connection with the Proposals, California has a statutory public policy, as set forth in CSL , encouraging the uniform application of state securities laws in conformity with the federal securities laws and those of other states. We respectfully recommend the Commissioner take this opportunity to clarify that California will treat bonus stock in the same manner as it is treated by the SEC, namely that if granted to an employee without individual bargaining, it is not a "sale" within the meaning of CSL B. Application of California Requirements to Persons in Other Jurisdictions. CCR and provide that options granted and securities sold pursuant to a plan or agreement must provide for all of the provisions thereafter enumerated. We suggest these enumerated provisions and any other California requirements for compensatory benefit plans under the CSL that are not repealed by the Proposal be clarified by expressly stating they are limited in application to offers or sales of securities issued only to California Participants. If an omnibus compensatory plan is adopted by a company with employees, officers, directors or other Participants residing in many states (or foreign countries), not just in California, the requirements for compliance with the Section 25102(o) exemption and the Regulations should not affect awards granted to non-california persons. Many companies that are not located in California have California Participants in their compensatory plans. Such companies should not be barred from claiming the Section 25102(o) exemption simply because their compensatory benefit plans include provisions that are not applicable to non-california Participants, and separate provisions incorporating the Regulations that are applicable to California Participants. While California has an interest in adopting rules and regulations that protect California Participants, California should not have the discretionary authority to deny the availability of an exemption for issuances to California Participants if the plan contains other terms applicable only to non- California Participants. The Commissioner should take this opportunity to clarify that required provisions under California law need only apply to awards granted, and the underlying stock issued, in California. 8

9 Ms. Karen Fong Office of Laws and Legislation California Department of Corporations December 7, 2006 Page 9 C. Rule Repurchase Rights. As proposed, CCR (b)(4)(ii) would permit further restrictions to be imposed on repurchase rights for "an officer, director, manager or consultant of the issuer or an affiliate of the issuer." Under the Commissioner's authority relating to compensatory benefit plans, we suggest that the provisions of Rule (b)(4)(ii) be changed, in conformity with Rule 701, to "officer, director, manager, advisor or consultant of the issuer, its parents, its majorityowned subsidiaries or majority-owned subsidiaries of the issuer's parents." To make the provision more comprehensive, we also suggest adding the language from Rule 701, namely "general partners and trustees (where the issuer is a business trust)." D. Rules and Scope of Eligible Persons. We generally support the proposed changes to CCR (relating to option plans and agreements) and (relating to securities purchase plans and agreements), broadening the scope of eligible persons to be more compatible with the language of Rule 701. We suggest, however, that the Commissioner further modify the proposed language to clarify that it covers insurance agents, perhaps matching the language of Rule 701, namely "insurance agents who are exclusive agents of the issuer, its subsidiaries or parents, or derive more than 50% of their annual income from those entities." The language currently proposed might be read to be limited to insurance agents who are "employees." We note these additions do not include certain other categories of persons within the scope of Rule 701, namely "general partners and trustees." We have not suggested adding them since CSL 25102(o) by its terms applies only to corporations and limited liability companies. The Commissioner might consider, however, whether references to general partners and trustees might be helpful in the context of qualification of securities. E. Rule Termination of Options. We support the proposed changes in CCR (e) that options for terminated employees will terminate on the option expiration date, if that date is earlier than other termination dates. We suggest, however, that the entire provision may be unnecessary, that investor benefits from California's micromanaging option exercise periods for terminated employees are questionable, and that there is not a sufficient rationale or justification to retain this non-uniform provision. In particular, we note that compliance with the provision may result in unfavorable tax results to Participants. For incentive stock option plans under Section 423 of the Internal Revenue Code of 1986, as amended, options must be exercised within three months of termination of employment, even in the case of death or disability, to receive favorable 9

