Selling Restricted Securities - Rule 144 Letter

If you invested in a company and received "restricted" securities (usually stock, but possibly notes or partnership units), you need to comply with the federal securities laws before you can sell or transfer the securities.

By default, the federal law requires that when a company (referred to as the "issuer") sells its securities, the offer and sale must be "registered" with the Securities and Exchange Commission ("SEC"). Over the years, Congress has given us exceptions to that general registration requirement in order to encourage investment in small and medium-sized businesses.

Registering a securities offering is expensive. In general, it requires the issuing corporation to file a detailed offering statement with the SEC, and publish an investor prospectus including detailed disclosures regarding the issuer's property and business operations, the industry in which it operates, general and specific risks of investing, the market for the company's stock, detailed financial information, and various other matters. Legal and accounting costs are substantial.

Registering a securities offering can cost anywhere from $20,000 to more than $1 million, depending on such factors as the size of the company, the complexity of its business operations, its financial history, and various other matters. Recognizing that cost, Congress has enacted laws that allow "small company" issuers an exemption from the registration requirements, provided that the issuer complies with certain rules intended to protect the investors.

If you invested in a private placement you received "restricted securities." You can recognize restricted securities by the presence of the printed or stamped word "RESTRICTED" on the faces of the share certificates, and also a "restrictive legend" on the reverse sides. This legend is usually printed in red ink (or occasionally in some other distinctive color) to make it conspicuous against the other printed text on the page. The legend informs you that the securities represented by the certificate were acquired in an unregistered transaction. The exact wording used may vary somewhat from one issuer to the next, but the following is typical:

THE SECURITIES REPRESENTED BY THIS CERTIFICATE HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED ("THE ACT") OR ANY OTHER SECURITIES LAWS AND MAY NOT BE OFFERED FOR SALE, SOLD, TRANSFERRED, ASSIGNED, HYPOTHECATED OR OTHERWISE DISPOSED EXCEPT (1) UPON EFFECTIVE REGISTRATION OF THE SECURITIES UNDER THE ACT AND OTHER APPLICABLE SECURITIES LAWS COVERING SUCH SECURITIES OR (2) UPON ACCEPTANCE BY THE COMPANY OF AN OPINION OF COUNSEL IN SUCH FORM OR BY SUCH COUNSEL, OR OTHER DOCUMENTATION, AS IS SATISFACTORY TO COUNSEL FOR THE COMPANY TO THE EFFECT THAT SUCH REGISTRATION IS NOT REQUIRED.

In addition, you will find similar language within the contract or subscription agreement you signed at the time of investing. That way the issuer ensures that the investor understands the restricted nature of the stock being purchased since typically, certificates may not be printed and delivered for one to several weeks after the stock is purchased and paid for.

The bottom line is that the restricted securities have to be held by the original investor for a minimum amount of time before they can be sold, transferred, or used as collateral for a loan. That's how the SEC ensures that the restricted securities were indeed acquired as an "investment" and not just to circumvent the registration requirement. And the logical way to enforce the holding period is to have the issuer itself restrict transfer of the stock certificates, since any change in ownership of a certificate has to go through the issuing corporation in order to be recorded on the issuer's stock records. If an attempt is made to convey a certificate that is not eligible to be resold, the company will intercept and prevent the trade.

So what is the mandatory holding period for restricted securities? Happily, it's not that onerous, but the best answer is, "it depends." There are several factors to consider. The first step is to determine if you are "affiliate" of the issuer. An affiliate is someone who has the power to exercise some control over the management of the issuing corporation. Typically, these are directors, executive officers, and large shareholders, but also might include a voting trust (a group of shareholders who have agreed to vote their shares in the same way) if the aggregate total of the voting shares is significant. If you are an affiliate, several requirements in addition to holding period apply.

Most "passive" investors, such as friends-and-family, seed money investors, and investors in publicly traded development-stage companies, are non-affiliates. In that case, the minimum holding period depends upon whether the issuer is a "reporting company" under the Securities Exchange Act of 1934. Reporting companies file quarterly, annual, and other periodic reports with the SEC that are available to the public. These reports provide current information on the company's business, finances, management, stock trading activity, and other matters. If you own restricted securities in a reporting company, you need only hold the securities for SIX MONTHS before they are eligible to be resold to the public. The holding period begins on the date the securities were purchased and fully paidt for, not necessarily the date the certificate was printed and delivered.

But being "eligible" for resale is only the first step. You still have to satisfy the issuer's requirements for getting the restrictive legend removed from the certificates before you can sell the securities in a public market. That means you have to obtain a letter from an attorney who practices securities law. The letter is commonly called an "opinion of counsel" or an "opinion letter," wherein the attorney attests that upon his/her inquiry and professional judgment, the certificates can legally have the legend removed and the shares can be resold to the public. (In lawyer-speak, we call this a "Rule 144 letter"). Then the certificates are tendered to the company's stock transfer agent along with the opinion letter, and the transfer agent will issue new certificates without the restrictive legend. Once you have legend-free certs, you can deposit them with any broker for resale, pledge them as security for a loan, or give them as gifts.

If the issuing corporation is NOT a reporting company under the Exchange Act, you may still be able to get the legend removed so long as the financial and other information on the issuer is publicly available, such as when companies whose stock trades in the over-the-counter market publicize their information. In that case, though, the minimum holding period is a full year, rather than six months. If you received the securities as or from an "affiliate," legend removal is a bit more complex, and you should seek professional advice.

In any case, Nevada Business Law Group can assist with the documentation necessary to allow you to resell your restricted stock. Give us a call for a no-charge consultation.