What Is Rule 144?

Say you’re sitting down with an investor who wants to buy a certain amount of stock in your startup. One question this investor might ask is, “Hey, when might I be able to resell this stock if I wanted to?” If you’re an executive or director of the company and you own securities that you’re interested in selling, you might have the same question. The answer requires a solid understanding of Rule 144, an exemption that allows for the public resale of restricted and control securities — provided certain conditions are met.

Wait a second, you might be thinking, I need an exemption to sell my own securities? The fact is that all securities need to be registered with the SEC unless they qualify for an exemption. Rule 144 is one such exemption that allows for the sale of restricted and control securities without registration under specific conditions. The Rule 144 exemption isn’t the only means by which you can sell these types of securities, but it’s usually preferable to registering the securities with the SEC.

In this guide, we’ll review the basics of Rule 144 — what it is, who it applies to, and what you need to do to meet its conditions for exemption. Fair warning: the rules governing the sale and resale of restricted securities can get a bit complex. We recommend seeking a legal opinion from your corporate counsel or from an attorney familiar with securities law if you have any questions about the particulars.

• What is Rule 144? 
• 5 conditions for selling restricted or control securities 
• How to remove the restrictive legend before selling securities
• Keep track of regulatory requirements with Pulley

What is Rule 144?

To better understand the what and the why of Rule 144, let’s go back to 1933—the Securities Act of 1933, to be precise. This significant piece of federal legislation was the first to set forth that all offers and sales of equity securities must be registered with the U.S. Securities and Exchange Commission (SEC), unless specific exceptions apply. 

A major idea behind the Securities Act was that, by requiring companies to register securities and provide potential investors with relevant information via a prospectus and registration statement, the SEC could cut down on investor fraud. But the SEC also realized that there are certain circumstances that may call for an exemption from the Securities Act’s registration and reporting requirements.

SEC Rule 144 is one such exception. In fact, it’s the most commonly used exception allowing for the resale of restricted, unregistered securities in the public stock market. Rule 144 essentially provides a “safe harbor” for sellers of these types of securities—although only if certain conditions are met. 

Of course, it would probably help to define the types of securities Rule 144 covers before moving on, so let’s take a look at what exactly constitutes restricted and control securities.

What are restricted and control securities?

The SEC defines restricted securities generally as “securities acquired in unregistered, private sales from the issuing company or from an affiliate of the issuer.” A more specific definition can be found in the text of Rule 144(a)(3), which spells out exactly which types of sales produce restricted securities. These include:

• Securities acquired directly or indirectly from the issuer or from an affiliate of the issuer, in a transaction or chain of transactions not involving any public offering.
• Securities offered pursuant to Regulation D, which allows certain companies to offer and sell securities without registering them.
• Securities acquired by accredited investors through private placement offerings (i.e. not on the open market)
• Securities acquired through employee stock benefit plans, including stock option plans
• Securities acquired as compensation for professional services
• Securities acquired in exchange for an investment of startup capital in the company 

Control securities are a type of restricted security defined by the security holder, who must be an affiliate of the issuing company. When we say “affiliate” in this sense, we basically mean a person who has direct or indirect control over the company. A person may have direct control over a company if they have a position in management (e.g. Director) or on the executive committee. A security holder may be said to be an affiliate with indirect control if they own a certain percentage of voting securities in the company, or if they’re the spouse or relative of a key decision-maker at the company.

OK, so now we know what Rule 144 is and which types of securities it applies to. But there’s one other thing that nearly all restricted securities come with, and it plays a big role in limiting the resale of such securities. It’s called a restrictive legend.

What is a restrictive legend?

Restricted securities are usually stamped with a restrictive legend, which is a label indicating that the stock is restricted and thus is subject to certain sale requirements and restrictions. 

This one’s a tricky little guy, because it can prevent you from selling your restricted securities to the public even if you’ve satisfied the conditions of Rule 144. We’ll review what those conditions are next, and then we’ll discuss how to get the restrictive legend removed. For now, just know that it’s there and that it must be removed from the stock certificate prior to any sale of the security.

5 conditions for selling restricted or control securities

So you’re ready to sell your restricted or control securities on the public market? Great! Only…not so fast. In order to qualify for Rule 144’s safe harbor exemption, you’ll need to make sure that you satisfy the rule’s five major conditions:  

1. You must hold the securities for a certain period of time

Before selling any restricted securities on the open market, you’ll need to hold them for a minimum length of time referred to as the holding period. The clock on this holding period starts ticking on the day the securities are bought and paid for in full by the security holder. This “original date” continues to apply even if the securities are resold or gifted to another security holder from an affiliate; in other words, the clock doesn’t restart from zero just because the securities change hands. 

