SEC posts release regarding revisions to Rules 144 and 145 // Cooley // Global Law Firm

By Cydney Posner

The SEC has posted the 110-page adopting release related to the final revisions to Rules 144 and 145. The amendments will become effective 60 days after publication in the Federal Register. The amendments shorten the Rule 144 holding period requirement for "restricted securities" of public reporting companies, reduce the restrictions applicable to the resale of securities by non-affiliates, simplify the Preliminary Note to Rule 144, amend the manner of sale requirements and eliminate them with respect to debt securities, amend the volume limitations for debt securities, raise the Form 144 filing thresholds, codify several staff interpretive positions, eliminate the presumptive underwriter provision in Rule 145 (except for transactions involving a shell company), and revise the resale requirements in Rule 145(d).

Background

Section 4(1) of the Securities Act provides an exemption from registration for transactions by any person other than an issuer, underwriter or dealer. Rule 144 creates a safe harbor from the painfully broad definition of "underwriter" to provide some assurance in determinations of whether the 4(1) exemption is available for the resale of securities. Rule 144 applies to the resale of both restricted securities and control securities. Restricted securities are securities acquired pursuant to one of the transactions listed in Rule 144(a)(3). The term "control securities," although not defined, generally refers to any securities held by an affiliate of the issuer. A security holder selling either control or restricted securities that satisfies all of the applicable conditions of the rule is deemed not to be engaged in a distribution (another painfully broad definition) and, therefore, not an "underwriter," within the meaning of the 4(1) exemption. The conditions include the following:

Adequate current public information about the issuer;
For restricted securities, satisfaction of a specified holding period;
Resale within specified volume limitations;
Compliance with the manner of sale requirements; and
Filing of a Form 144 if the amount of securities being sold exceeds specified thresholds.

In addition, Rule 144(k), as it existed before the current amendments, permitted a non-affiliate to publicly resell restricted securities without satisfying those conditions if the securities had been held for two years or more and the security holder was not, and, for the three months prior to the sale, had not been, an affiliate of the issuer.

Simplification of the Preliminary Note and Text of Rule 144

The preliminary note to the rule has been revised to simplify it, but not to change its substance.

Amendments to Holding Periods for Restricted Securities

Six-Month Rule 144(d) Holding Period Requirement for Exchange Act Reporting Companies

The amendments include, as proposed, a reduced, six-month holding period for securities of reporting companies. The SEC believes 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 reduced holding period is intended to facilitate capital raising, while maintaining investor protection, perhaps allowing some companies to avoid costly financing structures (like death-spiral preferred). Restricted securities of non-reporting issuers, that is, issuers that have not, or have not been for a period of at least 90 days before the Rule 144 sale, subject to the reporting requirements of Section 13 or 15(d) of the Exchange Act, will continue to be subject to a one-year holding period requirement. The SEC did not adopt the proposal that would have tolled the holding period if the security holder had engaged in certain hedging activities or the related proposal to reflect short or put-equivalent positions on the Form 144. (The primary reason given was the complexity that would have been added by the proposed tolling provision and the costs involved to monitor hedging transactions, which would have frustrated the SEC's objective of streamlining Rule 144 and reducing the cost of capital raising.) However, the issue will be revisited if the staff observes abuse relating to the hedging activities of holders of restricted securities. (The staff has previously stated that, with respect to short sales in reliance on Rule 144, where the borrower closes out using restricted securities, all the conditions of Rule 144 must be met at the time of the short sale. For purposes of Section 5, in a short sale, the sale of securities occurs at the time the short position is established, rather than when shares are delivered to close out that short position.)

Significant Reduction of Conditions Applicable to Non-Affiliates

Under the amendments as adopted, once the applicable holding period has been satisfied, a non-affiliate will be permitted to freely resell restricted securities without condition, except that, with regard to the resale of securities of a reporting issuer, the current public information requirement in Rule 144(c) will apply for an additional six months after expiration of the initial six-month holding period. Therefore, a non-affiliate will no longer be subject to the Rule 144 conditions relating to volume limitations, manner of sale or Form 144. (Interestingly, the release notes that the SEC generally believes that most abuses in sales of unregistered securities involve affiliates and shell companies.) Although the Rule 144(e) volume limitations will no longer apply to resales of restricted securities by non-affiliates, an affiliate pledgor, donor or trust settlor will be required to aggregate the amount of securities sold for the account of a pledgee, donee or trust, as applicable, even when there is no concerted action, in accordance with Rule 144(e)(3)(ii), (iii), and (iv), in order to determine the amount of securities that is permitted to be sold under Rule 144.

In a footnote, the SEC advises that it will not object if issuers remove restrictive legends from securities held by non-affiliates after all of the applicable conditions in Rule 144 have been satisfied. However, the SEC notes that the removal of a legend is a matter solely in the discretion of the issuer of the securities, and disputes about the removal of legends are governed by state law or contractual agreements, rather than federal law.

