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Rule 144 Financial Engineering
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UNDERSTANDING RESTRICTED STOCK
On the following pages you will learn in great detail about the complexities and strict guidelines which govern the sale of restricted and control securities.
The enclosed concepts and information were designed for educational purposes only. While we have attempted to be a thorough as possible we suggest individuals consult with qualified legal counsel prior to making any final decisions regarding the sale, exchange, exercise, or use of their restricted securities.
EVERY EFFORT HAS BEEN MADE TO ENSURE THAT THE INFORMATION CONTAINED HEREIN IS ACCURATE. HOWEVER, WE MAKE NO REPRESENTATIONS AS TO THE ACCURACY OR ADEQUACY OF THE MATERIAL, AND FURTHER, CHANGES IN SECURITIES RULES AND REGULATIONS MAY MAKE SUCH INFORMATION OBSOLETE.
Under Federal securities laws, persons who have Restricted Stock, which they have acquired in private transactions, may resell in the public market only if the company that has issued the stock takes steps to register the stock, or if the stock is sold in accordance with the conditions of Rule 144. The same is true of persons who, because they are directors, officers or otherwise in a control relationship with the issuing company ("insiders"), are deemed to own control stock.
Rule 144 stock includes both Restricted Stock and Control Stock. In addition to Rule 144, insiders must also concern themselves with Section 16 of the Securities Act of 1934. Section 16 of the "Act of '34" applies to officers and directors of an issuer which has a class of equity securities registered with the Securities and Exchange Commission under Section 12 of the 1934 Act, and to beneficial owners of more than 10% of such a class (insiders).
Generally, Section 16 imposes reporting obligations on insiders and permits the issuer to recover profits made by its insiders on certain purchase and sale transactions occurring during any period of less than six months. In addition, insiders are prohibited from selling any of the issuer's equity securities "short" or entering a transaction which is deemed to be the equivalent of a short sale.
In the absence of other transactions affected by an insider that may be subject to Section 16(b) "short swing profit" liability, an insider who has held an employee stock option for at least six months will be able to exercise the option and immediately sell the underlying security without short swing profit liability.
What is Restricted Stock?
Restricted Stock is stock that has not been registered with the Securities and Exchange Commission (SEC) and is acquired from the issuing corporation or from a control person (also known as an affiliate of the issuer). Typically, restricted stock will have been acquired in one of the following ways:
When a company goes through the process of an Initial Public Offering (IPO), the original owners, who gave up a percentage of their shares of stock in order to raise capital from public investors, will, after the offering, own Restricted Stock. The shares sold to the public (or "registered shares") are not considered "Restricted" and are freely tradable.
This occurs when a purchaser buys the stock directly from the original owner, whose shares are Restricted. The restrictions carry over, although certain holding period restrictions may be "tacked on" by the purchaser.
These are transactions in which the security has been acquired directly from the issuing corporation by the buyer in a negotiated transaction.
Mergers and Acquisitions
When company decides to merge or acquire another company, the vehicle of barter or payment in many cases is Restricted Stock. (A typical example is when an acquiring company issues unregistered stock to the owners of a target company as an inducement to accept the takeover.
Stock Options or Stock Purchase Plans
In many cases public companies will issue stock options or stock purchase plans to key employees, or others deemed important to the company. Under certain conditions the options offered may be for restricted stock of the company, and therefore, once exercised, would require registration prior to sale.
What is Rule 144(k) Stock?
Rule 144(k) stock is Restricted Stock that has been: (i) held at least three years, and (ii) the owner is not and has not been an affiliate of the issuer for three months preceding the sale.
What is Control Stock?
Control Stock is stock that is owned by persons who control the business affairs of the issuing corporation. In most cases, corporate directors and senior officers are considered control persons. Also, under certain conditions, close relatives, related trusts, estates, corporations, and partnerships may be considered control persons. (The terms "affiliate" and "insider" are used interchangeably with control persons)
In determining who is a control person, the SEC presumes anyone owning 10% or more of the outstanding shares of a corporation, whether he or she is a trustee or executor, or an officer or director, is usually considered a control person. Such a presumption may be rebutted by facts which establish that the person is not in a control position, or part of a control group.
What is 145 Stock?
Rule 145 applies to stocks or other securities which are issued to stockholders in connection with a plan of reorganization which has been submitted to the stockholders for their approval. Such types of reorganization include:
A reclassification of the securities of a corporation other than a stock split, reverse stock split or change in par value, which involves the substitution of one security for another;
Mergers or Consolidations
A statutory merger or consolidation, or similar plan of acquisition in which securities of one corporation become, or are exchanged for, securities of any other corporation (except where the sole purpose of the transaction is to change the issuer's domicile);
Transfers of Assets
A transaction in which the stockholders of a corporation, which sells or exchanges its assets, receive stock in the acquiring corporation as a result of the sale or exchange. In a registered merger of two companies - "Company A" takes over "Company B" - there are three types of shares that can result: Clean shares, Rule 145 shares, and Rule 144 shares.
