SEC Proposes Amendments to Rule 144 Holding Period Determination for Market-Adjustable Securities
On December 22, 2020, the US Securities and Exchange Commission (the ”SEC”) proposed certain amendments (the “Proposed Amendments”) to Rule 144, Forms 144, 4 and 5 and Rule 101 of Regulation S-T of the US Securities Act of 1933, as amended (the “Securities Act”). Most significantly, the Proposed Amendments would, if adopted, revise the Rule 144 holding period determination for securities acquired upon the conversion or exchange of certain market-adjustable securities of an issuer that does not have a class of securities listed, or approved to be listed, on a national securities exchange registered pursuant to Section 6 of the US Exchange Act of 1934, as amended (the “Exchange Act”). For such market-adjustable securities, the holding period would not begin until their conversion or exchange. The Proposed Amendments would also update and simplify Form 144 filing requirements found under Rule 101 and make certain changes to Forms 144, 4 and 5.
The public comment period will remain open for 60 days following publication of the proposing release in the Federal Register.
Rule 144 Holding Period for Restricted Securities
Rule 144 provides a non-exclusive safe harbor from the Security Act’s definition of “underwriter” to assist security holders in determining whether the Section 4(a)(1) exemption from registration is available for the resale of “restricted securities.” Restricted securities are securities acquired in unregistered sales directly from the issuer or an affiliate of the issuer. Typically, investors would receive restricted securities through private placement offerings, Regulation D offerings, employee stock benefit plans, as compensation for professional services or in exchange for providing “seed money” or start-up capital.
To satisfy the Rule 144 safe harbor, holders of restricted securities may not resell such securities until the expiry of the applicable “holding period.” The SEC designed the holding period concept to help ensure that securities are held at risk for a sufficient period of time prior to resale in order to demonstrate that the seller did not purchase such securities with a view to distribution and, therefore, is not an underwriter for the purposes of section 4(a)(1) of the Securities Act. Where the issuer of the restricted securities is, and has been for a period of at least 90 days immediately before the Rule 144 resale, subject to the reporting requirements of section 13 or 15(d) of the Exchange Act, the applicable holding period is six months. Where the issuer is not subject to the above reporting requirements of the Exchange Act, the applicable holding period is one year.
Important for the purposes of the Proposed Amendments is the concept of “tacking” under Rule 144. Tacking permits holders of restricted securities to aggregate the holding periods of prior holders in order to satisfy the applicable holding period. So long as the selling security holder did not purchase the securities from the issuer or an affiliate of the issuer, it may “tack,” or include in the calculation of its own holding period, the holding period of a prior holder.
Additionally, tacking is permitted where the new securities represent a continuation of the holder’s existing investment in another form. For instance, a holder may include, when looking to satisfy the applicable holding period under Rule 144, holding periods of certain related stock dividends, stock splits and recapitalizations, conversion or exchanges, change of domicile by the issuer, contingent issuances, acquisitions pursuant to anti-dilution rights and cashless exercise of options and warrants. Tacking is also permitted in the context of certain group restructurings.
Scope of the Proposed Amendments
The Proposed Amendments reexamine the tacking concept in the context of “market-adjustable securities,” meaning convertible or exchangeable securities that provide for a conversion rate, conversion price or other terms that, in each case, would have the effect of offsetting, in whole or in part, declines in value of the underlying securities that may occur prior to the conversion or exchange. Currently, Rule 144 deems securities acquired solely in exchange for other securities of the same issuer, including market-adjustable securities, to have been acquired at the same time as the securities surrendered for conversion or exchange. Thus, once the applicable holding period is satisfied, holders of market-adjustable securities could convert or exchange such securities and immediately sell the underlying securities into the public market at prices above the price at which they were acquired.
The Proposed Amendments seek to avoid this outcome. While the holding period determination for most convertible or variable-rate securities transactions would remain unchanged, the holding period for market-adjustable securities of an issuer that does not have a class of securities listed, or approved to be listed, on a national securities exchange would not commence until the underlying securities are acquired upon conversion or exchange.
In addition to revising the holding period determination for resales of market-adjustable securities under Rule 144, the Proposed Amendments would also update and simplify Form 144 filing obligations by requiring the electronic filing of all Form 144 notices related to the resale of securities of any issuer subject to the reporting requirements of Section 13 or 15(d) of the Exchange Act. Currently, such notices, while still required pursuant to Rule 101, may be submitted either or electronically or in paper. Where the issuer is not subject to such reporting requirements, the Proposed Amendments would eliminate the requirement to file Form 144 notices entirely.
Finally, the Proposed Amendments would amend the Form 144 filing deadline so that it may be filed concurrently with Form 5 by persons subject to both filing requirements, as well as update Forms 4 and 5 to add an optional check box to indicate that a reported transaction was intended to satisfy Rule 10b5-1(c), which provides an affirmative defense for trading on the basis of material non-public information in insider trading cases.
In addition to providing helpful updates to Forms 144, 4 and 5 and Rule 101, the Proposed Amendments seek to address concerns that the Rule 144 safe harbor enables issuers and holders of market-adjustable securities to circumvent the Security Act’s investor protections. As SEC Chairman Jay Clayton explains, the Proposed Amendments would, if adopted, ensure that such holders “are assuming the economic risks of their investment rather than acting as a conduit for an unregistered sale of securities to the public on behalf of an issuer.”
The impact of the Proposed Amendments on both issuers and investors, currently accustomed to converting or exchanging market-adjustable securities and quickly reselling the underlying securities into the public market in reliance on Rule 144, would be significant, delaying such resales for up to six months or one year. The Proposed Amendments are currently subject to a 60-day comment period.