Now that the stock markets are heating up in Israel and the United States, I thought it was time to review with those Israeli managers and investors the above rule of the Securities and Exchange Commission ("SEC"), just to make sure no one finds herself or himself in trouble when they try to sell restricted shares, that is,unregistered shares acquired in a private placement with a restrictive legend.
So let's back up in the story.
To raise money in the United States, as most readers will know, Israeli companies need to use a prospectus. This is part of the registration process with the SEC, which reviews the statement and makes it effective. I discussed this way back, under the heading "IPO". The Securities Act of 1933, as amended, covers the need for this, while the Exchange Act of 1934, as amended, covers the trading and activities of the company once it is public.
But let's say a company wants to raise money without having to go to a formal registration statement, which can be expensive, and wants to do a private placement. I also discussed the concept of a private placement in a previous article in the series, on "Raising Finance". You find yourself buying into a company making a private placement. The company tells you that it has found an exemption from the obligation to file a registration statement at this time with the SEC in order to sell you these shares. The company uses a Regulation D offering, which I also discussed in previous articles on "Raising Finance", and issues you some shares under this exception or another.
Now here you are with a bundle of shares of this Israeli company which is considered a foreign private issuer. You probably signed a series of contracts and documents to get these shares, paid your money, and received the share certificates that are not registered shares. You look at the certificate and find a legend stating that these are restricted shares. You sort of understood this, since this is the game you were willing to play to buy in early with a company and hopefully make some money when the shares are eventually registered and the company enjoys business success.
Just so you understand where the company was coming from… according to the SEC, the company was selling you the securities and asking you to agree not to resell them. Actually, by not registering the shares, the company made sure you could not go the stock market and sell these shares. Why? Because as I mentioned above, the company would have had to give you a securities prospectus meeting SEC requirements, and it did not want to do that at this time for a whole bunch of reasons, such as not allowing you to make a quick gain on the sale of shares while the company is trying to build the volume of shares that will eventually be traded.
Moreover, if you bought the securities with the intent to resell, you would then be considered by the SEC as an underwriter, who bought with the intent to distribute the shares. Instead of having a registration statement filed with the SEC to cover these shares, you would be allowing them to make their way into the market place in the United States without the usual safeguards of information and regulation that the SEC requires to protect American investors when they consider buying shares of a company. The company and you would be in "hot water" with the SEC. Actually, mostly you, since you sort of replaced the company as the "distributor" of shares.
The SEC was aware a long time ago about the problems the requirement of registration causes for companies that want to raise private equity at the beginning of their life cycle or for other reasons, and thirty years ago, it came up with Rule 144. The rule has undergone certain changes since. Rule 144 is really called "Persons Deemed Not to Be Engaged in a Distribution and Therefore Not Underwriters."
But before we get into Rule 144 and the conditions, we need to make quite sure you understand what "Restricted Securities" are. To recap, these are the shares that you buy in a private placement that come with the restricted legend, and securities acquired from the issuer or an affiliate in a transaction or chain of transactions not involving any public offering. Another scenario is one in which an executive of a public company buys some of his company's own shares (he is considered an affiliate and his shares are considered controlled shares) in an open market transaction, and wants to sells the securities on the open market. He has to comply with Rule 144 and the volume limitations which we discuss later on, since he is an affiliate.
But more than this, and this is the point that escapes most people, if this executive sells the shares in a private placement transaction to a non-affiliate, the securities are "restricted", meaning that the holder or buyer will have to meet Rule 144 to resell the securities on the open market if these securities are not registered. But if the executive has registered these shares under an effective registration statement, he is not subject to the volume limitations of Rule 144.
The legend on the Restricted Shares and its removal
SEC states the following: "If you acquire restricted securities, you almost always will receive a certificate stamped with a "restricted" legend. The legend indicates that the securities may not be resold in the marketplace unless they are registered with the SEC or are exempt from the registration requirements. The certificates of control securities are usually not stamped with a legend.
"Even if you have met the conditions of Rule 144, you can't sell your restricted securities to the public until you've gotten the legend removed from the certificate.
"Only a transfer agent can remove a restrictive legend. But the transfer agent won't remove the legend unless you've obtained the consent of the issuerusually in the form of an opinion letter from the issuer's counselthat the restricted legend can be removed. Unless this happens, the transfer agent doesn't have the authority to remove the legend and execute the trade in the marketplace.
"To begin the process, an investor should contact the company that issued the securities, or the transfer agent of the company's securities, to ask about the procedures for removing a legend. Since removing the legend can be a complicated process, if you're considering buying or selling a restricted security, it would be wise for you to consult an attorney who specializes in securities law. If a dispute arises about whether a restricted legend can be removed, the SEC will not intervene. The removal of a legend is a matter solely within the discretion of the issuer of the securities. State law, not federal law, covers disputes about the removal of legends. Thus, the SEC will not take action in any decision or dispute about removing a restrictive legend."
Rule 144 conditions
The SEC sums up the conditions of Rule 144 as follows:
"If you want to sell your restricted or control securities to the public, you can follow the conditions set forth in Rule 144. The rule is not the exclusive means for selling restricted or control securities, but provides a "safe harbor" exemption to sellers. The rule's five conditions are summarized below:
- Holding Period. Before you may sell restricted securities in the marketplace, you must hold them for at least one year. The one-year period holding period begins when the securities were bought and fully paid for. The holding period only applies to restricted securities. Because securities acquired in the public market are not restricted, there is no holding period for an affiliate who purchases securities of the issuer in the marketplace. But an affiliate's resale is subject to the other conditions of the rule. Additional securities purchased from the issuer do not affect the holding period of previously purchased securities of the same class. If you purchased restricted securities from another non-affiliate, you can tack on that non-affiliate's holding period to your holding period. For gifts made by an affiliate, the holding period begins when the affiliate acquired the securities and not on the date of the gift. In the case of a stock option, such as one an employee receives, the holding period always begins as of the date the option is exercised and not the date it is granted.
- Adequate Current Information. There must be adequate current information about the issuer of the securities before the sale can be made. This generally means the issuer has complied with the periodic reporting requirements of the Securities Exchange Act of 1934.
- Trading Volume Formula. After the one-year holding period, the number of shares you may sell during any three-month period can't exceed the greater of 1% of the outstanding shares of the same class being sold, or if the class is listed on a stock exchange or quoted on Nasdaq, the greater of 1% or the average reported weekly trading volume during the four weeks preceding the filing a notice of the sale on Form 144. Over-the-counter stocks, including those quoted on the OTC Bulletin Board and the Pink Sheets, can only be sold using the 1% measurement.
- Ordinary Brokerage Transactions. The sales must be handled in all respects as routine trading transactions, and brokers may not receive more than a normal commission. Neither the seller nor the broker can solicit orders to buy the securities.
- Filing Notice with the SEC. At the time you place your order, you must file a notice with the SEC on Form 144 if the sale involves more than 500 shares or the aggregate dollar amount is greater than $10,000 in any three-month period. The sale must take place within three months of filing the Form and, if the securities have not been sold, you must file an amended notice.
If you are not an affiliate of the issuer and have held restricted securities for two years, you can sell them without regard to the above conditions."
Published by Globes [online] - www.globes.co.il - on January 27, 2004