Raising capital will become easier for many small companies on Friday when an amended Securities and Exchange Commission rule goes into effect. Issued in December, the new provisions of Rule 144 lift several limitations for selling restricted and control stock, which should make those privately-held shares more attractive to investors looking to plow seed money, or other capital into private companies.
Particularly, the amended rule reduces the holding period for unregistered shares, and eliminates reporting requirements and trading volume caps in specific instances. Currently, the limits placed on restricted and control securities dampen demand for the shares, say experts. As a result, restricted and control shares often trade at a 10 percent to 15 percent discount off their market value, notes Megan Gates, an attorney with Mintz Levin, and co-chair of the law firm’s securities practice. The amended Rule 144 may change that, she told CFO.com, explaining that demand for the privately-held stock will rise if the shares are easier to resell into the public market.
To protect investors, the SEC forces companies to register shares before offering the stock to the public. Private companies bypass the costly and time-consuming process by limiting distribution of their shares to insiders who are deemed to be aware of the risks involved with holding unregistered stock. To be sure, restricted shares are often issued through private placement offerings, employee stock benefit plans, as compensation for professional services, or in exchange for providing start-up capital.
Similarly, control securities, which are unregistered shares held by investors that have power to direct management and corporate policies, are awarded to company directors and officers, as well as large shareholders that usually hold 20 percent or more of the company’s stock. The SEC estimates that 60,500 notices to sell unregistered shares under Rule 144 are filed annually, so the rule should have widespread affect.
To sell unregistered shares to the public, investors must garner an exemption from the registration process by meeting the requirements of Rule 144. Doing that just got easier. The SEC splits Rule 144 into two sections: reporting and non-reporting companies. The regulator defines a reporting company as an issuer that is obligated to file periodic financial reports with the SEC — including audited financial statements — and make them available to the public 90 days before a 144 sale.
For investors holding restricted stock in reporting companies, the amended rule reduces the holding period from one year to six months, and eliminates the trading volume cap. Currently, after the one-year holding period, the number of shares that may be sold during any three-month period cannot exceed 1 percent of the outstanding shares of the same class being sold. After one year, public resale in unlimited. In addition, a reporting company must file its financial statements on time during the six-month holding period for a 144 sale to be valid. After one year, however, none of the Rule 144 requirements need to be met – including the timely reporting mandate.
Investors that hold control shares in non-reporting companies follow the same rules, except that trading volume restrictions apply.
The mandates are slightly more stringent for investors holding shares of non-reporting companies. The holding period for both restricted and control shares for non-reporting companies will drop from two years to one year. After that, restricted shares can be sold on an unlimited basis, and all other Rule 144 restrictions are eliminated. Control shares are treated differently. After the one-year holding period, these so-called affiliate shares may be sold if Rule 144 requirements are met. That means that the company must provide current company information to the public – although audit financial statements are not required – and volume limits are imposed.
The theory behind requiring a holding period for unregistered shares is to satisfy the SEC’s investor protection tenets, says Gates. Indeed, the issuer has not been vetted by the registration process, but the regulator reckons that a six month holding period suggests that a shareholder assumes the economic risk of the stock, and is not a middleman or underwriter in the business of flipping the shares for a quick profit.
One reason why the SEC’s is comfortable with slashing holding periods is the recognition that the public has greater access to company information than it did in the past. With the proliferation of the Internet, company Web sites, online regulatory filings, and media coverage about investments, the public receives more information, faster about the financial health of companies than ever before, surmises Gates. In fact, SEC officials contend that the latest iteration of Rule 144 should increase liquidity of privately sold securities and decrease the cost of capital for all issuers, “without compromising investor protection.”