NEW PARADIGMS IN INVESTOR LIQUIDITY: PRIVATE AND “OFF-MARKET” RESALES OF SECURITIES UNDER RULE 144 AND

BEYOND

By Brian Korn and David P. Russo*

July 2013

I. Introduction ......................................................................................................................... 2

II. Securities Act Registration Requirement and Exemptions ................................................. 3

III. Rule 144: Resales of Restricted and Control Securities – Overview................................. 4

IV. Rule 144: Resales by Affiliates.......................................................................................... 6 A. General .................................................................................................................... 6 B. Definition of “Affiliate” and “Control” under Rule 144 ........................................ 7 C. Rule 144 Regulatory Intent and Requirements – Overview ................................... 8 D. Restricted and Control Securities.......................................................................... 10 E. Applicability of Rule 144...................................................................................... 10 F. Conditions for Affiliate Resales ............................................................................ 11

1. Condition 1: Holding Period .................................................................... 11 2. Condition 2: Issuer Information. .............................................................. 12 3. Condition 3: Manner of Sale. ................................................................... 13 4. Condition 4: Volume Limitation. ............................................................. 13 5. Condition 5: Resale Notice and Timing................................................... 14

V. Rule 144: Resales by Non-Affiliates ............................................................................... 15 A. General .................................................................................................................. 15 B. Definition of Restricted Security. ......................................................................... 15 C. Conditions for Non-Affiliate Resales ................................................................... 16 D. Tacking Issues ....................................................................................................... 17 E. Removal of Restrictive Legends ........................................................................... 18

VI. Section 4(a)(1½) Resales .................................................................................................. 19 A. Overview ............................................................................................................... 19 B. Requirements ........................................................................................................ 20

VII. Block Trades ..................................................................................................................... 20 A. Overview and Types of Block Trades .................................................................. 20 B. Rule 144A Resales ................................................................................................ 21 C. Regulation S Resales............................................................................................. 22

* BRIAN KORN is Of Counsel in Pepper Hamilton LLP’s New York and California offices and DAVID P. RUSSO is

an associate in the New York office. They are members of the firm’s Corporate and Securities Practice Group,

representing issuers, underwriters and shareholders in capital markets transactions. Their e-mail addresses are

kornb@pepperlaw.com and russod@pepperlaw.com.

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1. Overview ................................................................................................... 22 2. Requirements ............................................................................................ 23 3. Extraterritorial Securities Liability ........................................................... 24

VIII. Conclusion ........................................................................................................................ 26 I. INTRODUCTION

Over the past decade, a paradigm shift has been occurring in the capital markets that has

opened a new panoply of options for security holders desiring liquidity. The convergence of the

Securities and Exchange Commission’s (“SEC”) 2005 Securities Offering Reforms, most

notably the automatically – and permanently – effective shelf registration by well-known

seasoned issuers, the 2008 shortening of holding periods required by SEC Rule 144, the

proliferation of alternative trading platforms and the direct engagement of mutual funds, hedge

funds, private equity funds, exchange-traded funds (ETFs) and other large market players with

distribution portals has enabled shareholders, their brokers and investment banks to be more

creative and efficient than ever before in obtaining liquidity for investors.

Traditionally, there were two dominant scenarios for an investor holding exempt,

restricted or control securities who wished to sell some or all of his or her position: either the

securities were, or could be registered, or he or she would wait a year from the time of

acquisition and rely on Rule 144 for resale into the market. In contrast, evolving practice and

law now feature more accelerated and diverse avenues for reselling restricted or control

securities than the largely binary choice of the past.

For registered securities, the convenience of automatic shelf registrations (providing for

both primary offerings and secondary sales) facilitates liquidity more than ever before.1 For

exempt securities, resales through the private placement format and the now-accepted

“Section 4(a)(1½)” offer an alternative to Rule 144, including Rule 144A2 institutional resales

and Regulation S offshore trades. “Free stock blocks” and other block trade formats have also

been developed for investors, while “dark pools” of liquidity3 via the sale of a large holding of

1 Securities Act Rule 415. 2 Securities Act Rule 144A. 3 The term “dark pool” generally refers to trading activity in publicly listed securities, typically but not exclusively

in large blocks, apart from the open public market. Dark pools were originally developed to prevent brokers from

front-running trade orders from large institutions.

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securities to a small number of hedge funds offer an alternative for investors and broker-dealers

to avoid the disruptive potential (and possible liability) such resales could bring if executed on

the open market. With respect to the use of dark pools or the “upstairs market,” market

participants must maintain a difficult balance between transactions that risk characterization as

offering an unfair advantage to a small group of buyers and sales that run counter to the

obligation to maintain an orderly market. At the same time, Rule 144 remains an important tool

for investors, investment banks and their counsel, particularly since the revisions to the rule

effective in 2008 which now provide for an accelerated timetable for resales of restricted

securities (six months for securities of reporting companies under the Securities Exchange Act of

1934 (the “Exchange Act” or “1934 Act”)).4

II. SECURITIES ACT REGISTRATION REQUIREMENT AND EXEMPTIONS

Under the Securities Act of 1933 (the “Securities Act” or “1933 Act”), securities may be

legally offered for sale, or sold, only if covered by an effective registration statement filed with

the SEC5 and, generally, accompanied by a prospectus, or pursuant to an exemption from the

registration requirement under Sections 3 or 4 of the act. By imposing registration and

concomitant disclosure requirements, Congress sought to protect prospective investors by

ensuring the availability of information regarding the issuer and its business. With respect to

securities not required to be registered, the 1933 Act describes “exempted securities” in

Section 3. Section 3(a) includes securities issued by federal, state or local authorities, securities

of certain financial institutions, insurance policies and annuities, and bankruptcy securities.

Section 3(b)(1) contains the “Small Issues Exemptive Authority” for issues of up to $5 million

underlying Regulation A, while Section 3(b)(2), inserted by the Jumpstart Our Business Startups

Act of 2012, or “JOBS Act,” allows the SEC to enact a new alternative for issuances of up to $50

million, commonly referred to as “Regulation A+.” Also of note, Section 3(a)(9) exempts

exchanges of securities by an issuer with its existing securityholders.

Section 4 lays out “exempted transactions” under which securities may be issued without

registration. Section 4(a)(1) exempts “transactions by any person other than an issuer,

underwriter, or dealer,” permitting holders of securities to undertake “routine trading” in the

4 See infra Part IV.F.1. 5 Securities Act § 5.

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secondary market so long as they are not engaged in a “distribution” of securities,6 which would

result in their being deemed “underwriters” under the statutory definition.7 As noted below in

Part IV.C, investors seek to avoid conduct that could contribute to their being deemed an

“underwriter,” lest they risk violation of Section 5 (absent registration or an exemption). This

potential is magnified by the fact that the 1933 Act’s definition of “underwriter” encompasses

not only persons who purchase from an issuer but also those who purchase from an affiliate or

control person of the issuer.

Section 4(a)(2), the “issuers’ exemption” or “private placement exemption,” allows

companies to issue and sell securities to investors without registration or the use of a prospectus

to the extent not constituting a “public offering.” Nonetheless, the complexity of ascertaining the

boundaries of a transaction “not involving any public offering” has prompted the SEC’s

establishment of safe harbors such as Regulation D.8 Finally, Sections 4(a)(3)-(4) exempt

certain broker and dealer transactions, respectively, Section 4(a)(5) permits small offerings made

solely to accredited investors and Section 4(a)(6), added by the JOBS Act, sets out the

framework for exempt crowdfunding transactions.