10 Ms. Karen Fong Office of Laws and Legislation California Department of Corporations December 7, 2006 Page 10 tax treatment. The California six-month requirement will result in exercise after three months, and thus less favorable tax treatment for employees. Certain other options granted at a discount to market value may be subject to federal tax penalties if their terms extend for more than 2'/2 months after the end of the year of termination, a distinct issue if the termination occurs towards the end of the year. F. Rules and Approval Requirements. We support the proposed changes that would modify the approval provision of CCR (g) and (e), by (1) permitting approval to be granted prior to grant of an option or issuance of a security in California, and (2) providing relief for foreign private issuers who would not have to comply with approval provisions if, in the aggregate under all plans and agreements, grants and securities issuances were made to 35 or fewer persons in California. We suggest, however, that this non-uniform provision is not justified on investor protection grounds and should be eliminated. If the Commissioner desires to retain this provision, we suggest it be modified as follows: First, approval should be permitted both prior to and within 12 months after grant of an option or issuance of a security in California, which would correlate more closely with the existing provision and would not cause delay or detriment, for example, with respect to new offices in and expansion of business to California. Second, approval should not be required at all for foreign private issuers, since such requirements are often in conflict with requirements in their home jurisdictions. Alternatively, the number of participating persons should be determined with respect to any single plan or agreement, and the number of California Participants increased from 35 to 100. The restrictive approval requirement, even as proposed to be relaxed, would still be a deterrent to companies that might otherwise establish or expand their operations in California, and creates an uneven playing field and disadvantage for the California workforce such that California employees may not be offered the same benefits as workers in other jurisdictions. 10

11 Ms. Karen Fong Office of Laws and Legislation California Department of Corporations December 7, 2006 Page 7 We appreciate any consideration given by the Commissioner to the foregoing comments, and would be pleased to discuss these comments further with staff, should that be necessary or desirable. Respectfully submitted, STATE REGULATION OF SECURITIES COMMITTEE By Michele A. Kulerman Co-Chair Employee Plan and Other Exempt Securities Subcommittee Drafting Committee: Ellen Lieberman, Esq., Chair, The Committee Alan Parness, Esq., Vice Chair, The Committee Edward Alterman, Esq. Andrew Brooks, Esq. Peter Danias, Esq. Michele A. Kulerman, Esq. Peter LaVigne, Esq. R. Michael Underwood, Esq. C:\NrPortbl\PALIB2\BLF\ DOC

12 ATTACHMENT B. Comment letter from the Corporations Committee of the State Bar of California regarding the proposed amendments to the Compensatory Benefit Plan Rules. Corporations Committee Business Law Section The State Bar of California 180 Howard Street San Francisco, California calbar.org/buslaw/corporations December 18, 2006 To: California Department of Corporations Attn: Colleen Monahan, Senior Corporations Counsel 1515 K Street, Suite 200 Sacramento, CA regulations@corp.ca.gov Re: Request for Comment regarding Amendments to Sections , , , and of Title 10, California Code of Regulations under the Corporate Securities Law of 1968 regarding Compensatory Benefit Plan Rules Committee Position: Support Amendment with Suggested Modification Approved by the Corporations Committee on December 1, 2006 Approved by Business Law Section Executive Committee on December 15, 2006 Committee Contact: Michael A. Occhiolini, Esq. Corporations Committee Wilson Sonsini Goodrich & Rosati, PC 650 Page Mill Road Palo Alto, CA mocchiolini@wsgr.com I. Statement of Position The Corporations Committee (the "Committee") of the Business Law Section of the State Bar of California welcomes this opportunity to provide this comment letter ("Comment Letter") in response to the October 30, 2006 request by the Department of Corporations for comments on the proposed amendments to Sections , , , and C:UVrPortbl\PALIB2\BLF\ DOC -3-

13 California Department of Corporations December 18, 2006 Page 5 (the "Proposed Amendments " ) of Title 10, California Code of Regulations Under the Corporate Securities Law of 1968 Regarding Compensatory Benefit Plan Rules (the "Compensatory Benefit Plan Rules"). For the reasons set forth in this Comment Letter, the Committee supports the Proposed Amendments to the Compensatory Benefit Plan Rules. The Committee looks forward to working with members of the staff of the Department of Corporations to address any questions with respect to the information set forth in this Comment Letter. II. Comments Committee Support for the Proposed Amendments to the Compensatory Benefit Plan Rules. The Committee supports the adoption of the Proposed Amendments to the Compensatory Benefit Plan Rules in order to conform the existing Compensatory Benefit Plan Rules more closely with the requirements of Rule 701 ("Rule 701") of the U.S. Securities Act of 1933, as amended. The Committee notes and supports the following improvements to the Compensatory Benefit Plan Rules set forth in the Proposed Amendments: conforming the class of eligible persons to the class of eligible persons set forth in Rule 701 and eliminating other restrictions not imposed by Rule 701 from the Compensatory Benefit Plan Rules; eliminating restrictions on minimum exercise prices for options and minimum purchase prices for other securities for any Rule 701-compliant offering; eliminating minimum vesting period requirements for non-management employees for any Rule 701-compliant offering; conforming information delivery requirements to those set forth in Rule 701 for any Rule 701-compliant offering; conforming limitation on the number of securities available under a plan to those set forth in Rule 701 for any Rule 701-compliant offering; permitting shareholder approval of a plan at any time prior to the issuance of securities under such plan; providing limited waivers from the rules for foreign private issuers; and implementing other technical modifications to the Compensatory Benefit Plan Rules. C:\NrPortbl\PALIB4\BLF\ DOC

