What Can You Do with Your Restricted Stock?

You may have restricted stock, but you may not know exactly what it means to be restricted or what you can do with it once you have it. In this article we discuss some of the options you have.

What is Restricted Stock and How Does it Work?

Restricted stock is compensation that employees receive from their employers in the form of company stock. The “restricted” label means that the employee cannot immediately sell or trade the stock. Instead, as long as the employee works for the company and remains an “affiliate”, there are a number of restrictions for which they must abide per SEC regulation. These restrictions are the result of Rule 144 and Rule 145 and aim to inhibit insider trading since owners of restricted stock may be privy to certain information the public does not have.

There are five basic requirements of restricted stock governed by Rule 144 but not all requirements pertain to every sale.

  1. Current public information. Specified current Information concerning the issuer must be publicly available.
  2. Holding period. A six-month holding period is required for “restricted securities” of an issuer that has been a reporting company for at least 90 days. A one-year holding period is required for “restricted securities” of a non-reporting company.
  3. Volume limitation. The amount of securities that can be sold in any three-month period for listed companies is limited to the greater of (i) one percent of the shares or other units of that class outstanding, or (ii) the average weekly trading volume during the four calendar weeks preceding the filing of a Form 144, or if no such notice is required, the date of receipt of the order to execute the transaction. The amount of securities that can be sold in any 3-month period for companies with over-the-counter, or OTC, securities is limited to one percent of the shares or other units of that class outstanding.
  4. Manner of sale. Equity securities (but not debt securities) must be sold in unsolicited “brokers’ transactions,” directly to “market makers,” or in “riskless principal transactions.”
  5. Notice of sale. The seller must file a Form 144 with the SEC at the time the sell order is placed with the broker if the seller is an affiliate and intends to sell during any three-month period more than 5,000 shares or securities with a value in excess of $50,000.

What Can You Do with Your Restricted Stock?

Once an employee’s restricted stock becomes unrestricted (which happens once they become unaffiliated with the company), they can do whatever they’d like to with it. While they are still an ‘Affiliate’ then must abide by the rules listed above.

Here are the three common selling strategies for restricted stocks:

  1. Sell Your Shares: This option is particularly ideal if the employee doesn’t have a favorable outlook on the share price of their company’s stock or is looking to diversify their wealth. However, it is important that when selling shares of restricted stock, you comply with SEC regulations. This means if you are an affiliate, you will likely continue to hold the majority of position. It’s important to know that if you sell between the 6-month and 12-month period, you’ll be subject to short-term capital gains tax, which would be equivalent to your ordinary income tax rate. On the other hand, if you wait past 12-months, you’ll have to pay long-term capital gains tax, which is oftentimes much lower. However, in either case, you will be subject to taxes so plan accordingly.
  2. Keep Your Shares: If you’re optimistic about the future of your company stock, you can always choose to hold onto the stock for as long as you want. The overall goal for this strategy is for the company stock price to rise over time, which in turn generates wealth. However, as an affiliate, keeping all your shares reduces liquidity (since you likely can only sell one percent of your restricted stock shares at a time) and may create an unfavorable diversification situation since you’ll be highly invested in one company.
  3. Invest Your Shares in an Exchange Fund: An exchange fund allows owners of restricted stock to exchange their shares for interest in an investment and diversify their assets. A traditional exchange fund works in that by exchanging your restricted stock shares for shares in another investment managed by an intermediary with no affiliation with the company of the restricted stock, the restricted stock is able to be leveraged and the owner can be more diversified. The problem with traditional exchange funds is that they don’t necessarily assist with your tax liability or preserve the principal and they limit the upside if your shares increase in value.
  4. Invest Your Shares in a Different Type of Exchange Fund: Some accredited investors with restricted stock can exchange their restricted stock shares into a private placement offering that may provide many benefits including:
    1. Multiple payment options – Provides for the ability of investors to pay for the investment with illiquid securities including Rule 144 Restricted Stock – a largely untapped marketplace estimated to exceed $7 trillion.
    2. Unique “Preservation of Principal” – Adds a component that assures a 100% collateralized return of principal in 7-10 years, in cash, held in segregation on behalf of the investor.
    3. Growth potential – Adds a separate growth component that provides upside participation in the future growth of a contributed security or the S&P 500.
    4. Substantial tax benefits – Provides a first-year cash distribution that can be used to cover the long-term capital gains tax (up to 23.8%) that may be due on the constructive sale of the securities after exchange.
    5. Long-term growth – Provides a growth component in private companies that enables investors to participate in future growth of those investments in perpetuity.

The Takeaway

Owning restricted stock has many advantages and disadvantages. Restricted stock can have a lot of value, but it is also very illiquid. We strongly recommend contacting your financial advisor or family office to see which option makes the most sense for your finances and your financial goals.