III. RULE 144: RESALES OF RESTRICTED AND CONTROL SECURITIES –

OVERVIEW

Rule 144 under the Securities Act, first adopted in 1972, establishes a safe harbor

providing liquidity primarily to directors, officers, large shareholders and other affiliates of

issuers, as well as investors in securities acquired in exempt offerings. Through its direct and

indirect effects on exempt and restricted securities and their issuers’ access to financing, the rule

6 SEC v. Holschuh, 694 F.2d 130, 137-38 (7th Cir. 1982). While “distribution” is undefined in the Securities Act, it

is generally understood as including any sale or resale that approximates a public offering. 7 “The term ‘underwriter’ means any person who has purchased from an issuer [or affiliate] with a view to, or offers

or sells for an issuer in connection with, the distribution of any security, or participates or has a direct or indirect

participation in any such undertaking, or participates or has a participation in the direct or indirect underwriting of

any such undertaking. . . .” Securities Act § 2(a)(11). The definition excludes agents or brokers whose “interest is

limited to a commission from an underwriter or dealer not in excess of the usual and customary distributors' or

sellers' commission.” Id. 8 Rule 506 under Regulation D was issued pursuant to the authority of Section 4(a)(2) of the 1933 Act, while Rules

504 and 505 were enacted under Section 3(b)(1). Rule 506 permits raising of capital in an unlimited amount, while

issues under Rules 504 and 505 are capped at $1 million and $5 million, respectively.

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is something of an unsung cornerstone in the federal securities laws and the integrated scheme of

regulation that forms the backdrop for capital formation in the United States. By mandating,

among other things, the length of time investors must hold securities issued under most exempt

offerings (representing a significant proportion of financing activity in the United States9), Rule

144 affects the desirability of investing in such offerings in the eyes of individuals and financial

institutions and, thus, the ease with which businesses large and small can raise funds for growth

or operations through private transactions.10 Key among the factors affecting the desirability of

such financing techniques is the illiquidity discount that investors generally demand due to the

securities’ restricted status.11

These issues shape the opportunity costs associated with public and private forms of

financing,12 thus helping to determine the demand for exempt transactions, such as those under

Regulation D and Rule 144A, and overall capital formation levels across the country. Rule 144

also affects the financial position of myriad individuals and institutions by determining how soon

they can turn securities into cash so as to reallocate their investment dollars where they will

obtain the greatest return or make consumption decisions that, in turn, stimulate other sectors of

the economy.

The evolution of the rule over time marks a trend of increasing liberalization of the

holding period requirement, enhancing investor liquidity and indirectly promoting private

9 See, e.g., VLAD IVANOV AND SCOTT BAUGUESS, SEC, DIV. OF RISK, STRATEGY, & FIN. INNOVATION, CAPITAL

RAISING IN THE U.S.: THE SIGNIFICANCE OF UNREGISTERED OFFERINGS USING THE REGULATION D EXEMPTION

(2012), available at http://www.sec.gov/info/smallbus/acsec/acsec103111_analysis-reg-d-offering.pdf. 10 See generally, James D. Cox et. al., SECURITIES REGULATION: CASES AND MATERIALS (6TH ED. 2009) (“Rule 144 is widely viewed as one of the Commission’s most successful undertakings.”).

11 As the SEC stated in its release adopting changes to Rule 144 that took effect in 2008, “Investors, suppliers, or

employees who are restricted from selling securities and who cannot hedge their positions are generally exposed to

more risk than those who are not subject to such limitations, and generally require higher compensation (or a larger

discount with respect to the securities) for this risk.” Rel. No. 33-8869 (2007) (hereinafter “2008 Adopting

Release”). 12 Such costs include not only advisor and filing fees associated with a public offering, but also the significant

reporting obligations and less tangible but no less material effects of operating a business under continual public

investor and analyst observation, including pressures on short-term earnings.

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issuances.13 Adopted in 1972, Rule 144 initially required that security holders wait two years

before reselling restricted securities (subject to limitations), and permitted resales with no

limitations only after three years.14 Changes enacted in 1997 established one- and two-year

holding periods for restricted and unrestricted resales, respectively.15 Subsequently, in the

amendments effective in 2008, the SEC authorized certain resales after a period as brief as six

months.16 Moreover, in shortening the timeframe before resale, the amended Rule 144 may act

to reduce investors’ need to require registration rights provisions as a sweetener in executing

financing transactions, though registration rights have still remained common in practice.

Rule 144 is also unique in the securities laws in that it allows securities to change

character from restricted to unrestricted without undergoing SEC registration. In most contexts,

a buyer receives securities with the same level of restriction as the seller. However, in sales

under Rule 144, a restricted security in the hands of the seller can transform into an unrestricted

security in the hands of the buyer. This “hocus pocus” mechanism has captivated the

imagination of investors since the rule’s adoption. But the 2008 amendments that reduce the

required holding period to a very short period really served to drive home the magical quality of

Rule 144 and have taken much of the investor headaches away from purchasing restricted

securities.

IV. RULE 144: RESALES BY AFFILIATES

A. General

To explore the current Rule 144 and its application in practice, let us examine a

hypothetical resale of securities by an affiliate of the issuer. Sheila Smith, a director of Acme,

Inc., holds 20,000 shares of common stock of Acme, Inc., a 1934 Act reporting company whose

shares trade on NASDAQ. If Smith decides to sell some or all of her Acme stock, what options

are available to her?

13 For an additional discussion of the effects of the liberalization of the holding period and other regulatory

requirements relevant to the resale of privately-issued securities, see William K. Sjostrom, Jr., Berle IV: The Future

of Financial and Securities Markets: The Fourth Annual Symposium of the Adolf A. Berle, Jr. Center on

Corporations, Law & Society: Rebalancing Private Placement Regulation, 36 SEATTLE UNIV. L. R. 1143 (2013). 14 See 2008 Adopting Release. 15 Id. 16 Id.

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Several possibilities may be applicable. First, Smith may be able to sell them

immediately in the public market (subject to restrictions on transactions by “control” persons), if

the shares were freely tradable when she acquired them. For example, she may have bought

them in an ordinary market purchase, or the shares may have been registered for resale by Acme

using Form S-1, S-3, S-8 or S-11. Under such a scenario, Smith could order her stockbroker to

sell the shares in the open market, or, if necessary, she could pursue a “free stock block” trade

(essentially a distribution of freely tradable shares using the special selling efforts of a bank’s

syndicate desk). Second, if Smith’s securities are not covered by an effective registration

statement or are “control” securities, Smith could still attempt to rely on the Section 4(a)(1)

statutory exemption – especially if she has held the securities for a lengthy period of time – or

Section 4(a)(1½) (further examined in Part VI below). A third option is Rule 144, while a fourth

could be Rule 144A. Rule 144A permits resales to “qualified institutional investors” (more

particularly described below in Part VII.B below). In this case, Rule 144A is probably not

available because Smith’s shares are likely of the same class as Acme’s listed securities, thereby

running afoul of the “fungibility” restriction under that rule.17 (Furthermore, although not

applicable in this case, as Acme is publicly listed, Regulation A, intended for small issues,

permits resales of securities by affiliates without full-scale registration under Section 5.

However, such resales are limited to an aggregate maximum of $1.5 million by all selling

holders.18)

B. Definition of “Affiliate” and “Control” under Rule 144

In considering such possible avenues for resale, at least two significant factors must be

considered. First, as a director, is Smith an “affiliate,” making her shares “control securities”

and subjecting Smith’s resale efforts to the Rule 144 requirements for affiliates of an issuer? The

rule defines “affiliate” of an issuer as any person that “directly, or indirectly through one or more

intermediaries, controls, or is controlled by, or is under common control with, such issuer.”19

The question next becomes whether Smith “controls” the issuer (either individually or as part of

a “control group”). It should be noted that affiliate status – and, therefore, “control” – is a

factual determination and the SEC generally declines to provide interpretive assistance in

17 See infra Part VII.B. 18 Securities Act Rule 251(b). 19 Rule 144(a)(1). This definition is substantively identical to the definition of “affiliate” in Rule 405.