14 California Department of Corporations December 18, 2006 Page 5 Suggested Modification to the Proposed Amendments Set forth below are a number of proposed changes to the Proposed Amendments that the Committee would suggest ("Suggested Modification"): (1) The Committee notes the discrepancy between California Family Law Code Section 297.5, which provides that registered domestic partners shall have the same rights, protections and benefits as are granted to a spouse, and the definition of "Family Member" within Rule 701, which does not recognize domestic partners. As a result, the inclusion of registered domestic partners within a plan or offering that otherwise complies with Rule 701 would cause such offerings to fail one of the conditions of Rule 701. The Committee believes such result under the Proposed Amendments is unintended and inappropriate. The Committee recommends that Section (c) and the last sentence of be amended to read as follows: This section shall not apply to any plan or agreement that complies with all conditions of Rule 701 of the Securities Act of 1933, as amended (17 C.F.R ); provided that for purposes of determining such compliance, any registered domestic partner shall be considered a "Family Member " as that term is defined is defined in Rule 701. (2) The Committee recommends deletion of the term "Bonus Plans" from the title of Section since the term is not defined under the Proposed Amendments, or alternatively, include such term but clarify its definition. (3) The Committee recommends elimination of the ten year maximum plan requirement set forth in both Section (f) and Section (d). The Committee notes there is no similar requirement under Rule 701, and believes there should not be a statutory maximum time period requirement for benefit plans. Plan documents typically provide that various provisions will continue to apply as to outstanding awards even after a plan's termination. In addition, the terms of the individual awards incorporate the plan document by reference, and the termination of a plan will not typically trigger the termination of an outstanding award. The Committee acknowledges that most issuers will impose a ten-year maximum term in order for a plan to comply with ISO rules, but does not believe that is it necessary to specify a maximum term for compensatory benefit plans in the Proposed Amendments. (4) The Committee also recommends removal of Section (b)(4) of the Proposed Amendments, which provides that if an issuer has a repurchase right with respect to securities sold to consultants, managers, directors and employees then the terms are presumptively reasonable if the following terms are included in the company's plan: C:\NrPortbl\PALIB2\BLF\ DOC -5-

15 California Department of Corporations December 18, 2006 Page 5 the repurchase price is not less than the fair market value of the securities on the date of termination of employment, the right to repurchase must be exercised within 90 days of termination of employment (or in the case of securities issued upon exercise of options after the date of termination, within 90 days after the date of the exercise), and the right to repurchase terminates when the issuer's securities become publicly traded; or the repurchase price is at the original purchase price, provided that the right to repurchase at the original purchase price lapses at the rate of at least 20% of the securities per year over 5 years from the date the option is granted (without respect to the date the option was exercised or became exercisable) and the right to repurchase must be exercised within 90 days of termination of employment (or in the case of securities issued upon exercise of options after the date of termination, within 90 days after the date of the exercise). The Committee also concurs with the view expressed in Ms. Suzanne Graeser's comment letter to the California Department of Corporations regarding the Compensatory Benefit Plan Rules dated November 15, 2004 that the requirement that the right to repurchase shares within 90 days is inconsistent with the requirements under Financial Accounting Statement 123(R), in particular the need for a period of longer than six months (instead of 90 days) for the award to be classified as an equity award for accounting purposes. In addition, the Committee believes that the same policy reasons cited by the California Department of Corporations in support of its decision to eliminate the vesting requirements from Section (f) apply equally in support of deleting this requirement from Section Therefore, the Committee recommends deleting Section (b)(4), since the Committee believes that an issuer and an option grantee should be able to determine an appropriate exercise schedule that meets the requirements of each of the respective parties. Past Compliance with Existing Compensatory Benefit Plan Rules Has Been Difficult. The members of the Committee believe on the basis of their own experience that meeting the requirements of the existing Compensatory Benefit Plan Rules has been difficult for many issuers. The restrictions set forth in the existing Compensatory Benefit Plan Rules are more extensive than the requirements set forth in Rule 701, therefore making it difficult for issuers to comply with existing Compensatory Benefit Plan Rules. Application of the existing Compensatory Benefit Plan Rules to foreign private issuers has been difficult as well, as a number of the requirements set forth in the Compensatory Benefit Plan Rules are not requirements for such issuers under Rule 701 or under the rules governing such issuers in the country of their organization. Therefore, the Committee supports the adoption of the Proposed Amendments to ease compliance by issuers with the Compensatory Benefit Plan Rules. \\\DC C:\NrPortbl\PALIB2\BLF\ / v2 8.DOC -6-

