On June 22, 2007, the Securities and Exchange Commission (the "SEC") proposed amendments to Rules 144 and 145 promulgated under the Securities Act of 1933 (the "Securities Act"). Rules 144 and 145 provide safe harbors for resales of securities that satisfy certain conditions. If adopted, the proposals will enhance liquidity for holders of "restricted securities" by shortening holding periods and reducing the conditions applicable to public resales, especially for security holders not affiliated with the company issuing such securities.
Under the Securities Act, any offer or sale of securities in interstate commerce or by use of the U.S. mails must be registered unless an exemption is available. Routine sales of securities by investors are generally made under Section 4(1) of the Securities Act, which provides an exemption for transactions not involving the issuer, an underwriter or a dealer. Since a person seeking to resell securities is not the issuer, and is not a dealer unless he is in the business of dealing in securities, the question arises, is the seller an underwriter? In particular, this question arises when the seller acquired the securities from the issuer directly or in a series of private transactions; these securities are referred to as "restricted securities."
The Securities Act defines an underwriter as "any person who has purchased from an issuer with a view to, or offers or sells for an issuer in connection with, the distribution of any security, or participates or has direct or indirect participation in any such undertaking." Rule 144 was adopted in 1972 to provide a safe harbor from the definition of "underwriter" and facilitate the determination by security holders as to whether the Section 4(1) exemption was available for the resale of restricted securities. Assuming a selling security holder satisfies the applicable conditions of Rule 144 in connection with a resale of restricted securities, he or she is deemed not to be an "underwriter" and the Section 4(1) exemption would be available for the resale.
The SEC last made major changes to Rule 144 and Rule 145 (discussed below) in 1997. At that time, the required holding period under Rule 144 for the resale of "restricted securities" was shortened. Before the 1997 amendments, an affiliate or non-affiliate of the issuer could resell restricted securities, subject to certain limitations, after the seller (together with certain predecessors who were not affiliates of the issuer — so-called "tacking") had held the securities for two years, and a non-affiliate (who had not been an affiliate during the three months prior to the sale) could resell restricted securities without limitation after the seller (together with such predecessors) had held the securities for three years. The 1997 amendments changed these two-year and three-year periods to one-year and two-year periods, respectively, and made tacking considerably easier.
The issue of whether a seller may be an underwriter also arises in the context of mergers, reclassifications and similar transactions. Specifically, Rule 145 provides that exchanges of securities in connection with reclassifications of securities, mergers or consolidations, or transfers of assets that are subject to a shareholder vote constitute a sale of these securities, and Rule 145(c) presumptively deems that, with the exception of the issuer, all persons who were parties to such transaction or affiliates of such parties are underwriters. The resale of such securities by such deemed underwriters is subject to certain restrictions set forth in Rule 145(d), similar to the restrictions of Rule 144.
The SEC now proposes to further shorten the Rule 144 holding periods for affiliates and non-affiliates, substantially reduce the restrictions on resales by non-affiliates after they have satisfied the shortened holding period, eliminate the "presumptive underwriter" provision in paragraph (c) of Rule 145 and change the resale provisions in Rule 145(d) to conform to the changes to Rule 144.
Current Limitations of Rule 144 and SEC's Proposed Amendments to Rule 144
Under current Rule 144, a selling security holder will be deemed not to be engaged in a distribution of securities, and therefore not an underwriter with respect to such securities, provided certain criteria are satisfied. The Section 4(1) exemption from registration will then be available for such resale. If the seller is an affiliate of the issuer, or a non-affiliate that has held the restricted securities for at least one year, these criteria include:
- Certain information about the issuer must be publicly available;
- The number of securities to be resold must fall within specified volume limitations;
- The resale must comply with "manner of sale" conditions, generally requiring that the securities be sold in ordinary brokerage transactions; and
- The seller may be required to file a Form 144 reporting the sale (or proposed sale).
Currently, if the security holder has held the security for at least two years (subject to the same tacking rules) and is not, and for the prior three months has not been, an affiliate of the issuer, such security holder may publicly resell restricted securities without being subject to the other limitations above.
Under the proposed amendments, the holding period under Rule 144 for "restricted securities" of issuers that are subject to the reporting requirements of the Securities Exchange Act of 1934 (the "Exchange Act") would be shortened to six months for affiliates and non-affiliates. This proposed six-month holding period for restricted securities, however, would be subject to a tolling provision that would extend the holding period, for up to an additional six months, by the amount of time a holder of such securities has engaged in a hedging transaction1. The current one-year holding period would continue to apply to restricted securities issued by non-reporting companies, but the tolling provision would not apply.