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particular cases.20 Factors the SEC has indicated as relevant to the determination of “control”

include an individual’s status as a director, officer or 10% shareholder21 though none of these

alone is dispositive.22 Moreover, a person claiming an exemption as a non-affiliate bears the

burden of proof on the issue.23 For purposes of the hypothetical, let us assume Smith’s status as

director confers on her sufficient control of Acme to deem her an affiliate.

Second, independent of the determination of whether Smith is an affiliate, if Smith

received her securities pursuant to a Form S-8 registration statement by Acme, an additional

issue remains. Form S-8 permits reporting companies to register securities for issuance to

directors, employees and others under certain benefit plans. However, resales of securities

acquired by officers, directors, etc. pursuant to a Form S-8 registration statement is permissible

only if specifically authorized in the registration statement. For the sake of this hypothetical, let

us assume Acme specifically provided for resales in the Form S-8 and Smith’s securities are

freely tradable, other than any restrictions arising due to her status as an affiliate.

C. Rule 144 Regulatory Intent and Requirements – Overview

As titles go, Rule 144’s says it all: “Persons deemed not to be engaged in a distribution

and therefore not underwriters.” By relying on the rule, a reseller will be shielded from being

deemed an “underwriter” under the 1933 Act and will be permitted to freely sell securities

20 “Affiliate or control status [under the 1933 Act] . . . is an area involving factual questions which the staff is not in

a position to resolve.” SEC Rel. No. 33-6253 (1980). First General Resources Company (SEC No-Action Letter

1988) '88-'89 CCH Dec. P 78,836 (“The Division has historically declined to express any view on the affiliation of

any person to an issuer of securities on the ground that the question is a matter of fact best determined by the parties

and their advisors.”). 21 American-Standard (SEC No-Action Letter 1972), '72-'73 CCH Dec. P 79,071. 22 Id. Moreover, the significance of these factors is heightened by the fact that directors, officers and holders of over

10% of any registered class of any equity security of an issuer must file statements disclosing the total ownership of

equity securities in the issuer under Section 16(a) of the Exchange Act. At the same time, an additional factor for

consideration as to “control” with respect to shareholders is that, at least in the context of audit committee

membership, Rule 10A-3(e)(1)(ii) under the 1934 Act sets forth a safe harbor that a person who beneficially owns

10% or less of any class of voting equity securities of the issuer is not in “control” of the issuer. Concurrently with

adopting the 1997 changes to Rule 144, the SEC also made proposals for additional modifications to the rule,

including adopting a “bright-line” test for the definition of “affiliate,” Rel. No. 33-7391 (1997), but, as the 2008

Adopting Release notes, the SEC took no further action to adopt such proposals. 23 American-Standard (SEC No-Action Letter 1972), '72-'73 CCH Dec. P 79,071.

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without registration pursuant to the Section 4(a)(1) exemption applicable to persons other than

issuers, underwriters and dealers, while the issuer likewise obtains assurance that its initial

private placement is not placed in jeopardy. What is more, upon satisfaction of the relevant

conditions, persons purchasing from affiliates or non-affiliates who resell securities under Rule

144 receive non-restricted, freely tradable securities (except where a purchaser is him- or herself

an affiliate or has been such within the past three months).24 Finally, the conditions required to

be satisfied to obtain the benefit of the rule differ for affiliates and non-affiliates: in outline,

affiliate resales must fulfill holding period, issuer information, manner of sale, volume and filing

requirements, while non-affiliate resales effectively need only comply with the holding period

condition.25

The rule thus furthers the intent of Section 5 of the Securities Act and SEC and judicial

interpretation thereof restricting “distributions” of securities while endorsing “routine trading” of

securities already issued and in the hands of investors.26 However, as the SEC indicates in its

preliminary notes to Rule 144, the unclear boundary separating the conduct of investors engaging

in trading and those who “act as links in a chain of transactions through which securities move

from an issuer to the public” (and thus are to be deemed “underwriters”) had formerly resulted in

uncertainty in the market, necessitating a clear safe harbor.27 Rule 144 is non-exclusive,28 hence

resellers may still rely on Section 4(a)(1), Section 4(a)(1½) or other avenues.29 (Moreover, in

24 Rule 144 (preliminary note); SEC, Div. of Corp. Fin., Compliance & Disclosure Interpretations: Securities Act

Rules § 530.07 (Jan. 26, 2009) (hereinafter “Compliance & Disclosure Interpretations”). 25 Rule 144(b). 26 SEC v. Holschuh, 694 F.2d 130, 137-38 (7th Cir. 1982). 27 Rule 144 (preliminary note). The direct impetus for SEC’s proposal (and eventual adoption) of Rule 144 was a

1969 study dubbed the Wheat Report, whose drafting was directed by Commissioner Francis Wheat. See Halloran,

Michael J. "The Public Disposition of Restricted Securities and of Securities Held by Controlling Persons—The

Wheat Report, SEC Proposed Rule 144 and the Search for Certainty," 45 ST. JOHN'S L. REV. 665, 666 (1971). The

authors of the report advocated the replacement of subject tests governing the resale of privately-acquired securities

with objective ones, such that the purchaser's "‘inner thoughts’ would no longer be a factor in a later attempt to

ascertain his ‘investment intent.’” Hugh L. Sowards, Private Placements and Secondary Transactions: The Wheat

Report Proposals for Reform, 1970 DUKE L. J. 515, 517. 28 Rule 144 (preliminary note). 29 Nevertheless, market participants should remain mindful of the SEC’s statement in the 1972 release originally

adopting Rule 144: “persons who offer or sell restricted securities without complying with Rule 144 are hereby put

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connection with a tender offer, compliance with Rule 144 is not required in order to tender

restricted securities so long as the tendering holder otherwise complies with the Securities Act.)30

D. Restricted and Control Securities

Rule 144 governs the public resale of two categories of securities: restricted and control

securities.31 “Restricted securities” are acquired directly or indirectly from the issuer or an

affiliate of the issuer, generally in connection with a private transfer or sale.32 “Control

securities” refer to any securities of the issuer held or acquired by an affiliate of the issuer,

regardless of how they are acquired (including in the open market).33 A security held by an

affiliate is inherently a “control security” and, to the extent it falls within the definition in Rule

144(a)(3), such security may be both a control and restricted security.34 On the other hand, if an

affiliate meeting the threshold for “control” acquires unrestricted securities from a non-affiliate

in the open market, the affiliate will be deemed to hold “control” securities, but not “restricted”

securities.35

E. Applicability of Rule 144

Rule 144 is an exemption for any security holder other than the issuer of the securities,36

and may be used in domestic or non-U.S. markets.37 However, with the exception of “business

combination related shell companies” and “asset-backed issuers,” the rule is not available for

securities of shell companies or of any entity formerly a shell company unless issued at least one

on notice by the Commission that in view of the broad remedial purposes of the Act and of public policy which

strongly supports registration they will have a substantial burden of proof in establishing that an exemption from

registration is available for such offers or sales and that such persons and the brokers and other persons who

participate in the transactions do so at their risk.” Rel. No. 33-5223 (1972). 30 Compliance & Disclosure Interpretations § 128.05 (Jan. 26, 2009). 31 See 2008 Adopting Release. 32 See infra Part V.B. 33 The 2008 Adopting Release acknowledges that although the term not defined in Rule 144, this is the typical

definition of control securities (citing the 1997 release in which the SEC proposed additional reforms to Rule 144,

Rel. No. 33-7391 (1997)). See also American-Standard (SEC No-Action Letter 1972), '72-'73 CCH Dec. P 79,071. 34 See 2008 Adopting Release. 35 Compliance & Disclosure Interpretations § 529.02 (Jan. 26, 2009). 36 Id. at § 128.01 (Jan. 26, 2009). 37 Id. at § 528.02 (Jan. 26, 2009). However, “[a]ny arrangement to return the restricted securities to U.S. markets

may indicate . . . an evasive scheme to avoid registration, which would invalidate any safe harbor claim.” Id.