16 California Department of Corporations December 18, 2006 Page 5 Adverse Impact of Existing Regulations on Californians. The Committee believes that the existing Compensatory Benefit Plan Rules have reinforced the oft-expressed perception that California's regulatory environment is more burdensome for companies compared with the regulatory regime in other state jurisdictions. The Committee is aware of situations where corporations have avoided providing compensatory plans to their employees in California because of the existing requirements of the Compensatory Benefit Plan Rules. The Proposed Amendments will make it easier for companies to provide compensation benefit plans to its California employees by, among other things, conforming the California Compensatory Benefit Plan Rules more closely to the Rule 701 requirements. Conformity with Federal Law. The Committee believes the Compensatory Benefit Plan Rules should conform more closely to the requirements of federal law, particularly Rule 701. Accordingly, the Committee supports the adoption of the Proposed Amendments as that would reduce the existing conflicts between the California requirements and federal law. Similar Laws in Other States. The Committee is not aware of any other states having requirements similar to the requirements set forth in the existing Compensatory Benefit Plan Rules, and therefore the Committee supports the Proposed Amendments as a way to eliminate these restrictions unique to the existing California Compensatory Benefit Plan Rules. III. Recommendation The Committee recommends the following actions be taken with respect to the Compensatory Benefit Plan Rules in order of preference: 1. Adopt the Proposed Amendments to the Compensatory Benefit Plan Rules with the Suggested Modifications. 2. Adopt the Proposed Amendments to the Compensatory Benefit Plan Rules as stated in the California Department of Corporations release dated October 30, IV. Germaneness The Committee believes that its members have the special knowledge, training, experience, and technical expertise to provide helpful comments on the Compensatory Benefit Plan Rules, and that the position advocated herein would promote clarity and consistency in the law and improve coordination between state and federal law in the regulation of corporate disclosure to security holders without compromising the Compensatory Benefit Plan Rules' purpose. C:\1VrPortbITALIB2\BLF\ DOC -7-

17 California Department of Corporations December 18, 2006 Page 6 V. Caveat Membership in the BUSINESS LAW SECTION is voluntary and funding for section activities, including all legislative activities, is obtained entirely from voluntary sources. There are currently more than 8,800 members of the Business Law Section. Positions set forth in this letter are only those of the Committee. As such, they have not been adopted by the State Bar's Board of Governors, its overall membership, or the overall membership of the Business Law Section, and are not to be construed as representing the position of the State Bar of California. Michael A. Occhiolini Corporations Committee Neil J. Wertlieb, Esq. Chair, Executive Committee, Business Law Section Keith P. Bishop, Esq. Vice-Chair, Legislation, Executive Committee, Business Law Section Bruce Deming Co-Chair, Corporations Committee Russell Wood Co-Chair, Corporations Committee Steven B. Stokdyk, Esq. Corporations Committee Peter W. Wardle, Esq. Corporations Committee Daniel J. Weiser, Esq. Executive Committee Liaison to Corporations Committee 3/27/ :37:18 PM Rule 701 Chart # v3 (2/2/2006 modified)

