What is Rule 144?
Rule 144 permits the public resale of control or restricted stock without having to register with the Securities and Exchange Commission (“SEC”). The difference between a control security and a restricted security is exceptionally important since the process and limitations varies significantly. A restricted security is an unregistered security acquired directly from an issuer; while a control security is an unregistered security held by an affiliate (discussed below). In order to not be deemed an dreaded “underwriter,” as defined in Section 2(a)(11) of the Securities Act of 1933 as amended (“Securities Act”), a person or entity selling restricted securities or control securities who satisfies all the applicable requirements of Rule 144 may then rely on Section 4(a)(1) of the Securities Act exemption for the resale of those securities.
Who and What does Rule 144 apply?
Rule 144 applies to people or entities that wish to resale restricted or control securities to the public. Additionally, for the purposes of Rule 144, “securities” includes common stock, preferred stock, and debt securities. Debt securities include asset-backed securities and nonparticipating preferred stock.
Restricted securities. Restricted securities are securities acquired in a transaction that was exempt from the registration requirements of Section 5 of the Securities Act. There are a number of different types of restricted securities including stock issued in a private placement by the issuer or securities acquired privately from affiliates of the issuer; stock issued prior to an issuer’s initial public offering; securities issued in Rule 144A transactions; equity securities of domestic issuers acquired from the issuer, a distributor, or any of their respective affiliates in a transaction subject to the conditions of Rule 901 or Rule 903 of Regulation S.
Control securities. Control securities are securities that are owned by any person or entity who directly or indirectly controls the issuer as a member of a control group or alone. The SEC uses the term “affiliate” to describe a control person or entity. So, then who is an affiliate? Under Rule 405 of the Securities Act, an “affiliate” of or a person “affiliated” shall mean a person that is directly, or indirectly through one or more intermediaries, controls or is controlled by, or is under the common control with, the person specified by the company. The affiliate inquire is fact-specific and must be determined by considering all relevant information in accordance with Rule 405. The SEC has stated that an individual’s status as a director, officer, or ten (10) percent shareholder is one fact which must be taken into consideration when determining the affiliate statues. Additionally, under Rule 405, the term “control” means the possession, direct or indirect, of the power to direct or cause the direction of management and policies of a person, whether through the ownership of voting securities, by contract or otherwise. In the light of this definition, the mere fact that an individual does not have the title as director or officer or is not a 10% shareholder, is not indicative of not being an affiliate. However, those often considered affiliates, and thus subject to Rule 144, are those under Section 16(a) of the Securities Exchange Act of 1934 (“Exchange Act”). Section 16(a) holds every person who is directly or indirectly the owner of more than ten (10) percent of any class or any equity security that is registered under the Exchange Act, or who is a director or an officer of the issuer of the security, must file statements with the SEC disclosing the amount of all equity securities of such issuer of which the filing person is a beneficial owner.
It is also highly important to note that, all control securities are subject to Rule 144, even if the affiliate purchases them on the open market.
How to use Rule 144?
As discussed in further detail below, there are five basic requirements of Rule 144, although not all requirements apply to every sale of control or restricted securities.
Current Public Information – Rule 144(c). The current public information requirement varies depending on three types of entity; reporting companies, non-reporting companies, and insurance companies. A reporting company satisfies the public information requirement if it has been subject to the SEC reporting requirements of Section 13 or Section 15(d) of the Exchange Act for a period of at least ninety (90) days and has filed all reports required during the preceding twelve (12) months prior to the sale. In some cases, the reporting company may have a shorter period of filings depending on a number of factors that can be determined on a case by case analysis. A non-reporting company can satisfy the current public information requirement by making specific information under Rule 15c2-11(a)(5)(i) to (xiv) and (xvi) “publicly available.” This information is similar to the information a reporting company is required to provide its shareholders annually and is often posted on the company’s website to meet the requirement. An insurance company can compile with the current public information requirement if it files the reports described in Section 12(g)(2)(G)(i) of the Securities Act for which state it is domiciled.
