What is a Section 4(1) Legal Opinion for the Sale of Restricted Stock?

Shareholders of restricted stock in over-the-counter Issuers soon become familiar with SEC Rule 144 since it is the most popular method by which a securities lawyer can help a Shareholder remove the restrictive legend from their shares.  However, there are some instances when Rule 144 cannot be used.

Rule 144 Holding Period for SEC Reporting Issuers

Rule 144 has a holding period requirement of six (6) months for shares in an SEC Reporting Company like an OTC Bulletin Board, OTCBB, and OTC Markets OTCQB and OTCQX.  This means that a Shareholder must have held the shares for that long before trying to sell under Rule 144.

Rule 144 Holding Period for Pink Sheets

The holding period under Rule 144 for shares in a Non Reporting Company such as an OTC Markets Pink Sheet Issuer is twelve (12) months.   So a Shareholder in a Pink Sheet must have held the shares for a year before using Rule 144 to clear the restricted stock.

Current Public Information Requirement Under Rule 144

Rule 144 also requires that the Issuer of the restricted stock provide “current public information” and this is where many Shareholders in OTC stock are prevented from removing the restrictive legends and selling their restricted stock.

Some companies fall behind in their filings and soon become Pink Sheet No Information (Pink Sheet Stop Sign) on OTC Markets.  This happens when an Issuer is more than a quarter behind in its SEC filings or the posting of its financials and disclosures on OTCMarkets.com.

Section 4(1) Can Be Used to Sell Restricted Stock in Pink Sheet Stop Signs

When an Issuer is a Pink Sheet Stop Sign, Rule 144 cannot be used to sell the restricted stock, even if the Shareholder is a Non Affiliate and the Shares have been held for greater than a year.   This is a problem for many Shareholders because it is difficult to persuade or force an Issuer to become current in its filings, especially in development stage public companies that may have little cash flow.

Holding Period Under Section 4(1)

For Shareholders that have held their restricted stock in a Pink Sheet Stop Sign for at least two (2) years, Section 4(1) may be available where Rule 144 is not.   This is because the elements of a Section 4(1) legal opinion are centered around the identity and role of the Shareholder, rather than the Issuer itself.

Shareholder Must Not Be an Underwriter, Broker or Dealer Under Section 4(1)

If the Shareholder can be shown not to be an Underwriter, or Broker, or Dealer, and if the origin and history of the Shares can be documented, an experienced securities attorney like Matt Stout can draft a Section 4(1) opinion.  These Section 4(1) opinions are often longer and more detailed than a standard Rule 144 opinion because they discuss case law in depth.

As always, the best policy is to provide a securities lawyer with a copy of the Shareholder’s restricted stock certificate, and as much of the underlying documentation as possible, including stock purchase agreement, promissory notes and debt conversion paperwork or consulting agreements, as applicable.

The more detail provided to the securities lawyer, the faster the restricted stock opinion can be researched and drafted, whether that is under Rule 144 or under the provisions of Section 4(1).   Securities lawyer Matheau J. W. Stout can be reached at (410) 429-7076 with questions on clearing restricted stock.

What are Control Securities under Rule 144?

Under SEC Rule 144, Control Securities include restricted stock held by an Affiliate of the Issuer. An Affiliate is a person, such as an executive officer, a member of the company’s board of directors or large shareholder, owning greater than 10%.   These positions imply that the Affiliate is in a position of control with the issuer, and thus Affiliates are also sometimes called “Control Persons” when securities lawyers are analyzing restricted stock.

Control Person means that the Affiliate has the power to direct the management and policies of the Issuer.  This power can be derived through the ownership of 10% or more of the Issuer’s voting securities, by some contract or agreement with the Issuer, or otherwise.

When a Shareholder in an OTC Bulletin Board or OTC Markets Issuer purchases stock from a Control Person or Affiliate, they receive restricted stock.

Removing Restricted Legend from Certificates Under Rule 144

Shareholders of OTC Bulletin Board and OTC Markets OTCQX, OTCQB and Pink Sheets Issuers who purchase stock privately usually have stock certificates bearing a Rule 144 restricted legend.  The same is true when Shareholders receive stock in Over-the-counter microcap public companies in exchange for services, such as consulting.

