Tracking the history of securities is vital to companies as they have to ensure that they adhere to the SEC rule 144. SEC rule 144 specifies conditions that companies in public and private markets need to meet to sell their securities. This rule makes it essential to track companies’ security issues in the private sector, who want to make a shift to the public market. They have to avoid all the problems that arise during the review with the SEC. It is essential to comply with Rule 144 as it prevents you from being treated as an underwriter. If you are treated like one in any case, and you sell stock without registering, you will violate the civil and criminal provisions of the Securities Act of 1922. Thus you will have to register them before you can sell your stock.
SEC Rule 144
In the Securities Act of 1933, the sale of restricted and controlled securities is not permitted in the public marketplace. The SEC rule is an exemption to this act allowing the sale of such securities only if specific conditions are adhered to. The SEC rule 144 sets the conditions for selling or reselling controlled, unregistered, and restricted stocks. You will have to satisfy five conditions to freely transact including quantity restrictions, minimum holding period, and disclosure of transactions.
What is Rule 144?
According to the SEC rule, some securities are procured in unregistered private sales. These securities are issued by the company or an affiliate of the company. The issuer may provide preferred issues from the capital contributions, stock benefit plans, and transfer agreements between the company’s shareholders.
The security and sale are required to be registered with the U.S Securities and Exchange Commission for a shareholder to sell a security in the public share market. Generally speaking, securities that are not registered and are marked “restricted” can’t be sold in the public market. Thus, the U.S Securities and Exchange Commission implemented a regulation called SEC Rule 144. Some conditions have to be satisfied before selling or reselling controlled and unregistered securities under this regulation. This regulation is also applicable to other types of sellers such as dealers and underwriters.
To whom does Rule 144 apply?
The Rule 144 securities act applies to you only if you are a person who wants to sell securities and :
- A person who is about to sell a restricted stock in the public market
- Is an affiliate or controlling person of the company that issues the securities intending to sell it in the public market, whether the security is for free trading or restricted.
- Someone who is a non-affiliate shareholder of the issuing company and wants to put their restricted shares for sale.
Why is Rule 144 important?
If you are an employee, businessman, or even an investor, there are chances that you own controlled or restricted securities. This type of security is generally issued as:
- A professional services compensation
- A part of the transaction of a merger or acquisition
- An exchange for startup capital or seed money
- As a benefits package for employees
Restricted and Control Securities
Sometimes a company issues securities to certain individuals with limitations or restrictions. This creates a border preventing them from freely trading those securities. The SEC rule 144 exemption provides them the permission to trade those securities.
What are restricted and controlled securities?
When a company issues unregistered securities through a private sale to an investor, the security is restricted. Investors generally receive restricted securities through Regulation D offerings, professional service compensation, employee stock benefit plans, providing start-up capital, or private placement offerings.
The securities that are held by an affiliate of the issuing company are controlled securities. An affiliate is someone in a relationship with the company or issuer, such as large shareholders, directors, or an executive director. Control is the power to influence the company’s policies and management whose securities are in question. Control is provided through a contract, ownership of voting securities, or otherwise. When you buy securities from an affiliate or a controlling person, you take restricted securities even if they are not restricted in their hands. When acquiring these securities, you will be issued a certificate with the “restricted” title. This title signifies that you can’t sell these securities unless they are exempted from registration requirements or already registered. Control securities certificates are generally not stamped with the title.
Conditions of Rule 144
To sell securities that are controlled or restricted in the public market, one needs to satisfy certain conditions according to Rule 144. SEC rule 144 exemption provides the sellers and buyers a safe harbor. There are five conditions to this rule.
The holding period of the same class’s previously purchased securities is not affected by the purchase of additional securities. When you purchase restricted security from a non-affiliate, you can track their holding period to yours. If the restricted security is received as a gift, the holding period does not begin from when you received the gift but from when the holder acquired the security. The stock options holding period starts from the date it was exercised, and not from when it is granted. The employee stock option is also included in this.
The conditions of the Rule 144 securities act are as follow:
#1 Current Public Information
Before any sale is made, there should be sufficient current data publically available on the issuing company. In the case of reporting companies, the Securities Exchange Act of 1934 requires its companies to comply with the requirements of periodic reporting. Other organizations that are non-reporting companies need to make sure specific data about the business is publically available such as its financial statements, directors’ and officers’ identities, and the nature of the business.
#2 Holding Period
You are required to hold restricted security for a specific amount of time before you sell it. In the case of a reporting company that is subject to the requirements of reporting according to the SEC Act 1934, the security must be held for a minimum of six months. Otherwise, if the company is not a reporting company, the holder must hold the security for a minimum of one year. According to rule 144, the holding period starts only when the security is bought and completely paid for. These holding periods are only subject to restricted securities as publicly sold securities are not bound to restrictions. If an affiliate buys general security from the issuer in the public market, there will be no holding period. Also, the resale of the shares as control securities of an affiliate is subservient to different rule conditions.