Below is a table summarizing the revised Rule 144 conditions:

Amendments to the Manner of Sale Requirements Applicable to Resales by Affiliates

Before the current amendments, the manner of sale requirements in Rule 144(f) required securities to be resold in unsolicited "brokers’ transactions" or in transactions directly with a "market maker." The revisions to Rule 144 include two amendments to the manner of sale requirements designed to better reflect current trading practices and venues. (Remember that the manner of sale requirements now apply only to affiliates.)

First, Rule 144(f) is being revised to permit the resale of securities through "riskless principal transactions" in which trades are executed at the same price, exclusive of any explicitly disclosed markup or markdown, commission equivalent or other fee, and the rules of a self-regulatory organization permit the transaction to be reported as riskless. A "riskless principal transaction" is defined as "a principal transaction where, after having received from a customer an order to buy, a broker or dealer purchases the security as principal in the market to satisfy the order to buy or, after having received from a customer an order to sell, sells the security as principal to the market to satisfy the order to sell." As with agency trades, under the revised rule, the broker or dealer conducting the riskless principal transaction must meet all the requirements of a brokers’ transaction, as defined by Rule 144(g), except the requirement that the broker does no more than execute the order to sell the securities as agent for the person for whose account the securities are sold. The broker or dealer may not solicit or arrange for the solicitation of customers’ orders to buy the securities in anticipation of or, in connection with, the transaction, must receive no more than the usual and customary markup or markdown, commission equivalent or other fee, and must conduct a reasonable inquiry regarding the underwriter status of the person for whose account the securities are to be sold.

Second, the definition of "brokers’ transactions" in Rule 144(g) is being amended to provide that the posting of bid and ask quotations in alternative trading systems will not be deemed to be a prohibited solicitation under the rule. The new provision will permit a broker to insert bid and ask quotations for the security in an alternative trading system, as defined in Rule 300 of Reg ATS, provided that the broker has published bona fide bid and ask quotations for the security in the alternative trading system on each of the last 12 business days.

Changes to Rule 144 Conditions Related to Resales of Debt Securities by Affiliates

Elimination of Manner of Sale Requirements for Resales of Debt Securities. The amendments eliminate the manner of sale requirements for resales of debt securities held by affiliates, as proposed. (Remember that the manner of sale requirements will no longer apply to the resale of securities by a non-affiliate. The manner of sale requirements also will not apply to securities sold for the account of the estate of a deceased person or for the account of a beneficiary of such estate, provided that the estate or beneficiary is not an affiliate of the issuer.) "Debt securities" are defined in Rule 144(a), as in Reg S, to include non-participatory preferred stock (which has debt-like characteristics) and asset-backed securities (where the predominant purchasers are institutional investors including financial institutions, pension funds, insurance companies, mutual funds and money managers), in addition to other types of nonconvertible debt securities. "Non-participatory preferred stock" is defined as non-convertible capital stock the holders of which are entitled to a preference in payment of dividends and in distribution of assets on liquidation, dissolution or winding up of the issuer, but are not entitled to participate in residual earnings or assets of the issuer.

Increased Volume Limitations for Debt Securities. The amendments also raise the Rule 144(e) volume limitations for debt securities. Prior to the current amendments, the amount of securities sold in a three-month period could not exceed the greater of (1) 1% of the shares or other units of the class outstanding as shown by the most recent report or statement published by the issuer, or (2) the average weekly volume of trading in the securities over the four-week period preceding the sale. However, these volume limitations seriously constrain the ability of holders to resell debt securities. To address this problem, the amendments add an alternative to Rule 144(e) to permit the resale of debt securities (or non-participatory preferred stock or asset-backed securities) in an amount that does not exceed 10% of a tranche (or class when the securities are non-participatory preferred stock), together with all sales of securities of the same tranche sold for the account of the selling security holder within a three-month period.

Increase in the Thresholds that Trigger the Form 144 Filing Requirement for Affiliates

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 amendments raise the dollar threshold to $50,000 and the share threshold to 5,000 shares, rather than the proposed 1,000 shares. The SEC expects to issue a release in the future to provide affiliates that are subject to both the Form 4 and Form 144 filing requirements with greater flexibility in satisfying these requirements.

Codification of Several Staff Positions

To make staff positions more transparent and readily available to the public, the SEC is codifying 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 million 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 the 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 is codifying, through amendments to Rule 144(a)(3), 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 codifying, in an amendment to Rule 144(d), 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 were 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 received 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 these 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 had no significant assets other than securities of the predecessor and its existing subsidiaries and had substantially the same assets and liabilities on a consolidated basis as the predecessor had before the transaction.

The SEC believes that tacking is 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 amendment to Rule 144(d)(3)(ii) codifies 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, even if the securities surrendered were not convertible or exchangeable by their terms. However, if the surrendered securities originally did not provide for cashless conversion or exchange by their terms and the holder provided consideration, other than solely securities of the same issuer, in connection with the amendment of the surrendered securities to permit cashless conversion or exchange, then the newly acquired securities would be deemed to have been acquired at the same time as the amendment to the surrendered securities, so long as, in the conversion or exchange, the securities sold were acquired from the issuer solely in exchange for other securities of the same issuer.