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year following such a company’s filing of Form 10 information and certain reporting

requirements are satisfied.38 Any provision in Rule 144 governing the resale of securities by a

person also applies to the relatives or spouse of such person (or relative of such spouse) who

share the “same home” as the security holder and any trust, estate, corporation or organization

(other than the issuer) of which 10% or more is owned by the security holder (alone or with

relatives or spouse).39 In general, provisions applicable to affiliates of the issuer also apply to

any person who had been an affiliate within the preceding 90-day period.

F. Conditions for Affiliate Resales

1. Condition 1: Holding Period

With respect to the minimum period for which affiliates must hold securities before being

able to resell pursuant to Rule 144, if shares are merely “control” securities and not restricted, no

holding period would apply40 (such as in the case of Smith’s registered securities) or for

securities obtained on the open market or privately-issued securities under certain bonus plans.41

For restricted securities in the hand of an affiliate, the mandatory time before resale is 6 months

if the issuer has been a 1934 Act reporting company for at least 90 days, or 1 year for non-

reporting company issuers42 (in either case, the public information condition43 must be

independently satisfied).

In connection with calculating an investor’s holding period, it is necessary to ascertain

when the period precisely begins. As a general principle, the SEC has interpreted “date of

acquisition” to indicate the time that full risk of economic loss was assumed by the transferee.44

38 Rule 144(i). Certain short sales and securities granted to an underwriter as compensation for services in

connection with a registered public offering (with exceptions) are also ineligible. Compliance & Disclosure

Interpretations § 528.03-04 (Jan. 26, 2009). 39 Rule 144(a)(2). 40 Compliance & Disclosure Interpretations § 529.02 (Jan. 26, 2009). 41 SEC Rel. 33-6188 (1980). Securities sold on behalf of an estate or a beneficiary thereof (if neither is an affiliate

of the issuer) are also exempt from the minimum holding period, even where the decedent was an affiliate,

Rule 144(d)(3)(vii), except securities acquired by the estate after the death occurred (e.g., through the exercise of an

option), Compliance & Disclosure Interpretations § 132.04 (Jan. 26, 2009). 42 Rule 144(d)(1). 43 See infra Part IV.F.2. 44 See, e.g., Rel. 33-6099 (1979) (Question 23).

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If acquired by outright purchase, the holding period commences upon payment in full by the

acquiror.45 When securities are purchased under a subscription agreement, the acquisition date

will be the date on which the subscription agreement is accepted by the issuer (and not

necessarily the date of transfer or execution of the agreement), provided the full purchase price

has been paid.46 With respect to securities obtained pursuant to an option, the holding period

begins upon the exercise of the option, including payment.47 Additionally, subsequent

acquisition of additional securities of the same class does not alter the holding period with

respect to securities already held by the investor.48 Lastly, as the SEC noted in its release

adopting Rule 144, "Certain securities acquired in connection with, or as a result of ownership or

acquisition of, other securities, are deemed to have been acquired when such other securities

were acquired.” The Commission, characteristically, expresses in twenty-nine words what is

commonly understood by practitioners in a single term, “tacking” (this crucial concept will be

more fully explored below in Part V.D below).

2. Condition 2: Issuer Information.

Rule 144 also imposes a public information requirement, mandating that if the issuer of

the securities to be resold is a 1934 Act reporting company, its periodic reports and required

Interactive Data Files must be current for the preceding 12 months.49 For non-reporting

company issuers, certain specified company information must be publicly available.50 It should

be noted that, for reporting issuers, the condition is that reports have been filed for 12 months,

45 Rule 144(d)(1)(iii). Consideration in the form of promissory notes, other obligations or installment contracts is

deemed full payment only to the extent there exists a full right of recourse against the purchaser of the securities, the

obligation is secured by collateral (other than the securities purchased) with a fair market value at least equal to the

purchase price, and such obligation is discharged by payment in full prior to the resale of the securities. Id. at (d)(2). 46 Compliance & Disclosure Interpretations § 132.07 (Jan. 26, 2009). Restricted securities issued under an

employee benefit plan are deemed “acquired” when the securities are allocated to the account of an individual plan

participant, even if the securities vest on a future date. SEC Rel. 33-6099 (1979) (Question 22). By contrast, the

time of vesting is deemed the date of acquisition for securities granted pursuant to an individually negotiated

employment agreement. Compliance & Disclosure Interpretations § 532.06 (Jan. 26, 2009). 47 Compliance & Disclosure Interpretations § 132.11 (Jan. 26, 2009). 48 See, e.g., id. § 532.09 (Jan. 26, 2009). 49 Rule 144(c)(1). 50 Rule 144(c)(2).

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without technically mandating that they be “timely” filed (a requirement most often used for

Form S-3/F-3 eligibility purposes).

3. Condition 3: Manner of Sale.

For equity (but not debt) securities, Rule 144 transactions must be executed by one of

three designated methods.51 The permissible approaches are (i) “brokers’ transactions” pursuant

to Section 4(a)(4) of the Securities Act, (ii) sales to or through a market maker52 or (iii) “riskless

principal” transactions.53 In any such trade, the security holder and its representatives may

neither solicit or arrange for the solicitation of orders for the purchase of the security nor make

any payment in connection with the resale other than to the broker or dealer who executes the

sale.54 In Rule 144 deals, investment banks will act as “agents” in the sale and not as

underwriters. Such transactions need not be filed with FINRA as a distribution pursuant to

FINRA Rule 5190.

4. Condition 4: Volume Limitation.

During any rolling three-month period, resales by an affiliate of the issuer are subject to a

volume limit (excluding from such calculation resales by an affiliate of registered securities and

those sold in exempt transactions or under Regulation A or S).55 During the period, resales by an

affiliate such as Smith may not exceed the greatest of the following:56

(i) 1% of the outstanding securities of same class as the securities being sold, or

(ii) for listed securities (not those traded over-the-counter), the average weekly trading

volume, excluding public offerings by the issuer,57 during four calendar weeks prior to

the filing of the Form 14458 (or the order or execution date of the trade, if no filing is

51 Rule 144(f)(3)(ii). Securities sold on behalf of an estate or a beneficiary thereof (if neither is an affiliate of the

issuer) are also exempt from manner of sale requirements. Id. at (f)(3)(i). 52 Defined in Exchange Act § 3(a)(38). 53 Rule 144(f)(1). 54 Rule 144(f)(2). 55 Rule 144(e)(3)(vii). 56 Rule 144(e)(1). However, the volume limitation does not apply to estates and estate beneficiaries which are not

affiliates of the issuer. Note to Rule 144(d)(3)(vi). 57 Compliance & Disclosure Interpretations § 133.05 (Jan. 26, 2009). 58 “[T]he ‘four calendar weeks preceding the filing of notice’ . . . are the four weeks preceding the week in which the

[Form 144] is transmitted for filing . . . .” Compliance & Disclosure Interpretations § 133.06 (Jan. 26, 2009).

