Removing a Restricted Stock Legend

Background

Under the Securities Act of 1933, as amended, an offer of a security must be registered with the Securities and Exchange Commission before the offer may be made, with limited exceptions. These exceptions are registration exemptions which center on either the nature of the security or the nature of the transaction in which the security is offered. A similar approach is taken in the securities laws of most states.

If the stock is offered in a private transaction, the offering may be exempt from registration under the Securities Act. However, the stock issued in that transaction is considered “restricted stock.” That is, it was offered and sold without benefit of prior registration.

The Stock Legend

The SEC has required, in the context of such a private transaction, that the certificate or other evidence of ownership of the stock must include a prominently displayed disclosure of the restrictions on transferability which attach to such a security. This disclosure is referred to as a “restrictive legend.” (This is the reason Restricted Stock is also sometimes referred to as “Legend Stock.”)

The restrictive legend applies regardless of the form of security. For example, it applies to a common stock, preferred stock, debenture or other security of a company, or units of a limited partnership. In short, it applies to any form of security as set forth in the Securities Act (or in the case of a state legend, the corresponding state law) which is offered and sold without benefit of registration under that act.

Typically, a restrictive legend includes:

A statement that the security has not been registered under the Securities Act. It may also make reference to the lack of registration under state securities law.
A disclosure that the security has been acquired for investment and may not be sold or transferred in the absence of an effective security registration under the Securities Act, with limited exception – when the transaction is exempted from registration under that act. The restrictive legend may include a similar statement applying to required registration under state securities law, except when exempted from such state requirements.

The Securities Act private transaction exemption is silent as to whether the restricted nature of a restrictive legend ends after passage of time. For a company not having publicly-traded securities, this limitation on transferability is formidable and difficult to overcome. Here, the only means of transfer in compliance with the Securities Act (or state law), and short of an expensive registration process, maybe a private sale to an existing security holder of, or buy-back by, the issuer-company. There simply is no public market for the restricted security.

Similarly, for a company having publicly-traded securities (a company whose securities are listed on an exchange or stock market such as the New York Stock Exchange or the NASDAQ Stock Market), the exemption does not specifically extinguish the transferability limitation with the passage of time. However, Rule 144 adopted by the SEC pursuant to the Securities Act, in part, addresses this issue and allows transferability under limited conditions and subject to the provisions of the rule.

The provisions of Rule 144 are detailed. Suffice it to say that a seller of restricted securities of a publicly-traded company may, in satisfying the provisions of the rule, have the Securities Act restrictive legend removed.

Removal of a restrictive legend may be necessitated to accommodate a timely sale of the security. For example, the prospective seller may wish to transfer the securities into the name of the seller’s broker-dealer for the benefit of the seller and to accomplish a faster response to a possible purchase of the securities in the public marketplace.

The Role of a Transfer Agent

Even if you’ve satisfied Rule 144, you still can’t resell restricted stock into the public market until you get the restrictive legend removed from the certificate by a transfer agent, the only authorized entity allowed to do so. The transfer agent is usually a specialized outside firm appointed by a company to maintain stock records. It issues and cancels certificates; deals with problems like lost, stolen or destroyed certificates; removes outdated legends, and handles other such chores.

Only a transfer agent can complete the task of removing a restrictive stock legend. The transfer agent will require an opinion letter from the issuer’s counsel or from his or her own lawyer plus 144 papers completed by a broker—stating that the restricted legend can be removed. Unless this happens, the transfer agent doesn’t have the authority to remove the legend and you cannot execute the trade in the marketplace. If a dispute arises about whether a restricted legend can be removed, the SEC will not intervene. Removing a restricted stock 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. Since removing the legend can be a complicated process, if you’re considering buying or selling a restricted security, it would be wise for you to consult an attorney who specializes in securities law.