Holding Period – Rule 144(d). The holding period requirement is one of the most complicated aspects of Rule 144 and requires fact specific information in order to properly evaluate each and every case. There is a holding period for all restricted securities and those securities cannot be resold to the public without the holding period being satisfied. It is important to note that there is no holding period for unrestricted securities; they are deemed “free-trading.” For a reporting company, Rule 144 requires a six (6) month hold after the securities are paid in full and a one (1) year hold after the securities are paid in full for a non-reporting company. Generally, the holding period starts once the shares are fully paid for by the shareholder. However, if the securities are financed through the issuer as a loan, then the holding period commence immediately upon purchase if the following are met: the loan provides for full recourse against the purchaser; is fully collateralized by assets other than those purchased securities which have a fair market value at least equal to the purchase price; and is discharged by payment in full prior to the sale of securities. If the securities are financed through an independent third party, then the securities are considered fully paid for at the time of purchase from the issuer as long as the loan is made on a full recourse basis. Though, if the issuer collateralized the loan from the third party, the securities are not considered fully paid for. For example, if Bank of Western America finances securities from Company A and Company A is fully responsible for the amount under full recourse, then the securities purchased will be considered paid in full at the time of purchase. However, if Bank of Western America receives collateral from Company A instead of full responsibility under full recourse, the securities purchased are not considered paid in full at the time of purchase. Full recourse is a near guarantee that no matter what occurs, the issuer will repay the debt of the loan.
Tacking. Another complex analysis for the holding period requirement is tacking. Generally, the concept of tacking under Rule 144 allows a holder of restricted securities to combine the separate holding periods of prior owners of the restricted securities together in order to satisfy the applicable holding requirement for that type of security. This is a fact and circumstance heavy analysis. For example, a selling security holder may tack or include as part of its own holding period, the holding period of a prior holder unless the securities being tacked were purchased from an affiliate. If the securities were purchased from an affiliate then the holding period starts over. Further, the tacking on prior security holdings is allowed as long as the new securities is simply a continuation of the holder’s existing investment. Tacking events that may calculate into the holding period include, but are not limited to, (i) stock dividends, (ii) stock splits, (iii) recapitalizations, (iv) change of domicile by the issuer, (v) cashless exercise of options or warrants, (vi) contingent issuances, and (vii) acquisitions pursuant to anti-dilution rights. Further, tacking is allowed in holding company formations including when (a) the new holding company was formed, and immediately following formation there is no significant assets except the predecessor securities and substantially the same assets and liabilities of the predecessor; (b) the newly formed holding company issues securities solely in exchange for the securities of the predecessor company as part of reorganization; (c) the security holders receive securities of the same class, rights, and interest as the securities exchange for in the predecessor company. A change in legal form of a company will normally restart the holding period but, the SEC has provided guidance to the holder of restricted securities that may want to tack and permit them to do so if the following conditions are met: (1) the controlling agreement entered in between the two companies specifically addressed the change in legal form; (2) the partners or members of the company wishing to tack had no veto or voting right over the reorganization; (3) the reorganization does not result in a change in the business or operations of the newly formed company; (4) the proportionate equity interests are the same as the interest in the successor as the predecessor company; and (5) the equity holders provide no additional consideration for the securities.
It is also important to know when tacking is not permitted. The most common exceptions to tacking is the exercising an estate of a decedent’s stock options or purchases of restricted securities in private transactions from an affiliate.