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required), as reported (a) on national securities exchanges or an automated quotation

system of a registered securities association, or (b) under an effective transaction

reporting plan/national market system plan.59

However, for securities classified as debt securities under the Rule 144 (which includes non-

participatory preferred stock and asset-backed securities), the applicable limit during the three-

month window is 10% of sales of securities of the same tranche or class.60

Sales by affiliates of the seller or certain others, such as pledgees (e.g., financial

institution to which investors have made a collateral assignment of securities), may be

aggregated in computing the permitted amount. For example, as suggested above,61 sales by a

spouse or relatives of the primary reseller who live in the same household as the “primary”

reseller will be combined to determine whether total resales are within the limit. Similarly, sales

by two or more affiliates of the issuer or other persons who “agree to act in concert” to resell

securities will be aggregated.62 Moreover, in some cases, sales are aggregated when analyzing

the volume limit as it applies to certain parties but not others: for example, a donor must

aggregate its sales with those of all donees for six months or one year (depending on the issuer’s

status), while each donee’s sales aggregate only with those of its donor.63 Additionally, for

volume limit purposes, convertible securities are computed as if they had been converted

whenever the underlying securities are also sold in the same three-month period as the

convertibles.64

5. Condition 5: Resale Notice and Timing.

Finally, affiliates of the issuer reselling under the rule must file with the SEC a notice of

the intended sale on Form 144 concurrently with the broker order or execution directly through a

market maker.65 The form may be provided via paper filing or EDGAR and, if applicable, the

59 Defined in Securities Act Regulation NMS. 60 Rule 144(e)(2). 61 See supra Part IV.E. 62 Rule 144(e)(3)(vi). 63 Rule 144(e)(3)(iii). 64 Rule 144(e)(3)(i). However, where warrants are traded separately from the underlying security, sales are likewise

computed separately under the rule. Compliance & Disclosure Interpretations § 533.06 (Jan. 26, 2009). 65 Rule 144(h)(1).

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reseller must also forward a copy to the relevant exchange.66 However, Form 144 is required

only for sales representing, in any-three month period, over 5,000 shares or other units or over

$50,000 in aggregate price.67 Additionally, following any filing of Form 144, the resale should

be consummated within a “reasonable time” (generally understood to be three months),

reflecting a “bona fide intention” to resell as required at the time of filing.68

V. RULE 144: RESALES BY NON-AFFILIATES

A. General

To further understand the many types of investors and situations to which Rule 144 is

applicable, we now consider a hypothetical resale of securities by a non-affiliate of the issuer. A

real estate developer named Steve Lynn sells a Nevada hotel to a real estate investment trust

(“REIT”) in exchange for one million common shares of the REIT in a private transaction. The

REIT’s common shares trade on the New York Stock Exchange. Lynn’s shares are not covered

by an effective registration statement and he does not have demand registration rights. If Lynn

decides to sell some or all of his shares of the REIT, what are his choices?

For sales of restricted securities by a non-affiliate, possibilities include taking advantage

of piggyback registration rights – if parties holding demand rights opt to exercise them – the

Section 4(a)(1) statutory exemption, Section 4(a)(1½) or Rule 144. Much as was the case for

Sheila Smith’s securities, use of Rule 144A to sell to a “qualified institutional buyer” would most

likely be foreclosed under that provision’s fungibility rules.69

B. Definition of Restricted Security.

The threshold question in connection with the resale of securities by a non-affiliate of the

issuer is to determine whether, in fact, the securities he or she holds are restricted. “Restricted”

securities are defined in Rule 144 as those acquired “directly or indirectly from the issuer [or] an

affiliate . . . in [one or more transactions] . . . not involving any public offering,” and also include

those acquired under: 70

66 Id. 67 Rule 144(h)(2). 68 Id. No amendment to Form 144 is needed if a holder does not sell the securities referred to in the form,

Compliance & Disclosure Interpretations § 136.01 (Jan. 26, 2009), but an amendment should be filed upon a change

in broker, id. § 136.06 (Jan. 26, 2009). 69 See infra Part VII.B. 70 Rule 144(a).

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• Regulation D (except Rule 504);

• Rule 144A;

• private placements (including Section 4(a)(1½) and Section 4(a)(2)) and other

non-public transactions (even open-market securities “acquired by an affiliate and

then transferred in a non-public transaction to another person[,] . . . become

restricted”71)

• private issuances under stock-based compensation plans (e.g., Rule 701);

• Regulation S (at least as to equity securities of U.S. issuers);

• Section 4(a)(6) crowdfunding; and

• Rule 801 and 802 transactions, both of which involve foreign private issuers.72

Securities received pursuant to approved bankruptcy plan under Section 1145(a) of the

Bankruptcy Code are not restricted securities73 (though other bankruptcy securities may be74) nor

will be securities issued under the “Regulation A+” exemption to be enacted by the SEC.75

Additionally, certain spin-offs not required to be registered pursuant to Staff Legal Bulletin No. 4

also do not result in restricted securities.76 Assuming Lynn received his securities in a private

transaction from the REIT, the shares would be restricted.

C. Conditions for Non-Affiliate Resales

Resales by non-affiliates under Rule 144 are considerably more streamlined than those by

affiliates of the issuer. In essence, for non-affiliates who have not had affiliate status within the

past 90 days, the only Rule 144 requirement is the holding period. The rule thus offers the

majority of investors a simplified pathway to being able to sell restricted securities in six months

(for reporting issuers who are current on their periodic reports) or one year otherwise. Under

Rule 144, non-affiliates need not concern themselves with filing forms or comparing the amount

of their sales to the float or trading volume, or even the restrictions as to sales through brokers

71 Rel. 33-6099 (1979) (Question 9(a)). 72 For additional examples, see, e.g., Compliance & Disclosure Interpretations § 132.08 (Jan. 26, 2009), Compliance

& Disclosure Interpretations § 528.08 (Jan. 26, 2009) and Compliance & Disclosure Interpretations § 529.05 (Jan.

26, 2009). 73 Compliance & Disclosure Interpretations § 128.03 (Jan. 26, 2009). 74 Id. at § 528.05 (Jan. 26, 2009). 75 Securities Act § 3(b)(2)(C). 76 SEC, Div. of Corp. Fin., Staff Legal Bulletin No. 4 (CF) (Sept. 16, 1997).

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and the like. Upon an aggregate of one year after acquisition (including tacking), non-affiliates’

previously restricted securities can be resold freely with no limitations and in an unlimited

amount.

D. Tacking Issues

Non-affiliates are frequently in a position to take advantage of the tacking principles of

Rule 144, under which a non-affiliate holder (who has been such for at least three months) can

amass the requisite minimum time enabling it to resell its securities by combining its period of

ownership with the period accrued by one or more previous holders from the time each prior

party acquired the securities. Significantly, tacking is not permitted in the context of a purchase

of restricted securities from an affiliate of the issuer,77 but is permitted for gifts of securities from

an affiliate78 and for trusts, estates and beneficiaries of an affiliate.79 Securities received in a

cashless conversion or exchange80 or cashless exercise of warrants/options81 are generally

deemed acquired when the initial securities were acquired. The same principle of tracing the

date of acquisition of the original underlying securities generally applies for stock

splits/dividends82 and securities acquired pursuant to anti-dilution rights.83

Moreover, tacking as to securities of the predecessor issuer is also allowed in connection

with certain holding company reorganizations.84 Pledgees can tack on to their pledgors’ holding

period when such pledgees sell the pledged securities upon a default by the borrower, except if

the securities were pledged without recourse and the pledgor was the borrower under the

77 See Rule 144(a)(3)(i). 78 Rule 144(d)(3)(v). 79 Rule 144(d)(3)(vi)-(vii). 80 Rule 144(d)(3)(ii). Where the securities surrendered in the conversion or exchange did not provide for cashless

exercise at the time of acquisition, but the holder subsequently provides consideration in connection with an

amendment permitting such cashless exercise, then the securities received are deemed to have been acquired at time

of such amendment. Note to Rule 144(d)(3)(x). A functionally identical rule applies to amendments permitting

cashless exercise of warrants and options under Note 1 to Rule 144(d)(3)(x). 81 144(d)(3)(x). Even a de minimis cash payment in connection with a warrant exercise bars the exercise from being

deemed cashless, however. Compliance & Disclosure Interpretations § 132.13 (Jan. 26, 2009). 82 Rule 144(d)(3)(i). 83 Compliance & Disclosure Interpretations § 132.06 (Jan. 26, 2009). 84 Rule 144(d)(3)(ix).

