Rule 144 Privately Offered and Restricted Securities

The average individual has generally only been permitted to purchase stock in large companies whose securities trade on public exchanges such as the NYSE or NASDAQ. To own a share of a smaller private company, one usually needed to either be a direct investor in that company, like an venture capitalist or angel investor that puts in a very large and illiquid investment, or be an employee of that company that receives stock options as part of their compensation.

Recently though, another option has emerged. Secondary private investment markets such as SecondMarket and Shares Post allow shares in pre-IPO private companies to be sold by employees and investors, thanks to a special securities rule called Rule 144. Normally, securities such as stock that are acquired in many kinds of private offerings and transactions, especially when conducted directly with the issuing company, or with an executive, director, or controlling shareholder of an issuing company, are deemed to be “restricted” (when coming from an executive, director, or controlling shareholder, the securities are sometimes called “control” securities).

When securities are restricted, they cannot be resold to the public except under an applicable exemption to the securities laws. At the federal level, the most commonly used exception is Rule 144, which acts as a safe harbor for the Section 4(a)(1) registration exemption, and permits holders of a security to resell provided they do not qualify as either the issuer of the securities or as an “underwriter” or “dealer”, which is a person or entity that acquires securities with a view to distributing or reselling them.

What is Rule 144

Rule 144 provides a safe harbor for holders of restricted securities to resell their securities to the public, and “unrestricts” the securities. This means that while Rule 144 is not the exclusive method by which restricted securities can be resold, compliance with the provisions of the rule means that the transaction is in compliance with federal securities laws and regulations.

It is important to note that Rule 144 only applies to holders of restricted securities attempting to resell them and is not available to issuing companies of the security.

Rule 144 permits resale of restricted securities as long as several conditions are met. The conditions that must be met depends on whether the selling security holder is an “affiliate” of the issuer company, which is defined as a person or entity with control of, controlled by, or under common control with, the issuer company (affiliates are typically an executive officer, director, or controlling shareholder).

For all resellers, one condition of Rule 144 that must be met is a mandatory holding period. If the issuer is a “reporting company” — that is, it is a company subject to regular reporting requirements under the Securities Exchange Act of 1934 (commonly known as the ’34 Act) — then the holding period is six months. If the issuer is not a reporting company, the holding period is one year. The “holding period” begins when the securities are bought and fully paid for, so for example, securities acquired through options only start the holding period when the options are exercised and the securities are paid for. Holding periods can also be tacked when acquiring restricted securities from a non-affiliate, so that if you acquire restricted securities with a one year holding period from a non-affiliate who has held those securities for six months, you need only hold the securities for another six months in order to comply with the holding period requirement.

Another condition that must be met for all resellers is the public availability of information regarding the issuer. If a company is a reporting company under the ’34 Act, they have likely complied with the public information requirement. Where the company is non-reporting, Rule 144 provides citation to a list of information that must be made publicly available in order to comply with the public information requirement, including:

–    Facts about the company, such as its name, state of organization, names and address of its principal officers and directors, its principal line of business and products and services offered, financial information such as balance sheets and P&L statements stretching back two years;
–    Information about the securities and the offering, such as the class and par or stated value of the securities, the name and address of the transfer agent, whether a broker or dealer or associated person is affiliated with the issuer, and whether the sale is being made on behalf of a broker or dealer or beneficial owner of more than 10% of any equity security of the issuer.

Affiliates of the issuer have additional conditions, including:

–    Limits on the amount of resale in any three-month period of the greater of: (1) 1% of the outstanding securities of the same class being sold, or if the securities are being sold on an exchange, (2) 1% or (3) of the average reported weekly trading volume of the four preceding weeks.
–    The transaction must be completed as an ordinary brokerage transaction, and the broker must receive a normal commission. Orders to buy cannot be solicited.
–    Filing of a Form 144 with the SEC if the sale involves more than 5,000 shares or units or the aggregate amount is greater than $50,000 in any three month period.