The proposals would also simplify compliance with Rule 144 by both affiliates and non-affiliates of the issuer. Under the proposed amendments, a non-affiliate holder of restricted securities of a reporting company could resell such securities after the new six-month holding period, subject to the tolling provision described above and satisfaction of the current public information requirement regarding the issuing company. The volume limits, manner of sale limits and filing of Form 144 would not apply. Non-affiliates holding restricted securities of a non-reporting company could resell those securities without any additional conditions under Rule 144 after a one-year holding period rather than the current two-year period. An affiliate could resell restricted securities of a reporting company after the shortened six-month holding period, subject to the tolling provision and satisfaction of the current Rule 144 requirements, except that the SEC also proposes to eliminate the manner of sale requirements for resale of debt securities. Despite the tolling provision, in no event would the holding period exceed one year.
For security holders who are affiliates of the issuer, the proposals would also raise the thresholds for the Form 144 notice filing requirement and eliminate the existing manner of sale conditions for resales of debt securities. Currently, Rule 144(h) requires a selling security holder to file a Form 144 if such holder's intended sale exceeds either 500 shares or $10,000 within a three-month period. The proposals would increase the Form 144 filing thresholds to trades of 1,000 shares or $50,000 within a three-month period for affiliates. No Form 144 filing would be required for security holders who are not affiliates of the issuer.
Proposed Changes to Rule 145
The proposals would also amend Rule 145 to make conditions on resales of securities received in business combination transactions less restrictive. The proposed amendments would eliminate the presumed underwriter provision in Rule 145(c) except with regard to most transactions involving a "shell company" and would harmonize the requirements in Rule 145(d) with the proposed provisions in Rule 144 that would apply to the securities of shell companies.
Codification of Several Staff Interpretative Positions
The proposals also would codify several staff interpretative positions, the most significant of which include:
1. Tacking of holding periods when a company reorganizes into a holding company structure
As was also proposed in 1997, the SEC again proposes codifying the Staff's interpretive position that holders may tack their Rule 144 holding periods in connection with transactions undertaken solely to form a holding company. Under this provision, tacking of the holding period would be permitted if:
- The newly formed holding company's securities are issued solely in exchange for the securities of the predecessor company as part of a reorganization of the predecessor company into a holding company structure;
- Security holders receive securities of the same class evidencing the same proportional interest in the holding company as they held in the predecessor company, and the rights and interests of the holders of such securities are substantially the same as those they possessed as holders of the predecessor company's securities; and
- Immediately following the transaction, the holding company has no significant assets other than securities of the predecessor and its existing subsidiaries and has substantially the same assets and liabilities on a consolidated basis as the predecessor had before the transaction.
2. Tacking of holding periods for conversions and exchanges of securities
The SEC also proposes, as it did in 1997, codifying the Staff's position that, if securities were acquired from the issuer solely in exchange for other securities of the same issuer, the newly acquired securities should be deemed to have been acquired at the same time as the securities surrendered for conversion or exchange, even if the securities surrendered were not convertible or exchangeable by their terms. However, a note to this provision is proposed that clarifies that the shares will be deemed to have been acquired on the date that the original securities were amended to permit cashless conversion or exchange if:
- The original securities do not permit cashless conversion or exchange by their terms;
- The parties amend the original securities to allow for cashless conversion or exchange; and
- The security holder provides consideration, other than solely securities of the issuer, for that amendment.
3. Cashless exercise of options and warrants
The SEC proposes to codify the Staff's position that, upon a cashless exercise of options or warrants, the newly acquired underlying securities are deemed to have been acquired when the corresponding options or warrants were acquired, even if the options or warrants originally did not provide for cashless exercise by their terms. As above, if the original options or warrants do not permit cashless exercise by their terms, and the holder provides consideration, other than solely securities of the issuer, to amend the options or warrants to allow for cashless exercise, the options or warrants would be deemed to have been acquired on the date that the original options or warrants were so amended.
In addition, the rule would codify the Staff's position that the grant of certain options or warrants that are not purchased for cash or property, such as employee stock options, does not create any investment risk and, therefore, in a cashless exercise of such options or warrants, the holder would not be allowed to tack the holding period of the option or warrant and would be deemed to have acquired the underlying securities on the date the option or warrant was exercised and the underlying shares of common stock were fully paid for.
