Securities Act Rule 144 is good knowledge to have for those working in startups. Suppose you’ve recently acquired some stock options from your company. And while it’s a generous gesture by the company, you’re not interested in hanging onto the stocks and want to sell them.
That sounds easy enough, right? Well, not so fast. Selling securities, like stocks, in the public market can be a complicated process.
For starters, you’ll need to understand the requirements of the Securities Act Rule 144. To help understand how to sell securities in the public market, we’ve got what you need to know about Rule 144.
What Is Rule 144?
Before we get into Rule 144, it’s worth having a little refresher about the Securities Act of 1933.
The main objectives of the Securities Act are to ensure that investors receive the necessary information about securities being offered for public sale and eliminate fraud and deceit in the sale of securities. To accomplish these goals, the Securities and Exchange Commission (SEC) requires all securities offered in the U.S. to be registered or qualify for a registration exemption.
That’s where Rule 144 comes in. Rule 144 provides an exemption from registration requirements and allows the public resale of “restricted” and “control” securities if specific conditions are met.
Want to learn more about securities? Check out our guide on the Howey Test for more detailed information.
What Are Restricted and Control Securities?
To fully understand Rule 144, it’s essential to know about restricted and control securities.
Restricted securities, also known as restricted stock, refer to securities obtained through unregistered, private sales from an issuing company or its affiliate. For example, investors typically receive restricted securities through Regulation D offerings (another type of exemption to SEC registration requirements), professional service compensation, employee stock benefit plans, private placement offerings, or in exchange for providing startup capital.
Meanwhile, control securities are held by an affiliate of the issuing company. According to the SEC, an affiliate is someone “such as an executive officer, a director or large shareholder, in a relationship of control with the issuer. Control means the power to direct the management and policies of the company in question, whether through the ownership of voting securities, by contract, or otherwise.”
With restricted securities, you will typically receive a certificate stamped with a “restrictive” legend. This legend indicates that the securities can’t be sold in the marketplace unless registered with the SEC or exempt from registration requirements. Certificates for control securities generally aren’t stamped with a legend.
Why Is Rule 144 Important?
It’s pretty common for employees, business owners, and investors to own control or restricted securities. For example, you might receive these securities as part of a merger and acquisitions transaction package or an employee benefits package.
What makes Rule 144 important is the registration exemption it provides, which enables investors and shareholders to sell their restricted securities for profit. And that makes the securities more valuable than if they were held onto indefinitely.
What’s more, compliance with Rule 144 protects sellers from being treated as “underwriters.” The Securities Act definition of “underwriter” includes “those who acquire securities from the issuer with a view to distribution.” If you’re treated like an underwriter and sell securities in the public market without registration, you’ll very quickly find yourself in hot water with the SEC.
What Are the Conditions of Rule 144?
So how can you go about selling restricted or control securities in the public market? As mentioned earlier, Rule 144 contains specific conditions that must be met to sell these securities. However, not all requirements apply to every resale.
While the rule is not the “exclusive means for selling restricted or control securities,” it does provide a safe harbor exemption. That means sellers will be protected from legal or regulatory liability so long as they follow the required conditions.
The five conditions of Rule 144 are:
The first requirement to address is the holding period. To sell restricted securities, you have to hold them for a certain amount of time. If the company that issued the restricted securities is a “reporting company” (meaning it’s subject to reporting requirements of the Securities Exchange Act of 1934), then the minimum holding time is six months. If the issuer is not a reporting company, the holding period is at least one year. The holding period only applies to restricted securities, but control securities are subject to other conditions under Rule 144.
Current Public Information
Before a sale, there must be sufficient public information about the issuing company. For reporting companies, this means filing periodic reports as required by the Securities Exchange Act of 1934. Though a non-reporting company doesn’t have as stringent reporting requirements, it must still ensure that certain information – such as details about the nature of its business, the identity of its officers and directors, and financial statements – is publicly available.
Trading Volume Formula
The third condition gets a bit more complicated and involves limiting the number of securities an affiliate can sell during a specific time frame. Under this condition, an affiliate cannot sell more than 1% of the outstanding shares of the same class during any three-month period. Outstanding shares refer to the total shares of a company’s stock held by investors, including restricted shares.
If a share class is listed on a stock exchange, then only the greater of 1% of outstanding shares or the average of the previous four-week trading volume can be sold. For over-the-counter stocks (securities traded via a broker-dealer network rather than on a major exchange), the 1% measurement applies.
Ordinary Brokerage Transactions
The fourth condition dictates that standard trading practices apply for affiliate sales. In particular, this means that brokers can’t receive a higher than normal commission. Plus, brokers and sellers can’t solicit others to buy the securities.
Notice of Proposed Sale
Lastly, affiliates must file a notice with the SEC if the sale involves more than 5,000 shares or the value is higher than $50,000 in any three-month period.
It’s important to note that even if you’ve met all the requirements of Rule 144, you still cannot sell restricted securities in the public market until the “restrictive” legend is removed from the certificate. And only a transfer agent can remove a restrictive legend. Transfer agents are usually banks or trust companies, but occasionally a company acts as its own transfer agent.
How can you get the restrictive legend removed? It’s best to contact the company that issued the securities, or the company’s transfer agent, to ask about the procedure for removing a legend. Tip: Transfer agents are often identified on company websites under “Investor Relations.”
Who Does Securities Act Rule 144 Apply To?
So how do you know if Rule 144 applies to you?
First of all, if you’re an affiliate of the issuing company, or someone selling on behalf of an affiliate, you’ll have to comply with all conditions of Rule 144 to sell restricted and control securities.
Things are a bit different for sellers that aren’t associated with the issuing company (aka non-affiliates). For example, say you’re a non-affiliate who has owned restricted securities for more than one year. In that case, there’s no need to meet any of Rule 144’s conditions. Now, if you’ve held onto restricted securities for more than six months but less than one year and the issuer of the securities is a “reporting” company, you can sell the securities so long as you meet the current public information condition.
Due Diligence Is Key
There’s no question that Rule 144 is a useful exemption to registration requirements. But it’s also a complicated process that can be confusing and daunting.
If you intend to follow Rule 144 to sell securities in the public marketplace, the first step in the process should be to check in with your broker. Verify if your broker accepts restricted or control securities and if they can address Rule 144’s conditions to enable you to sell. You may also want to consult with a lawyer who specializes in securities law.
A good rule of thumb to follow when it comes to Rule 144 is that due diligence is key to a successful (and legal) securities sale.