Comment on Rule 144 Changes

In an effort to facilitate companies with raising capital and complying with disclosure and reporting obligations, in December 2007 the SEC unanimously adopted amendments to Rule 144 to reduce the requirements on the resale of restricted securities. Among the significant changes, the new rules reduce the holding period and the resale restrictions applicable to holders of such securities. The SEC has stated that it believes the “amendments will increase the liquidity of privately sold securities and decrease the cost of capital for all issuers without compromising investor protection.” These amendments are effective February 15, 2008 and will apply to securities issued before and after that date. There are also changes to Rule 145, which are not discussed here.

Reduction of Holding Period and Resale Limitations

In general, the Securities Act of 1933 requires registration of offers and sales of securities unless an exemption is available. Rule 144 creates a safe harbor for the sale of securities by a person other than an issuer, underwriter, or dealer if certain conditions are met. In common practice, Rule 144 serves as the principal path to allow resales of “restricted securities” – those that were originally issued in private, unregistered transactions, under Regulation D or otherwise.
Under the existing regime, Rule 144 required an issuer’s affiliates (its directors, executive officers and significant beneficial owners) to hold their restricted securities of the issuer for at least one year before they could sell them. Any resale thereafter would be subject various limitations based on publicly available information on the issuer, the manner of sale, volume limitations and certain filing requirements. Non-affiliates of an issuer were subject to the same one-year holding requirement and subject to resale limitations during the following year. However, once securities were held by a non-affiliate for at least two years, the limitations would no longer apply and the securities could be freely resold.
Under the new rules, the holding period for restricted securities of public reporting companies was reduced from one year to six months. For non-affiliate holders of these securities, the new rules effectively eliminate after six months all resale restrictions other than the “current public information” requirement, and eliminate all resale restrictions after one year. Affiliates, however, will still need to comply with all resale limitations after they meet the six-month holding requirement.
For private companies, the holding period was effectively changed to one year. The SEC retained the one-year holding requirement for these companies out of their concern that “the market does not have sufficient information and safeguards with respect to non-reporting issuers.” After the one-year holding period is met, non-affiliates may sell their securities with no other resale limitations. While affiliates of these companies are subject to the same one-year holding period, their transactions will still continue to be subject to various resale limitations under Rule 144, including certain current public information requirements for non-reporting companies.
Based on significant comments from practitioners, one of the significant revisions from the amendments originally proposed in July 2007 was that the SEC chose not to adopt its proposal to suspend (or “toll”) the running of the holding period in the event of hedging of restricted securities. A previous tolling provision in the original Rule 144 was eliminated in 1990. Concerned that hedging activities significantly diminish a holder’s economic investment risk that serves as the basis for the holding period, the SEC again proposed that the holding period be tolled by up to six months for any short sales, puts or other hedging activities. Due to the overall concern over the burden placed on investors from complying with this regime and having to disclose information on their hedging transactions, the SEC has agreed not to adopt the tolling provisions, with the caveat that it will revisit the issue if hedging activities are abused.
Codification of SEC Staff Positions on Tacking
The SEC Staff has previously taken the position that tacking of prior holding periods is allowed in certain circumstances upon conversion or exchange of an issuer’s securities, including cashless exercise of options and warrants. The new rule provides that if the securities were originally acquired from an issuer solely in exchange for other securities of the same issuer, tacking will be allowed, even if the securities surrendered were not convertible or exchangeable by their terms. However, if the original securities did not permit cashless conversion or exchange by their terms and are later amended to cover this aspect, under the new rule tacking will not be allowed if the security holder provides consideration for the amendment other than solely securities of that issuer. In other words, if additional consideration is received for the amendment to provide for a cashless exercise feature, that consideration will be treated as a new investment decision by the holder and will restart the clock on tacking.
However, the new rules also codify that the grant of certain options or warrants that are not purchased for cash or property, such as the grant of employee stock options, does not create any investment risk and, therefore, in a cashless exercise of such options or warrants, the holder would not be allowed to tack the holding period and would be deemed to have acquired the underlying securities on the date of exercise and when the underlying shares were fully paid for.