Restricted and control securities cannot be freely traded in the public market. The Securities and Exchange Commission's (SEC) restricted-stock resale rule governs when and how these securities can be resold.
Restricted Stock
- Restricted securities = shares acquired through unregistered transactions (private placements, Reg D offerings, employee compensation plans, seed capital)
- Cannot be freely traded in the public market
- Subject to holding periods and volume limitations
Control Securities
A note on terminology: The SEC's standard term is "control securities" (no -ed). The word "control" describes the holder's relationship with the issuer, not a past-participle adjective.
- Definition: Shares held by affiliates (officers, directors, or shareholders owning 10%+ of outstanding shares)
- Even if the shares are registered, they are still subject to the resale rule's restrictions
- The restriction follows the person, not the security
Think of it this way: Restricted stock is restricted because of what it is (unregistered). Control stock is restricted because of who holds it (an affiliate). Either way, the SEC's restricted-stock resale rule governs the resale.
Exam Tip: Gotchas
- Control securities are restricted because of who holds them, not how they were acquired. Even registered shares become restricted when held by an affiliate.
The Restricted-Stock Resale Rule: Selling Restricted and Control Securities
The SEC's restricted-stock resale rule is the primary mechanism for selling restricted and control securities into the public market.
Holding Period Requirements
| Issuer Type | Minimum Holding Period |
|---|---|
| SEC-reporting company | 6 months |
| Non-reporting company | 12 months (1 year) |
- Holding period begins when securities are bought and fully paid for
- Holding period applies only to restricted securities (not to control securities that were acquired in the open market)
Why 6 months vs. 12 months?
- Reporting companies file regular 10-K, 10-Q, and 8-K reports with the SEC, so the market already has fresh public information about the issuer
- Non-reporting companies do not, so the market needs more time to develop reliable information about the security on its own
- Rule of thumb: the more public disclosure already on file, the shorter the required holding period
Exam Tip: Gotchas
- Reporting company holding period is 6 months; non-reporting is 1 year. The shorter period applies to companies that file regular reports with the SEC.
Volume Limitations (Affiliates/Insiders Only)
In any 3-month period, an affiliate cannot sell more than the greater of:
- 1% of outstanding shares, OR
- Average weekly trading volume over the prior 4 weeks
What is the volume limit, and who is it on?
- The cap is on the affiliate selling, not on the buyer or the firm. It limits how many shares the affiliate may sell over the rolling 3-month window
- The "greater of" formula prevents two things at once:
- A sudden flood of insider shares from crashing the market price and signaling insider distress
- Insiders from effectively running their own unregistered public distribution, sidestepping the disclosures registration would require
- An affiliate who needs to sell more than the cap allows must wait for the 3-month window to refresh, or use a registered offering instead
Exam Tip: Gotchas
- Volume limitations apply to affiliates regardless of how long they have held the shares. Affiliates are never fully free from the resale rule's restrictions.
Form 144 Filing
- Affiliates must file Form 144 with the SEC if proposed sales within a 3-month period exceed 5,000 shares or $50,000
- Filed at the time the sell order is placed
- Non-affiliates are not required to file Form 144
Insider Reporting Forms (Forms 3, 4, and 5)
- Form 3: Initial statement of beneficial ownership filed when an insider (director, officer, or 10%+ shareholder) first becomes a reporting insider
- Form 4: Reports any change in beneficial ownership and must be filed within 2 business days of the transaction; assume this 2-business-day deadline for the exam
- Form 5: Annual catch-all filing for certain exempt transactions not required on Form 4
Exam Tip: Gotchas
- Form 4 is about timing, not size. Even a single share trade triggers the 2-business-day filing requirement for insiders. Volume thresholds apply to Form 144, not Form 4.
Restricted-Stock Resale Rule Summary Table
| Requirement | Affiliate (restricted stock) | Affiliate (control stock) | Non-Affiliate (restricted, reporting co.) | Non-Affiliate (restricted, non-reporting co.) |
|---|---|---|---|---|
| Holding period | 6 months (reporting) / 12 months (non-reporting) | None | 6 months | 12 months |
| Volume limits | Yes | Yes | No (after holding period) | No (after holding period) |
| Form 144 filing | Yes (if > 5,000 shares or $50,000) | Yes (if > 5,000 shares or $50,000) | No | No |
| Manner of sale | Ordinary brokerage transactions | Ordinary brokerage transactions | No restriction | No restriction |
| Current public info | Required | Required | Required (6-12 months); not required after 12 months | Required (first 12 months); not required after 12 months |
Exam Tip: Gotchas
- Affiliates always face restrictions (volume limits, Form 144, and manner-of-sale requirements) even for shares purchased on the open market (control stock).
- Non-affiliates who satisfy the holding period can sell freely with no volume limits or filings.