Legends and Restricted Stock

tamer hamed 12:04:00 PM
 Legends
A certificate with a legend stamped or printed on it provides notice to the owner that the unregistered security may not be transferred unless it is registered or sold through an exemption under the Securities Act of 1933. The legend is a contract between the issuer and the securities holders, an agreement they will not sell their stocks or bonds before the holding period expires.

Therefore, many restrictive legends are removed by the issuer's transfer agent only if the owner provides an opinion by a qualified attorney. Some require the issuer's counsel to issue an opinion before the legend may be removed and the security sold or otherwise transferred to another party.

Restricted stock
The term restricted stock means the owner's ability to sell or transfer the stock is restricted because of a required holding period. Stock purchased in a private placement is restricted stock, restricted in terms of the investor's ability to sell it to another party. Officers and key employees may also receive restricted shares subject to a holding period as opposed to stock options that can be exercised right away.

When purchasing restricted securities, investors typically receive a certificate with a legend stamped on it indicating the securities may not be resold in the marketplace unless they are registered with the SEC or are exempt from the registration requirements. If the securities are electronic/book entry, the electronic record contains the legend.

Either way, the SEC does not want people acting like underwriters and funneling unregistered stock to the securities markets in a way that bypasses the Securities Act of 1933's concerns for full disclosure. Rule 144 provides a safe harbor exemption for those who want to sell restricted stock without violating securities law And, though a registered representative will perhaps never own restricted stock, if he executes a sale for a customer who does, he could get in trouble if he doesn't know and follow the rules.
The text of a restrictive legend typically looks something like this:

THIS SECURITY HAS NOT BEEN REGISTERED OR QUALIFIED UNDER THE SECURITIES ACT OF 1933 OR THE SECURITIES OR BLUE SKY LAWS OF ANY STATE AND MAY BE OFFERED AND SOLD ONLY IF REGISTERED AND QUALIFIED PURSUANT TO THE RELEVANT PROVISIONS OF FEDERAL AND STATE SECURITIES OR BLUE SKY LAWS OR IF AN EXEMPTION FROM SUCH REGISTRATION OR QUALIFICATION IS APPLICABLE.

Typically, the legend is stamped or printed on the back of the certificate, with notice on the front such as:
TRANSFER OF THE SHARES REPRESENTED BY THIS CERTIFICATE IS RESTRICTED. SEE LEGEND ON REVERSE SIDE.

The first requirement for selling a restricted stock is that the issuer must have been a reporting company under the Securities Exchange Act of 1934 for at least 90 days immediately before the sale. And, the issuer cannot have missed filing any of the reports they were required to file during the preceding 12 months. Without this requirement, worthless securities in companies no one knows anything about could be dumped onto the securities markets at great harm to investors.

So, first, the issuer must be someone about whom investors can receive material information. Even if the issuer is an insurance company or a company not subject to reporting (non-reporting company) under the Securities Exchange Act of 1934, the SEC requires that certain basic information on these issuers be available including information on the nature of its business, the identity of the officers and directors, and financial statements. Otherwise, no sale.

Restricted stock is subject to a holding period. If the issuer is a reporting company subject to reporting requirements at least 90 days, purchasers must hold the securities a minimum of six months before reselling them. If the issuer is not a reporting company, the minimum holding period is one year.

Once the holding period is met, a non-affiliate can sell his shares if he wants to.

For affiliates of the company, Rule 144 has further requirements, whether selling restricted or control stock. Restricted stock is unusual because of the way it was offered to investors. For control stock, on the other hand, it's the owner who triggers the requirements, not the securities. Control stock is held by investors who can control the issuer or could harm the market price of the stock by selling a large amount. So, whether selling restricted or control stock, affiliates must file a Form 144 with the SEC no later than at the time of the sale. The filing is good for 90 days. if the transaction is not larger than 5,000 shares and $50,000, the sale can be made without filing a Form 144.

Typically, affiliates sell large amounts of securities, but they must comply with the volume limits under Rule 144. For exchange-traded securities, affiliates can sell the issuer's stock provided they sell no more than the greater of 1% of the outstanding shares or the average weekly trading volume over the four most recent weeks. If the company has 1 billion shares outstanding, the affiliate could sell whichever is greater over the next 90 days-10 million shares or the average weekly trading volume going back four weeks. For stocks that either don't trade or trade on the OTC Bulletin Board or Pink Quote, only the 1% figure is used.

That's the amount that can be sold. As for the method of sale the rule states, "If you are an affiliate, the sales must be handled in all respects as routine trading transactions, and brokers may not receive more than a normal commission. Neither the seller nor the broker can solicit orders to buy the securities."
Also, affiliates can never sell the company's stock short. And, although control stock is not subject to a holding period, an affiliate can't take a profit on their company's stock held less than 6 months. This is called a short-swing profit, which must be turned back over to the company with the gain being taxed by the IRS.
FINRA is concerned that agents and their firms sometimes help customers sell unregistered restricted securities, which violates federal securities law. If the customer does not conform to all the stipulations we just went over, but wants to take his unregistered restricted shares and sell them, firms must be sure they don't help him skirt securities law in this manner. FINRA alerts its member broker-dealers that some customers are companies trying to sell their shares illegally. If the customer deposits certificates representing a large block of thinly traded or low-priced securities, that's a red flag. If the share certificates refer to a company or customer name that has been changed or that does not match the name on the account, that's another red flag. If a customer with limited or no other assets under management at the firm receives an electronic transfer or journal transactions of large amounts of low-priced, unlisted securities, that's another red flag.
Broker-dealers must do a reasonable inquiry to ensure they are not helping people get around securities law.

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