Securities Related Legal Opinons
Rule 144 of the Securities and Exchange Commission
If you’ve read the Glossary section posted on Mr. Wilke’s “indie attorney” website (PWindieatty.com), or are otherwise familiar with the subject at hand, you know that there are primary and secondary stock markets. Primary means the security is sold directly by the company itself; secondary refers to stock sold by one shareholder to another.
Issuing companies have two general means of selling their own securities. They can register the shares in a public offering. The shares offered for sale are filed with a securities regulatory body (The SEC and/or state securities regulators, depending on the nature of the offer. These securities are sold directly to members of the investing public. Because of the registration process itself, the “oversight,” if you will, provided by the regulatory staff’s review of the offering documentation, followed by the receipt of an “effective date” for the “registration statement,” paves the way for the sale of “unrestricted” securities to purchasers. The importance of this in the secondary market is that unrestricted securities are freely tradable to other shareholders. What a wonderful concept!
Of course, there is expense, which can be considerable, and the passage of time, which can amount to months, in obtaining the ability to offer your company’s stock directly to anyone with the means to purchase the security. The second general method of securities sales, made by the offering company itself, involves “exemptions from registration.” Rather than navigating through the regulatory process of obtaining an effective date for a public offering (the regulatory authorities provide an effective date, but do not “approve” the offering itself), offering companies offer their securities through “private placement” offerings.
Instead of having the input of securities regulators in complying with disclosure of material information law, offering companies rely on rules providing guidance for private offerings. The main difference in relying on these exemptions from registration, instead of going down the public offering road, is that securities issued in a private placement offering are “restricted.” That means they cannot be re-sold to others immediately. Instead, rules are in place providing guidance to shareholders owning restricted stock as to when they can re-sell the shares and be in compliance with the law. Selling unregistered securities illegally can lead to all sorts of financial and legal problems. “Uff da,” as my father used to say.
There are federal and state exemptions from securities registration. The granddaddy of private placement offering authority is the Securities Act of 1933 (“the Act”). Section 4(2) of the Act provides that offering companies supplying the same kind of information as would otherwise be contained in a public registration statement can sell their securities on a private placement basis. Over time, the SEC has promulgated (a fancy word for writing and publishing something) rules providing guidance on what is needed to comply with “the same kind of information” requirement of the law.
Finally, this brings us to the topic of this dissertation, Rule 144 of the SEC (“the Rule”). The Rule tells us how long we have to wait to remove the “restrictive legend” that the issuing company’s transfer agent placed on the stock certificate when it was issued to the private placement offering purchaser. Over time, the Rule has been liberalized to a degree, meaning, generally, the waiting periods for removal of the restrictive legend have been shortened.
The main areas of concern in Rule 144 are, first, to identify whether a stockholder is an “affiliate” or “non-affiliate” of the issuing company. The other is whether the issuing company provides financial reporting information to the public (in one of a couple different ways). Affiliates are defined basically as certain “control persons,” such as members of management and significant company owners (10% or more of the outstanding securities of a company). Affiliates must follow certain procedures to sell their company stock, generally involving volume limitations (1% of the outstanding shares), selling through a licensed broker/dealer and the issuance of restricted shares to the purchaser (even though the “waiting period” to be eligible to sell securities in the secondary market has been satisfied).
Non-affiliates have more leeway in selling their shares in the open market. If the issuing company is reporting its financial information on the SEC’s informational filing website, EDGAR, non-affiliates can sell their shares on an unrestricted basis six months after the date on their share certificate (and upon the removal of the restrictive legend, done with the assistance of an authorizing legal opinion and the issuing company’s transfer agent. If the issuing company is not a “reporting company,” then the shareholder must wait a year before the stock can be offered in the secondary marketplace.
Here’s a chart and some other information from the SEC’s website:
Revisions to Rules 144 and 145:
A Small Entity Compliance Guide 1
The Securities Act generally requires all sales of securities to be registered, unless the transaction is exempt. A sale of securities by anyone who is not an issuer, underwriter, or dealer is exempt from registration. Although the Securities Act defines “underwriter” to include those who acquire securities from the issuer with a view to distribution, the determination of when securities are acquired “with a view to distribution” is a fact-sensitive inquiry. To provide market participants with greater certainty, Rule 144 of the Securities Act provides a non-exclusive safe-harbor from being treated as an “underwriter”: if a sale of securities meets all applicable Rule 144 requirements, the person selling the securities is deemed not to be an underwriter, making the transaction exempt from the Securities Act’s registration requirements.
In general, Rule 144 requires restricted securities to be held for a particular length of time, and prescribes the conditions which must be satisfied prior to the sale of the securities. The rule also distinguishes between security holders who are affiliates of the company and those who are not, and between companies that report information publicly and those that do not. Finally, information about certain sales made in reliance on Rule 144 must be filed on Form 144.
The Securities and Exchange Commission recently adopted amendments that ease many restrictions in Rule 144. Among other things, these amendments:
- Shorten the holding period for restricted securities of reporting issuers to six months
- Substantially reduce the restrictions applicable to non-affiliates’ sales of securities
- For sales of debt securities, eliminate the manner of sale limitations and raise volume limitations
- Increase the Form 144 filing thresholds; and
- Codify several staff interpretations relating to Rule 144.
