Amendments to Rules 144 and 145– A Source of Additional Revenues?

Rules 144 and 145, since 1990 providing a method for sales of restricted and control securities, were amended by the Securities and Exchange Commission (“SEC”) effective February 15, 2008.

Reasons for Expanding Rule 144 Business.

As discussed below, the amendments to Rules 144 and 145, on balance, significantly reduce requirements for sellers and broker-dealers in processing sales of “control” and “restricted” securities in Rule 144 transactions. As amended, the Rule 144 restrictions no longer apply to the sale of debt securities. Prior to amendment, the primary task for the broker-dealer was preparation (for the customer) of Form 144 both in transactions for affiliates and for non-affiliates. After amendment, the requirement to file Form 144 for non-affiliates has been eliminated. Also, prior to amendment, the broker-dealer had to assure that sales, even by non-affiliates, met the limitations (discussed below) on volume of securities sold and manner of sale. As amended, however, those limitations no longer apply to non-affiliate sales. The amendments should make the process of sale of control and restricted securities easier and less fraught with danger for the small broker-dealer processing the transaction.

Just the elimination of manner of sale limitations on non-affiliates, by itself, may increase the ability of a broker-dealer to generate revenues. That is, prior to amendment, sales for non-affiliates could be made only in “brokers transactions,” i.e., agency transactions. As amended, sales for non-affiliates may be made in riskless principal transactions and in transactions directly with market makers, possibly allowing increased revenues for the broker-dealer. And since the non-affiliate customers’ holding periods have been significantly reduced, it is likely that a greater number of clients will seek to use Rule 144, thus also increasing the possibility for greater revenues from increased business. Small broker-dealers with contacts with (i) unregistered companies with a significant number of security holders, or with (ii) control persons of registered companies may want to consider offering Rule 144 services to those companies and security holders, or possibly even making a market in their securities, while of course maintaining a legal compliance program.

A Bit of Background

Federal and state securities laws make it illegal to sell securities in transactions which are not registered with the Securities and Exchange Commission (“SEC”), unless an exemption for the sale can be found. Any “seller”, including a broker-dealer acting for the owner of the securities, is liable to any suing purchaser to repay the purchase price to the purchaser, if the seller cannot prove an exemption is applicable. Such unregistered securities are generally called “restricted.” Other terms sometimes used are “legended” and “lettered.”

Although technically not labeled “restricted”, but similarly not freely tradeable and needing an exemption from registration are securities of publicly held companies, even though they have been registered, which are or have been owned by an “affiliate,” i.e., a control person, of the issuing company, usually an officer or director. They are also sometimes called “control” securities. To qualify as a non-affiliate, a person may not have been an affiliate during the prior three months.

The SEC adopted Rule 144 to allow purchases and sales through broker-dealers of such securities under specified and restricted conditions. Over the years since its adoption, broker-dealers have developed processes to implement Rule 144. The February 15, 2008 amendments will require broker-dealers to change those processes, but as changed, the broker-dealers’ efforts are simplified and reduced.

Rule 144 allowed holders of restricted and control securities to sell them only after holding them for certain periods of time (holding periods), only in restricted amounts (volume limitations), only in certain types of transactions (manner of sale limitations), only if certain information about the issuer was available to the public (publicly available information), and only if a Form 144 was filed with the SEC. These limitations continue after the recent amendments, but are altered and generally reduced in severity by the amendments. The amendments therefore will make it easier for clients and probably will bring about more requests for small broker-dealers to process Rule 144 transactions. In preparation therefore, small broker-dealers should be aware of the effects on them of such amendments and of changes they should consider in their operations.

For the below discussion, a “reporting company,” is one which is required to file and has filed all required periodic reports (excluding Forms 8-K) during the 12 month period preceding the sale of the restricted securities.

The below discussion will cover the Rules’ amendments, with at least a brief mention of the pre-amendment requirements for comparison purposes. This discussion will cover only federal requirements for exemptions for resales of control and restricted securities. The laws of Missouri and other states must also be complied with and should be checked.

The Amended Rule 144 Requirements.

Form 144. The amended Rule requires the filing of Form 144 in some cases, but significantly less frequently than before amendment. The Form 144 is signed and (in a legal sense) filed by the selling holder of the securities, but the assisting broker-dealer usually prepares the Form 144 and explains it and Rule 144 to the seller. That broker-dealer will now need to prepare and assist in filing the Form 144 less frequently because the threshold size of the sale, below which the Form need not be filed, has been increased. As amended, the Form 144 need be filed only for sales in excess of 5,000 shares or $50,000.00. Prior to the amendment, these thresholds were 500 shares or $10,000.00. Also, the requirement for filing Form 144 at all has been eliminated for sales by non-affiliates.

Volume Limitations. Rule 144 continues to set limits upon the amount of securities which may be sold by affiliates under Rule 144 in any three month period, but the amendment eliminates the volume limitations on non-affiliates. As thus applied to affiliates, both before and after amendment, volume limits never expire.

The volume limits restrict sale by affiliates within a three month period to the greatest of (i) one percent of the outstanding shares of the relevant class of the issuer, or (ii) the average weekly trading volume in such securities during the four calendar weeks preceding the filing of Form 144 or, if no such filing is required, the date of execution of the transaction, or (iii) the average weekly trading volume in such securities reported pursuant to an “effective transaction reporting plan”.