18 Attachment C. The attached survey reports on the adoption of USA 2002 by a number of states, and in particular, the adoption of Section 202(21) of USA 2002 verbatim. STATE ADOPTED USA 2002 and EFFECTIVE HAWAII IDAHO IOWA KANSAS MAINE MINNESOTA MISSOURI NORTH DAKOTA OKLAHOMA SOUTH CAROLINA SOUTH DAKOTA TENNESSEE VERMONT VIRGIN ISLANDS UTAH VERMONT STATE ALABAMA CALIFORNIA DELAWARE DISTRICT OF COLUMBIA GEORGIA MICHIGAN Effective July 1, 2008 Effective September 1, 2004 Effective January 1, 2005 Effective July 1, 2005 Effective December 31, 2005 Effective July 1, 2007 Effective September 1, 2003 Effective July 1, 2005 Effective July 1, 2004 Effective January 1, 2006 Effective July 1, 2004 Effective January 1, 2005 Effective Modified, Effective October 1, 2006 Effective July 1, 2006 Effective July 1, 2006 USA 2002 ADOPTION UNDER CONSIDERATION Legislation pending Proposed Legislation pending Legislation to be reviewed & re-submitted for adoption Legislation pending Legislation pending -9-

19 NEBRASKA OHIO WEST VIRGINIA WISCONSIN Under review Proposed Legislation pending Under review 2006 UPDATED LIST OF STATE SECURITIES LAW PROVISIONS THAT (1) EXEMPT RULE 701 OFFERINGS FROM SECURITIES AND ISSUER-DEALER AND AGENT REGISTRATION REQUIREMENTS (2) POLICY STATEMENTS, NO-ACTION POSITIONS AND SIMILAR INTERPRETATIONS ON POINT ALABAMA NO NOTICE 7110, Alabama, (10), Exempt Securities - Any investment contract issued in connection with an employee s stock purchase, savings, pension, profit-sharing or similar benefit plan. 7111, Alabama, (10), Exempt Transaction - Any transaction pursuant to an offer to existing security holders of the issuer, including persons who at the times of the transaction are holders of convertible securities, nontransferable warrants or transferable warrants exercisable within not more than 90 days of their issuance, if (i) no commission or other remuneration is paid for soliciting any security holder in Alabama, or (ii) notice is filed and not disallowed within next 5 full business days. Staff considers employees who have received grants of options to be existing security holders. B E & K, Inc., Ala. Corp. Com. No-Action Letter, 1993 WL (Dec. 13, 1993) (3)(a), Alabama, 7102, Definitions - An issuer is excluded from the definition of broker-dealer (2), Alabama, 7102, Definitions - Agent does not include a person who represents an issuer or dealer in effecting a transaction in a security exempted by (i) section (10), (ii) effecting transactions exempted by , or (iii) effecting transactions with existing employees, partners or directors of the issuer if no commission or other remuneration is paid or given directly or indirectly for soliciting any person in Alabama. 7574, Alabama, Policy Statement It has consistently been the position of the Alabama Commissioner s staff that the conditions of (10) will be met if the Plan qualifies for exemption pursuant to Rule 701 of the Securities and Exchange Commission and 3(b) of the Securities Act of Accordingly, if a plan qualifies under Rule 701 then grants can be made to non-employee directors, independent consultants and affiliate employees pursuant to the states employee plan exemption at Section (10). See Statement htm USA 2002 Pending Adoption. ALASKA NO RULE 701 EXEMPTION Alaska has not adopted a Rule 701 compliant exemption. -10-

20 (a)(5), 8134 Employee Plan Exemption - A security issued in connection with an employee s stock purchase, savings, pension, profit-sharing, or similar employees benefit plan. Exemption covers both grant of options and issuance of stock upon exercise (3)(B), 8150 An issuer is excluded from the definition of broker-dealer (5), 8150 An agent does not include an individual who represents an issuer in effecting transactions in a security exempted by (a) or effecting transactions with existing employees, partners, or directors of the issuer if no commission or other remuneration is paid or given directly or indirectly for soliciting any person in Alaska. Reprinted With Permission From The Corporate Counsel 2006 E.P. Executive Press, Inc. Concord, CA -11-

