A colleague asks, can a closely held company in the State of Washington issue stock options to just a few employees without preparing and approving the kind of complex stock option plan that is typical of a large public company? Can the company instead simply enter into separate stock option agreements with each individual employee?
The short answer: Absolutely, but the Company will need to (1) put the option contracts into writing, (2) provide copies to securities regulators in the State of Washington 30 days ahead of time, and (3) ensure that there are enough shares authorized in its Articles to fulfill the options when exercised.
Expanding on this a bit, the grant of a stock option is deemed an “offer or sale” of securities and is thus subject to regulation under both state and federal securities laws. On the federal level, SEC Rule 701 provides guidance. There, you’ll find various restrictions on the amount that can be “sold” during any one year and to whom grants can be made. But this is the operative language for our purposes here:
This section exempts offers and sales of securities . . . under a written compensatory benefit plan (or written compensation contract) established by the issuer, . . . , for the participation of their employees, directors, general partners, trustees (where the issuer is a business trust), officers, or consultants and advisors, and their family members who acquire such securities from such persons through gifts or domestic relations orders.
(Emphasis mine.) In other words, a “plan” is not required under Rule 701 so long as there is a written compensation contract.
On the State level, RCW 21.20.310 permits an “offer or sale” of:
Any security issued in connection with an employee’s stock purchase, savings, pension, profit-sharing, or similar benefit plan if: … the director is notified in writing with a copy of the plan thirty days before offering the plan to employees in this state.
Importantly, the Securities Administrator in the State of Washington has issued an “interpretative release” that makes clear that a “plan” under RCW 21.20.310 includes written compensation contracts, just the same as Rule 701. According to the release:
“The term “employee benefit plan” means any written purchase, savings, option, bonus, appreciation, profit sharing, thrift, incentive, pension or similar plan, or written compensation contract, solely for employees, directors, general partners, trustees (where the registrant is a business trust), officers, or consultants or advisors, provided that bona fide services shall be rendered by consultants or advisors and such services must not be in connection with the offer or sale of securities in a capital-raising transaction.” (emphasis added).
Securities Act Interpretative Statement -06 (emphasis in original).
So, recapping, a Washington state company can grant options to its employees (among others) who work in our State without adopting a grandiose stock option plan. Any company doing so, however, must:
- include the grant in a written compensation contract;
- share the written compensation contract with state regulators; and
- ensure there’s enough authorized but unissued shares to honor the options.
Note: The astute reader might notice that I’ve omitted provisions from the Washington state law that would allow a company to bypass the requirement of notifying securities regulators in advance. In doing so, I’m assuming that the company granting one-off stock options like that addressed here would not go the extra mile of including provisions that would make the stock option agreement qualify for treatment as an “incentive stock option” plan.