4. Treatment of securities issued by "reporting and non-reporting shell companies"
The staff had previously taken the position that Rule 144 was not available to securities issued by "blank check" companies. A blank check company is a company that: (1) is in the development stage; (2) has no specific business plan or purpose, or has indicated that its business plan is to merge with or acquire an unidentified third party; and (3) issues penny stock. The SEC now proposes to broaden this so that Rule 144 would not be available for the resale of securities issued by any "shell company," which includes blank check companies. A shell company is a registrant, other than an asset-backed issuer, that has: (1) no or nominal operations and (2) either: (a) no or nominal assets; (b) assets consisting solely of cash and cash equivalents; or (c) assets consisting of any amount of cash and cash equivalents and nominal other assets.
In 2000, the SEC concluded that Rule 144 is not available for the resale of securities issued by companies that are, or previously were, blank check companies. The SEC is proposing to codify this position with some modifications. The Staff interpretation would be modified to address securities of companies meeting the definition of "shell company." Under the proposed rule, in most instances, a person who wishes to resell securities issued by a shell company would not be able to rely on Rule 144 to sell the securities.
Although the SEC had originally extended the ban on Rule 144 reliance for companies that had been blank check companies even if they no longer were, the SEC has now concluded that, because the reasons for prohibiting reliance on Rule 144 do not appear to be present after a reporting company has ceased to be a shell company, reliance on Rule 144 for resales by a security holder would be permitted when: (1) the issuer of the securities that was formerly a reporting or non-reporting shell company has ceased to be a shell company; (2) the issuer of the securities is subject to the reporting requirements of Section 13 or 15(d) of the Exchange Act; (3) the issuer of the securities has filed all reports and material required to be filed during the preceding 12 months (or for such shorter period that the registrant was required to file such reports and materials); and (4) at least 90 days have elapsed from the time the issuer files current "Form 10 information" (information ordinarily filed on a current report on Form 8-K) with the Commission reflecting its status as an entity that is not a shell company.
5. Representations required from security holders relying on Exchange Act Rule 10b5-1(c)
Rule 10b5-1 under the Exchange Act defines when a purchase or sale constitutes trading "on the basis of" material nonpublic information in insider trading cases brought under Exchange Act Section 10(b) and Rule 10b-5. Under Rule 10b5-1, a purchase or sale of a security of an issuer is "on the basis of" material nonpublic information about that security or issuer if the person making the purchase or sale was aware of the material nonpublic information when the person made the purchase or sale. However, Rule 10b5-1(c) provides an affirmative defense that a person's purchase or sale was not "on the basis of" material nonpublic information. For this defense to be available, the person must demonstrate that:
- before becoming aware of the material nonpublic information, he or she had entered into a binding contract to purchase or sell the securities, provided instructions to another person to execute the trade for the instructing person's account or adopted a written plan for trading the securities;
- the contract, instructions or written trading plan satisfy the conditions of Rule 10b5-1(c); and
- the purchase or sale that occurred was pursuant to the contract instruction or plan.
Form 144 currently requires a selling security holder to represent, as of the date that the form is signed, that he or she "does not know any material adverse information in regard to the current and prospective operations of the issuer of the securities to be sold which has not been publicly disclosed." The staff has previously indicated that a selling security holder who satisfies Rule 10b5-1(c) may modify this representation to indicate that he or she had no knowledge of material adverse information about the issuer as of the date on which the holder adopted the written trading plan or gave the trading instructions, specifying that date and indicating that the representation speaks as of that date.
The proposals would codify this interpretive position by modifying Form 144 to state that a filer who is relying on Rule 10b5-1(c) makes the required representation as of the date that the filer adopted the written trading plan or gave the trading instructions that satisfy Rule 10b5-1(c).
If adopted, the proposed amendments to Rules 144 and 145 would improve liquidity for affiliate and non-affiliate holders of restricted securities. The holding period for restricted securities would be shortened to six months, subject to a tolling provision for the amount of time a holder of such securities engaged in a hedging transaction. The proposals would also eliminate the presumptive underwriter provisions of Rule 145, thereby facilitating the resale of restricted securities received in business combination transactions. The proposal would also codify several staff interpretative positions, thus providing more accurate guidance to security holders.