A non-insider of Company B who has registered or non-registered shares in Company B, but does not become an insider of Company A gets clean shares. These shares are saleable in the open market with no restrictions.
Rule 145 Shares
An insider of Company B who has registered or non-registered shares in Company B but does not become an insider of Company A, gets shares subject to resale pursuant to Rule 145.
Rule 144 Shares
An insider of Company B who has registered or non-registered shares in Company B and becomes an insider of Company A, gets fully registered shares in Company A. These shares are "control shares" and are subject to sale under Rule 144 but are not subject to the two year holding period.
RULE 144 SELLING RESTRICTED AND CONTROL SECURITIES
When you acquire restricted securities or hold control securities, you must find an exemption from the SEC's registration requirements to sell them in a public marketplace. Rule 144 allows public resale of restricted and control securities if a number of conditions are met. This overview tells you what you need to know about selling your restricted or control securities. It also describes how to have a restrictive legend removed.
What Are Restricted and Control Securities?
Restricted securities are securities acquired in unregistered, private sales from the issuing company or from an affiliate of the issuer. Investors typically receive restricted securities through private placement offerings, Regulation D offerings, employee stock benefit plans, as compensation for professional services, or in exchange for providing "seed money" or start-up capital to the company. Rule 144(a)(3) identifies what sales produce restricted securities.
Control securities are those held by an affiliate of the issuing company. An affiliate is a person, such as an executive officer, a director or large shareholder, in a relationship of control with the issuer. Control means the power to direct the management and policies of the company in question, whether through the ownership of voting securities, by contract, or otherwise. If you buy securities from a controlling person or "affiliate," you take restricted securities, even if they were not restricted in the affiliate's hands.
If you acquire restrictive securities, you almost always will receive a certificate stamped with a "restrictive" legend. The legend indicates that the securities may not be resold in the marketplace unless they are registered with the SEC or are exempt from the registration requirements. Certificates for control securities usually are not stamped with a legend.
What Are the Conditions of Rule 144?
If you want to sell your restricted or control securities to the public, you can meet the applicable conditions set forth in Rule 144. The rule is not the exclusive means for selling restricted or control securities, but provides a "safe harbor" exemption to sellers. The rule's five conditions are summarized below:
1. Holding Period. Before you may sell any restricted securities in the marketplace, you must hold them for a certain period of time. If the company that issued the securities
is a “reporting company” in that it is subject to the reporting requirements of the Securities Exchange Act of 1934, then you must hold the securities for at least six months. If the issuer of the securities is not subject to the reporting requirements, then you must hold the securities for at least one year. The relevant holding period begins when the securities were bought and fully paid for. The holding period only applies to restricted securities. Because securities acquired in the public market are not restricted, there is no holding period for an affiliate who purchases securities of the issuer in the marketplace. But the resale of an affiliate's shares as control securities is subject to the other conditions of the rule.
Additional securities purchased from the issuer do not affect the holding period of previously purchased securities of the same class. If you purchased restricted securities from another non-affiliate, you can tack on that non-affiliate's holding period to your holding period. For gifts made by an affiliate, the holding period begins when the affiliate acquired the securities and not on the date of the gift. In the case of a stock option, including employee stock options, the holding period begins on the date the option is exercised and not the date it is granted.
2. Current Public Information. There must be adequate current information about the issuing company publicly available before the sale can be made. For reporting
companies, this generally means that the companies have complied with the periodic reporting requirements of the Securities Exchange Act of 1934. For non-reporting companies, this means that certain company information, including information regarding the nature of its business, the identity of its officers and directors, and its financial statements, is publicly available.
3. Trading Volume Formula. If you are an affiliate, the number of equity securities you may sell during any three-month period cannot exceed the greater of 1% of the
outstanding shares of the same class being sold, or if the class is listed on a stock exchange, the greater of 1% or the average reported weekly trading volume during the four weeks preceding the filing of a notice of sale on Form 144. Over-the-counter stocks, including those quoted on the OTC Bulletin Board and the Pink Sheets, can only be sold using the 1% measurement.
4. Ordinary Brokerage Transactions. If you are an affiliate, the sales must be handled in all respects as routine trading transactions, and brokers may not receive more
than a normal commission. Neither the seller nor the broker can solicit orders to buy the securities.
