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.

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.

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.

What are Control Securities?

Control Securities are Held By Affiliates Under Rule 144

Control securities are those held by an Affiliate of the Issuer. An Affiliate is a person, such as an Officer, Director or Shareholder owing greater than 10% of the issued and outstanding shares, and is presumed by the SEC to be in a position or relationship of control over the Issuer.  

Under Rule 144 A Control Person Has the Power to Direct the Policies of the Issuer

Under Rule 144, the term “control” is defined as the power to direct the management and policies of the Issuer, either by voting rights, under a contract or agreement, or in any other manner. 

Buyers of 144 Stock from Affiliates Receive Restricted Stock

The important part for buyers of OTC Bulletin Board and OTC Pink Sheets stock to know is that under Rule 144, if you purchase stock from an Affiliate in a private sale, you receive restricted stock.  This is true even if the Affiliate had purchased the stock on the open market.  For this reason, a crucial element of a Rule 144 legal opinion is the Affiliate status of the Shareholder and all prior holders of the stock.

What is a Rule 144 Non Shell Opinion?

Clearing Firms Can Request Opinions Regarding the Issuer’s Non Shell Status Even if the Certificate is Without Restriction

Sometimes Shareholder already hold stock certificates with the restricted legend removed, so a typical 144 letter is not requested by a clearing firm.  However, even when the cert appears free trading, sometimes the Issuer’s financials and filings are light on detail, leading some to question whether or not the Issuer is an undeclared shell.  When this happens, Shareholder’s can obtain a Non Shell Opinion Letter from an experienced securities attorney, like those at OTCLawyers.com.

What is a Shell According to Rule 144?

Under Rule 144, a Company does not meet the definition of a “shell” if it has more than

  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.

When a staff attorney or compliance specialist at a brokerage requests a Non Shell Opinion Letter, they are looking for specific details which demonstrate that the Issuer has an operating business and significant assets.

Not All Securities Attorneys Draft Rule 144 Non Shell Opinions

Not every securities attorney will be comfortable with drafting a Non Shell letter under Rule 144 if the Issuer’s filings show zero dollars on the balance sheet.

However, an experienced securities law firm like the Law Office of Matheau J. W. Stout, Esq. knows that sometimes Issuers hold significant assets that are not highlighted in their financials, but may be referenced within their disclosures, such as intellectual property, land, equipment, accounts receivable and leases.

Shareholders should consult with a securities attorney who is willing to research the Non Shell issue thoroughly, and who can document an OTC Issuer’s assets and operations in a detail Non Shell Opinion Letter.

When Does the Rule 144 Holding Period Start for Consulting Services?

At the Law Office of Matheau J. W. Stout, Esq., we are often called upon to research and draft SEC Rule 144 legal opinions for Shareholders who acquired stock as payment for consulting services.

The Consulting Agreement Should State the Holding Period Under Rule 144

The underlying Consulting Agreement is the most important document for a securities attorney to review when preparing a 144 letter in this situation because the language in the document will determine the holding period.  Sometimes consultants working with OTCMarkets Issuers do not specify when the services are fully performed, and that can be problematic.

Under Rule 144, the Holding Period Does Not Start Until the Stock is Fully “Paid For”

The key here is that the holding period does not begin until the stock was fully earned, or paid for by the services.  Sometimes Consulting Agreements are not specific in this regard, and that makes clearing restricted stock difficult, even when all other aspects of Rule 144 are met.   Situations like this call for an experienced securities law firm, which can thoroughly review all of the facts and documents on which the legal opinion relies.

Vague Wording in Consulting Agreements Can Make Clearing Restricted Stock Difficult

If the Consulting Agreement states that in exchange for 1,000,000 shares, “the Consultant will provide services until August 1, 2020”, then the consideration paid for the Shares may not be fully “paid” until 2020 even if the document is over a year old. That is a terrible result due to vague language.   That ambiguity can sometimes be remedied by a Board Resolution or letter from an Officer or Director of the Issuer, provided that relationship is still good.  But what if the Consultant and Issuer are no longer working together?  Or what if the Issuer is under the control of new management?

Specific Rule 144 Language in Consulting Agreements is Recommended

Contrast that with a Consulting Agreement that specifically states

“Issuer agrees that all 1,000,000 Shares shall be fully earned on June 1, 2010.  Upon Consultant’s request, Issuer shall issue a Board Resolution and Transfer Agent instructions confirming that on June 1, 2010, Consultant shall be deemed to have paid full consideration for the 1,000,000 Shares under SEC Rule 144.”

Language like this is a good indicator that a securities attorney with expertise in Rule 144 drafted the document.    Whether you are a consultant who would like a tightly drafted Consulting Agreement to use when providing services to OTC Bulletin Board and Pink Sheet companies, or a Shareholder trying to clear restricted stock, visit OTCLawyers.com to learn the next steps.