20 March 2018
Rule 144 regulates the resale of two categories of securities-restricted securities and control securities. Restricted securities are securities acquired in a private placement without registration under the Securities Act of 1933, as amended (the “Securities Act”). Although it is not defined under Rule 144, the term “control securities” is commonly used to refer to securities held by an affiliate of the issuer, regardless of how the affiliate acquired the securities. Therefore, if an affiliate acquires securities in a private placement without registration under the Securities Act, those securities are both restricted and control securities. The resale of both restricted and control securities must be either registered under the Securities Act or qualify for an exemption from the registration requirements of that Act. The most common exemption relied on for the resale of restricted securities and control securities is Rule 144.
Amendments to Rule 144
The Securities and Exchange Commission (the “SEC”) recently adopted amendments to Rule 144, which became effective on February 15, 2008. The amendments were designed to enhance liquidity for non-affiliate holders of restricted securities and affiliate holders of restricted securities or control securities.
Relevance of Amendments to Corporate and Private Clients
The amendments to Rule 144 are relevant to corporations and private individuals in that the amendments:
- Shorten the holding period requirement for restricted securities of issuers that are subject to the reporting requirements of the Securities Exchange Act of 1934, as amended, to six months;
- Significantly simplify Rule 144 compliance by allowing non-affiliates of reporting companies to freely resell restricted securities after satisfying a six month holding period, provided the issuer has been a reporting company for 90 days prior to the Rule 144 resale, without satisfying any of the other Rule 144 requirements;
- Allow non-affiliates of non-reporting companies to resell restricted securities following a one-year holding period without having to comply with any Rule 144 conditions¹;
- Revise the “manner of sale” requirement for equity securities by permitting resale of these securities through certain “riskless principal transactions” in addition to the previously permitted brokers’ transactions;
- Eliminate the manner of sale requirement for debt securities and ease the volume limitations for resales of debt securities by affiliates (increased to 10% of a tranche (or class when the securities are non-participatory preferred stock), together with all sales of securities of the same tranche sold for the account of the holder within a three-month period);
- Revise Rule 144 filing requirements for sales by affiliates such that no report will be required for sales of less than 5,000 shares or $50,000 over a three-month period;
- Codify certain staff interpretations issued by the Division of Corporate Finance (the “Division”) regarding Rule 144, such as:
- when calculating the holding period of restricted securities of a holding company, holders may tack the period during which they held the restricted securities of a predecessor company before the predecessor company reorganized into a holding company structure,
- securities acquired in conversions or exchanges solely in exchange for other securities of the same issuer (without payment of additional consideration) are deemed to have been acquired at the same time as the securities surrendered for conversion or exchange, even where the securities were not convertible or exchangeable by their terms,
- securities acquired by cashless exercise of non-compensatory options or warrants are deemed to have been acquired when the corresponding options or warrants were acquired, even if the options or warrants originally did not provide for cashless exercise by their terms,
- a pledgee may sell pledged securities without having to aggregate the sale by other pledgees of the same securities from the same pledgor, as long as there is no concerted action by those pledgees and the pledgees are not the same person, and
- Rule 144 is not available for the resale of securities of reporting or non-reporting shell companies (other than a business combination related shell company); and
- Simplify and clarify the Preliminary Note to Rule 144 and text of Rule 144 and to incorporate plain English principles.
For a summary of the current rule and changes adopted in Rule 144, please see the chart in Appendix A.
Funds and their Partners
The amendments to Rule 144 have significant potential benefits; most notably, increased liquidity for private equity funds, venture capital funds, hedge funds and their respective members or partners. Below is a discussion of how the amendments to Rule 144 impact various types of funds and their respective members or partners.
The reduced six month holding period for non-affiliates will generate significant liquidity for funds, such as hedge funds, that do not meet the definition of an affiliate. Under the old Rule 144, non-affiliates were not permitted to resell restricted securities unless the securities were held for at least one year. Additionally, under the old Rule 144, resales by non-affiliates were subject to the four other requirements under the rule until the securities were held for two years. As summarized above, under new Rule 144, non-affiliates holding restricted securities of reporting companies can sell the securities without further restriction following a six-month holding period.
