Developments in the Resale of Restricted Securities
| Publication year | 1990 |
| Pages | 1803 |
1990, September, Pg. 1803. Developments in the Resale of Restricted Securities
On April 9, 1990, the Securities and Exchange Commission ("Commission") approved amendments to Rule 144 and the adoption of Rule 144A.(fn1) The amendments to Rule 144 are designed to permit "tacking" in certain circumstances in order to satisfy the two-year holding period requirement. Rule 144A provides an exemption from the registration requirements of the Securities Act of 1933(fn2) ("Securities Act") for the resale of unregistered or "restricted" securities to qualified institutional buyers.(fn3)
Rule 144A is expected to result in a more liquid and efficient resale market for restricted securities. This liquidity is expected to be further enhanced by the establishment of "PORTAL" (Private Offerings, Resales and Trading through Automated Linkages)---a computerized, screen-based trading system for securities sold in reliance on Rule 144A. PORTAL was created by the National Association of Securities Dealers, Inc. ("NASD").(fn4) The amendments to Rule 144, Rule 144A and PORTAL will make it easier for investors to sell and trade restricted securities originally issued in a private placement. With a more liquid secondary market, private issuers should find a broader primary market and more favorable pricing for their privately placed securities.
This article examines Rule 144A and the amendments to Rule 144. It also briefly reviews the PORTAL system.
The private offering exemption provided by Securities Act § 4(2) does not require that restricted securities be held indefinitely.(fn5) However, prior to the adoption of Rule 144, the conditions imposed by the Commission on the resale of restricted securities resulted in differing interpretations regarding the holding period required before resales could be made, as well as the manner in which such resales could be effected. It was not until the Commission adopted Rule 144 in 1972 that holders of restricted securities were provided with any comfort regarding the circumstances in which their shares could be resold publicly without registration.(fn6) Beginning in 1981, the requirements regarding the resale of restricted securities have been liberalized through oral and written interpretations from the Commission and its staff, as well as by amendments to Rule 144 itself.(fn7)
The Commission's latest rule-making efforts reflect the most far-reaching and controversial developments in the resale of restricted securities. These developments have taken place following a period of exponential growth in the private placement market. The primary market for private placements of debt and equity securities in the United States grew from $16 billion in 1980 to $166 billion in 1989.(fn8) The rise in popularity of privately raised capital reflects the increased costs of accessing the public markets, as well as the increased liquidity in the secondary market for private placements.(fn9) The increased liquidity stems, in part, from (1) the development of a more active and formal trading market for restricted securities; (2) the liberalization by the courts and the Commission of the exemption from registration provided by Securities Act §§ 4(2) and 4(1); and (3) the expanded reliance on the so-called "§ 4(1-2)" exemption for the private resale of restricted securities.(fn10)
This newsletter is prepared by the Business Law Section of the Colorado Bar Association to apprise members of the Bar of current information concerning substantive areas of business law. This month's column was written by Daniel W. Rumsey, Denver, an associate of Davis, Graham & Stubbs. Rumsey formerly was with the SEC's Division of Corporation Finance, Office of International Corporate Finance, where he worked extensively on proposed Rule 144A and the amendments to Rule 144. The author acknowledges with gratitude the assistance of Davis, Graham & Stubbs' word processing department in the preparation of this article.
Recognizing that the private placement market for the resale of restricted securities existed despite the absence of a statutory articulation of the requirements for the exemption, and desiring to give effect to congressional intent in the adoption of the Securities Act, the Commission proposed Rule 144A. Rule 144A is designed to exempt private transactions which, on the basis of a few objective standards, can be defined as outside the purview of Securities Act § 5, without the necessity of undertaking the traditional analysis under Securities Act §§ 4(1), 4(2) and 4(3).(fn11)
If the conditions of Rule 144A are met, persons other than issuers or dealers will be deemed not to be engaged in a "distribution" and, therefore, not to be an "underwriter" within the meaning of Securities Act §§ 2(11) and 4(1). Similarly, if the conditions of Rule 144A are met, dealers will not be deemed to be participants in the distribution of securities within the meaning of Securities Act § 4(3), and the securities will be deemed not to have been offered "to the public." Thus, qualified institutions can claim the § 4(1) exemption, and dealers can claim the § 4(3) exemption with respect to their resales under Rule 144A.
Certain transfer restrictions and other requirements that existed prior to the adoption of Rule 144A may no longer be necessary in the case of initial private placements and resales made in compliance with the Rule. In a pre-Rule 144A market, securities originally issued pursuant to the exemptions from registration provided by § 4(2) or Regulation D typically were issued only after the issuer received an investment letter containing representations regarding knowledge, sophistication, access to information, ability to bear the economic risk of the investment and intention to hold such securities solely for investment.
Compliance with these restrictions was enforced by the issuer through:
1) restrictions on resales unless the securities were registered under the Securities Act or an exemption therefrom was available;
2) stop transfer orders that prevented transfers without evidence of compliance with the restrictions (including, in certain cases, delivery of a § 4(1 1/2) legal opinion);
3) legends referring to the restrictions on certificates representing the securities; and
4) information in the offering materials which described the restrictions, as well as covenants from investors regarding their compliance with such restrictions.
The foregoing procedures are designed to protect issuers and sellers from liability for resales not in compliance with Securities Act § 4(1). If the original purchaser subsequently sold such securities without registration or in a manner not exempt from registration under the Securities Act, the purchaser could be deemed an underwriter, and the resale would be in violation of Securities Act § 5. If the issuer did not exercise reasonable care to prevent such a...
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