Re: Everything you ever wanted to know about Rule 144
VI. Individual Sales of Shares
Generally, the 1933 Act requires that a sale of securities that is not otherwise exempt from registration must be registered under the 1933 Act. One of the most widely used resale exemptions from registration is Section 4(1) of the 1933 Act. Section 4(1) exempts from registration transactions by any person other than "an issuer, . . . underwriter or dealer." The difficulty in qualifying for this exemption, however, arises from the 1933 Act's definition of the term underwriter," which broadly defines underwriter to include any person who participates in the distribution of the issuer's securities or "who has purchased from an issuer with a view to ... distribution." Because of this expansive language, an individual attempting to resell restricted securities and an affiliate attempting to resell securities, whether restricted or not, risks qualifying as an "underwriter" if the Commission determines that such person originally purchased the securities with a view to distribution."
To provide a safe harbor for the resale of restricted securities and securities held by affiliates of an issuer, the Commission adopted Rule 144. Although Rule 144 is available only when there is an established trading market for the securities in question, it provides clear, objective guidelines that, when followed, insulate a person (affiliates and nonaffiliates) selling restricted securities and an affiliate selling securities from being deemed an underwriter engaged in the distribution of securities. Thus, Rule 144 enables individuals to resell certain securities without registration under the 1933 Act. By its terms, Rule 144 applies only to the following two categories of individuals: (i) affiliates and (ii) persons holding restricted securities of a company. The term "affiliate" is broadly defined as "a person that directly, or indirectly through one or more intermediaries, controls, is controlled by or is under common control with such issuer." (See Rule 144(a)(1)). Although the Commission has taken the position that an individual's status as an affiliate is a factual question to be determined by considering all relevant facts, the Commission has found in the past that all officers and directors of an issuer are presumptively members of a controlling group, and thereby "affiliates." While a company may take a public position as to its controlling persons, the basic factual determination of who is in control remains open to question and a company's determination may be "second guessed." In addition, Rule 144(a)(2) identifies persons, who because of their relationship with the affiliate seller, are deemed the same person as the affiliate for purposes of Rule 144. Accordingly, where a person is found to be an affiliate, close family relatives of such person, certain trusts or estates that such person has a substantial interest in and corporations or organizations in which an affiliate has a ten percent or greater equity interest may also be deemed affiliates of an issuer. (See Rule 144(a)(2)). Securities which have been acquired directly from the issuer or an affiliate of the issuer in a private transaction or chain of private transactions are designated as "restricted" securities. (See Rule 144(a)(3)).
Due to the restrictions on the sale of securities by affiliates, it is a common practice for public companies to issue "stop transfer" instructions to their transfer agents for all shares (regardless of how acquired) owned by their officers and directors, as well as their immediate families and controlled corporations, and to require all officers and directors to conduct public resales of shares only by means of the Commission's Rule 144 safe harbor (discussed more fully below). This procedure provides a company a degree of control over at least the sale side of its officers' and directors' trading activities in order that inadvertent insider trading and Section 16(b) problems may be avoided. Companies also place legends on certificates representing restricted shares of common stock in order to identify that the transferability of such certificates is restricted by law.
A nonaffiliate may sell restricted securities under the Rule 144 resale exemption. Such nonaffiliates, however, are limited only with respect to their privately acquired, or restricted, shares. If such persons own shares that were acquired in the public securities market, the resale restrictions do not apply to such shares. An affiliate may use the Rule 144 exemption whether selling restricted or unrestricted securities; provided, however, that the two year holding period discussed below does not apply to an affiliate selling unrestricted securities. The following five requirements must be satisfied before a person may safely rely on the Rule 144 exemption to avoid characterization as an underwriter and thereby sell securities without registration under the 1933 Act.
(i) Adequate Public Information: There must be available to the public adequate current information about the issuer. This requirement is satisfied for an issuer that has been subject to the periodic reporting requirements of the 1934 Act for at least ninety days preceding the contemplated sale of securities and has filed all the required reports for the twelve months preceding such sale. If an issuer is late in filing or fails to file, this public information requirement is not satisfied until such report has been filed.