Volume Limitations – Rule 144(e). Volume limitations on restricted and control securities is much more straight forward than the tacking analysis but, like the tacking rules discussed above, it requires stringent adherence to protocol. First, it is important to know that volume limitations apply to affiliates selling securities under Rule 144 regardless of whether the company is reporting or non-reporting. Volume limitations do not apply to non-affiliates including (i) estates; (ii) beneficiaries of estates; (iii) reporting company non-affiliates who have held their restricted securities for six (6) months and the issuer is current in its filings and the seller has not been an affiliate during the previous three (3) months; and (iv) non-reporting company non-affiliates who have held their restricted securities for one (1) year and who have not been an affiliate during the previous three (3) months. If the selling holder is an affiliate there are volume limitations that apply to the sale of the security under Rule 144. The volume limit of securities that can be sold in any three (3) month period for listed companies is limited to the greater of:
- one (1) percent of the shares or units of the class outstanding; or
- the average weekly trading volume during the four (4) calendar weeks before the filing of the Form 144. (If no such notice under Form 144 is required, the date of receipt of the order to execute the transaction.)
However, if the company is listed on the OTC, the amount of shares that can be sold for any three (3) month period is limited to one (1) percent of the shares of that class outstanding. For calculating the time requirements, the three (3) month period is a rolling period that includes only the three (3) months immediately before the date of the sale. The four (4) week period includes only four (4) calendar weeks, and not twenty (20) business days, before the filing of the Form 144 notice or, if no notice is required, the date of receipt of the order when sold directly to a market marker. Additionally, for outstanding debt securities there is an alternative volume limitation of up to ten (10) percent of the class. Debt securities are Rule 144 include nonparticipating preferred stock and asset-backed securities. It is important to note that, sales outside of Rule 144 including registered sales and sales under Section 4(1), are not included in the volume limitations calculation. Though, any sales outside Rule 144 must be disclosed in Table II of Form 144 if they occur during the three (3) months before the use of Rule 144.
Manner of Sale – Rule 144(f) and (g). As with the volume limitations mentioned above, the manner of sale requirements under Rule 144(f) and (g) are only applicable to affiliates. Under this requirement, the manner of sale must be sold in: (i) an unsolicited brokers’ transaction within the meaning of Section 4(a)(4) of the Securities Act; (ii) a transaction directly with a market maker; or (iii) riskless principal transactions.
Unsolicited Brokers’ Transaction. Under Rule 144, an unsolicited brokers’ transaction is the very basic transaction in which a broker does nothing more than execute a sell order as an agent of the affiliate selling the securities but the broker cannot receive more than the usual or customary commission for the transaction. If a broker commits certain actions, the buy order may not be considered an unsolicited brokers’ transaction. For example, a broker that maintains a trade market for the issuer’s securities may continue to do if the brokerage firm published quotes in an interdealer quotation system for twelve (12) out of the thirty (30) preceding days in succession and had no more than four (4) consecutive business days without a quotation. The use of research reports by the broker will not be considered solicitation of buy orders if the reports: (a) are in the broker’s regular course of business; (b) are similar reports have been released regarding the issuer; (c) have no consideration from the seller; and (d) are not issued to facilitate any part of the seller’s transaction. If the broker makes the following inquires, the broker will not be deemed to be making a solicitation if other brokers and/or dealers have indicated an interest in the securities of the seller in the last sixty (60) days or customers who have a bona fide interest in the securities within the last ten (10) business days and were not prompted by solicitation from the seller. Also, under Rule 144, a broker can permit bid and ask quotations in an alternative trading platform or a non-exchange venue and not be considered solicitation if a buy order of the broker has published quotations in the same market on each of the last twelve (12) business days.
Market Maker Transaction. A market maker is a broker-dealer firm that accepts the risk of holding shares of a particular security in order to facilitate trading in that security and includes specialist, block posititioners, and the market makers. Under Rule 144(f), securities held by affiliates can be sold directly to market makers. The market maker exception will apply only be applicable if the market maker purchases as a principal using Rule 144. After the market makers have completed the transaction, the market maker may solicit buyers for the securities. Block positioners are exempt from the no solicitation requirement because they are committed to buy the stock at a particular price and verified time-stamped at purchase.
