Restricted stock refers to unregistered shares issued by public companies in private placement transactions and also to registered and unregistered securities held by affiliates and issuers. Restricted stock cannot be sold through public transactions due to securities laws and regulations. This class of stock was created as further regulation stemming from the Securities Act of 1933, which was intended to prevent market manipulation through selling large blocks of stock. The law was largely a reaction to the stock market crash of 1929.
In early 1972, the Securities and Exchange Commission adopted the new Rule 144 under the Securities Act to provide a mechanism by which restricted stock could be sold under certain conditions. Rule 144 became a vehicle for enhancing liquidity while preventing large shareholders from manipulating markets by “dumping” large blocks of shares in a single company and seeking to profit from the ensuing large single-day price movements. Before the adoption of Rule 144, the SEC and the courts needed to make subjective decisions regarding petitioners' motivations for wanting to sell restricted stock.
Public Reporting Requirements
For affiliates -- including shareholders who hold at least 5 percent of the outstanding shares of a company -- to sell securities under Rule 144, sales must be handled in all respects as routine trading transactions. Brokers cannot receive unusually high commissions, and the broker and seller are prohibited from soliciting orders to buy the securities. Also, the seller must file a Notice of Proposed Sale with the SEC using Form 144 before the sale and effective for three months if the sale involves more than 5,000 shares or the shares are cumulatively valued at more than $50,000.
Holding Period Limits
Several amendments have been made to Rule 144 to enhance restricted stock liquidity. As of 1983, Rule 144(k), an amendment to Rule 144, allowed nonaffiliates to sell unregistered securities without volume limits after three years from the purchase date. In 1997, the initial holding period for nonaffiliates was reduced from three to two years. For affiliates the initial holding period was reduced from two years to one year. Since 2008, affiliates have been subject to an initial holding period of only six months, and nonaffiliates are subject to a one-year holding period.
Secondary Markets for Illiquid Securities
Changes to Rule 144 that allow more liquidity and increased demand for restricted stock in technology companies have resulted in the creation of a number of online secondary markets for restricted stock and other illiquid securities that otherwise would have thin or no markets. These markets are highly speculative, and restricted stockholders must ensure compliance with what are often complicated rules issued by employers regarding potential sales of restricted shares. Some of these exchanges include SecondMarket, which originally did business as Restricted Stock Partners; the Private Equity Exchange; Cogent Partners; and several others, including a small number of dealer-brokers that have maintained thin markets for private companies for many years.
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