Understanding SEC Rule 144 for Selling Restricted Securities

# Understanding SEC Rule 144 for Selling Restricted Securities ## Understanding SEC Rule 144 for Selling Restricted Securities If you have restricted or control securities, you might wonder how you can sell them. SEC Rule 144 provides a way to sell these securities if certain conditions are met. This article will help you understand restricted and control securities, the role of affiliates, and restrictive legends on certificates. ## How to Identify Restricted and Control Securities ### Definition and Characteristics of Restricted Securities Restricted securities are stocks or bonds that come from unregistered, private sales. You usually get them through: - **Private Placements**: Companies sell securities privately to a small group of investors. - **Employee Compensation**: Companies give securities as part of employee benefit plans or as professional service compensation. - **Start-up Capital**: Securities given in exchange for providing initial funding to a company. These securities can't be sold publicly until certain conditions are met. They often have a restrictive legend, which we'll discuss later. ### Common Sources of Restricted Securities You receive restricted securities from places like: - **Private Placement Offerings**: Securities sold to a select number of investors rather than the public. - **Regulation D Offerings**: A way for companies to raise capital without registering with the SEC. - **Employee Stock Benefit Plans**: Companies give employees stocks as part of their benefits. - **Compensation for Services**: Companies pay service providers with stocks. - **Seed Money or Start-up Capital**: Early investors get securities for funding new businesses. These securities are not registered with the SEC and have restrictions on their resale. ### Definition and Identification of Control Securities Control securities are held by those who have control over a company. This includes: - **Executive Officers**: People who make major decisions for the company. - **Directors**: Members of the board who help guide the company's direction. - **Large Shareholders**: Investors who own a significant percentage of the company's stock. These individuals are known as affiliates and their securities are subject to restrictions even if the securities themselves are not restricted. ### Role of Affiliates and Controlling Persons Affiliates are people or entities that control, are controlled by, or are under common control with the company. This means: - **Power to Direct Management**: They can influence how the company is run. - **Significant Ownership**: They own a large portion of the company's voting securities. - **Contractual Control**: They have agreements that give them control over company policies. Affiliates must follow certain rules under Rule 144 to sell their securities. ### Explanation of Restrictive Legends on Certificates When you get restricted securities, the certificate often has a restrictive legend. This legend states that the securities cannot be sold publicly unless they are: - **Registered with the SEC**: The company files the necessary paperwork to register the securities. - **Exempt from Registration**: Conditions of Rule 144 are met, allowing the securities to be sold without registration. The legend serves as a warning that these securities are not free to be traded in the open market until specific conditions are met. Understanding these aspects is key to navigating the regulations around selling restricted and control securities under Rule 144. ## Conditions and Requirements of Rule 144 ### Holding Period Requirements Rule 144 sets specific holding periods for restricted securities before you can sell them. The holding period depends on whether the company issuing the securities is a reporting or non-reporting company. **Reporting Companies**: - **Minimum Holding Period**: 6 months - These companies file periodic reports with the SEC. **Non-Reporting Companies**: - **Minimum Holding Period**: 1 year - These companies do not file periodic reports with the SEC. **Calculation of the Holding Period**: - The holding period starts when the securities are bought and fully paid for. - **Additional Purchases**: Do not affect the holding period of previously purchased securities of the same class. - **Tacking**: If you bought restricted securities from another non-affiliate, you can add on that non-affiliate's holding period to your own. **Special Cases**: - **Gifts**: The holding period begins when the affiliate acquired the securities, not on the date of the gift. - **Stock Options**: The holding period starts on the date the option is exercised, not the date it is granted. ### Current Public Information Before selling restricted securities, there must be adequate and current public information about the issuing company. **Need for Adequate Information**: - Reporting companies must comply with the periodic reporting requirements of the Securities Exchange Act of 1934. - Non-reporting companies must have public information about the business, its officers and directors, and financial statements. **Differences Between Reporting and Non-Reporting Issuers**: - **Reporting Issuers**: Information is available through SEC filings. - **Non-Reporting Issuers**: Information must be available through other public means, such as company websites or press releases. ### Trading Volume Formula For affiliates selling control securities, Rule 144 limits the number of shares that can be sold during any three-month period. **Limitations**: - The number of shares sold cannot exceed the greater of: - **1% of the outstanding shares of the same class**. - **The average reported weekly trading volume during the four weeks preceding the filing of a notice of sale on Form 144**. **Calculation Methods**: - For stocks listed on a stock exchange: Use the greater of 1% or the average weekly trading volume. - For over-the-counter stocks: Use the 1% measurement. ### Ordinary Brokerage Transactions Sales of restricted securities by affiliates must be handled as routine transactions. **Requirements**: - **Routine Trading**: Sales must be routine trading transactions. - **Broker Commissions**: Brokers cannot receive more than a normal commission. - **No Solicitation**: Neither the seller nor the broker can solicit orders to buy the securities. ### Notice of Proposed Sale Affiliates must file a notice with the SEC under certain conditions. **Filing Requirements**: - **Form 144**: Affiliates must file this form if the sale involves more than 5,000 shares or the aggregate dollar amount is greater than $50,000 in any three-month period. **Thresholds for Filing**: - **Number of Shares**: More than 5,000 shares. - **Dollar Amount**: Greater than $50,000 in any three-month period. Understanding these conditions and requirements helps ensure compliance with Rule 144 when selling restricted and control securities. ## What Non-Affiliates Need to Know About