SEC posts proposed revisions to Rules 144 and 145

By Cydney Posner

The SEC has posted its release proposing revisions to Rules 144 and 145.

The proposal would:

• Shorten the holding period requirement under Rule 144 for "restricted securities" of public reporting to six months;
• Extend the holding period for restricted securities of reporting companies for up to an additional six months commensurate with the amount of time the security holder has engaged in hedging transactions;
• Maintain the current one-year holding period for restricted securities of companies that are not subject to the Exchange Act reporting requirements;
• Reduce the restrictions on the resale of securities by non-affiliates;
• Simplify the Preliminary Note to Rule 144;
• Eliminate the manner of sale restrictions with respect to debt securities;
• Increase the Form 144 filing thresholds;
• Codify several staff interpretive positions that relate to Rule 144;
• Coordinate Form 144 and Form 4 filing requirements; and
• Amend Rule 145 to eliminate the presumptive underwriter position in Rule 145(c), except for transactions involving a shell company, and to revise the resale requirements in Rule 145(d).

General

Rule 144 provides a safe harbor from the definition of "underwriter" to assist security holders in determining whether the Section 4(1) exemption for any person other than an issuer, underwriter or dealer is available for their resale of securities. Currently, if the security holder is an affiliate of the issuer, or a non-affiliate that has held the restricted securities for less than two years, Rule 144 requires that:

• There be available adequate current public information about the issuer;
• If the securities being sold are restricted securities, the seller have held the security for a at least one year;
• The resale be within specified sales volume limitations;
• The resale comply with the manner of sale conditions; and
• The selling security holder file a Form 144.

Currently, under Rule 144, non-affiliates (who have not been affiliates during the prior three months) can resell restricted securities without limitation after two years.

The proposed rule changes are reflected in the chart below:

Simplification of the Preliminary Note and Text of Rule 144

No substantive changes are proposed for the preliminary note. Rather, the note and the text are proposed to be simplified and written in a language the SEC purports to be plain English.

Amendments to Holding Period Requirement in Rule 144(d) for Restricted Securities and Reduction of Requirements Applicable to Non-Affiliates

Six-Month Holding Period for Exchange Act Reporting Companies; Tolling Provision. The proposed amendments would reduce to six months the Rule 144(d) holding period for restricted securities of Exchange Act reporting companies held by affiliates and non-affiliates, so long as the holder has not engaged in hedging transactions with respect to the securities. (Public reporting companies must have been reporting for at least 90 days prior to the sale.) The holding period for restricted securities in non-reporting companies would remain at one year for affiliates and non-affiliates.

Assumption of the economic risk of investment is a critical factor in determining whether a security holder purchased the securities for distribution, and hedging activities can shift the economic risk of investment away from the security holder. Because the proposed shortening of the holding period requirement would make hedging arrangements significantly easier, the SEC is proposing to reintroduce a tolling provision that would toll the holding period for restricted securities of reporting companies while the security holder is engaged in hedging transactions. Hedging transactions would include short positions or any "put equivalent position," as defined by Exchange Act Rule 16a-1(h), with respect to the same class of securities (or in the case of nonconvertible debt, with respect to any nonconvertible debt securities of the same issuer). In the event that holding periods were being tacked to those of previous holders, a selling security holder would be required to determine whether previous owners had engaged in hedging activities. The applicable standard is one of "reasonable belief": the security holder could tack to his or her holding period the period for which the holder reasonably believed that the previous owner did not engage in hedging activities. However, in a somewhat conflicting footnote, the SEC advises that if the holder is unable to determine that the previous owner did not engage in hedging activities with respect to the securities, then the holder should omit the period for which the holder is not able to make that determination. The proposed rule would impose a one-year ceiling on the tolling provision, regardless of the holder’s hedging transactions. Form 144 would be amended to require information regarding any short or put equivalent position held with respect to the securities. In addition, as part of their "reasonable inquiry" requirement, brokers selling the shares in "brokers' transactions" would need to inquire regarding hedging transactions. The tolling provision would not apply to securities of non-reporting companies.

Significant Reduction of Requirements Applicable to Non-Affiliates. Currently, when selling restricted securities that have been held for between one and two years, non-affiliates are subject to all other applicable conditions of Rule 144. The SEC is proposing that persons who are not affiliates of the issuer at the time of the sale and have not been affiliates during the three months prior to the sale be permitted to resell their restricted securities after a six-month holding period, subject only to the current public information requirement of Rule 144 ( c). After one year, no restrictions would apply.

The proposed modifications are summarized in the chart below:

* The holding period may be longer than six months (but not longer than one year), depending on hedging activities.

Elimination of Manner-of-Sale Limitations for Debt Securities

Rule 144(f) currently requires that securities be sold in unsolicited "brokers’ transactions" or in transactions directly with a "market maker." The SEC believes that the fixed income securities market does not raise the same concerns regarding abusive transactions as the equities market and is therefore proposing that the manner-of-sale limitations not apply to resales of debt securities (which would include non-participating preferred stock, which has debt-like characteristics, and asset-backed securities). As a result, holders of debt securities would have the option to privately negotiate the resale of the securities.

Increase of the Form 144 Filing Thresholds

Since 1972, Rule 144(h) has required the filing of a Form 144 if the security holder’s intended sale exceeded either 500 shares or $10,000 within a three-month period. The SEC is now proposing to increase the Form 144 filing thresholds to trades of 1,000 shares or $50,000 within a three-month period for affiliates. (The Form 144 requirement would be eliminated for non-affiliates.) In addition, the SEC is soliciting comment on ways to coordinate the filing deadline and the Form 144 with the filing deadline and Form 4 so as to permit affiliates subject to Section 16 to satisfy both requirements at the same time.

