When Should You Sell Restricted Stock?

By design, restricted stock has a number of constraints that make selling it challenging. While owners of other types of restricted stock such as Restricted Stock Units (RSUs), have a few choices for selling their shares when they vest, owners of ‘Control Stock’ face additional limitations. This post is for affiliates that own restricted stock governed by SEC Rule 144. So, when should you sell restricted stock? Let’s discuss.

What are the Rules for Selling Restricted Stock?

The Securities Act of 1933 put in place a number of regulations to protect investors after the stock market crash of 1929. Under the Act, Rule 144 governs the sale of restricted stock, also known as control stock for restricted securities and control securities.

There are five basic requirements of selling restricted stock per Rule 144, although not all requirements apply to every sale, as discussed below:

  • Must be current public information. Specified current Information concerning the issuer must be publicly available. See “Rule 144(c) – Current Public Information Requirement.”
  • Six-month 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. See “Rule 144(d) – Holding Period Requirement” and “What are restricted securities?”
  • Sale must be within 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. Rule 144 also has an alternative volume limit of up to 10% of the tranche (or class) outstanding for debt securities. See “Rule 144(e) – Volume Limitations.”
  • 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.” See “Rule 144(f) and (g) – Manner of Sale Requirements.”
  • 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 are the Strategies for Selling Restricted Stock?

As long as you are an affiliate, also known as a control person, you must abide by the Rule 144 limitations for selling restricted stock. For many owners of restricted stock, a large portion of their net worth is tied up in the restricted stock of a single company making for an extremely concentrated and illiquid investment. Ultimately, when you should sell restricted stock is up to you and your risk tolerance. A financial advisor well versed in restricted stock would be able to give guidance, however, below are a few common strategies for when you should sell restricted stock.

Immediately Sell 1% of Vested Shares Every 3-Months

In order to diversify a concentrated position of restricted stock, many restricted stock owners will sell 1% of their holdings every three months as they are permitted to under Rule 144. While not fast, this strategy will diversify your holdings over time while freeing up cash.

The drawbacks?

You will need to pay capital gains tax on any gains that occurred since your shares vested. This could trigger a 23.8% tax bill on capital gains with every sale, leaving you with less to reinvest. Plus, it will take a while and many transactions before a wealth advisor would consider you diversified.

Hold Shares Until Affiliate Status Can Be Removed   

Once you are no longer an affiliate of the company in question, you will have the ability to sell vested shares as you please. Depending on your plans to retire or separate from your current company, it may be in your best interests to hold and do nothing. While you retain a concentrated position in the company, holding the stock won’t generate tax bills.

The drawbacks?

Depending on your age, it could be many years before you’re able to realize the fruits of your labor. As long as you hang on to your stock, you’ll own a very concentrated position in a single company, and your net worth will be directly linked with company performance. While you may think it is unlikely, it is possible your company loses considerable value while you hold, causing your restricted stock shares to plummet in value.

Invest Restricted Stock Shares in an Exchange Fund (Swap Fund)

To diversify your holdings and avoid Rule 144 restrictions related to a sale, many owners of restricted stock use exchange funds to swap their shares for a pool of stocks. The idea behind an exchange fund is that by transferring your restricted stock shares into a fund managed by an unrelated party, and you the affiliate no longer have access or the ability to share insider information, you in effect diversify your position.

The drawbacks?

Once you transfer your shares into the exchange fund, those shares are typically locked up for at least seven years. While you are deferring taxes by not selling, if the exchange fund drastically underperforms the shares of your stock, or an alternative that you could have invested in had you sold in the first place, you’ll end up losing value. Generally, exchange funds charge hefty management fees while also retaining dividends from the stocks managed, so be sure to look at all the details. Lastly, once you sell, it is important to remember that you will still need to pay the 23.8% in capital gains tax based on your cost basis.

In Conclusion

It is our belief that you should develop a plan for selling or exchanging restricted stock as soon as possible. Of course, when to sell restricted stock is ultimately up to the shareholder’s risk tolerance, but the considerable restrictions and illiquid nature of restricted stock suggests that starting the process of selling or exchanging restricted stock earlier may be best. As long as a shareholder remains an affiliate of the company, they will need to abide by the volume limitations of Rule 144 which means the shareholder will likely retain a very concentrated position in their company stock.