There are rules that govern transactions with certain types of stock. In this section, we’ll focus on Rule 144, which covers restricted and control stock.
Restricted stock is stock that is not registered with the Securities and Exchange Commission (SEC). Common stock is non-exempt and must be properly registered to be eligible for trading in public markets. Unregistered stock lacks disclosure on the security and issuer, which is why the SEC prevents free trading of restricted stock.
Restricted stock can be obtained in multiple ways, but private placements are the most common. If you recall, Regulation D allows issuers to sell unregistered stock to private audiences not exceeding 35 non-accredited investors. Private placement investors purchase restricted (unregistered) stock.
Rule 144 requires restricted stock to be held by its investors for 6 months before resale. After this time period, the investor can sell their shares.
Control stock is stock held by an affiliate, which is an insider of the company. An affiliate is any officer, director, or 10% shareholder. Basically, if you are an executive for the issuer or own a bunch of their stock, you’re considered an insider (affiliate). Rule 144 regulates this type of stock and prevents insiders from selling significant amounts of their shares quickly.
This part of Rule 144 is referred to as the “dribble” rule. Insiders are the largest shareholders of their companies. Some CEOs own 51% or more of their companies to ensure their vote always controls the direction of their organization. If insiders were to liquidate all of their shares at once, it could significantly affect the price. A 51% shareholder selling all of their shares in one trade is similar to a manufacturer dropping off 10,000 lawnmowers at a local Home Depot and asking for them to be sold immediately. Dropping the price close to zero might be the only way to get this accomplished!
Affiliates (insiders) are subject to sales limitations to prevent this from happening. They are allowed to sell the greater of 1% of the outstanding shares or the four-week trading average, four times a year. Referred to as volume limitations, this rule prevents affiliates from selling significant amounts of shares in short periods of time.
You now know the definitions and rules of restricted and control stock. However, what happens if an affiliate owns unregistered stock? This is a common occurrence, as many executives of privately held companies own stock in their company. Restricted stock rules apply because the stock is not registered with the SEC. Control stock rules apply because they’re affiliate-owned shares. When this is the case, both sets of rules apply simultaneously.
To summarize, let’s take a look at a visual representation of Rule 144:
Regulators aim to create a transparent environment in the securities markets. One of the ways this is accomplished is by requiring public filings of transaction reports related to Rule 144.
Form 144 must be filed when an investor (affiliate or non-affiliate) intends to trade control or restricted stock at any point in the next 90 days. This form is typically filed electronically on the Electronic Data Gathering, Analysis, and Retrieval (EDGAR) system. All that’s required for Form 144 to be filed is an intention to trade a control or restricted stock; there is no requirement for a transaction to actually occur.
The SEC, which oversees the filing process and maintains EDGAR, allows investors performing small control or restricted stock transactions to avoid filing requirements. In particular, Form 144 must only be filed if an investor plans to sell more than 5,000 shares or $50,000 of total stock.
Form 4 must be filed when an affiliate actually trades control stock. Known as the form that reports beneficial changes in ownership for insiders, Form 4 must be filed within two business days of the transaction. Many financial media outlets pay close attention to these filings, especially forms filed by famous executives and investors. For example, this Form 4 filing was the reason why Elon Musk’s $6.9 billion sale of Tesla stock November 2021 was widely reported.
One last item to cover is Rule 144A, which relates to Rule 144 (obviously). If a sale of restricted or control stock occurs with a Qualified Institutional Buyer (QIB), the requirements of Rule 144 do not apply. A QIB is defined as an institution with $100 million or more of investable assets. When a QIB is involved in the sale of control or restricted stock, the 6 month holding period and volume limitations do not apply.
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