DFS Associates Corporate Finance: Selling Restricted Shares

Rule 144: Selling Restricted and Control Securities

When acquiring restricted securities or holding control securities, you have to look for an exemption from the SEC's registration conditions to trade them in the marketplace. Here is how: Rule 144 allows you to resell publicly restricted and control securities by satisfying several requirements. This article will show how to go about it. Likewise, it will also show how to have a restrictive legend removed.

Defining Restricted and Control Securities

Restricted securities are defined as securities obtained in unregistered, private sales from the issuer or from an issuer’s affiliate. Investors normally receive restricted securities through private placement offerings, employee stock benefit plans, Regulation D offerings, as remuneration for professional work, or as an exchange deal for delivering "seed money" or capital to start a company. Rule 144(a)(3) specifically defines what sales create restricted securities.

Control securities are defined as those held by an affiliate of the issuing firm. An affiliate is one who has management control over an issuer, for instance, a director or a majority shareholder. Specifically, management control means the capacity to direct the operations and policies of the firm involved, either through the ownership of voting securities, either by contract or otherwise. Hence, when you acquire securities from an affiliate or a controlling person, you acquire restricted securities, even though that person was not restricted while holding it.

When you take restricted securities, more often than not, you will get a certificate marked "restricted". The mark or legend signifies that you may not resell the securities in the marketplace unless they are SEC- registered or are exempt from the registration conditions. Control securities certificates often do not have such a legend.

What Are the Conditions of Rule 144?

To sell restricted or control securities publicly, follow Rule 144’s requirements. Although the rule does not cover all means for selling restricted or control securities, it provides a protective exemption to sellers, according to the five conditions listed below:

Holding Period. Before you are permitted to sell restricted securities publicly, you need hold them for at a minimum of a year. The one-year period holding period starts from the time the securities were acquired and fully paid for. The holding period only covers restricted securities. Because securities acquired publicly are not restricted, no holding period is required for an affiliate who buys securities of the issuer in the marketplace. However, an affiliate's resale falls under the rule’s other requirements.

Additional securities bought from the issuer do not affect the holding period of similar securities previously purchased. If you acquired restricted securities from another non-affiliate, you can apply on that non-affiliate's holding period to your own holding period. For gifts made by an affiliate, the holding period starts at the time when the affiliate purchased the securities, not at the time it was given. For a stock option that an employee receives, for instance, the holding period always starts from the date the option is exercised, not the time it was received by the employee.

Adequate Current Information. Sufficient current information is required about the issuer of the securities before a sale can be consummated. Generally, this signifies the issuer has satisfied periodic reporting stipulated by Securities Exchange Act of 1934.

Trading Volume Formula. Upon expiry of the one-year holding period, the number of shares you are allowed to sell within any three-month period must not be greater than 1% of the outstanding shares of the same class being sold; or if the class is listed on a stock exchange or Nasdaq-quoted, the higher of 1% or the reported weekly trading volume average within the four weeks prior to filing a notice of the sale on Form 144. Over-the-counter stocks, such as those quoted on the OTC Bulletin Board and the Pink Sheets, are permitted for sale using the 1% condition.

Ordinary Brokerage Transactions. Sales have to be implemented in all respects as ordinary trading transactions; and brokers are not allowed to receive above-regular commissions. Both the seller and the broker cannot solicit orders to purchase the securities.

Filing Notice with the SEC. At the time the order was made, you must submit a notice with the SEC on Form 144 if the sale covers over 500 shares or the total amount is more than $10,000 in any three-month duration. The sale must be done within three months of filing the Form and, if the securities have not been traded, you are required to file an amended notice.

If you are not an affiliate of the issuer and hold restricted securities for already two years, you are exempt from the above conditions.

Can the Securities Be Sold Publicly If the Conditions of Rule 144 Have Been Met?

Even after satisfying Rule 144 conditions, you are not allowed to sell your restricted securities publicly until you the legend has been removed from the certificate. The restricted legend can only be removed by a transfer agent. However, the transfer agent will not remove the legend until you have been allowed by the issuer to do so — often through an opinion letter from the issuer's counsel. Without that, the transfer agent is not permitted to remove the legend and consummate the trade in the marketplace.

To commence the process, an investor should get in touch with the firm that issued the securities, or the transfer agent of the firm's securities, to inquire regarding the process for removing a legend. The process of removing the legend can be an intricate step, in case you plan to buy or sell a restricted security.

What If a Dispute Arises Over Whether One Can Remove the Legend?

In case a dispute ensues about whether a restricted legend can be removed or not, the SEC is not obligated to intervene. The question is a matter exclusively left in the hands of the issuer of the securities. State law, not federal law, supervises such disputes regarding legend removal. As such, the SEC will not get involved in any decision or issue about removing a restrictive legend.

DFS Associates is recognized as a trusted investment banking company worldwide, recognized as a leader in mergers and acquisitions, corporate finance, tax efficiency and divestitures, especially in the middle tiers of the private sector. DFS Associates is recognized as a trusted investment banking company worldwide.