Last week, Uber sent a letter to the Securities and Exchange Commission (the “SEC”) seeking an amendment to Rule 701 promulgated under the Securities Act of 1933. Rule 701, which was recently modified in July 2018, allows non-reporting companies (i.e. startups and other privately held companies) to issue securities for compensatory purposes to eligible recipients (including employees, consultants, advisors, etc.) without registering such issuances with the SEC. In the letter, Uber stated its preference for the term “entrepreneurial economy” over the commonly used term “gig economy”. Presenting itself as a company that has “empowered millions of individuals around the world to take control of their lives through [their] technology platform”, Uber provides brief recommendations to expand the scope of Rule 701 to allow them to issue equity to its drivers.
Under the revised Rule 701(e), an issuing company must release financial statements, risk factors and other disclosures if the aggregate sales price or amount of securities sold by the company under Rule 701 during any consecutive, rolling 12-month period exceeds $10 million.
Aware that Rule 701 has not been updated since 1999 and the changing nature of business, SEC Chairman Jay Clayton stated in a press release, “The rule as amended, and the concept release, are responsive to the fact that the American economy is rapidly evolving, including through the development of both new compensatory instruments and novel worker relationships – often referred to as the ‘gig economy.’ We must do all we can to ensure our regulatory framework reflects changes in our marketplace, including our labor markets.”
It is well known that Uber has consistently and continually identified its drivers as independent contractors rather than employees not only in the press but also in court. Most recently, the United States District Court for the Eastern District of Pennsylvania held that Uber drivers were independent contractors. As Rule 701 is currently constituted and interpreted, it allows for issuances of restricted stock to ‘consultants’ as an eligible class of persons, but not to ‘independent contractors’. For obvious reasons, this interpretation doesn’t work within Uber’s framework, as it is cross-purposes with its essential argument that its workforce, is comprised of independent contractors. Thus, its recent letter to the SEC is an attempt to open the Rule 701 framework to be more inclusive as to eligible persons (among other matters).
Interestingly, Uber competitor Juno previously tried offering restricted stock units to its independent contractor drivers that would be redeemable when Juno went public or was sold, which it was sold to Gett in 2017. However, Juno ended the program due to implementation difficulties, a clear example of the complexity and expense which can be involved in internal company securities issuances.
Fellow “gig economy” company, Airbnb also sent a request to the SEC on September 21, 2018 to allow it to issue company stock to its hosts. Additionally, it offered suggestions to expand Rule 701(c) to include “persons with substantial, but non-traditional relationships with the issuer”.
Given the growth of the sharing economy, such changes to Rule 701 would seem to be a positive step toward the democratization of equity ownership; allowing more people to participate in the wealth generated from these companies when (and if!) they do go public.
It is unclear if the Uber and Airbnb requests are a peace offering to drivers and hosts or signaling that the dominant “gig economy” companies are truly maturing as they look into the IPO route. Regardless, other platforms based on the “gig economy” relying on alternative contractual relationships between companies and individuals who work with them could follow similar incentive packages, which could include other options like unit appreciation rights plans or restricted stock units, to attract necessary platform employees.
How the SEC will react to these entreaties is not yet certain. Clearly, the SEC is warm to the idea of updating and modernizing key Securities Act transaction exemptions to take current market realities into account, and the seemingly logical (but limited) expansion of eligible persons under Rule 701 is an appealing step in that direction. However, it would also represent another channel of securities distributions that essentially fly below the radar of regulatory and public scrutiny; and, in a world where the long-term trend away from IPOs seems to be unidirectional, the SEC may not wish to allow for more shade to darken the picture frame.
Commentary by Stan Sater & Jeffrey Bekiares, Esq. Jeff is a securities lawyer with over 8+ years of experience, and is co-founder at both Founders Legal and SparkMarket. He can be reached at [email protected]