A powerful tool for many Companies in attracting key employees and consultants is participation in employee benefit programs. Regulation S-8 (hereafter referred to as “S-8) provides an Issuer with a means to register securities issued to its employees, consultants or advisors. One of the primary benefits of Registration on Form S-8 is that the registration statement is effective upon filing. As such, these shares may be issued without a restrictive legend and are immediately marketable. However, S-8 securities may only be issued as compensation or as an incentive to individuals who provide services that do not involve capital raising transactions or market making activities. Generally, capital raising transactions are defined as any transaction that allows for cash proceeds to be received by the Issuer and market activities are defined as activities that promote or sustain a market in the Issuer’s securities.

As originally drafted, Regulation S-8 never permitted Form S-8 to be used to register securities used as compensation for services relating to capital raising activities. In fact, the instructions to Form S-8, specifically state that it is not to be used for capital raising purposes. Moreover, federal case law has firmly established that the use of S-8 for capital raising purposes constitutes an evasion of the registration requirements under the Securities Act of 1933, as amended (“the Act”).

Because of perceived abuses, in April 1999 the SEC amended Regulation S-8. The April, 1999 amendments stemmed from a concern that S-8 issuances were being used by promoters, Issuers or others to orchestrate purposeful and massive illegal distributions of securities by allowing “consultants” to sell their free trading S-8 securities to the public as part of a capital raising transaction or to promote and/or maintain a market in the Issuer’s securities. According to the SEC, the consultants were acting as “conduits” who performed little or no services for the Issuer, other than marketing the Issuer’s securities and conducting their illegal securities sales, the proceeds of which were being funded back to the Issuer or its promoters. Under the SEC’s theory, although, the Issuer pretends to have issued these securities to consultants for bona fide services, the public resale of these securities constitutes a distribution of unregistered securities. In addition, the SEC believed that promoters were disseminating fraudulent information about the Issuer in the form of press releases, tout sheets or company descriptive brochures to manipulate the market and profit from the S-8 securities sales by nominee consultants.

Advantages and disadvantages of S-8 Security Issuances

Despite the April, 1999 amendments, Regulation S-8 can still be effectively utilized by an Issuer. However, Form S-8 has its advantages and disadvantages.

A. Advantages

Immediately effective - Form S-8 is immediately effective upon filing. In other words, S-8 securities are freely tradable upon filing Form S-8 (subject to the Rule 144 volume

limitations of officers, directors and control persons). In contrast, securities registered on a long form registration statement, such as a Form SB-2 or S-1, frequently involve a costly, as well as an extensive and lengthy review process by the Commission that is difficult to predict. Obtaining effectiveness of the Registration Statement can take as little as two or as long as eighteen months or even longer to clear comments. This leaves the Issuer with uncertainty as to when or if ever, a registration statement will become effective.

 

Short form registration - Prior to 1990, S-8 had prospectus delivery and expansive disclosure requirements. The Commission dispensed of this requirements in the 1990 Amendments because much of the information contained in the S-8 prospectus had already been included in Issuer reports previously filed with the Commission. The Commission now permits an Issuer to file Form S-8 in an abbreviated disclosure format through extensive incorporation by reference to periodic and other reports filed by the Issuer. As such, S-8 does not require the Issuer to spend the time and expense involved with the expanded disclosure of a long form registration statements such as an SB-2 or S-1.

 

Promoting employee loyalty or commitment - Consistent with its regulatory purpose, Issuers may use Form S-8 to issue free trading securities (subject to volume limitations) to its employees, officers, directors, consultants or advisors as an incentive or for compensation for their non capital raising duties. In some instances, Issuers use S-8 to promote long term loyalty by issuing S-8 securities to its employees over several years.

 

Alternative to cash compensation - Issuers that have limited cash resources with little or no prospective financing (particularly small-cap/development stage companies) may issue S-8 securities as an incentive to obtain the services of its employees, officers, directors, consultants or advisors -- services that the Issuer may have otherwise been unable to obtain. S-8 also provides largely capitalized companies with economic alternatives. By issuing S-8 securities, Issuers may devote their cash resources to plant and equipment or other direct capitalized expenses, rather than cash compensation for their employees or consultants.

