It has become routine for public companies and private companies going public to mark their stock certificates with “Restrictive Legends” stating that the securities represented are not covered by a registration statement under the Securities Act of 1933, as amended (the “Securities Act”). Restrictive Legends provide notice to shareholders that the securities represented by the certificate are not covered by a registration statement and cannot be resold until they are registered with the SEC or an exemption from registration is available.
Where do restricted securities come from?
Most restricted securities are most often issued in exempt offerings such as private placements made under Rule 504, 505 and 506 of Regulation D. Restricted Securities are also securities held by a company’s officers, directors and control persons.
A typical Restrictive Legend looks something like this:
“The Securities represented by this certificate have not been registered under the Securities Act of 1933, as amended, or the securities laws of any state of the United States or in any other jurisdiction. The Securities represented hereby may not be offered, sold or transferred in the absence of an effective registration statement for the Securities under applicable securities laws unless offered, sold or transferred pursuant to an available exemption from the registration requirements of those laws.”
When restricted securities become eligible for resale under Rule 144, shareholders may remove the Restrictive Legend from their stock certificates and sell their shares publicly by depositing their shares with their stockbroker. Issuers and transfer agents require that the holder obtain a legal opinion from a securities lawyer as to whether shares are eligible for resale if a holder seeks to sell their shares under Rule 144.
In SEC Release No. 33-8869, the SEC stated with respect to restricted securities that it did not object if issuers remove legends restricted securities held by non-affiliates after all of the applicable conditions in Rule 144 are satisfied. The SEC acknowledged that the decision of whether to remove a legend from restricted securities is a matter solely in the discretion of the issuer of the securities, and that disputes about the removal of legends “are governed by state law or contractual agreements, rather than federal law.” When there is a question about removal of a restrictive legend, issuers seek the advise of a securities attorney as to tradability of the shares.
Holding Period for Restricted Securities
Generally, restricted securities held by non-affiliates are subject to a 6 or 12 month holding period. If the issuer is a shell or former shell company then more stringent rules apply to resales.
If the Issuer is subject to the SEC’s reporting requirements, Rule 144 provides for a 6 month holding period. Issuers should be cautious about removing legends from stock certificates representing restricted securities after only 6 months for SEC reporting issuers unless a prior or specific future public sale is contemplated. In order for the 6 month holding period to be applicable to a particular resale of shares, the company must have been subject to the SEC’s reporting requirements for a period of at least 90 days. Additionally, the issuer must have filed all SEC reports required during the preceding 12 months or such shorter period that they were required to file. If the issuer becomes delinquent in its SEC Reporting obligations, Rule 144 is unavailable or if the issuer does not have current public information available at the time of the sale, the Rule 144 holding period is increased to 12 months.
Holders of shares of non-reporting companies not subject to the SEC’s reporting requirements must hold their shares for a period of 12 months.
For a company that has at any time been a shell company, the holding period becomes 12 months after the date that the issuer files Form 10 information with the SEC.