The Removal Of Restrictive Legends From Stock Certificates: How To Comply With Rule 144 As A Non-Affiliate

How to Comply with Rule 144 as a Non-Affiliate

What is Rule 144?

Rule 144 under the Securities Act of 1933 is enforced by the Securities and Exchange Commission (“SEC”). When a shareholder acquires restricted securities or holds control securities, the shareholder must find an exemption from the SEC’s registration requirements in order to sell the securities in a public marketplace. One exemption is found under Section 4(a)(1), allowing shareholders to sell restricted or control securities in a public sale when specific conditions laid out in Rule 144 are met.

The specific conditions that must be met to rely on Rule 144 depend on whether or not the holder is an affiliate; this depends on the control that the individual/company has on the issuer company. Typically, affiliates are officers, directors, and 10% shareholders. Their shares are called “Control Securities” and have restrictions placed in them when sold to non-affiliates.

How do shareholders acquire restricted securities?

Shareholders often acquire restricted securities in two ways:

1. Private placement offerings, Regulation D offerings, or employee stock option plans, as compensation for services rendered or in exchange for providing start-up capital to the Company.[1] These are unregistered, private transactions that restrict stock from being sold in the public marketplace.
2. The shareholder buys securities from a controlling person or affiliate. Even if the securities were not restricted in the affiliate’s hands, they become restricted through the sale because they are control securities.

When securities are restricted, a restrictive legend is usually stamped on the back of the stock certificate, prohibiting its sale in the public marketplace unless they are registered with the SEC or are exempt from the registration. When a buyer acquires control securities, the stock certificate is not usually stamped with a restrictive legend but the restrictions still apply.

Rule 144 Non-Affiliate Conditions

For a non-affiliate to sell their restricted stock on the public marketplace using Rule 144, they must meet these conditions:

1. The shareholder must satisfy the holding period by holding the shares for a certain period of time.[2] If the company is a “reporting company” and is subject to the reporting requirements of the Securities Exchange Act of 1934, then the seller must hold the securities for at least six months. If the company is not subject to reporting requirements, then the shares must be held for at least one year.
   • Tacking can help a non-affiliate shareholder satisfy the holding period. If an individual or entity purchases restricted securities from another non-affiliate, the shareholder can tack on their holding period to the non-affiliate’s holding period.
2. There is adequate current information about the company publicly available. For reporting companies, this means compliance with the periodic reporting requirements of the Exchange Act.[3] For non-reporting companies this means that company information is publicly available, including information regarding the nature of its business, the identity of its officers and directors, and its financial statements.[4]

Rule 144 can be used to sell restricted or control securities of the company in the public marketplace, provided certain conditions are met. If you’re an affiliate within the meaning of Rule 144, then you will be subject to additional requirements. Oftentimes the company’s transfer agent will require a Rule 144 legal opinion letter stating that these requirements have been satisfied before the restrictive legends can be removed.

Wilson Bradshaw LLP is a boutique securities law firm in Irvine, California and New York City. We help individuals remove the restrictive legends on the back of their stock certificates in order to sell the securities in the public marketplace by providing Rule 144 legal opinions. We restrict our practice to securities law, focusing on private and public offerings and SEC enforcement work.

[1] Rule 144(a)(3).

[2] Rule 144(d).

[3] Rule 144(c)(1).

[4] Rule 144(c)(2).