Restricted Stock and Resale Restrictions

Now that you understand shareholder rights, the next question is: can you actually sell your shares whenever you want? Not always. Some securities come with restrictions on when and how they can be resold.

What Is Restricted Stock?

Restricted stock refers to securities acquired through:

• Private placements (Regulation D offerings)
• Employee compensation plans (stock grants, options exercises)
• Other unregistered transactions

These shares are not registered with the SEC, which means they cannot be freely traded on the open market. The SEC imposes holding periods and resale conditions to protect public investors.

Think of it this way: Registration is the SEC's way of making sure public investors get full disclosure before buying. If you got your shares without that disclosure process (through a private deal or as compensation), you cannot just turn around and dump them on the public market. You have to wait and follow specific rules first.

The Restricted-Stock Resale Rule

The SEC's restricted-stock resale rule is the primary rule governing how restricted and control securities can be sold in the public market.

Key Definitions

• Restricted securities: Shares acquired in unregistered transactions (private placements, compensation plans)
• Control securities: Shares held by affiliates (insiders: officers, directors, or anyone owning 10%+ of the company), regardless of how they were acquired
• Affiliates: People in a position to influence or control the company

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.

Holding Period Requirements

• The holding period begins when the securities are fully paid for
• After the holding period, non-affiliates of reporting companies can sell freely with no volume limits or filing requirements
• Affiliates must continue to follow volume limits and filing requirements even after the holding period

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

Volume Limitations (Affiliates Only)

Affiliates are limited in how many shares they can sell in any 3-month period. The limit is the greater of:

• 1% of outstanding shares of the same class, OR
• Average weekly trading volume over the prior 4 weeks

Non-affiliates are not subject to volume limitations once the holding period is satisfied.

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

Form 144 Filing Requirement

Affiliates must file Form 144 with the SEC if selling:

• More than 5,000 shares, OR
• More than $50,000 in value

The form must be filed at the time the sell order is placed.

Exam Tip: Gotchas

• Two holding periods: 6 months for reporting issuers, 12 months for non-reporting issuers.
• Volume limit is the GREATER of 1% of outstanding shares or average weekly trading volume (not the lesser).
• Affiliates never escape volume limits and filing requirements, even after the holding period. Non-affiliates can sell freely once the holding period is met.

The QIB Resale Safe Harbor

The SEC's QIB resale safe harbor provides a separate pathway for reselling restricted securities, but only to large institutional investors.

• Allows resale of restricted securities to Qualified Institutional Buyers (QIBs) without SEC registration
• A QIB must own and invest at least $100 million in securities of unaffiliated issuers (the threshold is $10 million for broker-dealers)
• No holding period required under the safe harbor
• Greatly increases liquidity in the institutional market for unregistered securities
• Securities sold under the safe harbor cannot be of the same class as securities listed on a national exchange

Exam Tip: Gotchas

• The restricted-stock resale rule has a holding period; the QIB safe harbor does not. This is a common source of confusion.
• QIB threshold is $100 million in securities (not $1 million or $25 million). For broker-dealers, the threshold is $10 million.