Restricted Stock Lock Up and Leak Out Periods

Shareholders receiving restricted stock in OTC Markets companies sometimes find out later that their documents contain Lock Up or Leak Out provisions designed to limit the Shareholder’s ability to clear and sell stock.

What is a Lock Up Period?

A Lock Up Period is a time frame in which a Shareholder is prohibited from selling restricted stock.  One reason behind a typical Lock Up Agreement would be that the company is planning an IPO, or initial public offering and its Underwriter insists that existing shares be subject to a “lock up” during that time period.  Another common reason is when employees or consultants receive shares and their work is not yet completed.  A Lock Up Period in that event serves as a way for their shares to “vest over time.”

What is a Leak Out Period?

A Leak Out Period is the time frame in which a Shareholder has volume trading limitations placed on selling restricted stock.  Shareholders are often limited to selling a percentage of the daily trading volume, for instance.

An Experienced Securities Lawyer Can Spot Lock Up and Leak out Restrictions

An experienced securities lawyer can easily locate these clauses within a Shareholder’s Subscription Agreement, Employment Agreement, or Consulting Agreement and inform Shareholders of their rights and restrictions on selling restricted stock under Rule 144 or Section 4(a)(1).

Rule 144 and Section 4(a)(1) Opinions Can Be Issued Despite Lock Up and Leak Out Agreements

Simply having a Lock Up or Leak Out provision in your documents does not automatically mean that an experienced Rule 144 lawyer cannot issue a legal opinion.

On the contrary, with a careful reading of the documents and knowledge of the Rule 144 or Section 4(a)(1), OTC securities lawyer like Matt Stout can issue legal opinions for clearing restricted stock which fully explains to the Broker and Transfer Agent, the scope of the Lock Up or Leak Out language, and clarifies exactly what can be sold and when.

Shareholders with restricted stock can contact Rule 144 lawyer Matt Stout for a no cost review of certs and documents at (410) 429-7076 or mstout@otclawyers.com

Difference in Rule 144 Holding Periods for SEC Filers and Pink Sheets

Shareholders in OTC Markets public companies with audited financials listed on the OTCQB are often surprised to learn that they cannot sell shares even after their six (6) month holding period.  Why?  The answer is usually because the company is a “voluntary filer.”

Only Mandatory SEC Filers Can Use a 6 Month Holding Period Under Rule 144

The Rule 144 holding period of six months only applies to mandatory SEC Reporting Companies.   These are otherwise known as “SEC Filers” or “mandatory filers.”  The technical reason is that under Rule 144, the SEC only considers a “fully reporting company” to be an SEC filer with audited financials that is subject to the reporting requirements of Section 12 of the Securities Exchange Act of 1934.

Voluntary SEC Filers Are Not Subject to Section 12 of the Exchange Act

That means that shareholders of public companies which went public by filing an S-1 Registration Statement under the Securities Act of 1933 may not actually qualify for the Rule 144 six month holding period unless they also filed a form 8A-12g or a Form 10, which are both 34 Act filings.

Voluntary Filers Have a 12 Month Holding Period Like a Pink Sheet

If not, they are subject to a twelve month holding period just like a non reporting Pink Sheet.

Prior to issuing a legal opinion for restricted stock, an experienced securities attorney can review an issuer’s filings to quickly determine your holding period at no cost.

Is there a limit to the number of shares I can sell under Rule 144?

For non affiliates, there is no limit.  If you are an affiliate of an Issuer, you are subject to the volume trading limitations under Rule 144.

In a three (3) month period, an affiliate can sell only

  1. a maximum of one percent (1%) of the number of issued and outstanding shares for an OTC Markets Pink Sheet or Bulletin Board stock; or
  2. if the stock is traded on NASDAQ or an exchange like the NYSE, the average weekly trading volume for the full four (4) week period preceding the date you file your Form 144 with the SEC, if it is higher than the one percent (1%) limitation.

Affiliate shareholders seeking to sell stock under the Rule 144 volume trading limit can contact Matt Stout, securities lawyer at (410) 429-7076 for a review of their documents at no cost.