21 ARIZONA NO NOTICE 9542, Arizona, R , Exempt offerings pursuant to compensatory arrangements - A. Offers and sales of securities that satisfy the requirements and provisions of Rule 701 under the Securities Act of 1933 and this Section shall be added to the class of transactions exempt under the provisions of A.R.S (Exempt Transactions). Rule 701 is incorporated by reference and on file with the office of the Secretary of State. The incorporated material contains no later editions or amendments. B. Bad Boy Provisions apply. This Section provides an exemption from the registration requirements of the Arizona Securities Act for securities issued in compensatory circumstances. The Section is not available to any issuer for any transaction that, while in technical compliance with this Section, is part of a plan or scheme to circumvent this purpose. 9136, Arizona, , Exempt Transaction Transactional exemption obviates broker-dealer/agent registration A.14, 9136 IRC Qualified Plans (See also no action letter at 9693) 1/ The sale or issuance of any investment contract or other security in connection with an employee s pension, profit sharing, stock purchaser, stock bonus, savings, thrift stock option or other similar employee benefit plan which meets the requirements for qualification under the United States Internal Revenue Code. 2/ Exemption covers both grant of options and issuance of stock upon exercise. R ; 9511 Non-IRC Qualified Plans An offering of securities within or from this State which is exclusively to bona fide employees and/or existing security holders of the issuer or a subsidiary of such issuer, or if the issuer is a subsidiary, is exclusively to the bona fide employees and/or existing security holders of the issuer and/or its parent, is exempt, and added to the class of transactions exempt under A.R.S provided that: 1.The aggregate amount of the offering to be made within or from this state shall not exceed $500,000.00; and 2.No commission or remuneration of any kind, other than transfer agent s fees, shall be paid directly or indirectly by the issuer to any person in connection with the distribution or sale of such securities; and 3.A verified statement of the details and purposes of the offering and the financial condition of the issuer (Notice of Intention to Sell Securities Under A.A.C. R ) shall be filed with the Commission at least 10 days before the offering is made, and no material change in the details of the offering shall be effected thereafter without the consent of the Commission; and 4.Any subscription contract calling for deferred payments shall be subject to the approval of the Commission; and 5.A consent to service (Form U-2) shall be filed. Notice filing must include statement of financial condition prepared in accordance with generally accepted accounting principles. Unaudited interim statements as of a date within 90 days of the date of the petition (Financial Information Required under R ) and $100 Filing fee under Section G. R (2), Dealer Registration, - A dealer or salesman shall not be required to register before engaging in transactions directed to existing securities holders, to employees of the issuer or to employees of the issuer or to employees of a wholly-owned subsidiary of the issuer if the subsidiary was not created to avoid the registration provisions of the Securities Act, and in which either of the following apply: 1/ In that no-action letter, the Division allowed a stock option plan providing for a combination of qualifying and non-qualifying options to be covered by the (a)(14) exemption / See Acceptance Ins. Co. Inc., Ariz. Corp. Com. No-Action Letter, 1994 WL (Feb ) (refusing to identify if plan interests are separable security from underlying stock offered under plan where there was transaction exemption). -12-