The February amendment provides also, however, that if the securities sold are debt securities, the limitation is the greater of the above-stated limits or, together with all sales by the seller of such class of debt securities within the preceding three months, ten percent of the principal amount of such class outstanding or tranche of such securities for the issuer.

Manner of Sale Requirements. Prior to the February amendments, Rule 144 transactions could be made only in “brokers’ transactions,” i.e., transactions in which the broker could only execute the order as agent for the seller, receiving no more than the usual and customary agency commission, and could neither solicit nor arrange for the solicitation of customers’ orders. The amendments reduce this restriction significantly. First, there are now no such restrictions on the sale of debt securities. Second, the Rule now adds to permitted methods of sale of non-debt securities (i) “riskless principal transactions”, where the offsetting trades are executed at the same price (exclusive of an explicitly disclosed fee) and the transaction is permitted to be reported as riskless under the rules of a self-regulatory organization, and (ii) transactions directly with a market maker of the securities.

Current Public Information Requirement. In sales by affiliates, “current public information” must be available concerning the issuer of the securities to be sold. Availability of “current public information” for a reporting issuer requires that such issuer have filed all required 1934 Act reports, except Forms 8-K, during the twelve months preceding the proposed sale. For the sale of securities of non-reporting issuers, there must be publicly available (usually meaning having been promulgated by the issuer to broker-dealers proposing to process transactions in the issuer’s securities) information describing the company, its business and management and its financial statements. Interestingly, this is the type of information generally found in private placement memoranda.

The nature of the current public information required was not changed in the February 2008 amendments. The current public information requirement, under the amended Rule applies always to sales by affiliates, and to sales by non-affiliates until the expiration of a one year holding period (amended from two years by the amendments).

Rule 145 – New Restrictions on Shell Company Securities.

Rule 145 concerns sales of securities obtained in “business combinations” such as mergers, stock for stock acquisitions and stock for assets acquisitions. Prior to amendment, Rule 145 imposed a “presumed underwriter” status on affiliates of both the acquired companies and the acquiring companies in such combinations. That underwriter status prevented such affiliates from selling their securities (“control securities”), even when such securities were registered under the 1933 Act in a registered public offering. Rule 145 also, however, allowed such affiliates to resell such securities under the limitations and restrictions of Rule 144.

Rule 145 was amended simultaneously with Rule 144 to eliminate this “presumed underwriter” status as to affiliates of the acquired company who received 1933 Act-registered securities of the acquiring company in a business combination registered under the 1933 Act. Such affiliates of acquired companies are now able to resell their control securities immediately upon obtaining them instead of after the one year holding period as previously required. Affiliates of the acquiring company, however, and those who become its affiliates, remain subject to all the Rule 144 resale conditions, including the holding periods discussed above. (If a business combination and its resultant securities issuances were not registered under the 1933 Act, and thus are in effect exempt private placements, the various restrictions applicable to restricted securities continue to apply.)

However, if either entity in the combination was a shell company, the presumption of underwriter status, together with its resale restrictions on affiliates, continue to apply to affiliates of both the acquirer and the acquired companies. And, importantly, Rule 144 is unavailable for the sale of securities of a company which was a shell when it issued the securities or at the time of the proposed resale.

Considerations for Small Broker-Dealers.

Small broker-dealers who process Rule 144 sales should take actions based upon the above changes. Some small broker-dealers who do not presently process Rule 144 sales may, in light of the easing of restrictions on such sales, and in some cases the reduction in possible liability of sellers and their assisting broker-dealers, want to consider making such sales a part of their business.

Amending Documents as Necessary. Sales under Rule 144 are frequently complicated and require the seller and the assisting broker-dealer to prepare and execute numerous documents. Normally, the broker-dealer requires the selling security holder to execute a representation letter setting forth the facts concerning his ownership (period held, relationship to the issuing company, etc.). The broker-dealer typically also requires the seller or the issuer to provide an opinion of the attorney of either the seller or the issuer, stating that, in light of the facts set forth in the representation letter, and possibly other facts, sale under Rule 144 by the broker-dealer is legal. And broker-dealers customarily furnish the issuer’s attorney with a letter establishing they have made the sales in conformance with Rule 144. Virtually all of these forms will require amendment to accommodate the changes to Rules 144 and 145. Also, though not mentioned in most articles about Rule 144, the broker-dealers should also require assurances of the attorney that the requested transaction will comply with relevant state securities laws.

Also, broker-dealers’ compliance manuals should have sections instructing their personnel concerning the requirements for Rule 144 sales. It is also possible that some sections of Rule 10b5-1 plans of holders of control securities may have provisions concerning Rules 144 and 145 sales. The text of these sections should also be amended to accommodate the Rule 144 and 145 changes.

A Possible Trap. One trap for the unwary broker-dealer is the new prohibition on the use of Rule 144 for the sale of securities of shell companies. Amended Rule 144(i)(1)(i)(B)(ii) prohibits the use of Rule 144 for the sale of the securities of a company that was ever a shell company. And even if the issuing company itself was never a shell company, it is conceivable that it was the acquiring company in a transaction involving a shell company, thus restricting (but not prohibiting) the use of Rule 144 for sale of its securities. Obviously, the forms above-mentioned should be amended to require the selling customer to indicate whether the issuer was ever a shell company, or was a party to a combination involving a shell company. However, some customers may not even know their company was a shell company, or involved with a shell company, in the past, the broker-dealer should also require the issuing company and the attorney giving the opinion to state that the issuing company was never a shell company.

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