The Commission also adopted amendments to Rule 145 of the Securities Act. Rule 145 governs registered transactions in connection with reclassifications of securities, mergers or consolidations or transfers of assets. Before Rule 145 was amended, the Commission presumed affiliates of the target entity to be underwriters in any sale of securities received in the transaction. The Commission eliminated this “presumptive underwriter” provision, except when the transaction involves a shell company. The amendments to Rules 144 and 145 are effective on February 15, 2008.
What are the new Rule 144 holding periods for restricted securities?
Rule 144(d) requires restricted securities to be held for a period of time before they can be resold. Under the amendments, if the issuer of the securities has been subject to the reporting requirements of Section 13 or 15(d) of the Exchange Act for at least 90 days, then the restricted securities of such an issuer are subject to a six-month holding period. Restricted securities of issuers that are not subject to the Exchange Act reporting requirements, however, must be held for one year before any public resale.
How does a non-affiliate resell restricted securities under Rule 144?
The amendments substantially reduce the restrictions applicable to resales of securities by a person who is not an affiliate of the issuer and has not been an affiliate for three months prior to the sale of the securities. Under the amendments, a non-affiliate that has held restricted securities of a reporting issuer for more than six months and less than one year can resell the securities in reliance on Rule 144, if current information (Exchange Act reports) is available about the issuer. After one year, the non-affiliate may freely resell the restricted securities of a reporting issuer without regard to any of the Rule 144 conditions.
A non-affiliate of a non-reporting issuer must hold the securities for one year before any public resale. After one year, a non-affiliate may freely resell such securities without regard to any of the Rule 144 conditions.
How does an affiliate resell securities under Rule 144?
An affiliate of the issuer reselling securities in reliance on Rule 144 must comply with a current public information requirement, a volume limitation, manner of sale requirements (for equity securities), and a requirement to file a notice of proposed sales on Form 144. An affiliate reselling restricted securities must also comply with a six-month or one-year holding period requirement, as applicable.
The following chart summarizes the revised conditions applicable to affiliates and non-affiliates selling restricted securities under Rule 144:
What are the new Form 144 filing thresholds for affiliates’ sales of securities?
The Commission raised the Form 144 filing thresholds so that affiliates must file Form 144 if their proposed sales in reliance on Rule 144 within a three-month period exceed 5,000 shares or $50,000. Non-affiliates no longer need to file Form 144.
How can securities of shell companies be resold?
The Commission also codified a staff interpretation relating to the treatment of the securities of shell companies. Under the amendments, Rule 144 is not available for the resale of securities initially issued by a shell company (reporting or non-reporting) or a former shell company. These securities can be resold only through a resale registration statement, unless certain conditions are met. These conditions are:
- the issuer of the securities has ceased to be a shell company;
- the issuer is subject to the reporting requirements of section 13 or 15(d) of the Exchange Act;
- the issuer has filed all reports and other materials required to be filed by section 13 or 15(d) of the Exchange Act, as applicable, during the preceding 12 months, other than Form 8-K reports; and
- one year has elapsed since the issuer has filed current ‘‘Form 10 information’’ with the Commission reflecting its status as an entity that is no longer a shell company.
If these conditions are satisfied, then the securities can be sold subject to all other applicable Rule 144 conditions.
How did the Commission amend Rule 145?
Except when a shell company is involved, the Commission eliminated the provision that previously deemed parties (other than the issuer) to a reclassification, merger, or asset transfer, or any affiliate of such party, underwriters in any sale of the securities received in the transaction. Under the amendments, this “presumptive underwriter” provision now only applies to any party, other than an issuer, to a Rule 145 transaction involving a shell company (other than a business combination related shell company), and any affiliates of such party.
Those presumed underwriters can resell their securities in accordance with revised resale provisions which require that:
- the issuer is not (or has ceased to be) a shell company, is reporting and has filed the requisite Exchange Act reports and registration statement reflecting the issuer’s status as no longer a shell company; and
- one of the following three conditions is met:
- The securities are sold in accordance with Rule 144’s current public information, manner of sale, and volume limitation requirements and at least 90 days have elapsed since the date the securities were acquired from the issuer in the Rule 145 transaction;
- The seller is not, and has not been for at least three months, an affiliate of the issuer, and at least six months have elapsed since the date the securities were acquired from the issuer in the Rule 145 transaction, and current information regarding the issuer is publicly available; or
- The seller is not, and has not been for at least three months, an affiliate of the issuer, and at least one year has elapsed since the date the securities were acquired from the issuer in the Rule 145 transaction.
Contacting the SEC
The SEC’s Division of Corporation Finance is happy to assist small companies with questions regarding the amendments and the SEC’s proxy rules. The Division’s Office of Chief Counsel answers questions submitted by on-line at their site (www.sec.gov) or by telephone at (202) 551-3500. Questions on other corporate finance matters concerning small companies may be directed to the Division’s Office of Small Business Policy by e-mail at firstname.lastname@example.org, or by telephone at (202) 551-3460.
1 This guide was prepared by the staff of the U.S. Securities and Exchange Commission as a “small entity compliance guide” under Section 212 of the Small Business Regulatory Enforcement Fairness Act of 1996, as amended. The guide summarizes and explains rules adopted by the SEC, but is not a substitute for any rule itself. Only the rule itself can provide complete and definitive information regarding its requirements.