Rule 144

What Is Rule 144?

Rule 144 is a regulation enforced by the Securities and Exchange Commission (SEC) that provides a "safe harbor" exemption from the registration requirements of the Securities Act of 1933. This rule outlines the conditions under which restricted securities and control securities can be resold publicly without the lengthy and costly process of formal registration. Falling under the broader category of securities regulation, Rule 144 aims to balance investor protection with the need for liquidity in financial markets by ensuring that adequate public information is available about the issuing company before such sales occur.

History and Origin

The genesis of Rule 144 lies in the fundamental principles of the Securities Act of 1933, which mandated that all securities offered to the public must be registered with the SEC unless an exemption applies. This foundational law, enacted in the wake of the 1929 stock market crash, aimed to ensure transparency and prevent fraud in the sale of securities.⁷ Prior to Rule 144's adoption in 1972, the determination of whether a resale constituted a "distribution" (requiring registration) or a routine transaction was often subjective and led to uncertainty.

The SEC recognized the need for a clearer framework for the resale of securities acquired in private placements or held by company insiders. Rule 144 was therefore introduced to provide objective standards, establishing a more predictable path for selling these securities into the public market while upholding the investor protection goals of the 1933 Act.

Key Takeaways

• Rule 144 permits the public resale of restricted and control securities under specific conditions, providing an exemption from SEC registration requirements.
• Key conditions include a minimum holding period, the availability of current public information about the issuer, limits on the volume of securities sold, and specified manners of sale.
• The rule differentiates between affiliates (insiders) and non-affiliates, with stricter requirements for affiliates.
• Compliance with Rule 144 helps ensure market integrity by preventing uncontrolled distributions of unregistered securities and curbing potential insider trading.
• Affiliates generally must file Form 144 with the SEC before executing a sale that exceeds certain thresholds.

Formula and Calculation

Rule 144 includes specific volume limitations for affiliates selling securities within any three-month period. These limitations are designed to prevent market disruption and ensure an orderly sale process. The amount an affiliate can sell is the greater of:

1. One percent of the outstanding shares of the class of securities being sold.
2. The average weekly reported trading volume of the class of securities during the four calendar weeks preceding the filing of Form 144, or if no Form 144 is required, the date of receipt of the order by the broker-dealer.⁶

For example:
If a publicly traded company has 100,000,000 shares outstanding, and the average weekly trading volume over the past four weeks was 800,000 shares:

• One percent of outstanding shares:
  $0.01 \times 100,000,000 \text{ shares} = 1,000,000 \text{ shares}$

• Average weekly trading volume:
  $800,000 \text{ shares}$

In this scenario, an affiliate could sell up to 1,000,000 shares within a three-month period, as 1,000,000 is greater than 800,000. This calculation applies only to equity securities listed on a stock exchange; for over-the-counter stocks, only the 1% measurement is typically used.⁵

Interpreting Rule 144

Rule 144 is interpreted as a set of prescriptive conditions that, if met, allow for the public resale of certain securities without registration. For investors, understanding Rule 144 is crucial when they hold restricted securities (e.g., acquired through a private placement or as compensation) or are considered affiliates of the issuer. The rule essentially provides a pathway to liquidity for otherwise illiquid holdings.

The significance of Rule 144 lies in its direct impact on how and when individuals can monetize their holdings. Compliance is paramount, as failure to adhere to its requirements can result in legal repercussions and the loss of the exemption, potentially leading to enforcement action by the SEC. Investors often work with legal counsel specializing in securities regulation to ensure proper interpretation and adherence to the rule's complex provisions.

Hypothetical Example

Sarah is a senior executive at Tech Innovators Inc., a publicly traded company. As part of her compensation, she received 50,000 shares of company stock through a private transaction. These are considered restricted securities because they were not registered with the SEC for public sale. Additionally, because Sarah is an executive, her shares are also deemed control securities due to her influence over the company.

To sell these shares in the open market, Sarah must comply with Rule 144. First, she needs to satisfy the holding period. Since Tech Innovators Inc. is a reporting company, she must hold the shares for at least six months from the date of acquisition. Second, there must be adequate current public information about Tech Innovators Inc. available, which is usually satisfied by the company’s regular SEC filings.

Assume Tech Innovators Inc. has 50 million shares outstanding and the average weekly trading volume for its stock over the last four weeks was 300,000 shares. Sarah wants to sell a portion of her shares.

• 1% of outstanding shares: $0.01 \times 50,000,000 = 500,000$ shares.
• Average weekly trading volume: 300,000 shares.

