1972, April, Pg. 31. New SEC Rules for Selling Restricted Securities.

• Author: David R. Johnson

1 Colo.Law. 31

Colorado Lawyer

1972.

1972, April, Pg. 31.

New SEC Rules for Selling Restricted Securities

311972, April, Pg. 31New SEC Rules for Selling Restricted SecuritiesDavid R. JohnsonDavid R. Johnson, Denver is a partner with the firm of Dawson, Nagel, Sherman & Howard.The SEC has adopted Rule 144(fn1) and Rule 237(fn2), effective April 15, 1972, which establish specific conditions for lawfully selling restricted securities to the public without registration under the Securities Act of 1933 (the Act). Concurrently the SEC has amended Regulation A to increase the availability of that method for selling restricted securities.(fn3) As defined in Rule 144, "the term 'restricted securities' means securities acquired directly or indirectly from the issuer thereof, or from an affiliate of such issuer, in a transaction or chain of transactions not involving any public offering."

This article is only a short tour of the primary points of general interest in this area. Some of the footnotes offer side trips to certain details and problems. As opportunities arise each lawyer should inspect the new rules in detail and review their treatment in the hands of judges, SEC administrators and fellow attorneys.

At the outset some background information will locate the new rules within the scheme of the securities laws. Assuming the use of federal jurisdictional means, any sale of any security by any person requires registration under the Act unless there is an exemption either for the security or for the transaction. When securities are sold by an issuer without, registration, the issuer frequently(fn4) relies upon the exemption provided in Section 4(2) for "transactions by an issuer not involving any public offering." Since ultimate purchases by a large number of persons or by unsophisticated persons would be indicative of a "public offering,"(fn5) the well-advised issuer, in order to avoid excessive distribution and to protect its Section 4(2) exemption for the original sale, (1) obtains representations from the purchasers that they are acquiring the securities for investment for their own accounts and without a view to distribution and (2) requires the purchasers to demonstrate their investment intentions by restricting transfers of their securities for an appropriate period after the original sale.

Later, when the original purchasers desire to sell their restricted securities, their sales would likewise require registration under the Act if no exemption were available. The primary candidate for their sales is the exemption found in Section 4(1) for "transactions by any person other than an issuer, underwriter or dealer."

32Usually there is no concern that a holder and prospective seller of restricted securities may be "an issuer" or "dealer," as defined in the Act,(fn6) so that the exemption in Section 4(1) is available unless the seller would be an "underwriter." The possibility that the seller of restricted securities would be an "underwriter" as defined in the Act is the bedrock problem in this area, although it has been buried beneath layers of informal doctrines deposited during the past several years in the absence of specific rules. As defined in Section 2(a)(11) of the Act:

"The term 'underwriter' means any person who has purchased from an issuer with a view to, or offers or sells for an issuer in connection with, the distribution of any security, or participates or has a direct or indirect participation in any such undertaking, or participates or has a participation in the direct or indirect underwriting of any such undertaking; but such term shall not include a person whose interest is limited to a commission from an underwriter or dealer not in excess of the usual and customary distributors' or sellers' commission. As used in this paragraph the term 'issuer' shall include, in addition to an issuer, any person directly or indirectly controlling or controlled by the issuer, or any person under direct or indirect common control with the issuer."

Any control-related person who is an "issuer" by virtue of the last sentence of this quoted definition is called an "affiliate" in the new SEC rules and in other parts of the securities laws.(fn7) As mentioned in the following discussion, different rules apply for the sale of securities, whether or not restricted, by affiliates.

Tying together the original sale by the issuer and the subsequent resale by the holder, if the holder purchased the securities from the issuer with a view to distribution the private offering exemption under Section 4(2) was never available for the original sale and the exemption under Section 4(1) would not be available for the resale, because the holder making the resale would be an "underwriter." Conversely, if the holder purchased without a view to distribution, the separate but related exemptions for the issuer and the holder would both be available, at least theoretically.

In the past this area has been notoriously muddy owing to the constantly evolving and occasionally conflicting viewpoints of the SEC, the different measures of experience and convervatism on the part of lawyers, the comforting but misleading talk about "changes of circumstances"(fn8) and the rotten apple theory called "fungibility."(fn9) All too frequently persons desiring to sell restricted securities have become stuck in these legal theories, having no obvious relationships with the public interest.

Based at bedrock on the definition of the term "underwriter" and constructed in part out of the old theories, the new rules surmount the old mud. After April 15, 1972, there will be at least four and possibly five methods for lawfully selling restricted securities to the public: (1) Rule 144, an entirely new rule applicable to securities of most publicly held companies; (2) Rule 237, an...