The specific holding period may depend on whether the company is a reporting company or not:

• If the company is a reporting company (i.e. it’s required to file regular reports with the SEC under the Securities Exchange Act of 1934), the minimum holding period is 6 months.
• If the company is a non-reporting company, the minimum holding period is 12 months.

Remember: this holding period only applies to restricted securities. If the securities were bought on the public stock market, there’s no holding period. The only exception would be if an affiliate of the issuing company bought shares on the public market, as those shares would then become control securities and would thus be subject to the other Rule 144 conditions in a public resale.  

2. There must be current public information about the issuing company

One reason why the Securities Act is such a big deal is that it requires companies to provide relevant (and readily available) information to investors. In a similar vein, for restricted securities to qualify for the Rule 144 exemption, the issuing company must have current and publicly available information that can be referenced prior to the sale of said securities.

This condition also looks a bit different depending on whether the company is reporting or non-reporting:

• Reporting companies typically must comply with the periodic reporting requirements of the Securities Exchange Act of 1934. 
• Non-reporting companies typically must provide the public with certain relevant information about the business and its officers and directors, along with verified financial statements.

3. You can only sell a certain number of shares as an affiliate

Affiliates of the issuing company are limited in terms of the number of securities they can sell within a certain time period. This limitation is based on a trading volume formula, which states that the number of securities sold in any three-month period can’t be greater than:

• 1% of the outstanding shares of the same class being sold, or
• 1% or the average reported weekly trading volume during the four weeks preceding the filing of a notice of sale on Form 144. (This one only applies if the class is listed on a stock exchange).

Over-the-counter (e.g. pink sheet) stocks can only be sold in accordance with this 1% trading volume formula.

4. The transactions must be ordinary and routine

This one is pretty straightforward: affiliates who plan to sell restricted shares must do it in a way that’s routine and not extraordinary. Importantly, this means that the broker of the transaction cannot receive a higher than normal commission on the sale. It also means that nobody involved in the transaction—not the buyer, not the seller—can actively solicit orders from folks who want to purchase the securities. 

5. You may need to file a Notice of Proposed Sale with the SEC

Affiliates who want to sell more than 5,000 shares (or sell shares whose aggregate sales price is greater than $50,000) in any three-month period will need to file a Form 144. Otherwise known as a Notice of Proposed Sale, Form 144 helps the SEC keep track of sales of a certain size that are planned for a certain time period. As such, anyone filing a Form 144 must have a bona fide intention to sell the securities within a reasonable time of filing. Form 144 can be filed in print or electronically via the SEC’s EDGAR database. 

How to remove the restricted legend before selling securities

If your proposed sale meets the above requirements, congratulations! You should be able to qualify for the Rule 144 safe harbor exemption and sell your restricted securities without the headache of registration. But as we mentioned earlier, you’re not out of the woods quite yet. You still need to have the restrictive legend removed from the certificate prior to the sale.

To do this, you’ll likely need to either:

• Reach out to the issuing company (or the transfer agent for its securities) and ask them about the specific process involved in removing the legend.
• Contact your broker (assuming you have one) and see if they can help you do the above. 

In any case, the two crucial parties involved in this process are the company and the company’s transfer agent. The transfer agent can remove a restrictive legend, but the company typically needs to provide explicit consent (i.e. in the form of an opinion letter from the company’s legal counsel) for the legend’s removal. 

It’s quite the process! If you’re sweating about it, reach out to an attorney familiar with securities law to help you through the steps.

Does the SEC resolve disputes over removing the restrictive legend?

You can perhaps imagine a scenario in which the company does not provide consent for the removal of a restrictive legend.

If this happens, the affiliate unfortunately cannot expect the SEC to intervene on their behalf. Legend removal is the stuff of state law, and the SEC is a federal regulatory agency. This means you’ll have to take it up with the company and/or explore your options for filing a dispute at the state level. Again, this is where an attorney can be a lovely asset.

Keep track of regulatory requirements with Pulley

As we noted above, complying with the Rule 144 holding period requirement is a key part of qualifying for the exemption. This means that it’s important for a company to know and track the original date of issuance for any securities it issues, regardless of whether those shares were subsequently resold or gifted in a secondary transaction.

Here’s the good news: Pulley’s cap table management platform tracks the Rule 144 date for you, leaving nothing up to chance or memory. And that’s not all we can do. Our compliance tools help startups and private companies cut through the complexity and prevent costly errors. And our admin controls ensure that the appropriate data is available to employees and investors. Schedule a call with one of our experts today and learn what we can do for you.

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