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obligation in question.85 Additionally, persons receiving restricted securities in a spin-off may

tack on to the parent’s holding period, provided the parent is a closely-held investment entity.86

E. Removal of Restrictive Legends

An additional concern for investors and issuers is the placement and removal of

restrictive legends on securities. Such warning statements are commonly placed on restricted

shares or bonds advising that any resale or transfer of the security requires registration or an

exemption from registration; such legends are rarely inserted on control securities. Legended

securities are not eligible for The Depository Trust Company’s clearing system and usually have

their own Committee on Uniform Securities Identification Procedures number (commonly

referred to as a “CUSIP” number).

Transfer agents will typically remove such a legend upon an opinion of issuer’s counsel

that the resale is exempt from Rule 144 holding period, notice and manner of sale requirements

(and sometimes a concurrence letter from the company).87 This process also generally requires

certifications from the reseller, as well as the agent in some cases. Except where removal is

requested by a non-affiliate holder in connection with a specific proposed resale, prudent practice

suggests retaining legends on security certificates for one full year, even for securities of a

reporting issuers, which would otherwise eligible for resale after six months assuming the Rule

144 conditions are met. Such an issuer could become delinquent in its filings, thus eliminating

eligibility for resale at the six-month mark. Finally, it is instructive to note the SEC’s statement

in an online publication for investors: “If a dispute arises about whether a restrictive legend can

be removed, the SEC will not intervene. Removal of a legend is a matter solely in the discretion

of the issuer of the securities. State law, not federal law, covers disputes about the removal of

legends.”88

85 Rule 144(d)(3)(iv). 86 See SEC, Div. of Corp. Fin., supra note 76. The securities are not required to be registered if the parent has held

them for at least two years and the spin-off satisfies the additional conditions in Staff Legal Bulletin No. 4. Id. 87 As the SEC states, “Under the amendments that we are adopting, we do not object if issuers remove restrictive

legends from securities held by non-affiliates after all of the applicable conditions in Rule 144 are satisfied.” 2008

Adopting Release n.65. 88 SEC, Rule 144: Selling Restricted and Control Securities, http://www.sec.gov/investor/pubs/rule144.htm (last

updated Jan. 16, 2013). See also 2008 Adopting Release n.65.

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Legend removal can sometimes be compared to “herding cats” and holders who are keen

to sell shares quickly should manage expectations, as the process involves back and middle

office processes within transfer agents and broker-dealers. Rarely can a legend be removed and

shares are free to trade on a same-day basis.

VI. SECTION 4(A)(1½) RESALES

A. Overview

Similar to Harry Potter’s “Platform 9¾” at London’s King’s Cross Station, Section

“4(a)(1½)” – formerly “4(1½)” – is a largely practitioner-created exemption acknowledged by

courts89 and the SEC90 that serves as one of the primary alternatives to Rule 144 for resales of

restricted and control securities. Section 4(a)(1½) transactions are non-public resales by

affiliates and non-affiliates (without the use of an underwriter), as enabled by Section 4(a)(1),

generally on same basis as an initial private placement by an issuer under Section 4(a)(2). The

technique can thus be understood as an attempt to incorporate the concepts underlying both

statutory exemptions, though technically centered on Section 4(a)(1), as it is a tool for secondary

sales and generally not for issuers. Nonetheless, the SEC offers little guidance on the specific

parameters of the statutory exemptions or 4(a)(1½), resulting in a residual uncertainty in any use

of this practitioner-crafted procedure. The critical focus is the avoidance of a “distribution” –

which would void eligibility for Section 4(a)(1) – necessitating what is essentially private

placement by the holder.91

Further resales of restricted securities are generally restricted,92 usually entailing the

placement of restrictive legends.93 As compared with Rule 144 resales to non-affiliates, the

89 See, e.g., U.S. v. Lindo, 18 F. 3d 353 (6th Cir. 1994). 90 Rel. No. 33-6188 n.178 (1980) (“‘Section 4(1-1/2)’ . . . is a hybrid exemption not specifically provided for in the

1933 Act but clearly within its intended purpose . . . so long as some of the established criteria [under] Section 4(1)

and Section 4[(2) . . . are satisfied.”). 91 The Supreme Court in Ralston Purina provided fundamental principles for analyzing whether an offering is

“public” or “private” under the 1933 Act, holding: “[T]he applicability of [Section 4(2)] should turn on whether the

particular class of persons affected needs the protection of the Act. An offering to those who are shown to be able to

fend for themselves is a transaction ‘not involving any public offering.’” SEC v. Ralston Purina Co., 346 U.S. 119,

125 (1953). 92 See, e.g., SEC No-Action Letter, Bank of New Hampshire Corp., Mar. 4, 1981.

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restricted status of the securities purchasers receive may lessen the attractiveness of Section

4(a)(1½) sales. At the same time, the potential drawback is partially offset by the absence of a

strict volume limitation or a publicly accessible filing (Form 144). Section 4(a)(1½) is

predominantly used for sales (i) by affiliates looking to exceed the volume restrictions of

Rule 144, (ii) among institutional investors of restricted securities, and (iii) to institutional (not

individual) accredited investors alongside a Rule 144A offering, certain other secondary

offerings and certain primary offerings by foreign private issuers.

B. Requirements

Section 4(a)(1½) resales largely track Section 4(a)(2)/Regulation D practice. Features

ordinarily include a limited number of purchasers, disclosure similar in scope to that required for

a public offering, prohibition on general solicitation/advertising (the JOBS Act reforms do not

expressly address the Section 4(a)(1½) technique), a right of the issuer to obtain closing opinions

from purchasers and a minimum denomination restriction for sale/transfer. This being the case,

Section 4(a)(1½) is intended for use with purchasers of high wealth and sophistication. Key

documentation in Section 4(a)(1½) deals includes express disclosure of the non-registered status

of the securities to investors as well as certifications by purchasers as to investor suitability and

intent (note that broker-dealers must still follow FINRA suitability rules pursuant to FINRA Rule

2111). Generally a purchaser will furnish a “big boy” letter which states that the purchaser is

knowledgeable about investments of the kind he or she is making, that the purchaser has done all

due diligence required by him or her to make an intelligent investment decision, that investments

can and often do lose value and that the purchaser is prepared to lose money on the investment.

Unlike other private placement approaches, the issuer is generally not involved and there are no

issuer representations and warranties or indemnification obligations.