When does my holding period start for stock I receive in exercise of a “cashless option” or “cashless warrant”?

There is good news for shareholders who acquire warrants or options that specify a cashless exercise.  Rule 144 allows a Shareholder to tack onto the holding period of the warrants if the exercise into shares is “cashless.”

That is, the holding period under Rule 144 starts on the date the cashless language was first inserted into the option or warrant.  That could be either when the warrant or option was originally issued or the date of an amendment which included the language.

In contrast, if consideration is paid for the option or in order to exercise the warrants, then the holding period starts when that consideration is paid.

Is Stock Purchased from an Affiliate’s Spouse Restricted Under Rule 144?

This depends on whether the Affiliate’s spouse lives in the same household as the Affiliate.

If the Affiliate’s spouse lives in the same home as the Affiliate of the Issuer, the Shares are restricted and considered “Affiliate Shares” as they are still “beneficially owned” by the Affiliate, no matter how long ago the Shares were transferred to the Affiliate’s spouse.

Under Rule 144(a)(2)(i), if they live at the same address the Affiliate and spouse are regarded as essentially the same person.

Is stock received under Section 1145(a) of the Bankruptcy Code restricted?

No. Shareholders who receive stock pursuant to a Bankruptcy Code proceeding under the facts described in Section 1145(a) of the Bankruptcy Code would not receive restricted stock.

The stock is not considered “restricted” because the Shares are considered to have been received in a “public offering” under Section 1145(c) of the Bankruptcy Code.

What happens if I do not sell all the shares indicated on my Form 144 within the three months?

Under SEC Rule 144, there are essentially three restrictions on the sale of restricted stock by officers, directors, insiders or shareholders owning greater than 10% of the issuer’s stock, or other control persons of a public company (“Affiliates”).

  1. Affiliates must file Form 144 with the SEC detailing the number of shares being sold under Rule 144, the total number of shares beneficially owned by the Affiliate, showing the total issued and outstanding shares of the same class of securities as those being sold; and
  2. Affiliates must sell their restricted stock through a registered broker-dealer; and
  3. Affiliates must comply with the trading volume limitations for Affiliates under Rule which says that Affiliates of OTC Bulletin Board and OTC Markets public companies cannot sell greater than 1% of the total issued and outstanding shares of stock in any 3 month period.

So, if an Affiliate filed Form 144 and was prepared to meet those three requirements but did not sell all of the shares indicated on Form 144, the Affiliate has two choices:

  1. Affiliates can file a new Form 144, which adds those shares unsold with other shares up to the 1% limit; or
  2. Affiliates can direct their broker to return the unsold shares to the Issuer’s Transfer Agent, which will reissue the Affiliate a certificate with a Rule 144 restrictive legend that adds the unsold shares back in.

Affiliates seeking assistance in preparing a Rule 144 legal opinion for the sale of restricted stock can contact securities lawyer Matt Stout at (410) 429-7076 or mstout@otclawyers.com

When does my holding period start for stock I received as a gift?

Under Rule 144 a Donee Can Tack Onto the Donor’s Holding Period

When discussing the gifting of restricted stock, the person giving the gift of shares is called the “donor” while the person receiving the gift is known as the “donee.” Under SEC Rule 144, the donee is allowed to tack onto the donor’s holding period, meaning that there is no additional holding period involved when stock is gifted versus purchased.

Rule 144 Holding Period for SEC Reporting Companies

For “fully reporting” Issuers, that file Forms 10-Q, 10-K and 8-K with the SEC under the Securities Exchange Act of 1934, the holding period is six (6) months from the date the donor acquired the restricted stock.

So if you receive a gift of restricted stock in an OTC Bulletin Board (OTCBB) or OTC Markets OTCQB or OTCQX Issuer that was acquired by the donor seven (7) months ago, you may tack onto the donor’s holding period and your Rule 144 legal opinion can state that you have satisfied the Rule 144 holding period for shares in an SEC reporting company.