This 144 legend tells the Transfer Agent and a prospective purchaser of the OTC stock that a legal opinion from an experienced securities attorney will be required before the securities can be sold under the provisions of SEC Rule 144.

The Process of Removing the 144 Legend

The process of removing the restricted or restrictive legend under SEC Rule 144 is straightforward for the Shareholder:

  1. The Shareholder contacts a securities lawyer and provides a copy of the certificate and all supporting documentation showing the origin and history of the restricted shares;
  2. The securities lawyer reviews the Shareholder’s documentation, and reviews the OTC Bulletin Board or OTC Markets Issuers filings at SEC.gov and OTCMarkets.com;
  3. If necessary, copies of agreements, letters from the Shareholder and/or Issuer, and board resolutions are requested to further document the transaction; and
  4. If the elements of Rule 144 are met, the securities lawyer drafts a Rule 144 opinion addressed to the transfer agent, citing each document and filing reviewed.

An Experienced Securities Attorney Can Help

Shareholders of OTCBB and Pink Sheets issuers can make the process of removing a restricted legend from 144 stock easier by contacting an experienced securities lawyer like Matt Stout at OTCLawyers.com or MJWStout.com.  If the requirements of SEC Rule 144 are clearly supported by the documents provided and the Issuer’s filings, a legal opinion can be issued promptly. Where information or documents are missing, a securities lawyer can work with the Shareholder, Issuer, Broker and Transfer Agent to confirm details and check facts.

 

 

 

What is the Current Public Information Requirement Under Rule 144?

Rule 144 Requires Current Public Information Before Stock Can Be Sold

In order for a securities attorney to draft a Rule 144 opinion letter, there must be adequate current information about the Issuer publicly available before the stock can be sold.

SEC Reporting Companies Must Have Filed SEC Forms 10-Q, 10-K, and 8-K

For SEC reporting companies, such as those on the OTCMarkets OTCQB, OTCQX, and OTC Bulletin Board (OTBB), this generally means that the companies have complied with the periodic reporting requirements of the Securities Exchange Act of 1934, which provides for the filing of SEC Forms 10-Q, 10-K, and 8-K.  This is easy for securities lawyers at the Law Office of Matheau J. W. Stout, Esq. to verify, either at OTCMarkets.com or via SEC.gov.

OTCMarkets Bulletin Board and Pink Sheet Companies Need to Be Current

For non-reporting companies, such as Pink Sheets, this means that certain company information about its business, its officers and directors, and its financial statements, is publicly available in Disclosure Statements and Quarterly and Annual Reports.

OTCMarkets Makes It Easy To See Which Companies Are Current in Their Filings Under Rule 144

As a practical matter, OTCMarkets.com has made confirming this requirement easy through its market tier system.  Simply put, a securities attorney can tell at a glance whether the current public information requirement of Rule 144 is met–if the Issuer is an OTCQX, OTCQB or Current Pink, then the Issuer is “current” under the Alternative Reporting Standard.

What to Do If the Issuer is Not Current Under Rule 144

If the Issuer is listed on OTCMarkets.com as Yield Sign (Pink Limited Information), the Company may only be late in one of its Quarterly or Annual Reports or a Disclosure Statement, which might easily be corrected by communicating with management and finding out how much longer they expect it will take to catch up.  

If, on the other hand, the Issuer is listed as a Stop Sign on OTCMarkets.com, the Company may be delinquent anywhere from a few months to several years in its filings, and there may be little hope of clearing the stock under Rule 144.  (When that happens, contact an experienced securities attorney like Matt Stout to inquire about other SEC provisions, such as 4(1), which might allow the stock to be cleared).

What are the Trading Volume Restrictions for Affiliates Under Rule 144?

Affiliate Trading Volume Formula According to the SEC

If now, or within the past ninety days, you have been an Officer, Director, Control Person, or if you beneficially own more than Ten Percent of an Issuer, you are an Affiliate according to the SEC.  

