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What Investors Need to Know About Private Transfers of Unregistered Stock


August 14, 2018
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In Recent Years, the Federal Government Has Eased Restrictions on Private Transfers of Unregistered Stock…

You bought stock in a private placement and the company is growing. Now you want to sell half of that stock to your neighbor or to transfer portions to your wife and children. How is this accomplished? What laws and rules apply? Where do you go for guidance?

What Investors Should Know About Private Transfers of Unregistered Stock

Photo courtesy of Chris Liverani (Unsplash.com)

These are common questions we often hear from investors. Thankfully, the federal government has eased restrictions in recent years, making the process of private transfers far less complicated than it once was.

What Is a Private Placement?

Under the federal securities laws, a company may not offer or sell securities unless the offering has been registered with the Securities and Exchange Commission (SEC) or an exemption from registration applies. A securities offering that is exempt from registration with the SEC is often referred to as an unregistered offering or private placement offering.

Private placements differ from traditional securities offerings in several key ways. Most notably, they have restrictions on their transfer, and you will need to comply with an exemption from registration to resell. When you acquired the restricted securities, you likely received a certificate stamped with a “restrictive” legend. The legend indicates that the securities may not be resold in the marketplace unless they are registered with the SEC or are exempt from the registration requirements. 

The good news is that over the last several decades, the federal government (Congress and the SEC) have eased the previously rigid restrictions on such transfers so that these types of private transactions between friends, neighbors, business associates or family members are no longer subject to regulations that used to call for waiting years to achieve required holding periods or obtaining complex legal opinions reciting facts supporting exemptions allowing private transactions before a stated holding period ran.

The federal government determined that encouraging capital formation by young companies was important for our economy, so it eased holding period and transfer requirements over the past several decades. An earlier long-standing two year holding period was reduced to one year twenty plus years ago and is now down to six months under Rule 144 under the Securities Act of 1933.

Privately Transferring Unregistered Securities

Today, with liberalized rules and shortened holding periods, privately transferring unregistered securities is far more easily accomplished. The liberalizations have virtually eliminated the need for the average investor to seek a no-action letter from the SEC — a letter that states that under the facts presented, the SEC would take no enforcement action against the proposed securities transfer.

Private transactions are now more readily seen by regulators as exempt under Section 4(a)(1) of the Securities Act or under the SEC’s shortened Rule 144 holding periods.

Private Resale Under Section 4(a)(1) of the Securities Act

Section 4(a)(2) of the Securities Act of 1933 authorizes private placements by exempting from registration “transactions by an issuer not involving any public offering.” Meanwhile, Section 4(a)(1) exempts from registration “transactions by any person other than an issuer, underwriter, or dealer.”

Accordingly, investors who hold private placements can sell their securities in a private sale without registration if they are not considered an “underwriter.” Under section 2(a)(11), a person may qualify as an “underwriter” if he acquires securities with a view to “distribution” or is participating in a “distribution,” which generally means an offering that is not a private offering. Because it is based on a combination of Sections 4(a)(1) and 4(a)(2), the resale exemption is often referred to as “Section 4(1-1/2).”

In 2015, the FAST Act created a new exemption for certain resales of securities. While the newly-created Section 4(a)(7) of the Securities Act is largely intended to codify Section 4(1-1/2), it contains its own specific requirements. They include:

  • All purchasers must be “accredited investors”;
  • Neither the seller, nor anyone acting on the seller’s behalf, can use any general solicitation or advertising in offering or selling the securities;
  • Issuers who are not subject to SEC reporting requirements or not exempt from reporting under Rule 12g3‑2(b) of the Securities Exchange Act of 1934 must provide the seller and prospective purchaser with certain disclosures;
  • Neither the seller, nor any person receiving a commission for participating in the transaction, is disqualified as a “bad actor” under Rule 506(d)(1) of Regulation D or subject to disqualification under Section 3(a)(39) of the Securities Exchange Act;
  • The issuer must be engaged in a business that is not in the organizational stage or in bankruptcy, and cannot be a blank check, blind pool or shell company;
  • The transaction cannot involve securities that are part of an unsold allotment to an underwriter; and
  • The securities to be resold must have been authorized and outstanding for at least 90 days prior to their resale.

Rule 144 Holding Periods

Rule 144 authorizes the public resale of restricted securities provided that a number of conditions are met. If you are not (and have not been for at least three months) an affiliate of the company issuing the securities and have held the restricted securities for at least one year, you can sell the securities without satisfying the conditions of Rule 144.  An affiliate is a person, such as an executive officer, a director or large shareholder, in a relationship of control with the issuer.

If the issuer of the securities is subject to the Exchange Act reporting requirements and you have held the securities for at least six months but less than one year, you may sell the securities as long as the current public information condition is satisfied. It mandates that there is adequate current information about the issuing company publicly available before the sale can be made. For reporting companies, this generally means that the companies have complied with the periodic reporting requirements of the Securities Exchange Act of 1934. For non-reporting companies, this means that certain company information, including information regarding the nature of its business, the identity of its officers and directors, and its financial statements, is publicly available.

Even if you can satisfy all the conditions of Rule 144, you must still have the legend removed from the certificate. Transfer agents can remove a restrictive legend; however, they will typically only do so if the issuer consents—usually in the form of an attorney’s opinion letter to the transfer agent. So, although transfer agents may still require a legal opinion letter to affect a private transaction, these letters have become far less difficult to obtain and require far less of an attorney’s fact review time.

Finally, state regulators remain relevant, depending upon where you reside.  Virtually all states have isolated transaction exemptions applicable to the typical investor in a private transaction. As a result, the entire process of privately transferring  your unregistered securities investments is now a “piece of cake.”

If you have questions, please contact us

If you have any questions or if you would like to discuss the matter further, please contact me, Dan Brecher, or the Scarinci Hollenbeck attorney with whom you work at 201-806-3364.

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