On December 6, the SEC announced in Release No. 33-8869 the adoption of revisions to Rules 144 and 145 under the Securities Act of 1933. The changes, which will become effective on February 15, 2008, liberalize many limitations on sales of “restricted securities” and securities held by affiliates, and codify various interpretations by the SEC staff.
Paramount among the revisions is a reduction from one year to six months in the holding period required for restricted securities sold by affiliates and non-affiliates of reporting companies. Nonaffiliates of these companies that meet the six-month holding period requirement and have not been affiliates during the preceding three months will be able to sell their restricted securities without any limitation, other than the issuer’s compliance with the reporting requirements of the Exchange Act during the six months following satisfaction of the six-month holding period requirement. Affiliates also will benefit from the reduced holding period, but will continue to be subject to the volume and other restrictions of the rule, as now amended, that historically have been applicable to their sales of restricted and other securities. The changes to Rule 145 eliminate presumptive underwriter status for affiliates of all companies (other than shell companies) that acquire securities in a Rule 145 business combination or similar transaction. The effect is to relieve these persons of the need to comply with certain restrictions of Rule 144 that formerly applied.
Sales Under Rule 144 of Restricted Securities and Securities Held by Affiliates
Rule 144 provides a safe harbor from registration under the Securities Act for sales of restricted securities and securities held by affiliates that satisfy all applicable conditions of the rule. (Restricted securities are securities acquired from the issuer or an affiliate in a private offering or one of the several other types of exempt offerings specified in the rule.) In addition to recasting the rule in plain English, the amendments will have the effects indicated below.
The SEC amended the Preliminary Note to Rule 144 to explain more clearly the rule’s theoretical basis and principal effects. Although the Preliminary Note remains lengthy, it affirms the following important principles:
- The rule provides a safe harbor from the definition of the term “underwriter” for a seller that complies with all applicable conditions;
- The buyer will receive securities that are not restricted, and
- The rule is not the exclusive means of selling restricted or affiliate securities.
The inclusion of the last item enabled the SEC to delete former paragraph (j) of the rule, which expressed the same position. The SEC also added to the Preliminary Note a statement found in other safe harbor rules under the Securities Act, which is that the rule is not available with respect to any transaction or series of transactions that, although in technical compliance with the rule, is part of a plan or scheme to evade the Act’s registration requirements.
The SEC expanded the definition of “restricted securities” in Rule 144(a)(3) to codify a staff position that securities acquired from the issuer in an offering to accredited investors that is exempt under Section 4(6) of the Securities Act are included in the definition.
Conditions to be Met
Non-Affiliates. As a result of the amendments, a non-affiliate will no longer be subject to the Rule 144 conditions relating to volume limitations, manner of sale requirements, and the filing of a notice of sale on Form 144. The revised rule provides that non-affiliates that have held restricted securities of a reporting company for at least six months and have not had an affiliate relationship with the issuer during the preceding three months may sell their securities without restriction or limitation, other than that the issuer must be in compliance with the rule’s current public information requirements during the six months following satisfaction of the six-month holding period requirement. (A reporting company is one that has been subject to the reporting requirements of Section 13 or 15(d) of the Exchange Act for at least 90 days.) A holding period of one year will apply to a non-affiliate’s sales of restricted securities of a non-reporting company, which, after the expiration of the holding period, will not be subject to any of the rule’s requirements.
The SEC based the reduction of the holding period on its belief that “a six-month holding period for securities of reporting issuers provides a reasonable indication that an investor has assumed the economic risk of investment in the securities.” The principal effect of this change is the elimination of former paragraph (k), which permitted non-affiliates that had not been affiliates during the preceding three months to sell without restriction after a two-year holding period. The SEC declined to adopt a proposal that would have tolled (or suspended) the holding period for up to six months for any period in which the holder had engaged in hedging activities. It felt that the proposal would unnecessarily complicate Rule 144, based on comments that there was no strong evidence that hedging activities had been abusive in the context of the rule, and that security holders and intermediaries would incur significant costs in complying with the tolling provision.
Affiliates. The revised rule will permit affiliates to sell restricted and other securities in accordance with the traditional conditions of the rule, including the current public information requirement, the limits on the amount that can be sold, and the requirement that the securities be sold in brokers’ transactions or in transactions directly with a market maker. The six-month and one-year holding period requirements, however, will apply only to restricted securities, and the requirement to file a notice of sale on Form 144 will apply only if the higher filing thresholds discussed later in this SEC Update are exceeded.
In addition to the reduction of the holding periods mentioned earlier, the SEC codified the following helpful interpretations previously issued by its staff.
Conversion or Exchange. A holder of restricted securities acquired from the issuer solely in exchange for other securities of the same issuer may “tack” the holding period of the surrendered securities to that of the newly acquired securities, even if the securities were not convertible or exchangeable by their terms. Tacking will not be permitted, however, where the surrendered securities were amended to allow for cashless conversion or exchange and the holder provided consideration other than solely securities of the issuer for the amendment.