(ii) Holding Period: To ensure that the holder of restricted securities is not acting as an underwriter for an issuer or an affiliate of an issuer, but has been subject to the full economic risks of investment, Rule 144 sets a mandatory holding period. Accordingly, any affiliate or nonaffiliate wishing to sell restricted securities must have beneficially owned such securities for at least one year preceding the sale. Where the securities were purchased, this one-year holding period begins to run at the date of purchase from the issuer or an affiliate of an issuer and only after the full purchase price for such securities has been paid. If the restricted securities were purchased with promissory notes, other obligations or installment contracts, Rule 144(d)(1) requires that the "promissory note, obligation or contract (i) provides for full recourse against the purchaser of the securities; (ii) is fully secured . . .; and (iii) shall have been discharged by payment in full prior to the sale of the securities." Where the securities were acquired in a transaction other than a purchase, such as by gift, the one-year holding period begins at the later of the date of acquisition of the securities from the issuer or the date of the acquisition from an affiliate of an issuer. Special tacking provisions under Rule 144(d)(3) permit a person to tack the time he or she has held certain restricted securities to either securities later acquired (i.e., restricted securities received as stock dividends, splits and recapitalizations) or to the holding period of another person (i.e., restricted stock received as a gift).
(iii) Limitation on the Volume of Securities Sold: The amount of securities sold by an affiliate and the amount of restricted securities sold by a nonaffiliate may not, during any three-month period, exceed the greater of (a) one percent of the outstanding securities of the class or (b) the average weekly trading volume in the security during the four calendar weeks preceding the sale. In measuring the volume of securities sold within any three-month period, the Commission may aggregate the securities sold by certain other persons that it deems to be the same person as the affiliate for purposes of Rule 144.
(iv) Manner of Sale: A seller may not solicit purchase orders. Rather, securities sold under Rule 144 must either be sold in brokers' transactions as defined by Section 4(4) of the 1933 Act or directly to a market maker. Section 3(a)(38) of the 1934 Act defines a market maker as "any specialist permitted to act as a dealer, any dealer acting in the capacity of block positioner, any dealer who, with respect to a security, holds himself out (by entering quotations in an inter-dealer communications system or otherwise) as being willing to buy and sell such security for his own account on a regular, continuous basis." In addition, Section 4(4) of the 1933 Act provides an exemption to the registration requirements for broker-dealers who function as brokers in "brokers' transactions executed upon customers' orders on any exchange or in the over-the-counter market but not the solicitation of such orders." Under this definition, if selling securities through a broker, a holder falls within the Rule 144 exception if the broker does no more that execute a sell order as the holder's agent and receives no more than the usual and customary commission.
(v) Notice of Sale: If during any three-month period the amount of securities sold exceeds five hundred shares or has an aggregate sales price exceeding $10,000, the seller must file three copies of a Form 144 at the time the seller places an order to sell or at the execution of a sale directly with a market maker. The Form 144 must be manually signed by the seller and at least one copy must be filed with the principal national securities exchange on which such securities are listed for trading and with the NASD for Nasdaq listed companies.
As an exception to the aforementioned requirements, the Commission adopted Rule 144(k), Rule 144(k) permits a holder of restricted securities who has not been an affiliate for the preceding three months to sell restricted securities without complying with the Rule 144 resale requirements if two years has elapsed since acquisition of the restricted securities from the issuer or an affiliate of the issuer. In such instances, any restrictive legends on such security may be removed.
Rule 144 relates solely to an exemption from the 1933 Act registration requirements. The antifraud provisions of the 1933 Act remain applicable whether or not registration is required with respect to any proposed sale. In addition, an exemption from the registration requirements under Rule 144 does not affect a person's exposure to the insider trading provisions, as discussed above. Thus, an exempt sale under Rule 144 may result in a short-swing profit recoverable by the company under Section 16(b) if the sale occurs within six months before or after the insider's purchase of a company's stock at a lower price. A securities transaction entered into while in the possession of material non-public information may also result in Rule 10b-5 liability.
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