Many private placements of stock result in what is known as restricted stock – stock that is subject to a “legend” stating that it cannot be resold unless it is registered with the SEC or is exempt from registration.
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Registration Basics
Before a company conducts an initial public offering (IPO), it will register the offered securities with the Securities and Exchange Commission (SEC) under the Securities Act of 1933. This is a very expensive and time-consuming process, as it requires the preparation and public filing of a detailed prospectus outlining the business and finances of the company, including risk factors.
Typically, a registration will only apply to the securities that are being sold on the market. If a company is offering common stock in an IPO, there is no automatic guarantee that existing common stockholders, or preferred stockholders who convert their stock to common stock, will be included in the registration.
Pre-IPO investors will often negotiate rights to have their securities registered. There are generally two kinds of registration rights: demand registration rights and piggyback registration rights. Demand rights allow the investor to require the company to register the investor’s securities, while piggyback rights allow the investor to include their securities in any other registration by the company. These rights are often very constrained, and are often unnecessary due to the availability of registration exemptions, but can still be useful to investors, particularly if they are taking a very large stake in the company.
Exemptions Under Rule 144
“Transactions by any person other than an issuer, underwriter, or dealer” are exempt from registration under the Securities Act of 1933. While the definitions of “issuer” and “dealer” are relatively obvious, the definition of “underwriter” is somewhat hazy under the Act. It is meant to encompass people who purchase securities in order to re-sell them to others. The most obvious example is an investment bank underwriting an IPO. An ordinary individual may also be an “underwriter” if they bought the securities for the purpose of distribution.
The SEC has given guidance under Rule 144 as to who constitutes an “underwriter.” Officers, directors, and holders of at least 1% of the issuer’s outstanding securities are considered to be “affiliates” and are subject to more stringent restrictions under Rule 144. Non-affiliates are generally permitted to sell their stock after one year, or after they have held the stock for six months and after the issuer has been subject to public company reporting requirements for 90 days.
A holder of restricted stock will often need to obtain a written legal opinion from a qualified attorney and submit it to the issuer’s transfer agent in order to have the restrictive legends removed from their stock. We offer this service for a flat fee of $900, including review of applicable investment documents.