September 22, 2021

Volume XI, Number 265

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Tacking When Floating and Other Proposed Amendments to SEC Rule 144

Rule 144 was originally adopted by the U. S. Securities and Exchange Commission (“SEC”) in 1972 to improve liquidity for investors in privately-placed securities. Under Section 5 of the Securities Act of 1933, as amended (the “33 Act”), it is unlawful to sell any security unless it is registered with the SEC or exempt from that registration requirement. One available exemption under Section 4(2) of the 33 Act is for offerings “not involving a public offering,” an exemption frequently relied upon to raise capital for start-ups and for local businesses. See my September 15, 2020, blog post, “‘Accredited Investor’: Regulatory Design, the Revised Definition, and the Unfinished Result,” for a history of the development of the so-called “private offering” exemption.

Proposed Amendments to SEC Rule 144

Once it was purchased, the questions were how and when could the investor sell his investment? The ability to sell made investing in privately placed securities far more attractive. For quite some time, sales were accomplished using the “change of circumstances” theory as a means for justifying the sale. Section 4(1) of the 33 Act permitted transactions by persons “other than an issuer, underwriter, or dealer.” Although Section 2(11) of the 33 Act does give a definition of “underwriter” the question was uncertain enough to make investors hesitate, frequently seeking so-called no-action letters from the SEC (i.e., letters stating that the SEC would not recommend bringing an enforcement action against the proposed seller if he sold under the circumstances described in the request to the SEC). By 1972, the SEC had determined to provide an organized system to allow resales of privately placed securities, and it adopted Rule 144. That Rule has been amended over the years, and as the size of the private securities market (i.e., the marketplace for securities that are not registered with the SEC) has grown, the importance of the liquidity provided by Rule 144 has grown in parallel.

On Tuesday, December 22, 2020, the SEC proposed new amendments (the “Amendments”) to the Rule to do some useful administrative “housekeeping” and to address an unforeseen loophole in the control of unregistered securities to restrict their reaching the public market. The proposal will remain open for public comment for 60 days once it is published in the Federal Register. Transactions under Rule 144 are reported to the SEC using Form 144, which originally was a paper form, and later filed on paper or electronically. The “housekeeping” in the Amendments includes requiring that all Forms 144 from now on be file electronically; eliminating the need to file a Form 144 with respect to sales of securities issued by companies not required to report under the Securities Exchange Act of 1934, as amended (the”34 Act”); changing the filing deadline for Forms 144 to match the filing deadline for Forms 4 (used by insiders to report transactions) rather than concurrently with placing a sell order; and amending Form 144 to eliminate certain personal identifiable information. Then-SEC Chair Jay Clayton (who stepped down last week) said in a statement accompanying the Amendments, that “… the proposed shift to electronic filing of Form 144 provides a necessary update to reflect today’s markets.” In addition to the changes proposed for Form 144, Form 4 and Form 5 (filed annually to report insider holdings) are to be amended to add a check-the-box, to allow the filer to indicate that a transaction reported on the Form was made pursuant to the terms of a plan that satisfies SEC Rule 10b5-1(c) (providing a defense against claims of illegal insider trading).

One of the key provisions of Rule 144 since its adoption has been the requirement that an investor owns the privately-placed security long enough to demonstrate that the investor is not simply serving as a conduit to distribute unregistered securities to the general public. When a privately placed security is converted into another security (such as happens in an acquisition or upon conversion of a convertible bond or convertible preferred) the holder is allowed to “tack” the time period that the original security was held with the time period that the new security is held to meet the Rule’s holding period requirement. For example, if one holds convertible debt for 14 months and then converts, it would be necessary to hold the resulting stock for only 10 months to meet a 24-month holding period.

Tacking When Floating

The designers of Rule 144 did not anticipate changes in the capital markets that have seen the development of “market-adjustable” or “floating conversion” securities. Unlike traditional convertible securities, or the exchange of securities that occur in acquisitions (in each case where the original investor bears the risk of loss from the date of purchase until the eventual sale, even if the security changes), “market-adjustable” securities have (in the SEC’s words) provisions that “adjust for, and protect the holder against, general decreases in the market value of the underlying securities.” As a result, under Rule 144 as it now exists, if the holding period has been met, the holder may, upon converting the “market-adjustable” or “floating conversion” security (where the new security is repriced such that the holder has not borne a risk of loss), immediately sell the new security to the general public. The Amendments would prevent the holder of a “floating conversion” security from tacking the period of holding the “floating conversion” security for purposes of meeting Rule 144’s holding period IF the securities received on conversion are not of a class of securities listed on, OR approved for listing on, a national securities exchange (such as the New York Stock Exchange or NASDAQ). The SEC reports that as of the end of 2019, there were approximately 2,760 unlisted reporting issuers.

In a statement on the Proposed Amendments to Rule 144, issued December 22, 2020, Commissioner Elad L. Roisman, who was named on December 28, 2020, as the Acting Chair of the SEC, said: “This proposed rulemaking would close a loophole that could put investors at risk and appears to have done little to forward the legitimate interests of smaller companies or their early-stage investors.” So it might be said that with these Amendments, a good sailer will know that one may not tack while floating.

©2021 Norris McLaughlin P.A., All Rights ReservedNational Law Review, Volume XI, Number 7
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About this Author

Peter D. Hutcheon Corporate Governance Lawyer Norris
Of Counsel

Peter D. Hutcheon practices primarily in the areas of business governance, commercial transactions, securities, banking, and finance.

Peter counsels management of public and private companies and banking institutions on governance matters.  He also has particular expertise with respect to indemnification and insurance issues affecting directors and officers.  Peter has represented parties in major public-private partnership financings.  He also represents clients seeking investment capital from private placements, venture capital, and private...

(908) 252-4216
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