Rule 144 Non-affiliates, or individuals not connected to the issuing company, have different conditions under Rule 144. These conditions are generally less strict than those for affiliates. **Conditions Applicable to Non-Affiliates**: - **Not an Affiliate**: You must not be an affiliate of the issuing company and must not have been for at least three months before the sale. - **Holding Period**: As a non-affiliate, you need to hold the restricted securities for at least one year if the issuing company is non-reporting. If the company is a reporting issuer, the holding period is at least six months. **Resale Conditions After Holding Period**: Once you have met the holding period requirements, you can sell the restricted securities without needing to comply with many of the other conditions in Rule 144: - **No Volume Limitations**: Unlike affiliates, non-affiliates are not subject to volume limitations. - **No Public Information Requirement**: Non-affiliates do not need to ensure that current public information about the issuer is available. - **No Notice of Sale**: Non-affiliates are not required to file Form 144 before selling the securities. **Differences in Conditions Based on Issuer's Reporting Status**: - **Reporting Issuers**: If the issuing company files periodic reports with the SEC, non-affiliates can sell the restricted securities after holding them for six months, provided they meet the current public information requirement. - **Non-Reporting Issuers**: If the company does not file periodic reports, non-affiliates must hold the securities for at least one year before selling them. **Simplified Conditions for Non-Affiliates After Holding Securities for a Year**: After holding restricted securities for a year, non-affiliates face fewer hurdles: - **No Restrictions on Sales**: You can sell the securities without worrying about volume limitations, current public information, or filing notices. - **Free Trading**: The securities become free trading, meaning they can be sold in the open market without any additional conditions. By understanding these conditions, non-affiliates can navigate the resale of restricted securities more easily. ## How to Remove Restrictive Legends **Importance of Removing Restrictive Legends for Public Resale**: Restrictive legends on stock certificates indicate that the securities cannot be resold publicly without meeting certain conditions. These legends are necessary to comply with SEC regulations. Without removing these legends, you cannot sell the securities in public markets — even if you meet all other conditions under Rule 144. **Role of Transfer Agents and Issuer's Consent**: - **Transfer Agents**: They manage the transfer of securities from sellers to buyers. To remove a restrictive legend, a transfer agent's involvement is crucial. - **Issuer's Consent**: The issuer must agree to remove the legend. This usually involves getting an opinion letter from the issuer's counsel confirming that the conditions for legend removal are met. **Steps to Initiate Legend Removal**: 1. **Contact the Issuer**: Begin by reaching out to the company that issued the securities. They will guide you on the specific requirements for legend removal. 2. **Engage the Transfer Agent**: Once you have the issuer's instructions, contact the transfer agent. They will handle the logistics of removing the legend from the certificate. 3. **Provide Necessary Documentation**: Submit all required documents, including the opinion letter from the issuer's counsel, to the transfer agent. 4. **Wait for Approval**: The transfer agent will review the documentation and, if everything is in order, proceed to remove the restrictive legend. **Potential Complexities and Need for Legal Assistance**: - **Complex Requirements**: The process can involve intricate legal and procedural steps, making it challenging to navigate alone. - **Legal Assistance**: Due to the complexities, hiring a securities lawyer can be beneficial. They can ensure all conditions are met and handle communications with the issuer and transfer agent. **Requirement for Opinion Letters from Issuer's Counsel**: - **Purpose of the Opinion Letter**: This letter confirms that the sale of the securities complies with SEC regulations and that the restrictive legend can be removed. - **Obtaining the Letter**: The issuer's counsel prepares this letter. You may need to request it formally and provide evidence that all Rule 144 conditions have been satisfied. In summary, removing restrictive legends involves several steps and parties, including the issuer, transfer agent, and sometimes legal counsel. Understanding each part of this process will help you navigate it more efficiently. ## Handling Disputes Over Restrictive Legends **SEC's Non-Intervention Policy in Legend Disputes**: When disputes arise over the removal of restrictive legends, the SEC typically does not get involved. The SEC views these matters as private issues between the shareholder and the issuer. If you face obstacles in removing a restrictive legend, you will have to seek resolution through other means, as the SEC will not mediate or intervene. **Role of State Law in Resolving Disputes**: State law governs disputes over restrictive legends. Each state may have different rules and procedures for handling these issues. For example, some states may offer specific legal avenues, such as filing a claim in a state court or seeking arbitration. Knowing your state's specific laws and regulations will help you understand your options for resolving the dispute. **Steps to Take if a Dispute Arises**: 1. **Review Communication**: Revisit any communication and documents exchanged with the issuer and transfer agent. Ensure that all Rule 144 conditions have been met and documented. 2. **Seek Mediation**: Attempt to resolve the issue through informal mediation or negotiation. Sometimes, a simple misunderstanding or missing documentation can be the cause of the dispute. 3. **Consult Legal Counsel**: If informal methods fail, consult a securities lawyer. They can offer expert advice and represent your interests. 4. **File a Claim**: As a last resort, you may need to file a claim in state court. Your lawyer can guide you through this process and help build a strong case. **Importance of Legal Advice and Representation Letters**: - **Legal Advice**: Navigating a dispute over restrictive legends can be legally complex. A securities lawyer can help you understand your rights and the best course of action. - **Representation Letters**: Your lawyer may draft representation letters to formally communicate your position to the issuer and transfer agent. These letters can outline the legal basis for removing the restrictive legend and request compliance. In summary, disputes over restrictive legends require understanding the SEC's non-intervention stance, state law's role, and the steps you can take to resolve conflicts. Legal advice and representation letters can be pivotal in reaching a resolution.