VII. BLOCK TRADES

A. Overview and Types of Block Trades

Three types of “block trades” for large volumes of equity securities distributions are

generally in use. The first is a sale by an issuer of registered securities or a holder undertaking a

large secondary distribution of the same. Such a trade can be a traditional underwritten offering

on an accelerated timetable or, often, a “bought deal” with multiple banks bidding as

93 The presence of the “indicia of private placements” is important to satisfying the Section 4(a)(1½) principles. See

Lindo, 18 F. 3d 353 at 358. See also SEC v. Cavanagh, 1 F. Supp. 2d 337 (S.D.N.Y. 1998).

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underwriters to pre-purchase the entire block or issuance at an agreed (discounted) price without

performing a standard “book building” process, thus offering committed proceeds to the seller.

Such transactions often consist of “takedowns” of shelf-registered securities. Second is the “free

stock block” transaction involving the sale of freely-tradable shares by an investor. Due to the

large quantity of securities involved, such a sale often requires “special selling efforts” by the

investor’s brokers. These transactions may be booked as a distribution by the selling firm to

avoid FINRA trade reporting requirements. Cynical bankers often refer to these transactions as

“non-league table blocks,” because the major investment bank league table compilers do not

count these transactions in the tables, despite being booked as distributions.

Finally, unregistered or restricted securities are also frequently traded in a block format.

The most common vehicles for such resales are Rules 144 or 144A, Section 4(a)(1½) and

Regulation S. For secondary block trades of unregistered securities, generally no offering

document is employed, resulting in time and cost advantages. Likewise, representations and

warranties and covenants in the purchase agreement are usually limited (generally addressing

good title of seller, no require consents and no preemptive rights). In Rule 144A and Regulation

S transactions, since investment banks act as principal in many cases, scrutiny of the issuer by

the underwriter/selling bank will likely be high. For similar reasons of risk management, such

offerings are typically limited to highly sophisticated institutional investors on the condition that

they acknowledge their non-reliance on the seller. Many of these trades are done in single

purchase, “desk-to-desk” crossings among banks and investment firms.

As an additional factor, although Section 4(a)(1½), Rule 144A or Regulation S require

investors to minimize publicity, resellers – especially affiliates – should consider possible

obligations arising under other provisions. Investment advisers and brokers may need to file

acquisition and ownership reports under Section 13 of the 1934 Act (in addition to the reporting

obligations for beneficial owners of registered equity securities on Schedule 13D or 13G).

Similarly, Section 16 requires designated insiders and 10% stockholders to disclose their

holdings of shares of the issuer and to comply with short-swing profit rules.

B. Rule 144A Resales

Following on our review of Rule 144 and Section 4(a)(1½) above, which are also

applicable to block trades, we briefly explore Rule 144A and Regulation S. Rule 144A is a non-

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exclusive safe harbor under the Section 4(a)(1) exemption94 facilitating the resale of private

placements if made to a class of investors termed “qualified institutional buyers” (“QIBs”).95 A

QIB is generally an institution holding or managing at least $100 million of investment securities

of non-affiliates.96 To rely on the rule, the seller must not be the issuer of the securities97 and

must “reasonably believe” all offerees and buyers are QIBs; reliance on certain compiled lists or

manuals of QIBs is permissible under certain conditions.98

Further requirements of Rule 144A are that (i) the seller must take “reasonable steps” to

inform buyers of the its reliance on Rule 144A to transact in unregistered securities99 and (ii) for

non-reporting issuers, buyers must be given the right to obtain certain “reasonably current”

prospectus-like issuer information at or before the sale.100 Additionally, securities sold under the

rule must not be fungible with (of the same class as) securities offered by the issuer on a national

securities exchange or automated inter-dealer quotation system.101 However, this fungibility

restriction is measured by whether securities of the issuer were traded on an exchange at the

time of issuance of the reseller’s shares (or bonds), thus allowing resales of “founders’ shares”

acquired prior to the company’s listing.102

C. Regulation S Resales

1. Overview

Regulation S consists of two non-exclusive safe harbors from registration for securities

sold outside the United States. The first is primarily an issuer safe harbor,103 while the second

permits immediate resale of securities – typically of non-U.S. issuers – by persons other than the

94 Rule 144A(b). Rule 144A(c) also permits sales by dealers under the Securities Act § 4(a)(3) exemption. 95 Rule 144A(d)(1). 96 Rule 144A(a)(1). 97 Rule 144A(b). 98 Rule 144A(d)(1). The JOBS Act directs the SEC to revise Rule 144A to allow solicitation and offers to persons

other than QIBs so long as the seller reasonably believes the actual purchasers to be QIBs. Pub. L. No. 112-106 §

201(a)(2), 126 Stat. 306, 314 (2012). See proposed amendment in Rel. No. 33-9354 (2012). 99 Rule 144A(d)(2). 100 Rule 144A(d)(4)(i). 101 Rule 144A(d)(3)(i). Convertible securities or warrants must bear at least a 10% conversion or exercise premium,

respectively, to avoid the fungibility limitation. Id. 102 Id. 103 Securities Act Rule 903.

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issuer, a distributor or affiliates thereof (except for any officer or director who is an affiliate only

due to holding such office).104 Resales may be of securities initially issued in an offshore

transaction or a private placement in the United States. It should be noted that the scope of

eligible persons who may rely on the rule excludes some intending resellers who are affiliated to

a greater extent than solely serving as director or officer.

2. Requirements

Resales under Regulation S must satisfy two central requirements. First, the offer or sale

must be made in an “offshore transaction,”105 which consists of two elements:106 (i) no offers

may be made to persons in the United States; and (ii) either

(a) at the time of originating its order, the buyer must be outside the United States (or the

seller must reasonably so believe); or

(b) the sale must occur in or through a “designated offshore securities market”107 and the

seller (or its agents) must not be aware of any preexisting arrangement with a buyer in the

United States for purchase of the securities.

Second, no “directed selling efforts” may be made in the United States by the seller or its

affiliates to condition the market there for the relevant securities.108 Moreover, where an officer

or director of the issuer or a distributor (if deemed an “affiliate” only by virtue of holding such

104 Securities Act Rule 904. 105 See Rule 904(a)(1). Note that “[o]ffers made in the United States in connection with contemporaneous registered

offerings or offerings exempt from registration will not preclude reliance on the safe harbors.” SEC Rel. No. 33-

6863 n.36 (1990). 106 See Securities Act Rule 902(h)(1). A selling dealer may not knowingly makes sales to a “U.S. person” prior to

the expiration of the distribution compliance periods described below. Rule 904(b)(1)(i). Moreover, prior to the

expiration of the distribution compliance period, if the purchaser is also a dealer or is receiving a selling concession,

the selling dealer must send a confirmation stating that the securities may be offered and sold during such period

only pursuant to registration or an exemption (including Regulation S). Id. at (b)(1)(ii). 107 These include exchanges in Africa (Egypt and South Africa), Asia-Pacific (Australia, Hong Kong, Japan,

Republic of Korea, Malaysia, Singapore, Taiwan and Turkey), Europe (Austria, Belgium, Channel Islands, Czech

Republic, Denmark, Finland, France, Germany, Ireland, Italy, Luxembourg, Netherlands, Norway, Poland, Spain,

Sweden, Switzerland and the United Kingdom) and North and South America (Bermuda, Canada, Mexico, Peru and

Panama). See LOSS, SELIGMAN AND PAREDES, SECURITIES REGULATION § 2-E-3 n.172 (2012). 108 Securities Act Rule 904(a)(2).

