Last year I discussed the legal requirements under Section 4(1) that an investor would have to follow in a sale of private company stock to another investor. I also wrote a post on the judicial construct referred to as Section 4(1½) under which founders and other affiliates can sell some of their control shares to an investor if they follow the practices the issuer would use in a 4(2) private placement. This is all fine and good if the seller can find a buyer on his own and the two of them can come to mutually satisfactory terms. However, what if the seller either can’t or doesn’t want to make the effort to find a buyer. Can that seller just go to a broker?
Rule 144 of the Securities Act of 1933 is a safe harbor for a public resale of restricted or control shares using a broker under Section 4(a)(1). Of course, this means that there is already a market for the stock, and that usually means that the issuer is an SEC reporting company and the seller is holding restricted shares. Shares are restricted if they have not been registered, even though the company itself may be registered and trade on a stock exchange, such as NYSE or NASDAQ. In addition, some unregistered companies have quoted stock prices and sufficient information may be publicly available for over-the-counter trading to be permitted.
If the issuer is a reporting company, and the securities have been held for more than one year, shares can be resold freely under Rule 144. If the securities have been held for more than six months but less than one year, they may be resold freely so long as there is current public information available about the issuer. If the issuer is not a reporting company, the securities may not be resold until they have been held for one year, after which time they may be freely resold if they are not control shares.
Rule 144 cannot be used to sell control shares if the Company is not a reporting company. It is theoretically possible for an issuer to meet that requirement simply by making public the required information. As a practical matter, it rarely is met other than by companies who are required to file reports with the SEC, usually as a result of having securities registered under the Exchange Act.
If the Company is a reporting company, holders of control shares (that is, affiliates of the issuer) may not sell more than a certain amount during any three-month period. That amount may not exceed the greater of 1% of the outstanding shares of the same class being sold, or if the class is listed on a stock exchange, the greater of 1% or the average reported weekly trading volume during the four weeks preceding the filing of a notice of sale on Form 144. Control shares in over-the-counter stocks, including those quoted on OTC Markets can only be sold using the 1% measurement.
If the seller holds stock certificates with restrictive legends on them, the broker will need to contact the issuer’s transfer agent to get the legends removed so that the stock can be traded in book entry form as if the shares were registered. This will involve the seller completing a form in which the seller represents that he is or is not an affiliate and that the appropriate holding periods have run, among other things. If the seller is an affiliate, he will need a securities lawyer to give a formal legal opinion and help comply with insider trading laws, volume restrictions and filing a Form 144. If the seller is not an affiliate, the transfer agent may still require a legal opinion. However, the issuer may be set up to provide support to the selling stockholder so that he does not need to retain his own attorney.
John A. Myer is a corporate and securities lawyer with Myer Law PLLC in Seattle, Washington. This posting does not constitute legal advice.