Securities Law Blog

Rule 701 under the Securities Act of 1933 allows non-reporting companies to offer their securities as part of stock option, restricted stock and other compensatory employee benefit plans to employees, directors, general partners, trustees, officers and certain consultants without having to comply with federal securities registration requirements if total equity award sales during a 12-month period do not exceed test limits specified in the rule.  In July 2018, the SEC issued a Concept Release on Compensatory Securities Offerings and Sales to solicit public comment on possible ways to modernize Rule 701’s registration exemption.  In response, Airbnb, Inc. recently provided the SEC with its unique “sharing economy” perspective with a recommendation to expand the eligibility of individuals who may receive equity under Rule 701 to so-called “sharing economy participants.”

In Airbnb’s view, Rule 701 needs to be amended to reflect the emergence of new types of contractual relationships between companies and the individuals who work with them, but are not otherwise employees in the traditional sense.  For Airbnb, this includes the hosts who use its marketplace to list unique accommodations and experiences, and whose services are aligned with the company’s in order to succeed.  According to Airbnb, “[i]ncreasing eligibility for Rule 701 grants would help democratize share ownership and wealth by allowing more ordinary Americans who participate in the sharing economy the opportunity to experience stock ownership and potential to benefit when a private company goes public.” 

Airbnb proposed to create a new subtype of the Rule 701 exemption that would apply specifically to sharing economy companies and their participants using their marketplace, to be known as the “Sharing Economy Award Exemption.”  Under Airbnb’s plan, companies must meet the following criteria to qualify for the special exemption:

• issuers must provide a marketplace platform the primary objective of which is to allow unaffiliated third parties to provide lawful goods and services to end users;
• issuers must derive a significant amount of their annual revenue from commissions or fees related to the purchase of goods or services from sharing economy participants through their marketplaces; and
• issuers must control the marketplace platform, demonstrating that (a) they are able and entitled to remove any person or listing from their marketplaces either at their discretion or upon violation of the terms of service or other contractual agreement, or (b) they establish the amount of user fees for using the platform and set the terms and conditions by which participants receive payment for the goods or services sold through their marketplaces.  

Conceding there may be potential abuse of the Sharing Economy Award Exemption, Airbnb (presumably with counsel) proposed to qualify the exemption so that:

• the amount and other terms of the equity awarded must not be subject to individual bargaining and recipients must not be permitted to elect between such equity awards and another type of payment to prevent the transaction from involving an investment decision by the recipient;
• no more than 50% of the value received by the recipient in connection with transactions that occurred on an issuer’s platform during any 24-hour period may consist of equity, as determined at the time the equity is granted to such individual; and
• the sharing economy participant’s receipt of a qualifying equity award must not be contingent upon receipt by the issuer of any capital contribution from such person at the time of issuance, so as to prevent the exemption from being exploited by companies wishing to use it to raise capital.

Turning to transferability limitations, Airbnb indicated that it may be appropriate to specify that equity acquired pursuant to the Sharing Economy Award Exemption be non-transferable to unaffiliated third parties prior to an initial public offering registered under the Securities Act or a change in control of the issuer to address the possible motive of stimulating the active secondary market for private companies. 

At the same time, Airbnb indicated that it believes it is not appropriate to limit the number of sharing economy participants to whom a company can issue equity awards using the exemption or to count all of the participants as “holders of record” for purposes of determining the level at which an issuer is required to register its class of equity securities under the Securities Exchange Act of 1934 (currently, employee shareholders are not counted towards this level).  Due to Airbnb’s continuing relationship with its hosts, they would be “more knowledgeable” about the business than outside investors, so hosts “would be less in need of disclosure materials,” it stated.

Essentially, Airbnb is seeking to bring its hosts into the same class as employees.  Perhaps this is not so farfetched as Rule 701 already allows exemptions on a facts and circumstances basis for offers to consultants and advisors who have significant “employment characteristics,” such as a bookkeeper, computer programmer or former employee hired as a consultant (so long as their services are not inherently capital-raising or aimed to promote or maintain a market for the issuer’s securities).  Alternatively, it would be reasonable for the SEC to be concerned about issuances of equity, especially riskier non-voting classes of stock in non-reporting companies, in lieu of a significant part of cash payments to large groups of unaffiliated, non-accredited sharing economy participants, so that the issuer can conserve its own cash assets.  It will be interesting to see if the SEC elects to extend Rule 701 to sharing economy participants such as hosts on Airbnb’s network or even drivers for ride-sharing companies like Uber.