PLAYING BY THE RULES, PART I

RULE 144 - ONE YEAR AND COUNTING

With this article, we begin a new series of features focusing on federal and state rules that govern securities transactions. We intend to provide an overview of these areas to help our readers navigate the marketplace. We encourage investors to explore these subjects in greater detail – by reading the rules, regulations and procedures; asking questions of their brokers and investment advisors; and, where appropriate, discussing these matters with an attorney or accountant.

Most investors have heard of Rule 144, or references to so-called "Rule 144 stock." But what is Rule 144 and how does is work?

First, however, investors should understand what "restricted" securities are, and how they are affected by Rule 144.

Why should a public customer care about either concept? After all, most investors buy and sell their shares freely on public stock exchanges or through electronic trading systems. It may seem, therefore, that the limitations imposed upon restricted shares are someone else’s problem.

Or are they? After all, companies frequently announce that they have acquired a business, hired a consultant or merged operations in exchange for issuing "restricted" shares of their stock. Public investors need to be concerned about the issuance of these restricted shares. After all, their interest in the company is likely to be diluted once those shares become unrestricted.

Why are some securities "restricted" while others are not? The federal securities laws provide, in general, that securities may not be sold in public transactions unless they have first been registered with the Securities & Exchange Commission or qualify for an exemption from registration. Securities that have never been included in a registration statement are considered "restricted." They cannot be sold to the public unless they are subsequently registered or an exemption from registration applies.

Sometimes a company issuing "restricted" shares agrees to register those securities in the future. In those cases, the securities are said to have "registration rights." This may occur when shares are transferred as consideration for a merger or acquisition, or when an employee or consultant receives stock in exchange for services. Investors can generally determine whether such "registration rights" exist by reviewing the company’s public filings. Failing that, they can attempt to obtain this information by contacting the company’s investor relations department.

Just because some securities do not have "registration rights" however, does not mean that they can never be sold to the public. Instead, they must qualify for one of the accepted registration exemptions. Perhaps the best known of these is the exemption afforded by Rule 144 to the Securities Act of 1933.

Although we will discuss those provisions in a general sense, this article does not provide a complete summary of every section of Rule 144 and investors should not rely upon the following synopsis when making investment decisions. For complete details, investors should read the rule carefully. The text can be obtained from the U.S. Government Printing Office at http://www.gpo.gov/ under Title 17, Part 230.144 of the Code of Federal Regulations.

A fundamental premise underlies the securities laws – investors must have access to adequate information. When securities are registered for sale, current data about a company becomes immediately available to the public. In the absence of such information, the securities laws strive to prevent shares from finding their way into the public marketplace.

Even where such information is available, the securities laws restrict sales of unregistered shares by "underwriters." What is an underwriter? While the definition typically describes an investment banking firm that undertakes to sell a company’s securities to the public, it also includes certain individual investors. Individuals may be considered "underwriters" if they acquire securities with a view toward participating in the "distribution" of those securities to the general public.

But how is it possible to determine an individual’s intent? Regulators consider a number of factors, including the holding period for securities, the number of shares sold and the circumstances of the stockholder. And, finally, they consider the availability of public information since, in the end, information is the ultimate protection against fraud.

Rule 144 responds to these concerns. It contemplates the public resale of restricted securities that have been held for a sufficient period of time, when adequate public information about a company is available. More specifically, it provides that all of the following conditions must be met before restricted securities can be sold to the public:

1. Holding Period. When investors hold shares for a specified period of time they bear the economic risk of their investment – the value of those shares may increase or decrease over that time. By holding those shares, the investor tends to demonstrate that he or she did not acquire the securities in order to distribute them to the public.

After One Year

Rule 144 does not simply permit the unlimited sale of restricted securities after one year. It places strict limits on the number of shares that can be sold after that holding period has run.

The number of restricted shares (or other securities) a person sells under Rule 144 may not, when combined with all other sales by that person within the preceding three months, exceed the greater of: (i) one percent of the outstanding shares; (ii) the average weekly reported volume of trading in such securities on all national stock exchanges or automated quotation systems during the previous four weeks; or (iii) the average weekly volume of trading for those securities as reported through certain trade reporting systems approved by the SEC during such four week period.

After Two Years

These volume limitations disappear once the restricted shares have been held for more than two years. After two years, there are no further volume limitations on sales of restricted shares under Rule 144 – unless the seller is an affiliate of the issuing company or has been an affiliate within three months prior to making a sale. Affiliates must continue to abide by the volume limits.

3. Availability of Current Public Information.

Rule 144 is not a one-trick pony. These holding periods do not automatically entitle a stockholder to sell restricted securities. First, there must be adequate public information available about the issuer of the restricted securities. What will suffice? The specific reporting requirements can be found in the text of Rule 144. In essence, they provide that: (i) the issuer must be a reporting company (a public company that regularly files reports with the SEC); (ii) which has previously registered securities for sale to the public; and (iii) which has filed all required reports, including financial statements, during the twelve months immediately preceding the proposed sale.

If the issuer does not file regular reports with the SEC, shares may still be sold under Rule 144 if there is adequate information available to the public, including details of the company’s business, its management, and its financial condition and performance over a two year period.

4. Manner of Sale.

If restricted shares meet all of the requirements of Rule 144, they may be sold through brokers or to market makers. There are, however, also limitations on the conduct of brokers. For instance, they may not solicit potential buyers in anticipation of a Rule 144 sale.


One more thing. Sellers must file a form, called a Form 144, with the SEC if they are planning to sell more than five hundred restricted shares, or expect to receive over $10,000 for their shares. That way the public will know in advance when a significant number of additional shares is likely to enter the market.


So remember, even restricted shares can find there way into the public float. When they are sold will they affect the value of your shares? That, of course, will depend on a variety of factors, including the number of restricted shares being sold, the size of the public float, and the issuer’s financial condition. Investors will have to assess that impact on a case-by-case basis. Fortunately, Rule 144 is fashioned so that there is enough public information for that analysis. In the meantime, as always, the buyer should be wary.

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