Affiliates of OTC Bulletin Board and Pink Sheet Issuers

If you are an Affiliate of an Issuer trading on the OTCMarkets, OTC Bulletin Board or Pink Sheets, the number of equity securities you are allowed to sell during any three-month period cannot exceed the greater of 1% of the outstanding shares of the same class being sold. You must file a Notice of Sale on Form 144 with the SEC for each sale.  An experienced securities attorney can quickly walk you through this process.

Affiliates of Issuers Listed on a Stock Exchange Have Another Option

If you happen to be an Affiliate of an Issuer listed on a stock exchange, such as NYSE or NASDAQ you could sell up to the greater of 1% or the average reported weekly trading volume during the four weeks prior to the filing of Form 144. 

However, Over-the-counter stocks, including those quoted on the OTC Bulletin Board and the Pink Sheets, can only be sold using the 1% measurement. 

How Do I Remove the Restricted Legend on Rule 144 Stocks?

The first step in removing the restricted legend from a stock certificate under Rule 144 is to contact a qualified securities attorney who has expertise in drafting 144 legal opinions.

Only the Issuer’s Transfer Agent can remove a restrictive legend from the cert, and usually cannot happen unless the Shareholder’s request is accompanied by a Rule 144 opinion letter from securities counsel.  Although the consent of the Issuer is helpful, it is not necessary, especially if the Issuer is uncooperative.

If the securities lawyer drafting the opinion is well known by the Transfer Agent due to having drafted 144 legal opinions many times in the past, and the requirements under SEC Rule 144 have clearly been met, the restricted legend can be removed even over the Issuer’s objection.

According to the SEC, removing the restricted legend can be “a complicated process requiring you to work with an attorney who specializes in securities law” and that is true.  However, for securities attorneys who frequently draft 144 legal opinions, like the Law Office of Matheau J. W. Stout, Esq., the turn around time for such a letter can be as little as one day if all of the shareholder’s documentation is presented at the outset.

Securities Lawyers Opinion Letters

Rule 144 Letters Written By Securities Counsel

Perhaps the most common type of securities attorney opinion letter for the sale of restricted stock is the Rule 144 opinion letter.  A 144 opinion is written by a securities attorney after careful research of not only the issuing company, but also the current Shareholder and all predecessor holders of the stock.

Rule 144 Exceptions to SEC Registration of Restricted Stock

Rule 144 deals with exceptions to registered securities and it is basically a safe harbor, or series of opportunities for Shareholders to sell restricted stock without SEC registration of the securities.  Several different rules exist for how long an investor must own or hold the stock, and a lot depends on whether or not the Shareholder is or was an Affiliate of the issuing company.

What is an Affiliate According to Rule 144?

An Affiliate is basically an “insider” and Rule 144 has many different criteria for deciding if one is an Affiliate.  However, in a broad sense Affiliates include officers, directors, founders and their immediate family members living in the same household because they are all presumed to have control over the company and thus the stock.  Another name for an Affiliate is a “control person.”

Rule 144 Exemptions for Non Affiliates Selling Restricted Stock

Rule 144 Opinions Discuss Safe Harbor Requirements

Shareholders of restricted stock who are not Affiliates now, or for the past ninety (90) days can sell their restricted stock under Rule 144 if the stock has been held by the Shareholder for a minimum of one (1) year.

Rule 144 Is More Lenient on OTC Bulletin Board Companies That Provide Current Public Information

If the Issuing Company of the stock is subject to the Exchange Act reporting requirements (typically reporting by posting regular filings, and listed on the OTC Bulletin Board, NASDAQ, etc) and the Shareholder has owned the stock  for at least six (6) months but less than one (1)  year, the SEC allows the Shareholder to sell the restricted stock, provided that the Company has satisfied the requirement to provide current public information to investors.

This requirement is researched by a securities attorney when drafting a 144 opinion letter and companies that file the typical 10-Q, 10-K and 8 reports with regularity and on time for the year prior to the Shareholder’s proposed sale of under 144 generally meet that requirement