Finally, in order to sell securities to the public pursuant to Rule 144, any legend on any certificate identifying the securities as restricted must be removed. The legend can only be removed by a transfer agent, who will only do so with consent of the issuer, who will typically require an opinion of counsel that the transaction complies with securities laws (both federal and state)

How Rule 144 Affects Private Offerings

Many private offerings result in sales of restricted securities, including the Regulation D exemptions (unless the securities are otherwise unrestricted pursuant to one of the Reg. D rules). Accordingly, purchasers in private offerings have no liquidity in their purchases unless the securities can be resold, which might be accomplished under Rule 144. Permitting investors in private offerings to be able to resell their restricted securities can improve the value of restricted securities sold issuers in the initial sales, since there is opportunity for the securities to be resold and investors do not have to hold the securities for an indefinite period of time.

Curiously, it is unclear if securities that would be acquired in a Title III/Section 4(a)(6) equity crowdfunding offering could be resold pursuant to Rule 144. Section 4(a)(6) does not designate the acquired securities as restricted as defined under Rule 144, instead explicitly restricting them through a one-year holding period unless resold (1) to the issuer, (2) to an accredited investor, (3) as part of a registered offering, or (4) to a member of the family of a purchaser or in connection with the death or divorce or other similar circumstance of the purchaser. The SEC’s proposed rules for equity crowdfunding also make no explicit reference to Rule 144.

Rule 144 and Secondary Markets

Rule 144 has made it possible for the proliferation of “secondary markets” for securities of private companies. These secondary markets allows for the resale of securities acquired in Regulation D offerings or other private offerings, which can make investing in private offerings much more attractive to investors, or to employees who have received equity compensation, who now have an option for liquidity in their investment (pursuant to any contractual restrictions on resale, such as a right of first offer or first refusal, that the issuer and investor may have agreed to).

However, the apparent ease of using secondary markets to create liquidity in restricted securities is perhaps a fine line. Remember that Rule 144 is only available where the security-holder purchased the securities without a view to distribute or resell the securities — that is, the securities-holder purchased for investment purposes for her/his/its own account. Although issuers typically have purchasers sign statements that the purchasers are purchasing only for their own account and not with a view to distribution, if a security-holder who purchased its securities from the issuer publicly states or clearly indicates her/his/its intent to resell as soon as legally possible, the holder may lose the benefit of Rule 144.


Recent Amendment to Rule 144A allowing for General Solicitation

Enacted in 2012, the Jumpstart Our Business Startups Act, or JOBS Act, is intended, among other things, to reduce barriers to capital formation, particularly for smaller companies.  The JOBS Act requires the SEC to adopt rules amending existing exemptions from registration under the Securities Act of 1933 and creating new exemptions that permit issuers of securities to raise capital without SEC registration.  On July 10, 2013, the SEC adopted amendments to Rule 144A under the Securities Act to implement the requirements of Section 201(a) of the JOBS Act.  The amendments are effective on September 23, 2013.

Rule 144A is a non-exclusive safe harbor exemption from the registration requirements of the Securities Act for resales of certain securities to qualified institutional buyers, or QIBS.  A QIB includes certain entities that, in the aggregate, own and invest on a discretionary basis at least $100 million in securities of unaffiliated issuers.  A registered broker-dealer qualifies as a QIB if it owns and invests on a discretionary basis at least $10 million in securities of unaffiliated issuers.  Prior to the recent amendment to Rule 144A described below, offers of securities under Rule 144A were required to be limited to QIBs, which effectively prohibited the use of general solicitation under Rule 144A.

Section 201(a) of the JOBS Act required the SEC to revise Rule 144A to provide that securities sold pursuant to Rule 144A may be offered to persons other than QIBs, including by means of general solicitation, provided that securities are sold only to persons that the seller and any person acting on behalf of the seller reasonably believe are QIBs.  To implement Section 201(a), the SEC adopted an amendment to Rule 144A to permit the use of general solicitation under Rule 144A, as long as the purchasers are limited to QIBs or to purchasers that the seller and any person acting on behalf of the seller reasonably believe are QIBs. [source]

Rule 144A has greatly increased the liquidity of the private securities affected, as institutions can now trade these formerly restricted securities among themselves, and list them


About the Author

James M. Johnson is a Massachusetts attorney. His practice focuses on corporate and commercial matters for early-stage startups and small businesses.

Disclaimer: This article is for educational purposes only, and is not intended to create an attorney-client relationship or to be relied upon for legal advice. If you require legal advice applicable to your circumstances, please contact an attorney.

James Johnson

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