Venture capital and private equity funds and their respective general partners or managers are typically deemed to be affiliates of their respective portfolio company issuers. Affiliate status is usually determined in one of two ways:
- the SEC presumes affiliate status based on the ownership of at least 10% of the outstanding voting securities of the issuer; or
- when a person controls a fund, such as a member of the general partner or manager of such fund, and the person is also a director of the portfolio company issuer, the fund (as well as the general partner or manager) will be an affiliate.
Leveraged buyout funds are typically affiliates of issuers because they often will acquire more than 10% of the outstanding voting securities of the target issuer or will have a contractual right to a board seat which is filled by a member of the fund’s general partner or manager (and the general partner or manager, in turn, controls the fund). Limited partners or members of these funds, however, should not be deemed to be affiliates, unless they have some other relationship with the issuer, which would qualify such limited partner or member as an affiliate.
Affiliates need not despair; the amendments shorten the holding period for affiliates to six months. Rule 144 compliance for affiliates does, however, require fulfillment of the four other requirements specified under Rule 144 (see Appendix I), but the amendments relax the manner of sale requirement and notice requirements for affiliate resales. Holders may now sell restricted securities pursuant to Rule 144 through “riskless principal transactions” (generally, a transaction by a broker or dealer with another person to offset a contemporaneous purchaser or sale by the holder executed at the same price specified in a buy or sale order, exclusive of any explicitly disclosed markup or markdown, commission or other fee, so long as they can be reported by a self-regulatory organization as riskless). In addition, brokers may insert bid and ask quotations for the security in an alternative trading system, provided that the broker has published bona fide bid and ask quotations on each of the last 12 business days.
Fund managers often invest in various types of derivative securities which are exercised or converted into or exchanged for an underlying security. A question often arising in this context is whether or not a fund may tack the holding periods of the derivative security and its underlying security. For example, if a fund receives warrants from a private company which then goes public and the fund receives common stock from the cashless exercise of such warrants, the fund may tack the holding periods of the two securities (i.e., the common stock and warrants) such that the holding period is deemed to have commenced when the warrants were first acquired. However, if the holder provides other consideration to amend the warrants to provide for the cashless exercise, then the holding period commences as of the time of the amendment. Funds that acquire preferred stock that is convertible into common stock without the payment of additional consideration, whether such conversion is mandatory or at the option of the fund, may also tack the holding period of the preferred stock to that of the common stock in determining whether the holding period requirements of Rule 144 are satisfied.
When the fund later distributes shares of common stock to its partners or members without consideration and in accordance with the distribution provisions of the fund’s constitutive documents, the partners may also tack the holding period of the fund. Since the distribution is not a sale, there is no investment decision or assumption of new risk to cause a new holding period to commence.
Funds and their partners or members should also be aware that the SEC has adopted conforming amendments to other rules which may be relevant to funds and their partners or members, such as, among other things, the reduction of the one-year distribution compliance period under Regulation S for Category 3 U.S. reporting issuers to conform with the six-month Rule 144(d) holding period.
¹Although the Rule 144(e) volume limitations will no longer apply to resales of restricted securities by non-affiliates, an affiliate pledgor, donor or trust settlor will be required to aggregate the amount of securities sold for the account of a pledgee, donee or trust, as applicable, even when there is no concerted action in order to determine the amount of securities that is permitted to be sold under Rule 144.
Summary of Amendments to Rule 144 Regarding Resales of Restricted Securities
(and has not been an
affiliate during the prior
During six-month holding period – no resales permitted.After six-month holding period but before one year -unlimited public resales under Rule 144 except that the current public information requirement still applies.After one-year holding period – unlimited public resales under Rule 144; need not comply with any other Rule 144 requirements.
During one-year holding period – no resales permitted.After one-year holding period – unlimited public resales under Rule 144; need not comply with any other Rule 144 requirements.
(or person selling on
behalf of an affiliate)
During six-month holding period – no resales permitted.After six-month holding period – may resell in accordance with all Rule 144 requirements including: current public information, volume limitations, manner of sale requirements for equity securities, and filing Form 144.
During one-year holding period – no resales permitted.After one-year holding period – may resell in accordance with all Rule 144 requirements including: current public information, volume limitations, manner of sale requirements for equity securities, and filing Form 144.