Rule 144 Holding Period for OTC Pink Sheet Stocks

The holding period for Non-Reporting companies such as OTC Markets Pink Sheets is one (1) year.  Just like with SEC reporting Issuers, the holding period for your gifted stock in an OTC Markets Pink Sheet begins when your donor’s holding period began, and you can tack onto the donor’s holding period in order to satisfy the one (1) year requirement under Rule 144.

What if the Donor Was an Affiliate at the Time of the Gift?

Whether the Issuer is an SEC reporting company or not, if the Donor was an Affiliate of the company at the time of the gift, you have received Affiliate stock, and you are subject to the Rule 144 trading volume limitations just as if you are were an Affiliate.

This means you must fill out Form 144 to provide notice of your sale of restricted stock, and that you cannot sell more than 1% of the total issued and outstanding shares during any three (3) month period) for OTC Bulletin Board and Pink Sheet stocks.

Moreover, both you and the Affiliate share the same 1%, so you must aggregate your restricted stock sales with your donor’s sales to determine the limit on the number of shares you both can sell under Rule 144.

What if the Donor Had Ceased to Be an Affiliate Prior to the Gift to You?

If, however, the Donor had ceased being an Affiliate of the Company greater than Ninety (90) days prior to the gift of restricted stock to you, then you are not treated as an Affiliate under Rule 144, and you are not subject to trading volume limitations, and you are not required to file Form 144 with the SEC.

Shareholders with restricted stock in OTCBB, OTCQB, OTCQX and OTC Pink Sheet public companes (as well as those with restricted shares in NASDAQ and NYSE MKT issuers) can contact Matt Stout, securities attorney at (410) 429-7076 with questions or find further information at OTCLawyers.com.

Can Rule 144 Be Used By a Shell Company?

The SEC defines a Shell Company as an Issuer that has either:

  1. Nominal operations;
  2. Assets consisting solely of cash and cash equivalents; or
  3. Assets consisting of any amount of cash and cash equivalents and nominal other assets.

Issuer Must File Reports for 12 Months After Ceasing to Be a Shell

SEC Rule 144 may not be used to sell stock in a current Shell Company.  Rule 144 also cannot be relied upon by a Shareholder to sell stock in a former Shell Company, unless the Issuer has been reporting to the SEC for at least 12 months after it ceased to be a “shell” and is current in its reports.

Alternatives to Rule 144 for Shareholders Stuck With Stock in Former Shells

This requirement does not concern the Shareholder or the shares themselves, and applies even if the Shareholder’s holding period is greater than 12 months…and even if the Issuer was not a “shell” when the Shareholder acquired the stock.

Shareholders stuck with illiquid stock in a former Shell Company that is not current in its reporting to the SEC or to OTCMarkets.com can contact an experienced securities attorney to discuss alternatives to Rule 144 when clearing restricted stock.

How Long Can an Affiliate Use Form 144?

SEC Form 144 Is Only Good for Three Months

For an Affiliate of an OTC Bulletin Board or OTC Markets Pink Sheet Issuer, each Form 144 is only good for 3 months from the date Form 144 is filed with the SEC. If any of the Affiliate’s restricted stock remains unsold at the end of the 3 months, those securities can be included in a new Form 144 filing.

The Affiliate’s Broker will most likely be on top of this process and the Affiliate can also benefit by contacting a securities lawyer to issue a new Rule 144 opinion, since the Transfer Agent will most likely request one prior to allowing the sale of shares under the new Form 144 notice.

Shares Unsold Must Be Covered By a New Form 144

Under Rule 144, it is important that the Affiliate promptly issue a new Form 144 and obtain a legal opinion, since any shares that are both unsold and not covered under a new Form 144 must be returned by the broker to the Transfer Agent for the issuance of new  stock certificate with a restrictive or restricted legend.  This unnecessarily complicates the process, and essentially causes the Affiliate, Broker and Transfer Agent to start at square one.

A Securities Lawyer Can Help By Issuing a New Rule 144 Opinion Letter

To streamline the 144 opinion letter process, Affiliate Shareholders of OTC Bulletin Board and OTC Markets Pink Sheet stocks can contact Matt Stout, securities lawyer with OTCLawyers.com for a Rule 144 legal opinion.