Cashless Exercise of Options or Warrants. A person who acquires restricted securities upon a cashless exercise of options or warrants may tack the holding period of the options or warrants to that of the newly acquired securities, even if the options or warrants originally did not provide for cashless exercise by their terms. Tacking, however, will not be permitted where (1) the options or warrants were amended to allow for a cashless exercise and the holder provided consideration other than solely securities of the issuer for the amendment, or (2) the options or warrants were not purchased for cash or property and did not create any investment risk to the holder (as in the case of option grants under any employee benefit plan).
Formation of Holding Company. A holder of restricted securities of a company that is reorganized into a holding company structure may tack the holding period of the predecessor company’s securities to that of the holding company’s securities where security holders receive securities of the same class evidencing the same proportional interest, and the holding company has substantially the same assets and liabilities on a consolidated basis as the predecessor company immediately after the transaction.
The limits on the amount of securities sold under the rule will apply only to affiliates. One significant change is the adoption of an alternative volume limitation for debt securities that will permit up to 10% of a tranche to be sold during a three-month period. The SEC took this action in response to comments that the former volume limitations effectively precluded sales of debt securities by affiliates. Another important change is the addition of a note codifying a staff position that a pledgee of securities need not aggregate its sales with sales by other pledgees of the same borrower unless the pledgees are acting in concert.
Manner of Sale
The SEC amended the manner of sale requirements of Rule 144 to apply only to sales of equity securities by affiliates. Sales of debt securities (a term that includes non-equity securities, non-participating preferred stock, and asset-backed securities) will not be subject to the manner of sale requirements. The SEC also refined the requirements in two respects to “better reflect current trading practices and venues.” First, “riskless principal transactions” executed at the same price must meet specified requirements. Second, the posting of bid and ask quotations in an alternative trading system will be deemed not to involve a solicitation of a buy order that will violate the rule.
Notice of Sale
The amendments apply the requirement to file a notice of sale on Form 144 only to affiliates, unlike the predecessor requirement that applied the requirement to all sellers whose sales exceeded the filing threshold. Further, in a long overdue move, the SEC increased the threshold for filing the notice for the first time since the rule’s adoption in 1972. The new threshold will require the filing of a notice only where the amount to be sold during a three-month period exceeds 5,000 shares or other units (rather than 500) or $50,000 (rather than $10,000).
The SEC also amended Form 144 to codify a staff interpretation that a seller that has adopted a written Rule 10b5-1 trading plan or given a trading instruction under Rule 10b5-1 may indicate on the form that the representation required by the form as to lack of knowledge of any material adverse information regarding the issuer is made as of the date of adopting the trading plan or giving the instructions.
The SEC received a number of responses to its request for comments on whether it should coordinate the Form 144 filing requirements with the Form 4 filing requirements applicable to affiliates subject to Section 16 of the Exchange Act. Although it decided not to adopt any changes to the filing requirements at this time, the SEC said that it expected to issue a separate release in the future to provide affiliates subject to both filing requirements with greater flexibility in satisfying them.
The SEC added a new paragraph (i) to Rule 144 to codify a staff position that the rule is not available for sales of the securities of a “shell company,” which is a company with no or nominal operations and non-cash assets. Securities of companies that formerly were shell companies, however, may be sold under the rule if specified Exchange Act disclosure conditions, including a one-year waiting period after Form 10 information is filed with the SEC, are met.
Conforming Changes to Regulation S and Rules 190 and 701
To implement fully the changes to Rule 144, the SEC made conforming changes to Regulation S relating to foreign offerings, Rule 190 relating to asset-backed securities, and Rule 701 relating to offers and sales pursuant to compensatory benefit plans of non-reporting companies.
Rule 145 Sales
Rule 145(d) provides that parties (other than the issuer) to a Rule 145 transaction and their affiliates are deemed to be underwriters of the securities acquired in the transaction and must comply with the restrictions on sales of those securities set forth in the rule. Transactions subject to Rule 145 include reclassifications, mergers, consolidations and transfers of assets subject to a vote of security holders. The SEC now believes that the presumptive underwriter provision of Rule 145(d) “is no longer necessary in most circumstances.” Based on its experience with abusive sales practices by shell companies, however, the SEC decided to continue applying the presumptive underwriter provision to Rule 145 transactions involving shell companies and their affiliates and promoters. Consistent with this approach, the SEC also adopted revisions that harmonize the requirements of Rule 145(d) with the Rule 144 changes.
The changes to Rules 144 and 145 are significant and should achieve their stated purpose of increasing the liquidity of privately sold securities and decreasing the cost of capital for all issuers. The amendments provide a welcome relaxation of requirements that had become more burdensome than necessary. Newly public companies, companies with active acquisition programs and other companies with significant amounts of outstanding restricted stock should consider how the easing of resale restrictions will affect the risks of perceived or actual selling pressure on their shares and how any changes in risk should be addressed in public disclosures.
Action remains to be taken on the issue of combining Form 144 with Form 4. There are various possibilities for achieving an effective combination of the two forms, so the hope is that the SEC will act sooner rather than later on this issue.