B. Disadvantages

Promoting shareholder disloyalty - Shareholders may interpret S-8 security issuances as self-serving acts by the Issuer’s officers and directors that unjustly enrich them at the expense of other Shareholders who will suffer dilution in their ownership as S-8 shares are issued.

Expenses of an S-8 registration statement - The filing of a Form S-8 involves legal expenses in connection with its preparation by a law firm. However, these expenses are generally less than those of a long form registration.

 

II. Current S-8 Requirements

An Issuer filing Form S-8 must strictly conform to the following requirements:

1. The Issuer must be subject to the reporting requirements under Section 13 or 15 (d) of the Exchange Act.

2. The Issuer must have filed all reports required to be filed during the preceding twelve month period or such shorter period the Issuer was required to file such reports;

3. The consultant or advisor receiving S-8 securities compensation must provide bona fide services to the Issuer;

4. The services provided by the consultant or advisor receiving S-8 securities must not be in connection with the offer or sale of securities in a capital raising transaction;

5. The services provided by the consultant or advisor receiving S-8 securities compensation must not be in connection with directly or indirectly promoting or maintaining a market for the Issuer’s securities.

6. The consultant or advisor must be a natural person, that is Form S-8 may not be used to issue stock to a corporation or other artificial entity;

7. The consulting contract regarding the services and the receipt of S-8 securities compensation must be between the Issuer and the natural person; and

8. The Issuer must issue the securities directly to the natural person as opposed to a corporate entity.

Because the following services of employees, consultants or advisors involve capital raising activities or the promotion or maintenance of a market on their face, they are strictly prohibited by S-8:

· Providing investor relations services to the Issuer;

· Providing shareholder communications services to the Issuer (i.e. preparation of press releases or other publicly disseminated information regarding the Issuer);

· Arranging for or affecting merger transactions on behalf of the Issuer;

· Arranging for reverse mergers;

· Arranging for or providing services designed to take a company public;

· Brokers, dealers or other persons who find investors;

· Internet newsletter writers who “hype” the Issuer’s securities, recommend the Issuer’s securities or who otherwise simply discuss the Issuer’s business; and

· Any person or entity that publishes or disseminates information “that reasonably may be expected to influence the price of the Issuer’s securities.”

S-8 may be used to provide securities compensation to advisors or consultants for the following services, assuming compliance with all other S-8 requirements:

· Arranging for or providing assistance with bank credit lines;

· Identifying prospective strategic partners for technology development;

· Business strategies;

· Bookkeeping services;

· Website design;

· Legal Services (for non capital raising/promotional services);

· Product or corporate imaging advertising; and

· Development of business compensation policies.

Because the following transactions are designed to affect capital raising transactions, they would be disallowed under S-8:

· A “consultant” or “advisor” or any other person that loans funds to the Issuer company who is repaid with S-8 securities;

· Any employee, consultant or advisor who sells S-8 securities and provides the proceeds from the stock sales back to the Issuer company;

· Any employee, consultant or advisor who sells S-8 securities, the proceeds of which are used to pay the Issuer’s bills or outstanding loan amount;

· Any employee, consultant or advisor who sells S-8 securities, the proceeds of which are used to invest in the Issuer’s restricted securities;

· A lawyer who receives S-8 stock for services in connection with the preparation or review of a Registration Statement for an Issuer’s Initial Public Offering; and

· Payment of Company debt or operational expenses.

In conclusion, to ensure compliance with S-8, Issuers should: (a) generally identify the type of services that are permissible under S-8; (b) conduct an adequate investigation to determine whether the consultant’s or advisor’s services constitute capital raising or the promotion or maintenance of a market; (c) incorporate contractual terms in employment or services agreement that clearly identify the services to be performed, as well as prohibit services in connection with capital raising or the promotion of maintenance of a market; and (d) consult with legal counsel to ensure compliance, including preparation of the Form S-8 and appropriate employment contracts for the Issuer’s employees, consultants and/or advisors.

Ms. Hamilton is a corporate and securities attorney with the law firm of Hamilton, Lehrer & Dargan, P.A. Her firm’s practice is located at 555 South Federal Highway, Suite 270, Boca Raton, Florida 33432. The firm’s telephone number is (561) 416-8956.