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Note that Rule 144 only comes into play when one is seeking an exemption from registration. If stock is registered and unrestricted and one is not an affiliate, one is free to sell it without reference to the conditions of Rule 144. If stock is registered when it is originally issued and later becomes restricted (as explained below), a sale transaction will require registration (often referred to as "registration for resale") anew, or an exemption from registration. Also, where one sells securities in a private transaction (as opposed to on the open market), the transactional exemption for non-public offerings will normally apply and Rule 144 will not. In that event, however, the stock will retain its restricted character even after the sale.
What is restricted stock?
Normally, if securities are registered when they are first issued, then they do not bear any restrictive legend and are not deemed restricted securities. Restricted securities are generally those which are first issued in a private placement exempt from registration and which bear a restrictive legend. The legend commonly states that the securities are not registered and cannot be offered or sold unless they are registered with the S.E.C. or exempt from registration. The restrictive legend serves to ensure that the initial, unregistered sale is not part of a scheme to avoid registration while effectuating some broader distribution than the initial sale.
Securities which are acquired from the issuer or an affiliate in a "transaction or chain of transactions not involving any public offering," are also deemed restricted securities for purposes of Rule 144, whether or not they bear a restrictive legend.
Thus if a director (an affiliate) of General Electric buys G.E. stock in the open market, that stock is deemed not to be restricted, because it was acquired in a "public" transaction. Even so, the director would have to comply with Rule 144 to sell the stock on the open market to avoid underwriter status simply because he is an affiliate. If the director instead sells the stock in a private sale to a non-affiliate, the stock becomes restricted in the hands of the buyer, because he has purchased from an affiliate in a transaction not involving any public offering. The buyer would have to comply with Rule 144 in order to resell the stock on the open market without registration.
The Basics of Rule 144
Rule 144 is used for sales of restricted stock by any person and for sales of restricted and non-restricted stock by or for the account of an affiliate. The conditions contained in Rule 144 with which one must comply in order to meet the safe harbor for non-underwriter status concern available information, the length of time the person has owned the securities, and the amount of securities sold. First, public information regarding the issuer, i.e., reports periodically filed with the S.E.C. by reporting companies, must be available. Second, generally, the seller must have owned the securities for at least one year. There are extensive rules concerning when one may "tack" onto his own holding period the length of time a previous owner held the securities. Also, for holding period purposes, securities are not fungible. The holding period requirement does not apply to affiliates selling unrestricted securities. Third, one may only sell under the Rule in any three-month period an amount equal to the greater of 1% of the outstanding shares of the issuer or the previous four-week period's average weekly trading volume of the issuer's securities. The sale must also be through a broker or market maker.
Where the seller is not an affiliate of the issuer, has not been an affiliate during the preceding three months, and the securities were acquired from the issuer or any affiliate at least two years prior to the sale, then Rule 144(k) allows sales without reference to the public information requirement, volume limitations, and requirement that the sale be through a broker or market maker.
Some Common Misperceptions
Many people who have extensive experience with both public and private companies and their securities, including experienced brokers, believe that even if an affiliate's entire block of stock is registered for resale with the S.E.C., the affiliate is still subject to the volume limitations of Rule 144. This is not the case. Once the affiliate's shares are registered for resale by the affiliate, Rule 144 has no applicability. The Rule is used only for determining whether one safely falls into an exemption from registration by virtue of non-underwriter status. Where the securities or the transaction are registered as required, the Rule does not apply.
Many also don't realize that, with the exception of subsection (k), Rule 144 is used only for "public sales." Where the owner of a controlling block of stock in a public company negotiates a private sale of his entire block with a buyer, the Rule does not come into play. In that event the buyer, who must have access to adequate information about the issuer and qualify as a "sophisticated investor," would receive restricted shares, since they would be acquired in a transaction not involving a public offering.
It is a common assumption that Rule 144 is only applicable to public companies which are subject to the reporting requirements of the Securities and Exchange Commission. As explained above, subsection (k) does not impose the public information and certain other requirements. Rule 144(k) is often used by nonaffiliates of small, non-public, non-reporting companies who have held their stock for two years. In those circumstances the sale of the stock, in any type of transaction, public or private, is exempt from registration, and the buyer receives unrestricted stock. In addition, if a public company has not been a reporting company for the required length of time, or has failed to meet all of its filing requirements, an owner of restricted stock might take advantage of Rule 144(k), where the rest of the Rule is unavailable. Since freely-trading, unrestricted stock commands a higher price than restricted stock, often up to twice as high, the benefits of this rule for owners of stock that is traded in a recognized market can be substantial.
One effect of Rule 144, although it is technically a "safe harbor," is that open-market sales of restricted securities of public reporting companies are made almost exclusively within the confines of the Rule. One must keep in mind, however, that many sales of restricted stock are not subject to the Rule, and also that it is not just for stock of public companies.
Julia K. O'Neill is a principal of
Fleming & O'Neill, P.C. in Boston, Massachusetts.
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