Section 144 of the US Securities Act is useful knowledge for anyone working at a startup. Suppose you recently acquired some stock options from a company. And while that’s a generous gesture by the company, you’re not interested in sticking with stocks and want to sell them.
That sounds easy, right? Well, not so fast. Selling a security like stock on the open market can be a complicated process.
To begin with, you should understand the requirements of Rule 144 of the Securities Act. public marketsummarizes what you need to know about rule 144.
What is Rule 144?
Before we get into Rule 144, it’s worth a little refresher on the Securities Act of 1933.
of Main Purposes of Securities Law Its purpose is to ensure that investors receive the information they need about public offerings of securities and to eliminate fraud and deception in the sale of securities. To achieve these goals, the U.S. Securities and Exchange Commission (SEC) requires that all securities offered in the United States be registered or qualify for an exemption from registration.
That’s where rule 144 comes into play. Rule 144 provides exemptions from registration requirements and permits the public resale of “restricted” and “administered” securities, provided certain conditions are met.
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What are restricted and controlled securities?
To fully understand Rule 144, it is essential to know about restricted and controlled securities.
Restricted securities, also known as restricted stock, are securities acquired through an unregistered private sale from the issuer or its affiliates. for example, Investor usually receive restricted securities Regulation D offerings (another type of exemption from SEC registration requirements), professional services fees, Employee Stock Benefit Planin exchange for a private offering or offering start-up capital.
Controlling securities, on the other hand, are held by affiliates of the issuer.by SECan affiliate is “a person, such as an executive officer, director, or major shareholder, who has a controlling relationship with an issuer. means the authority to direct the management and policies of the company in question.”
Restricted securities usually receive a certificate stamped with the “restricted” symbol. This legend indicates that securities cannot be sold in the market unless they are registered with the SEC or exempt from registration requirements. Deeds of managed securities usually do not have legends stamped on them.
Why Rule 144 Matters
It is very common for employees, business owners and investors to own controlling or restricted securities. For example, if we receive these securities as part of a merger and acquisition transaction package; Benefit package.
what to make Rule 144 Important The registration exemption it provides allows investors and shareholders to sell restricted securities for profit. And that makes the security more valuable than if it were held indefinitely.
Additionally, compliance with Rule 144 prevents the seller from being treated as an “underwriter.” The securities law definition of an “underwriter” states: “a person who acquires securities from an issuer for the purpose of distribution” If you are treated like an underwriter and sell securities on the open market without registration, you will quickly become involved with the SEC.
What are the terms of Rule 144?
So how do you sell restricted or controlled securities on the open market? As mentioned earlier, Rule 144 contains certain conditions that must be met in order for these securities to be sold. increase. However, not all requirements apply to all resales.
Although the rules are not “Exclusive Means for Selling Restricted or Managed Securities” It offers a safe harbor exemption. This means that sellers are protected from legal or regulatory liability as long as they comply with the required conditions.
The five conditions of Rule 144 are:
The first requirement to address is the retention period. To sell restricted securities, you must hold them for a certain period of time. If the company issuing the restricted securities is a “reporting company” (meaning it is subject to the reporting requirements of the Securities Exchange Act of 1934), the minimum holding period is six months. If the issuer is not a reporting entity, the holding period is at least one year. The holding period applies only to restricted securities, while controlling securities are subject to other conditions under Rule 144.
Current public information
Full public information about the issuer is required prior to the sale. For reporting companies, this means filing regular reports as required by the Securities Exchange Act of 1934. Non-reporting companies have less stringent reporting requirements, but must secure certain information, including details about their nature. The business, the identities of its officers and directors, and financial statements are public.
trading volume formula
The third condition is a little more complicated and involves limiting the number of securities an affiliate can sell in a particular time frame.Under this condition, the affiliate cannot sell any more 1% of outstanding shares Same class for 3 months. Number of issued shares Refers to the total number of shares of a company held by an investor, including restricted stock.
If the stock class is listed on a stock exchange, you can only sell 1% of the outstanding shares or the average trading volume over the last four weeks, whichever is greater.for Over-the-counter inventory (securities traded through broker-dealer networks rather than major exchanges), a 1% measure applies.
Regular intermediary transaction
The fourth condition states that standard trade practices apply to affiliate sales. In particular, this means that brokers cannot receive higher than normal commissions.
Notification of Proposed Sale
Finally, if the sale involves more than 5,000 shares or is valued at more than $50,000 in three months, the affiliate must file notice with the SEC.
It is important to note that restricted securities cannot be sold on the open market even if they meet all the requirements of Rule 144. Until the “restrictive” legend is removed from the certificateAlso, only Transfer Agents can remove the definitive legend. transfer agent Usually a bank or trust company, but in some cases the company acts as its own money transfer agent.
How do I remove the limited legend? We recommend contacting the company that issued the security or their transfer agent for instructions on how to remove the legend. Tips: Transfer agents are often listed under “Investor Relations” on the company’s website.
Who does Securities Act Rule 144 apply to?
so how do you know Rule 144 applies?
First of all, if you are an affiliate of the issuer or a person selling on behalf of an affiliate, you must comply with all the conditions of Rule 144 to sell restricted and controlled securities. there is.
Sellers who are not affiliated with the issuer (unaffiliated companies) are a little different. For example, let’s say you are a non-affiliate and he has owned a restricted security for over a year. In that case, you are not required to meet any of the conditions of Rule 144. If you currently hold restricted securities for more than six months but less than one year and the issuer of the securities is a “reporting” company, you may sell the securities as long as they meet the current public information requirements. .
Due diligence is key
There is no doubt that Rule 144 is a valid exemption from the registration requirement. But it is also a complex and difficult process.
When selling securities on the open market pursuant to Rule 144, the first step in the process is to check with your broker. Find out if your broker accepts restricted or managed securities and if your broker can sell on Rule 144 terms. You can also consult a lawyer who specializes in securities law.
A good rule of thumb to follow regarding Rule 144 is that due diligence is key to a successful (and legal) securities sale.