Cashless exercise of options and warrants. New Rule 144(d)(3)(x) codifies an analogous position with respect to the cashless exercise of options and warrants (other than employee options). Under the new rule, if the securities sold were acquired from the issuer solely upon the cashless exercise of options or warrants issued by the issuer, the newly acquired securities will be deemed to have been acquired at the same time as the exercised options or warrants, even if the options or warrants exercised originally did not provide for cashless exercise by their terms. However, if the options or warrants originally did not provide for cashless exercise by their terms and the holder provided consideration, other than solely securities of the same issuer, in connection with the amendment of the options or warrants to permit cashless exercise, then the newly acquired securities will be deemed to have been acquired at the same time as the amendment to the options or warrants, so long as the exercise itself was cashless. Employee options are not viewed by the SEC to create investment risk in the holder and, therefore, no tacking would be permitted. Accordingly, a note to the rule provides that if the options or warrants are not purchased for cash or property and do not create any investment risk to the holder, as in the case of employee stock options, the newly acquired securities will be deemed to have been acquired at the time the options or warrants are exercised, so long as the full purchase price or other consideration has been paid 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, under a new amendment to Rule 144(e), 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 new Rule 144(i), Rule 144 will not be available for the resale of securities initially issued by either a reporting or non-reporting shell company (other than a business combination-related shell company) or an issuer that has been at any time previously a reporting or non-reporting shell company, unless the issuer is a former shell company that meets all of the conditions discussed below. Note that the resale of securities is not prohibited under Rule 144(i) if the securities were not initially issued by a reporting or non-reporting shell company or an issuer that has been at any time previously such a company, even when the issuer is a reporting or non-reporting shell company at the time of sale. The release makes clear that Rule 144(i)(1)(i) is not intended to capture a "startup company," or a company with a limited operating history, in the definition of a reporting or non-reporting shell company, because those companies should not meet the condition of having "no or nominal operations."

Rule 144 would become available for the resale of restricted or unrestricted securities that were initially issued by a shell company if the following conditions were met:

The issuer of the securities that was formerly a reporting or non-reporting shell company has ceased to be a shell company;
The issuer of the securities is subject to the reporting requirements of Section 13 or 15(d) of the Exchange Act;
The issuer of the securities has filed all reports and material required to be filed under Section 13 or 15(d) of the Exchange Act, as applicable, during the preceding 12 months (or for such shorter period that the issuer was required to file such reports and materials), other than Form 8-K reports; and
At least one year has elapsed from the time that the issuer filed current Form 10-type information (required by Form 8-K) with the SEC reflecting its status as an entity that is not a shell company (note the modification to one year from the proposed three months).

The Form 10 information will be deemed filed when the initial filing is made with the SEC, rather than when the staff has completed its review of the filing.

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 amendments to Form 144, filers of the form would 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 resale applicable to securities received in connection with reclassifications of securities, mergers or consolidations or transfers of assets that are subject to shareholder votes. Rule 145(c) deems persons who were parties to such transactions, other than the issuer, or affiliates of such parties to be underwriters. The amendments to Rule 145 eliminate the presumptive underwriter and resale provisions in Rule 145 other than for business combinations involving shell companies. With respect to Rule 145(a) transactions that are exempt under 3(a)(10), if any party to the transaction is a shell company, then any party to the transaction, other than the issuer, and its affiliates will be permitted to resell its securities in accordance with Rule 145(d). The release notes that the staff intends to issue a revised Staff Legal Bulletin No. 3 concurrently with the effective date of the amendments that will address the treatment of parties that have acquired securities in a 3(a)(10) transaction.

Under the amendments to Rule 145, if the issuer has met the requirements of new paragraph (i)(2) of Rule 144 (relating to shell companies discussed above):

the persons and parties deemed underwriters will be able to resell their securities subject to paragraphs (c), (e), (f), and (g) of Rule 144 after at least 90 days have elapsed since the securities were acquired in the transaction;
after six months have elapsed since the securities were acquired in the Rule 145(a) transaction, the persons and parties will be permitted to resell their securities, subject only to the Rule 144(c) current public information condition, provided that the sellers are not affiliates of the issuer at the time of sale and have not been affiliates during the three months before the sale; and
after one year has elapsed since the securities were acquired in the transaction, the persons and parties will be permitted to resell their securities without any limitations under Rule 145(d), provided that they are non-affiliates at the time of sale and have not been affiliates during the three months before the sale.

Conforming and Other Amendments

Conforming amendments were adopted to Reg S relating to the distribution compliance period for category three issuers, Rule 701(g)(3) and rules related to asset-backed securities.

SEC posts release regarding revisions to Rules 144 and 145

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