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position) is reselling Regulation S securities, he or she may not pay an agent or broker

remuneration beyond the “usual and customary” commission.109

After the expiration of the relevant distribution compliance period, subsequent resales of

Regulation S securities (whether in the U.S. or overseas) are, in general, not restricted,110 except

for equity securities of U.S. issuers,111 though these may be resold in reliance on Rule 144. (The

distribution compliance period is 40 days for Category 2 offerings and Category 3 debt offerings;

as to Category 3 equity offerings, it is six months for reporting company securities and one year

otherwise.112) However, parties who intend, at the time of their purchase of securities overseas

from an affiliate of the issuer, to widely resell Regulation S securities into the United States

subsequent to the compliance period may be deemed statutory underwriters in light of their

“view to . . . distribution”113 at the time of acquisition.

3. Extraterritorial Securities Liability

Section 10(b) of the 1934 Act and Rule 10b-5 are ambiguous as to the extent to which the

prohibition on fraud in connection with the purchase or sale of “any security registered on a

national securities exchange or any security not so registered” applies to conduct or transactions

outside the United States or to securities listed or traded abroad.114 For decades, federal district

and appeals courts applied some form of “conduct” or “effects” tests to find applicability of the

securities laws where certain links to the United States exist. Since the Supreme Court’s

decision in Morrison v. National Australia Bank,115 however, the prevailing test is a transaction-

based one centering on whether “the purchase or sale is made in the United States, or involves a

109 Rule 402(b)(2). 110 Rel. No. 33-6863 (1990). 111 Rel. No. 33-7505 (1998) (adopting Rule 905). 112 Rule 903(b)(2)-(3). There is no distribution compliance period for Category 1 securities. Rule 144(b)(1). The

criteria for distinguishing the three categories are set forth in Rule 903(b). 113 Securities Act § 2(a)(11). 114 Both provisions govern transactions involving the instrumentalities of “interstate commerce” (defined as “trade,

commerce, transportation, or communication among the several States, or between any foreign country and any

State, or between any State and any place or ship outside thereof.” Exchange Act § 3(a)(17). 115 130 S. Ct. 2869 (2010).

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security listed on a domestic exchange.”116 In consequence, persons transacting in securities

outside the United States would seem to be protected from liability in “foreign-cubed” cases like

Morrison (foreign investor, foreign-issued securities and overseas transaction) and, according to

at least one district court, “foreign-squared” cases (U.S. investor, foreign-issued securities and

overseas transaction).117

The Dodd–Frank Wall Street Reform and Consumer Protection Act of 2010 (“Dodd-

Frank”) amended the 1933 Act, 1934 Act and the Investment Advisers Act of 1940 in an attempt

to give federal courts certain “[e]xtraterritorial [j]urisdiction.”118 Courts may hear anti-fraud

suits by the SEC or federal government alleging (i) “conduct within the United States that

constitutes significant steps in furtherance of [a] violation,” even if the transaction occurs abroad

or involves only non-U.S. investors or (ii) conduct abroad with “foreseeable substantial effect

within the United States.”119 This language approximates the “conduct and effects tests”

squarely rejected by the Supreme Court, seemingly overriding Morrison for the purposes of

government enforcement actions. However, the Morrison court explained that its ruling was

predicated on the substantive scope of Section 10(b) and Rule 10b-5 and not on jurisdictional

issues.120 Therefore, while the question remains open absent federal court rulings on Dodd-

Frank’s extraterritoriality provisions, the amendments may not have the impact Congress appears

to have intended,121 although some commentators suggest courts could theoretically give effect

116 Id. at 2886. Even where some relevant fraudulent conduct occurs in the United States, this would not seem to

bring an extraterritorial transaction into the purview of the 1934 Act. See id. at 2884 (“[t]he focus of the Exchange

Act is not the place where the deception originated, but upon the purchases and sales of securities in the United

States”). 117 Cornwell v. Credit Suisse Group et al., 729 F. Supp. 2d 620 (S.D.N.Y. 2010). 118 Pub. L. 111-203 § 929P(b), 124 Stat. 1376, 1864 (2010) (per section captions). 119 Id. 120 130 S. Ct. at 2877. 121 Dodd-Frank does not address the substantive scope of the securities liability provisions at issue and “accordingly

does not expand the territorial scope of the government’s enforcement powers at all.” George T. Conway III

(Wachtell, Lipton, Rosen & Katz), Extraterritoriality After Dodd-Frank, HARVARD LAW SCHOOL FORUM ON

CORPORATE GOVERNANCE AND FINANCIAL REGULATION (Aug. 5, 2010, 8:58 AM),

http://blogs.law.harvard.edu/corpgov/2010/08/05/extraterritoriality-after-dodd-frank/. See also Genevieve Beyea,

Morrison v. National Australia Bank and the Future of Extraterritorial Application of the U.S. Securities Laws, 72

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to the purported expansion in jurisdiction for policy-based or other reasons.122 Those engaging

in securities transactions abroad (especially if in reliance on SEC safe harbors such as

Regulation S) will need to wait for judicial interpretation or clarifying legislation before there

can be fuller certainty.

VIII. CONCLUSION

While the rule may sometimes be overlooked as more in the nature of a technical or

ancillary rule, the SEC’s progressive relaxation of the holding period requirement, extensive

fact-based and situation-based hypothetical interpretations by the SEC Staff, and other reforms

of Rule 144 have allowed the provision to contribute, in no small way, to overall corporate

financing activity in the United States and even overseas. Without tools such as Rule 144

permitting certain and relatively prompt resale of restricted securities, the feasibility of private

capital raising efforts would be sharply diminished, as investors would hesitate to provide funds

in exchange for illiquid investments. By authorizing “outside the box” investor resale, measures

such as Rule 144, Rule 144A, Section 4(a)(1½) and Regulation S facilitate exempt issuances of

debt and equity by U.S. and non-U.S. businesses. In this sense, they may indirectly stimulate

private avenues of financing as compared with the use of public exchanges and the cost burden

on issuers, shareholders and perhaps the economy as a whole, due to the higher advisor, filing,

exchange, reporting and other expenditures (and, arguably, often exaggerated focus on short-

term earnings and share price) associated with registration and listing.

The accessibility of such exemptions for a variety of types of resales, including the

burgeoning area of block trades and “dark” liquidity, provide a greater number of options than

ever before. In the latter approach, investors and financial intermediaries tread a fine line

between pursuing non-open market deals that may risk market fragmentation and even the

OHIO ST. L. J. 537, 571 (2011) (“While Congress's intent . . . was clearly to preserve the conduct and effects tests,

the language . . . as drafted does not actually do so.”) 122 See, e.g., Marco Ventoruzzo, Like Moths to a Flame? International Securities Litigation After Morrison:

Correcting the Supreme Court's "Transactional Test", 52 VA. J. INT'L L. 405, 440 (2012). See also Richard W.

Painter, The Dodd-Frank Extraterritorial Provision: Was it Effective, Needed, or Sufficient?, 1 HARV. BUS. L. REV.,

195, 208 (2011) (depending on the reasoning they apply, courts could “be forced to find that Section 929P was

‘stillborn’ in that it conferred jurisdiction that could not be used for anything substantive—in cases without a U.S.

securities transaction—until a further statute were enacted. Whether a federal court will so hold, despite the very

likely congressional intent to the contrary, remains to be seen.”)

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appearance of privileging a small number of funds or institutions and transactions that could

disrupt markets and could unnecessarily disadvantage issuers where large volumes of securities

are attempted to be resold at the market. Nevertheless, securities holders, banks and broker-

dealers today face an expanded range of choices for resale of restricted and control securities,

which should tend to promote overall market liquidity and investor enthusiasm and contribute to

the long-term solvency and growth of issuers.

It is certain that the creativity of market professionals will continue along this course and

“create” or “discover” ever more efficient methods of investor liquidity as this paradigm expands

even further.

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