#3 Notice of Proposed Sale
If you are an affiliate and the aggregate total dollar amount is higher than $50,000 in three months, or the sale is of 5,000 shares or more, you will be required to file a notice with the Securities Exchange Commission on Form 144.
#4 Ordinary transactions of the Broker
The sale of restricted security should be handled the same way as a regular trading transaction if you are an affiliate. The commission on the transaction should not be higher than normal, and the broker should not solicit to buy the securities.
#5 Formula for Trading Volume
During the three-month period, the number of equity shares you can sell should not exceed more than 1% of the same class’s outstanding shares if you are an affiliate. Also, it should not exceed the listed class’s stock exchange by 1%, nor should it exceed the preceding four weeks to the filing of the sale notice on Form 144 average weekly trading amount. All over-the-counter stocks can only be sold using the 1% scale; the stocks include the Pink Sheets and the OTC Bulletin Board.
On December 22, 2020, the U.S. SEC proposed to amend Rule 144 and revise the holding period for the exchange of some adjustable market securities of companies that are unlisted or any securities that are acquired upon conversion so that the period does not begin until the stakes are acquired on exchange or conversion. This should lower the risk of unregistered dealings that are connected with the sales of market-adjustable stakes.
Additionally, they proposed several technical amendments. The amendments will now:
- Mandate an electronic filing of Form 144 regarding the reselling of shares issued by companies governed by the Exchange Act reporting. At the same time, it will remove the requirement to file Form 144 for the resale of shares that are not subject to the Exchange Act Reporting. For shareholders that are affiliates of an issuer and want to sell a number of the issuer’s shares above the threshold of 5,000 shares or shares valued higher than $50,000 within three months to comply with Rule 144, they will be required to fill the Form 144. Form 144 should be filed at the side while placing an order with the broker to perform the sale or directly perform the deal with a market maker.
- They will extend the deadline for filing all Forms 144 to match the same deadline as Form 4. (within two business days). Separately, Section 16(a) of the Exchange Act requires that some insiders report any alteration in their beneficial ownership of the issuer’s securities. A majority of these transactions are reported on Form 4, which is due within two working days from the transaction. On the other hand, on the annual Form 5, some transactions can qualify for deferred reporting. This will be due within 45 days after the issuer’s fiscal year ends. The SEC requires all the Section 16 filings to be submitted online, which results in insiders under Rule 144 making two filings for Form 4, which is due in 2 days, and Form 144, which is due the same day.
- Amend Forms 4 & 5 to include an additional checkbox where you may indicate that the listed transaction is made compatible with Rule 10b5-1 plan. Rule 10b5-1(c) creates a strong defense to the allegations of insider trading for the specific people who trade in the issuer’s shares. If an insider assumes a written Rule 10b5-1 trading plan when they did not have the custody of any material information that was not yet public, the transactions that happened consecutively after it may be performed in the future where he would not be able to trade. The transactions can be performed when in the custody of the information not gone public or during a closed trading window. Some insiders choose to write an explanatory note to the same effect even though it was not required. So, now the SEC proposed that there should be a check box in Form 4 & 5 to obtain that information. The check box can be filled voluntarily in case the filler is not relying on this for Form 144.
Exemptions to Rule 144
There may be some federal laws that deem specific securities to be controlled or restricted securities. It can be a tiring and complicated process to sell controlled or restricted securities. The federal security law states that all sales and offers of securities should either qualify for exemption from registration requirements or should be SEC-registered. The SEC rule 144 exemption permits the resale of control and restricted securities provided they satisfy every condition. The conditions include the process of the sale of these securities, the holding period by the affiliate, and the number of securities that can be sold at a given period of time.
But let’s say you meet all these conditions, you still cannot sell the securities in the public marketplace. This is because you will need a certified transfer agent to remove the restricted stamp or legend. If the stock in question is in a registration statement and is sold as described in the prospectus, it does not come under SEC Rule 144.
When a non-controlling person resells a stock purchased from the issuing company under Regulation D of Rule 504, it will not be subject to Rule 144. However, even if the company issuing leaned on a counsel’s opinion and still did not meet the conditions for Rule 504, the security will still be restricted.
Interested to know more about SEC Rule 144?
Thus companies must maintain a clean record of all their securities transactions and records. Companies that do not do so may face issues if they want to come under SEC Rule 144. The company needs to comply with the specific conditions in order to sell its securities in the public marketplace.
Tracking is an important part for businesses that want to shift from private to the public marketplace. This is why companies need to stay in the clear and have a good and transparent review of their shares. It is the same for an affiliate to the issuer and the holder; they need to comply to sell the shares. The rule 144 holding period requirement is also necessary as it comes under a condition.
One good way of tracking your shares is by using tools to keep track of who they were sold to and when. Tools like Eqvista make it easier for companies to keep track and stay up to date. Eqvista provides you with tools that can assist you, such as cap table management, 409 valuation, and company shares issuance.