22 ARKANSAS NO NOTICE 10,163, Arkansas, (a)(9), Exempt Security - Any security as to which the commissioner by rule or order finds that registration is not necessary or appropriate in the public interest or for the protection of investors. 10,672, Arkansas, Administrative Order It is ordered pursuant to Section (a)(9), that the offer and sale of securities under a written compensatory benefit plan or contract that is exempt from registration under Rule 701 under the Securities Act of 1933 shall be exempted from Sections (Sale of unregistered nonexempt securities) and 502 (Filing of prospectus, sales literature, etc.) of the Arkansas Securities Act (3)(B), Arkansas, 10,102, Definitions - An issuer is excluded from the definition of broker-dealer (2)(B), Arkansas, 10,102, Definitions - Agent does not include an individual who represents an issuer in effecting transactions in a security exempted by (a)(1)-(4), or (8) and any other transactions in a security exempted by other clauses of which the commissioner may by rule or order prescribe; or effecting transactions with existing employees, partners, or directors (but not consultants or advisors) of the issuer if no commission or other remuneration is paid or given directly or indirectly for soliciting any person in Arkansas (2)(B)(d), Arkansas, 10,102, Definitions Agent does not include an individual who represents an issuer in effecting transactions with existing employees, partners, or directors of the issuer if no commission is paid for soliciting any person in Arkansas. CALIFORNIA NOTICE REQUIRED 11,133, California, 25102(o), Exempt Transaction An offer or sale of any security issued by a corporation or limited liability company pursuant to a purchase plan or agreement, or issued pursuant to an option plan or agreement, where the security at the time of issuance or grant is exempt from registration under the Securities Act of 1933, as amended, pursuant to Rule 701 adopted pursuant to that act (17 C.F.R ), the provisions of which are hereby incorporated by reference into this section; provided that (1) the terms of any stock purchase plan or agreement shall comply with Sections , , and of Title 10 of the California Code of Regulations, (2) the terms of any stock option plan or agreement shall comply with Sections , and of Title 10 of the California Code of Regulations, and (3) the issuer files a notice of transaction in accordance with rules adopted by the commissioner within 30 days after the initial issuance of any security under that plan, accompanied by Form U-2 Consent to Service of Process and a filing fee as prescribed by subdivision (y) of Section ($200 plus 1/5 of 1% of the aggregate value of the securities proposed to be sold in California, up to a maximum aggregate fee of $2,500). However, the failure to file the notice within the time specified in this subdivision shall not affect the availability of this exemption. Offers and sales exempt pursuant to this subdivision shall be deemed to be part of a single discreet offering and are not subject to integration with any other offering or sale. Issuers relying on this exemption must file a notice of transaction within 30 days after the initial issuance of any security under the plan , California, 11,106, Definitions - An issuer is excluded from the definition of broker-dealer (b), California, 11,104, Definitions Agent does not include an individual who only represents an issuer in effecting transactions under Section (transactions exempted from a registration requirement) and (d) An officer or director of the issuer, or an individual occupying a similar status or performing similar functions, is an agent only if he otherwise comes within this definition and receives compensation specifically related to purchases or sales of securities. Proposed Rule PRO 27/06 to amend the regulations relating to compensation benefit plans. -13-

23 COLORADO NO NOTICE (1)(i), Colorado, 13,111, Exempt Securities Any security issued in connection with an employee s stock purchase, savings, pension, profit-sharing, or similar benefit plan , Colorado, 13,113, Exempt Securities The securities commissioner may, by rule or order and subject to such terms and conditions as prescribed therein, from time to time, add any securities to the securities exempted in section or any transaction to the transactions exempted in section , if the securities commissioner finds that the application of sections and to such securities or transactions is not necessary in the public interest and for the protection of investors. Exemption Request, Colorado, M [No-Action Request( ) A deferred compensation plan for sales agents of an insurance company was exempt from registration provided the plan was exempt under SEC Rule 701. All contributions to the plan were to be made in cash, and participants would not borrow against those contributions (2); 13,103, Registration Exemption (Dealer) Excludes an issuer selling its own securities (14); 13,103, Registration Exemption (Sales Representative) Excludes an individual, other than a brokerdealer, effecting or attempting to effect purchases or sales of securities including the issuer s own securities, and primarily performs substantial duties for or on behalf of the issuer otherwise than in connection with transactions in the issuer s own securities and the individual s compensations is not based, in whole or in part, upon the amount of purchases or sales of the issuer s own securities effected for the issuer. A partner, officer, or director of a broker-dealer or issuer, or an individual performing a similar function, is a sales representative only if the individual otherwise comes within the definition. CONNECTICUT FORM U-2 REQUIRED 14,120, Connecticut, 36b-21(b)(16), Exempt Transaction Any transaction exempt under Rule 701, 17 CFR Section promulgated under Section 3(b) of the Securities Act of 1933 is exempt from sections 36b-16 and 36b-22 of the Connecticut Securities Law and Business Opportunity Investment Act. 14,133, Connecticut, 36b-33(g) - A Form U-2 Consent to Service of Process and a cover letter indicating on which exemption the issuer is relying is required. There is no filing fee. 36b-3(5)(b), Connecticut, 14,102, Definitions - An issuer is excluded from the definition of broker-dealer. 36b-3(1), Connecticut, 14,102, Definitions - Agent does not include an individual who represents an issuer in (b) effecting transactions exempted by subsection (b) of section 36(b)-21, or (c) effecting transactions with existing employees, partners or directors of the issuer if no commission or other remuneration is paid or given directly or indirectly for soliciting any person in this state. 3/ The Section (1)(i) benefit plan exemption includes Rule 701 plans and stock option plans, provided no commission is being paid. -14-