Rule 144 (#94)
/In this podcast episode, we discuss the intricacies of Rule 144, which governs the sale of restricted shares. Key points made are noted below.
I’ve been talking a lot lately about registering stock. Rather than stringing out the topic, I’m going to polish it off in this episode and the next one. The next episode will be about Rule 10b5-1.
Overview of Rule 144
So, what is Rule 144? This is an important one. And even if you don’t have any particular need to know about it as an accountant, you may very well want to know about it as an investor – because a lot of people use it.
So let’s say that you own stock in a public company, but that stock is not registered, so you can’t sell it. And you want to sell it. If you flip over the stock certificate and take a look at the back, it probably has a legend on it – right in the middle – that says the shares have not be registered, so they can’t be sold, pledged or hypothecated.
Now I didn’t have a clue what hypothecated meant – maybe something to do with aggressive hyphenation – so I looked it up. The definition is “hypothecation describes the posting of collateral to secure the customer's obligation to the broker.” So, you can’t do that, either.
Rule 144 Requirements
You want to remove that pesky legend, so you can sell the shares. You do it with Rule 144. The SEC has a couple of requirements, and if you meet these items, then you can have the legend removed. Here’s the first one:
And it’s the most important one – there’s a holding period. You must have owned the securities for at least six months, and that’s if the company has been issuing its normal reports to the SEC, like the annual Form 10K and quarterly Form 10Q. If the company has not been keeping up with these filings, then the holding period is a year. So, this is the big one. If you’ve held onto your shares this long, and you’re not an affiliate of the company, then you’re basically in good shape, and you can have that legend removed.
Ah, but what if you’re an affiliate? An affiliate is someone who’s in a control position.
The real definition is kind of lengthy, but basically it’s people who can directly affect company operations, like board members, the CEO, CFO, division presidents, and people who own more than 10 percent of the company.
If you’re an affiliate, then things become a lot more restrictive. I won’t quite go so far as to say that you’re screwed, but it is a lot more difficult to sell your shares. So let’s return to those SEC requirements. We’re now at rule number two.
For affiliates, there’s a trading volume formula, which means that the SEC is going to make you string out your stock sales. The rule states that the amount of shares you can sell in a three-month period can’t exceed the greater of 1% of the total outstanding shares, or (if the stock trades on an exchange) the average weekly trading volume during the past four weeks.
So for this rule, if the stock is trading on an exchange, chances are good that the trading volume will be high enough that it drives the number of shares you can sell. But if the shares only trade on the Pink Sheets, then the second part of the rule doesn’t apply, and you can only sell an amount equal to 1% of the total shares in any three-month period.
And then we have the third rule, which also only applies to affiliates. They’re only allowed to sell their shares through a broker as a routine trading transaction. This one means that the SEC doesn’t want affiliates trying to solicit orders to buy their stock.
And then we have the final and fourth rule, which is that an affiliate has to file any proposed sale with the SEC on a Form 144. This is only if the sale is for more than 5,000 shares or the dollar amount is for more than $50,000, and this filing is for any three-month period. If you keep selling past the three month period, then you keep amending the Form.
So, you can see that being an affiliate is a bit of a pain. But there is a way out of these affiliate rules. If you’ve held those shares for at least a year, and you’ve not been an affiliate for at least the last three months, then you can sell without all of those extra conditions. And if the company is still filing all of the usual reports with the SEC, then the holding period drops from a year to just six months.
So that covers all of the rules. Let’s say that you meet all of the requirements – how do you get that pesky legend off the back of the certificate?
How to Remove the Certificate Legend
Here’s the procedure. First, send the certificate to a broker. The broker contacts the company’s attorney, and asks for an opinion letter. The attorney will want a standard representations letter from the broker, and a copy of the certificate, and the Form 144, if there has to be one.
Then the attorney writes the opinion letter and sends it back to the broker. The attorney will also send a copy of the letter to someone at the company, so the company knows you’re probably going to be selling shares.
Once the broker receives the opinion letter, he sends it and the stock certificate and some other information to the company’s stock transfer agent. And after all of those steps, the stock transfer agent creates a new stock certificate without the restrictive legend, and sends it to the broker.
At that point, you can go out and buy a stiff drink – and you can finally sell the shares.
Parting Thoughts
Though – to be fair – most of this discussion has been about the extra rules for company affiliates. If you’re not an affiliate, then Rule 144 is pretty awesome. You just hold the shares for the minimum amount of time, and then you get the legend removed and sell the shares. Nice.
And that’s how people can sell restricted stock. As you may have noticed, Rule 144 is really for investors, not the company. The only real impact on the company is that the attorney who handles the opinion letters is probably going to charge the company for having issued the letters, and that may be a couple of hundred dollars for each letter.