Codification of Several Staff Positions

To make staff positions more transparent and readily available to the public, the SEC is proposing to codify seven of them:

Securities acquired under Section 4(6) of the Securities Act are considered "restricted securities." Section 4(6) exempts from registration offerings that do not exceed $5,000,000 that are made only to accredited investors, do not involve any advertising or general solicitation and for which a Form D has been filed. Because the SEC believes that resale status of securities acquired in Section 4(6) exempt transactions should be the same as securities received in other non-public offerings, the SEC proposing to codify its position that securities acquired under Section 4(6) should be defined as restricted securities for purposes of Rule 144.

Tacking of holding periods when a company reorganizes into a holding company structure. The SEC is proposing to codify Corp Fin's interpretive position that holders may tack the Rule 144 holding period in connection with transactions made solely to form a holding company if the following three conditions are satisfied:

• 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.

The SEC believes that tacking would be appropriate in these transactions because the securities being exchanged are substantially equivalent, and there is no significant change in the economic risk of the investment in the restricted securities.

Tacking of holding periods for conversions and exchanges of securities. The proposal would codify the staff's position that, if the securities sold were acquired from the issuer solely in exchange for other securities of the same issuer, the newly acquired securities would be deemed to have been acquired at the same time as the securities surrendered for conversion or exchange. However, in a change to its prior interpretive position, the proposal makes clear that, if the original securities do not, by their terms, permit cashless conversion or exchange and the parties amend the original securities to allow for cashless conversion or exchange and the holder provides consideration for the amendment (other than solely securities of that issuer), then the shares will be deemed to have been acquired on the date that the original securities were so amended.

Cashless exercise of options and warrants. The proposal would adopt and codify an analogous position with respect to the cashless exercise of options and warrants (other than employee options). Securities acquired in a cashless exercise would be deemed to have been acquired when the corresponding options or warrants were acquired unless the original options or warrants did not, by their terms, permit cashless exercise, and the holder provides consideration, other than solely securities of the issuer, to amend the options or warrants to permit cashless exercise. In that event, the options or warrants would be deemed to have been acquired on the date that the original options or warrants were so amended. However, options or warrants that were not purchased for cash or property, such as employee options, are not viewed by the SEC to create investment risk in the holder and, therefore, no tacking would be permitted. In that case, the underlying securities would be deemed to have been acquired on the date of exercise of the option or warrant, if the conditions of Rule 144(d)(1) and Rule 144(d)(2) were met at the time of exercise.

Aggregation of pledged securities. So long as the pledgees are not the same "person" under Rule 144(a)(2) and there is no "concerted action" by pledgees, in calculating the Rule 144 volume limitations, a pledgee of securities may sell the pledged securities without having to aggregate the sale with sales by other pledgees of the same securities from the same pledgor. The pledgee still must aggregate its sales with the pledgor’s sales.

Treatment of securities issued by "reporting and non-reporting shell companies." A "shell company" is a company, other than an asset-backed issuer, that has no or nominal operations and either:

• no or nominal assets;
• assets consisting solely of cash and cash equivalents; or
• assets consisting of any amount of cash and cash equivalents and nominal other assets.

Because the SEC views shell companies as possible vehicles for abuse, under the proposed rule, a person who wished to resell securities issued by a company that is, or was, a reporting or a non-reporting shell company, other than a business combination-related shell company, would not be able to rely on Rule 144 to sell the securities. However, Rule 144 would become available when:

• the issuer has ceased to be a shell company;
• the issuer is subject to the reporting requirements of Section 13 or 15(d) of the Exchange Act;
• the issuer 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
• at least 90 days have elapsed from the time the issuer filed with the SEC current "Form 10 information" (ordinarily filed on a Form 8-K) reflecting its status as an entity that is not a shell company.

These requirements are generally the same as those applicable to the use by shell companies of Form S-8. An affiliate selling control securities would have to wait at least 90 days before being permitted to resell the securities, and a holder selling restricted securities would be required to wait the duration of the holding period before being permitted to resell the securities.

Form 144 representations required from security holders relying on Exchange Act Rule 10b5-1(c ). Rule 10b5-1 defines when a purchase or sale constitutes trading "on the basis of" material nonpublic information in insider trading cases brought under Rule 10b-5. Rule 10b5-1(c) provides an affirmative defense that a person’s purchase or sale was not "on the basis of" material nonpublic information if, among other things, before becoming aware of material nonpublic information, the person enters into a binding contract or written plan to sell the securities. Corp Fin has permitted holders using Rule 10b5-1(c) to modify the Form 144 representation that he or she had no knowledge of material adverse information about the issuer at the time of execution of the Form to refer instead to the date on which the holder adopted the written trading plan or gave the trading instructions, specifying that date. Under the proposed amendments, Form 144 filers would be able to make the required representation as of the date that they adopted written trading plans or gave trading instructions that satisfied Rule 10b5-1(c).

Amendments to Rule 145

Rule 145(d) sets forth, for persons deemed underwriters, the restrictions on the resale of securities received in connection with reclassifications of securities, mergers or consolidations or transfers of assets that are subject to shareholder vote. The SEC is proposing to eliminate the presumptive underwriter and resale provisions in Rule 145 other than for business combinations involving shell companies. The proposed amendments would harmonize the requirements applicable to shell companies in Rule 145(d) with the proposed provisions in Rule 144.

That is, the "presumed underwriters" of a shell company would be permitted to resell their securities to the same extent that affiliates of a shell company would be permitted to resell their securities under Rule 144, as proposed.

Conforming and Other Amendments

Conforming amendments are proposed to Rule 701 and rules related to asset-backed securities.

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