The Ability of Pledgees to Dispose of Securities Under Rule 144
| Publication year | 1985 |
| Pages | 982 |
| Citation | Vol. 14 No. 6 Pg. 982 |
1985, June, Pg. 982. The Ability of Pledgees to Dispose of Securities Under Rule 144
Rule 144 was promulgated by the Securities and Exchange Commission ("SEC") under the Securities Act of 1933, as amended ("Securities Act").(fn1) The Rule has presented substantial problems to pledgees and their counsel since the Rule's passage in 1972.(fn2) Lenders frequently accept a pledge of securities which are not freely tradeable as security for a loan.
This article attempts to give pledgees some guidance regarding the effect of Rule 144 on their ability to dispose of collateral. However, Rule 144 is complex and its interpretation may depend upon the particular facts of a given situation. Any lender considering a pledge of restricted securities as collateral should be advised by securities counsel to assure itself that the securities meet lender's requirements for liquidity and that counsel will be able to issue an opinion to the transfer agent if a disposition of the collateral becomes necessary.
The Securities Act prohibits the sale of securities unless either (1) a registration statement, containing the form of a prospectus describing the issuer, has been reviewed and declared effective by the SEC, or (2) the transaction is exempt from such registration process. This basic prohibition applies to everyone who wants to sell a security, including the holder of one share of the most widely held public issuer.
One of the exemptions from registration is the normal trading exemption provided by § 4(1) of the Securities Act,(fn3) which is used when a publicly traded security is sold through a broker. This exemption is available for sales by someone other than "an issuer, underwriter, or dealer." If ordinary investors or pledgees could not take advantage of this exemption, they would have to register with the SEC the shares they are about to sell, usually a costly and time-consuming process.
Generally, there is no doubt that ordinary investors or pledgees do not come within either the "issuer" or "dealer" categories of § 4(1). However, "underwriter," which conceptually involves the direct or indirect reselling of securities for the issuer,(fn4) has been broadly interpreted by the courts and the SEC.
Underwriter status might arise in two basic situations. The first occurs when the securities being sold (or pledged) were initially sold by the issuer in an exempt transaction, such as a private placement exempt from registration with the SEC,(fn5) and have been transferred subsequently only in private transactions. These securities are referred to as "restricted securities," which are defined in paragraph (a) of Rule 1446 and which usually bear the traditional restrictive legend. Purchasers, including pledgees, of restricted securities may find that they have inadvertently directly or indirectly participated in a purchase of securities from an issuer with a view to a distribution. Therefore, they are statutory underwriters.
The second situation arises because the Act broadly defines an underwriter to include someone who buys securities from an affiliate of the issuer with a view to a distribution. Thus, an affiliate, usually a director, officer or major shareholder of the issuer, who buys securities of the issuer in an ordinary market transaction or a registered transaction may confer statutory underwriter status upon the purchaser or pledgee. These securities are referred to as "control securities."
Rule 144 was adopted as a "safe-harbor"(fn7) to provide persons who were unsure of their status as "underwriters" with a procedure for legally disposing of their securities. Prior to 1960, it had been generally thought that any sale by a pledgee after a default would be exempt pursuant to § 4(1). However, in 1960, the Second Circuit took the position that a pledge of stock was a "sale" for the purposes of definition of an underwriter, whether or not a pledgee actually sold the stock. Furthermore, the obvious intent of a pledgee to sell the stock in the event of default (a view to distribution) caused the pledgee to become an "underwriter" under the Securities Act.(fn8) Therefore, § 4(1) was not available as an exemption for the sale by the pledgee.
In recent years, Rule 144 has become a more reliable tool for all sellers of restricted and control securities, particularly with the introduction in 1979 of the principles now embodied in paragraph (k) of Rule 144.(fn9) This provision, with modifications adopted in 1983,(fn10) has virtually eliminated restrictions on sales by non-affiliates who have "beneficially owned" the securities for over three years. The SEC assisted in this development by issuing several helpful no-action letters, which have enhanced the usefulness of Rule 144 for the pledgee.(fn11)
There are five basic requirements of Rule 144 which...
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