Resale of Restricted Securities

In this article, I discuss how an investor resells securities that he bought in a private offering from a private company.  The investor usually will have received his stock in an angel round of financing or a private offering / private placement of securities, whether under Regulation D, Rule 504 or 506 or like state laws, for example, California’s Section 25102(f) limited offering exemption.  

I will explain how the investor can resell his restricted securities, either in compliance with Rule 144 or the Section 4(1½) exemption.

Stock Bought in a Private Offering is a Restricted Security

Stock bought in a private offering is restricted stock, meaning that the investor can only resell the stock through federal Rule 144, the Section 4(1½) exemption, or if the stock has been registered for resale.  For stock bought in a private offering, the stock certificate usually will bear a “legend” on the back that states that the securities are restricted.

How to Resell Restricted Securities through Rule 144

** Note that an “affiliate” is a person in a relationship of control with the issuer, for example, a director or large shareholder. **

Rule for Non-Affiliate Investors.  An investor can resell his stock once he has owned the stock for 1 year and if he has not been an affiliate of the issuer for 3 months prior to the resale.  If the issuer is a public, reporting company (that is, the issuer is current in filing its reports with the SEC), the 1 year holding requirement becomes only 6 months.

Rule for Affiliate Investors.  Affiliate investors have the same holding periods as non-affiliates — 6 months for securities of a reporting company and 1 year for securities of a private company.  Affiliates must comply with additional conditions, however, including:

• The issuer must be in compliance with the periodic reporting requirements of the Exchange Act.
• The investor will be subject to volume limitations, that is, restrictions on the amount of stock that he can sell.
• The investor must sell the stock through a market maker / broker and pay normal commissions. 
• The investor must file Form 144 for certain large sales.

Compliance = Unrestricted Stock.  Once the investor has complied with Rule 144, he can sell his stock as he chooses, without restriction.  The purchaser of the investor’s stock will take unrestricted securities.  Be aware, however, that if the stock certificates bear the restrictive legend, the investor likely will have to ask the issuer to print a new certificate without the legend.  This may be easy or hard depending on the issuer.

How to Resell Restricted Securities Using the Section 4(1½) exemption

The Section 4(1½) exemption refers to an investor’s private resale of restricted securities.  Various court cases over the years have developed the Section 4(1½) exemption.  Its essential requirement is this: the investor must resell the stock to a purchaser who is sophisticated and has access to the same information about the issuer of the stock as would be available if the securities were registered.  The resale of the restricted securities does not start a new holding period for the purchaser; instead the purchaser can take the holding period of the initial investor (provided the initial investor was not an affiliate).

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