What Are the Securities Law Implications of Incentive Compensation by LLCs Taxed as Corporations?

What Are the Securities Law Implications of Incentive Compensation by LLCs Taxed as Corporations?

Welcome to the 18th chapter of our thrilling exploration into incentive compensation. As we round the last bend of our journey, we prepare to dive into the labyrinth of securities law and its profound effects on incentive compensation. Business leaders, brace yourselves for this essential guide, as it will light your path through this intricate maze, transforming complexity into clarity. Buckle up, let’s embark on this enlightening journey!

Navigating the Regulatory Intersection of Equity Awards

Federal and State securities laws are the governing forces behind the issuance of equity awards for LLCs taxed as corporations. Imagine these rules as the red and green traffic lights at a bustling intersection, guiding the steady flow of equity offerings. At the state level, these statutes wear the charming alias of “Blue Sky Laws.” These comprehensive laws command that any offer or sale of securities, even as compensation, be registered with the SEC and with appropriate state regulators. However, much like finding a shortcut on your daily commute, there are exemptions to these registrations - a journey we’re about to embark on together.

In Search of Safe Harbor: Unraveling the Exemptions

For LLCs taxed as corporations, the cumbersome expense and impracticality of registering securities with the SEC necessitates finding an exemption. Several key exemptions allow these entities to navigate the regulatory sea safely, including:

  1. Rule 701: A lifeline for compensatory equity awards, Rule 701 exempts awards under a written compensatory benefit plan provided by non-reporting companies. However, it has a distinct cap, limiting the aggregate sale price or securities amount issued in any consecutive 12-month period to the greatest of $1 million, 15% of the company’s total assets, or 15% of the outstanding amount of the securities being offered and sold.
  2. Rule 506(b): When the tide rises above Rule 701’s limits, Rule 506(b) comes into play. It has no limit on the aggregate amount of securities issued. Companies often utilize it for executive officer or director awards that would otherwise breach Rule 701’s constraints.
  3. Section 4(a)(2): This statutory exemption, although rarely relied upon, shields offerings and sales of securities that don’t involve a public offering. Its application is nebulous due to undefined parameters of a private offering. Therefore, most companies opt for safer harbors like Rule 506(b). Nonetheless, in unique scenarios such as large compensatory awards to a company founder, Rule 4(a)(2) can serve as a viable alternative.

In this maze of exemptions, remember that each rule has its twists and turns, and it’s critical to understand their respective nuances. Picture yourself as a ship captain, where each exemption is a potential route to your destination. Choose wisely, understanding the currents of each passage, and sail towards successful incentive compensation.

An Overview of Blue Sky Laws

The legal framework governing state-level securities regulation in the United States is commonly known as Blue Sky Laws. These laws complement federal securities statutes by emphasizing the need for companies to provide accurate and transparent information about their offerings. For LLCs taxed as corporations, the relevance of Blue Sky Laws arises when they grant equity-based incentives, such as restricted stock or stock options, to team members. These incentives are classified as securities, making them subject to both federal and state securities laws.

Here are some key provisions under these securities laws:

  1. Register the security offering with the appropriate state securities regulator or qualify for a state-level exemption.
  2. Ensure the provision of accurate and transparent information to investors.
  3. Comply with state-specific laws governing the sale and distribution of securities.

It is crucial to recognize that the federal Rule 701 does not explicitly preempt Blue Sky Laws. As a result, even if a company qualifies for an exemption under this rule, it must still adhere to state-level securities law.

Steering Clear of Troubled Waters: The Fallout from Ignoring Compliance

Imagine the excitement of offering compensation security awards, only to see them crumble when the team member discovers past transgressions of Section 5 of the Securities Act. Your dreams of growth are not just delayed, they may be jeopardized. The ripple effects can hurt the financial prospects of your business. If you thought the storm ended there, brace yourself. Non-compliance may force you into offering a rescission for securities granted in non-compliant transactions. Worse still, your company and key members within could become the focus of a dreaded SEC investigation or enforcement action. And amid this storm, claims could arise from award recipients, further straining your enterprise. The moral of the story? Navigating the compliance waters is non-negotiable.


We hope this article has been informative and useful for your business. If you have any questions or comments, please contact us at info@wilkinsonlawllc.com. We plan to answer general questions in an upcoming FAQ series. If you need legal advice specific to your situation, please ask to schedule a consultation with an attorney to discuss your company’s goals.

Hold on to your hats, as our next piece will unveil the art and science of skillfully designing, executing, and managing such strategies specifically for LLCs taxed as corporations. Don’t miss out!

This article is for informational purposes only and should not be relied upon as tax or legal advice. Please consult professionals for advice tailored to your specific situation. The author and publisher assume no responsibility for any errors or omissions or for any actions taken based on the information presented.