The greater of the two is 500,000 shares. Therefore, in any three-month period, Sarah can sell up to 500,000 shares. If she plans to sell more than 5,000 shares or shares with an aggregate sales price greater than $50,000 within a three-month period, she must file a Form 144 with the SEC at the time the sell order is placed with her broker-dealer.

Practical Applications

Rule 144 plays a vital role in various aspects of financial markets and investing:

• Employee Stock Options and Grants: Employees of public companies, particularly executives and directors, often receive stock or stock options that, upon exercise or vesting, result in restricted securities or control securities. Rule 144 provides the framework for these individuals to sell their shares in the open market.
• Private Equity and Venture Capital Exits: Investors in private companies, such as private equity firms or venture capitalists, who acquire shares through private placement transactions, rely on Rule 144 to liquidate their positions once the company goes public, typically after its Initial Public Offering (IPO).
• Mergers and Acquisitions: Shares received as consideration in certain merger or acquisition transactions may also be subject to Rule 144 restrictions, especially if the recipient is an affiliate of the acquired or acquiring company.
• Investor Liquidity: The rule ensures that investors holding unregistered securities have a legal and transparent pathway to convert their holdings into cash, promoting market efficiency while maintaining regulatory oversight.
• Market Integrity: By imposing conditions like volume limitations and public information requirements, Rule 144 helps prevent large, uncontrolled sales that could distort stock prices or mislead investors, thus contributing to market stability.

⁴## Limitations and Criticisms

While Rule 144 provides a necessary framework for liquidity, it is not without limitations or criticisms:

• Complexity: The rule's various conditions, particularly those distinguishing between affiliates and non-affiliates and the intricacies of holding period calculations, can be complex. This often necessitates legal counsel and careful due diligence to ensure compliance, adding to the cost and time involved in selling shares.
• Volume Constraints for Affiliates: The volume limitations can significantly restrict the amount of stock an affiliate can sell within a given period. This might prevent large shareholders from quickly liquidating substantial portions of their holdings, even if they have valid personal reasons for doing so. While designed to prevent market manipulation, it can impact personal financial planning for insiders.
• Public Information Requirement: The need for current public information about the issuer can be a hurdle, especially for smaller or less transparent companies. If a company falls behind on its reporting requirements, even non-affiliates might face delays or inability to sell their restricted securities under Rule 144.
• Special Purpose Acquisition Companies (SPACs): The application of Rule 144 to securities from SPACs can be particularly complex. Shares of former SPACs or shell companies face additional requirements under Rule 144(i), which dictates that the company must have filed all required reports under the Securities Exchange Act of 1934 for at least 12 months preceding the sale, among other conditions. This adds a layer of complexity and potential delay for investors in such entities.

³## Rule 144 vs. Rule 144A

While both Rule 144 and Rule 144A pertain to the resale of unregistered securities, they serve distinct purposes and operate in different market segments.

The primary point of confusion often arises because both rules deal with unregistered securities. However, Rule 144 enables access to the broader public market, albeit with restrictions, whereas Rule 144A creates a separate, highly liquid market exclusively for sophisticated institutional investors.

FAQs

What are "restricted securities" under Rule 144?

Restricted securities are typically acquired in unregistered, private sales directly from the issuing company or an affiliate of the issuer. They often bear a "restrictive legend" indicating they cannot be resold publicly without registration or an applicable exemption like Rule 144.

What are "control securities" under Rule 144?

Control securities are shares held by affiliates of the issuing company. An affiliate is generally a person (or group of persons) who directly or indirectly controls, is controlled by, or is under common control with the issuer. This typically includes directors, executive officers, and significant shareholders. Control securities are subject to Rule 144's conditions whenever an affiliate sells them, regardless of how they were acquired.

How long do I have to hold restricted securities?

The minimum holding period depends on whether the issuing company is subject to the reporting requirements of the Securities Exchange Act of 1934. For reporting companies, the period is six months. For non-reporting companies, it is one year. A²fter this initial period, non-affiliates may be able to sell their restricted securities without many of Rule 144's other conditions, provided certain public information requirements are met.

Do I always need to file Form 144 when selling under Rule 144?

No. An affiliate must file Form 144 with the SEC if the amount of securities to be sold in any three-month period exceeds 5,000 shares or has an aggregate sales price greater than $50,000. If the sale falls below these thresholds, a Form 144 filing is not required, though other Rule 144 conditions still apply.

¹### What happens if I don't comply with Rule 144?
Failure to comply with Rule 144 can result in the loss of the exemption, meaning the sale of securities would be considered an unregistered and illegal distribution. This can lead to severe consequences, including civil penalties, rescission of the sale (requiring the seller to buy back the shares at the original price), and even criminal charges in cases of willful violation.