5. Filing a Notice of Proposed Sale With the SEC. If you are an affiliate, you must file a notice with the SEC on Form 144 if the sale involves more than 5,000 shares or
the aggregate dollar amount is greater than $50,000 in any three-month period. The sale must take place within three months of filing the notice and, if the securities have not been sold, you must file an amended notice.
If I Am Not an Affiliate of the Issuer, What Conditions of Rule 144 Must I Comply With?
If you are not (and have not been for at least three months) an affiliate of the company issuing the securities and have held the restricted securities for at least one year, you can sell the securities without regard to the conditions in Rule 144 discussed above. If the issuer of the securities is subject to the Exchange Act reporting requirements and you have held the securities for at least six months but less than one year, you may sell the securities as long as you satisfy the current public information condition.
Can the Securities Be Sold Publicly If the Conditions of Rule 144 Have Been Met?
Even if you have met the conditions of Rule 144, you can't sell your restricted securities to the public until you've gotten the legend removed from the certificate. Only a transfer agent can remove a restrictive legend. But the transfer agent won't remove the legend unless you've obtained the consent of the issuer—usually in the form of an opinion letter from the issuer's counsel—that the restrictive legend can be removed. Unless this happens, the transfer agent doesn't have the authority to remove the legend and permit execution of the trade in the marketplace.
To begin the legend removal process, an investor should contact the company that issued the securities, or the transfer agent for the securities, to ask about the procedures for removing a legend. Removing the legend can be a complicated process requiring you to work with an attorney who specializes in securities law.
What If a Dispute Arises Over Whether I Can Remove the Legend?
If a dispute arises about whether a restrictive legend can be removed, the SEC will not intervene. Removal of a legend is a matter solely in the discretion of the issuer of the securities. State law, not federal law, covers disputes about the removal of legends. Thus, the SEC will not take action in any decision or dispute about removing a restrictive legend.
For further information see: http://www.sec.gov/investor/pubs/rule144.htm
Recently the Securities and Exchange Commission (SEC) issued final amendments to Rules 144 and 145 under the Securities Act of 1933. The changes are designed to “increase the liquidity of privately sold securities and decrease the cost of capital for companies without compromising investor protection.”
The changes to Rule 144 include:
1. Shortening the minimum holding period for resale’s of restricted securities of reporting companies to six months (from one year) for both affiliates and non- affiliates; and
2. Easing compliance for non-affiliates by eliminating all restrictions, other than the current information requirement, for resale’s of restricted securities of reporting
companies after six months, and eliminating the current information requirement after one year (all of these restrictions previously applied for two years).
Additional changes to Rule 144 include:
3. Amending the manner of sale requirements for equity securities, and eliminating them for debt securities,
4. Amending the volume limitations for debt securities,
5. Raising the thresholds that trigger a Form 144 filing and
6. Codifying various SEC interpretive positions related to the Rule.
The most significant change to Rule 145 eliminates the presumptive underwriter provision in connection with business combination transactions, except for transactions involving “shell” companies.
Rule 144 Holding Period
The new amendments to Rule 144 have shortened by one-half the minimum holding periods for resale’s of restricted securities (generally, securities acquired in a private sale) for both affiliates and non-affiliates.
Affiliates may now resell restricted securities of reporting companies after only a six-month holding period (previously one year), subject to the current information, volume limitation, manner of sale (for equity securities only) and Form 144 filing requirements of the Rule. As before, affiliates may resell restricted securities of non-reporting companies after only a one-year holding period, subject to the same requirements for reporting companies, except that the current information requirement can be met by making certain company information publicly available, including three years of financial statements.
Also, the new holding period requirements apply only to resale’s by affiliates of restricted securities. Therefore, affiliates may resell “control securities” (generally, securities held by affiliates, however acquired) without satisfying the holding period requirements, but subject to the other Rule 144 requirements referred to above.
Non-affiliates who have not been affiliates of the issuer during the preceding three months may now freely resell unlimited amounts of restricted securities of reporting companies after only a six-month holding period (previously one year), subject only to the current information requirement of the Rule. The volume limitation, manner of sale and Form 144 filing requirements that previously applied to resale’s of restricted securities by non-affiliates that were held for more than one year but less than two years no longer apply.
In addition, non-affiliates may now freely resell unlimited amounts of restricted securities without even being subject to the current information requirement after a holding period of only one year (previously two years).
Omitted from the final Rule was a proposal to toll the six-month holding period for up to an additional six months for hedging transactions. The SEC indicates that it will revisit this issue if it observes abuses.
Manner of Sale Requirements
The Rule 144 manner of sale requirements no longer apply to resale’s of restricted securities by non-affiliates who satisfy the six-month holding period requirement and have not been affiliates of the issuer for the preceding three months. In addition, these requirements no longer apply to resale’s of restricted debt securities. Therefore, affiliates may resell restricted debt securities (but not equity securities) without satisfying the manner of sale requirements, but subject to the other Rule 144 requirements. For purposes of Rule 144, debt securities include fixed-income securities, asset-backed securities and non-participating preferred stock.