Riskless Principal Transaction. A riskless principal transaction meets the manner of sale requirement because it is equivalent to the brokers’ transaction in that it matches the buyer and seller without the broker taking any interest in the securities. In order to meet this requirement under Rule 144, the securities must be sold in a riskless principal transaction where the offsetting traders are executed at the same price, the transaction is permitted to be reported as riskless under the regulatory scheme, and the requirements of an unsolicited brokers’ transaction are met.
Notice of Sale – Form 144. The notice of sale on Form 144 only needs to be completed when the selling party is an affiliate. In generally, it must be filed at the time the order to sell is placed with a broker or the securities are being sold to a market maker. No filing of Form 144 is required, however, if the number of securities does not exceed 5,000 shares or units and the aggregate sale price does not exceed $50,000. Form 144 can only be filed when the affiliate has the bona fide intention of selling the securities referred to in the notice form but, Form 144 does not obligate the selling and there is no penalty for not selling. Three copies of the form must be filed with the SEC and one copy with the principal exchange on which the security of the company are traded. It is important to note that misstatements or omission can be corrected without penalty by filing an amended form but, if the corrections or omissions demonstrate that the selling affiliate did not adhere to requirements under Rule 144, the exception will not be available. Additionally, by signing a Form 144, the selling affiliate represents that he or she does not know any non-disclosed material adverse information about the issuer.
Special Circumstances
Trusts and Estates. A selling non-affiliate trust and estate does not have to comply with Rule 144, as long as the securities are unrestricted. This is true even if the trustee, executor, or beneficiary is an affiliate. However, a non-affiliate trust and estate with non-affiliate beneficiaries holding restricted securities are required to comply with only the current public information and notice of sale requirements under Rule 144.
Gifts. Everyone loves gifts especially securities gifts and, as a general rule, gifts are not sales under the law and therefore as not subject to Rule 144.
Bonus Plans. Just under gifts, lots of people love bonuses. Bonus plans are free of restrictions if (i) the issuer is a reporting company; (ii) there is an active trading market for the securities acquired in the bonus plan; and (iii) the number of shares being distributed is relatively small compared to the number of shares issued and outstanding. If these conditions cannot be met, the shares are deemed restricted and must compile with the applicable holding period unless the recipient is an affiliate then they must compile with the other provisions of Rule 144 but not the holding period.
Shell Company. Under Rule 405 of the Securities Act, a shell company is defined as registrant with no or nominal operations and either no or nominal assets, assets consisting solely of cash and cash equivalents, or assets consisting of any amount of cash and cash equivalents and nominal other assets. As such a shell company cannot rely on Rule 144 to sell securities but, if a shell company no longer is a shell, Rule 144 may become available. There is a complex analysis that must be performed by an experienced securities attorney like those available at Feinstein Law, PA. or else civil and criminal liability could result.
Are there other Exemptions?
Yes, there are several other exemptions that we will discuss in future article posts or, if you have a specific question regarding your situation, please feel free to contact us.
In conclusion, Rule 144 is a complex mechanism that allows restricted and control shares to become free-trading if specific criteria is met and if you have any questions regarding your shares and how to make them available to the public market, please contact us at (619) 990-7491 or by email at Todd@Feinsteinlawfirm.com for Todd Feinstein or JDunsmoor@Feinsteinlawfirm.com for Jonathan C. Dunsmoor.
This securities law blog post about Rule 144 is provided as a general informational service to clients and friends of Feinstein Law, PA and should not be construed as, and does not constitute, legal and compliance advice on any specific matter, nor does this message create an attorney-client relationship. © Feinstein Law, PA, 2014.
For more information concerning the rules and regulations affecting the going public direct transactions, direct public offerings, or dual listing, please contact Feinstein Law, PA at (619) 990-7491 or by email at Todd@Feinsteinlawfirm.com or JDunsmoor@Feinsteinlawfirm.com. Please note that the prior results discussed herein do not guarantee similar outcomes. Todd Feinstein is admitted in Florida and Jonathan Dunsmoor is admitted in New York.
