Overcoming the Problems Faced by Owners Restricted Stock
Owners of restricted stock tend to be very wealthy but a large part of their wealth – their Restricted Stock – remains mostly inaccessible because of the restrictions and limitations related to the Securities Act of 1933. If a restricted stock owner wants to publicly sell restricted stock, they will likely need to comply with Rule 144 per the SEC. Below are just a few of the problems faced by owners of restricted stock.
Problems Faced by Owners of Restricted Stock
- Lack of Liquidity – The limitation on sales of stock allowed under the Federal Securities Laws and Rule 144 make restricted stock highly illiquid. The slow process related to the sale of restricted stock make the stock subject to the fluctuations of the stock market.
- Potential Loss of Market Value – During the time the stock is held it could decline in price and severely reduce the overall value of the owner’s holdings. Further, even when the stock advances in price, the owner is restricted by the 1% of total shares outstanding per quarter limitation. Should the market subsequently fall after a periodic sale, the owner would end up in much the same position as prior to the advance.
- Private Sales – Exchange Funds utilize the technique of Private Sales to offer diversification to Restricted Stockholders but come fraught with their own set of disadvantages.
- Tax Obligation – Because most Rule 144 Restricted Stock has an extremely low-cost basis relative to its market value, when sales do occur, the owner will be subject to the payment of taxes on the long-term capital gains, currently at the rate of 23.8%.
So, What Can You Do as An Owner of Restricted Stock?
When you are an affiliate and an owner of restricted stock, what you can do with your restricted stock is limited due to rule 144 requirements. Below are a few options for what you can do with restricted stock with their pros and cons.
Do Nothing and Hold Your Restricted Stock
Pros:
- Holding your restricted allows you to get the maximum upside from your restricted stock awards
Cons:
- Illiquid
- Creates a highly concentrated position in a single security
- Wealth directly linked to the success of a single company
- No tax benefits
- No way to invest restricted stock awards
Sell 1% of Your Restricted Stock Every Three Months Per Rule 144
Pros:
- Holding most of your restricted allows you to get most of the upside from your restricted stock awards
- Turning shares into cash allows you to invest in other assets and slowly diversify your wealth
Cons:
- Illiquid
- Very slow process
- Maintains a highly concentrated position in a single security
- Most of your wealth directly linked to the success of a single company
- Likely paying 23.8% in taxes with the sale of restricted stock
- No way to invest restricted stock awards
- Significant work involved related to each transaction
Exchange Your Restricted Stock into a Traditional Exchange Fund
Pros:
- Diversifies a concentrated position of wealth
- Allows you to invest your restricted stock awards including Rule 144 restricted stock
Cons:
- Limited growth potential and upside if the shares and/or market increase in value
- Illiquid
- Likely paying 23.8% in taxes
- May pay high fees and/or a loading fee
Below is a table reiterating some of the pros and cons of each method, as well as providing additional insights related to each option for what you can do with restricted stock.
| Do Nothing Hold Position | Sell 1% at Regular Intervals per SEC Regulations | Traditional Exchange Fund | |
| Ability to Acquire with Restricted Stock | N/A | N/A | Yes |
| Risk Mitigated | No | Not Really | No |
| Return of Principal Collateralized | No | No | No |
| Distribution to Cover Long-Term Capital Gains Tax | No | No | No |
| Leverage of Illiquid Assets | No | No | No |
| Diversification of a Held Concentrated Position | No | A Little Bit | Yes |
| Participation in Private Project Profits and Growth | No | No | No |
| Performance Tied to Areas Other than Market Value | No | No | No |
| Ability to Participate in High Reward Enterprises on a Low-Risk Basis | No | No | No |