The scope of the manner of sale requirements for the resale of equity securities by affiliates was expanded to better reflect current trading practices and venues. Affiliates now may resell equity securities though “riskless principal transactions” (generally, transactions by a broker or dealer executed at the same price specified in a buy or sale order, exclusive of any explicitly disclosed fee, so long as they can be reported by the rules of the SRO as riskless). In addition, brokers now may insert bid and ask quotations in an electronic trading system if the broker has published these quotations for the last 12 business days.
The volume limitations under Rule 144 no longer apply to non-affiliates who satisfy the six-month holding period requirement and have not been affiliates of the issuer during the preceding three months.
The volume limitations continue to apply to resale’s by affiliates of restricted securities and control securities.
The volume limitations on the resale by affiliates of restricted debt securities are now increased to 10 percent (from 1 percent) of all sales of the same tranche within a three-month period. The increase also applies to sales of the same class of non-participatory preferred stock or asset-backed securities.
Form 144 Filing Requirements
The new Rule no longer requires a Form 144 filing by non-affiliates who satisfy the six-month holding period requirement and have not been affiliates of the issuer for the past three months. In addition, affiliates are now required to file a Form 144 only if they sell more than 5,000 shares, or if the aggregate sale prices exceed $50,000, within any three-month period (previously 500, shares or $10,000).
Omitted from the final Rule was any coordination of Form 144 and Form 4 filings (under Section 16(a) under the Exchange Act) for affiliates subject to both filing requirements. The SEC expects to issue a separate release in the future to provide greater flexibility for these affiliates.
Codification of Staff Interpretations
The SEC also codified several of its interpretive positions of Rule 144. The ones of principal importance are:
Formation of Holding Company A holder of restricted securities of an issuer that is reorganized into a holding company structure may tack the holding period of the newly acquired securities to that of the securities held in the predecessor entity, if the new securities are issued solely in exchange for the old, represent the same proportional interest, and have substantially the same rights, and the holding company has no significant assets, other than the predecessor’s securities, and has substantially the same assets and liabilities as the predecessor.
Cashless Conversions and Exchanges Securities received in a cashless exchange or conversion from the same issuer without other consideration are deemed acquired when the securities surrendered were acquired. If the holder provides other consideration to amend the surrendered securities to permit cashless conversion or exchange, then the newly acquired securities are deemed acquired at the time of amendment.
Cashless Conversions of Options and Warrants Securities received upon cashless exercise of options or warrants that were acquired for consideration (excluding employee stock options) are deemed acquired when the options or warrants were acquired. If the holder provides consideration other than securities of the issuer to amend the options or warrants to permit cashless exercise, then the newly acquired securities are deemed acquired at the time of amendment.
Aggregation of Sales of Pledged Securities In calculating the volume of securities a pledgee may sell within the Rule 144 volume limitations, the pledgee need not aggregate its sales with sales by other pledgees of the same securities from the same pledgor, as long as there is no concerted action by the pledgees. Each pledgee will continue to aggregate sales with those of the pledgor.
Rule 144 Not Available for Shell Companies Rule 144 is not available for resale’s of issuers that are “shell companies” (broadened to include any issuer, whether a reporting company or not). This does not apply to a shell company formed for redomiciliation or acquisition purposes. The SEC has redefined a shell company as a company with no or nominal operations, and either no or nominal assets, or a combination of cash and nominal other assets. Securities of former shell companies nevertheless may be sold under Rule 144 one year after certain specified Exchange Act disclosure conditions are met.
Amendments to Rule 145
The SEC has eliminated the presumptive underwriter provision of Rule 145(c), except as it applies to shell companies and their affiliates and promoters, and has harmonized the resale requirements of Rule 145(d) with the changes to Rule 144. Rule 145(c) previously presumed that parties (other than the issuer) to an exchange of securities in a business combination subject to shareholder vote were, together with their affiliates, underwriters of the securities acquired in the transaction and had to comply with the restrictions on resale’s of those securities set forth in Rule 145, which are similar to the resale restrictions of Rule 144. Under the amended Rule, these restrictions only apply in a Rule 145 transaction involving a shell company (other than a shell company formed for redomiciliation or acquisition purposes).
Other Conforming Amendments
The SEC also adopted conforming changes relating to trading in the U.S. after an exempt Regulation S offering, the securitization of Rule 144 restricted securities that are asset-backed and offers and sales pursuant to compensatory benefit plans of non-reporting companies.