Rule 144 Securities Act: How Does It Deter Insider Trading?‍

Casey Fenton

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January 9, 2024

In 2004, the world watched with bated breath as lifestyle icon Martha Stewart faced legal scrutiny, not for a home decor misstep nor a recipe gone wrong, but for allegations of insider trading. Stewart's case, which resulted in a five-month prison sentence, spotlighted the intricate web of securities regulations and the dire consequences of overlooking them.

These high-profile cases shed light on the importance of the often-misunderstood regulations that govern the financial markets. Rule 144 of the Securities Act of 1933 stands at the forefront of these regulations. For startups and established companies alike, mastering the intricacies of this rule isn't just about legal compliance; it's about preserving trust, transparency, and the very integrity of the financial world.

Understanding the Securities Act of 1933

When you're navigating the complex world of securities, the Securities Act of 1933, often dubbed the '33 Act, serves as a foundational pillar. But what prompted its creation? The Great Depression. This economic catastrophe led regulators to believe that the market crash was exacerbated by a lack of transparent financial information. Investors were making decisions based on incomplete or misleading information, and the aftermath was disastrous.

The '33 Act was a game-changer. It was the U.S.'s first federal legislation targeting the regulation of securities transactions. Rather than focusing solely on post-trade transparency like its counterpart, the Securities Exchange Act of 1934, the '33 Act centers on transactions and the issuance of securities. Its primary goals are twofold:

Disclosure of Material Information

The Act requires companies to provide comprehensive financial and other pertinent details before selling their securities to the public. This disclosure, typically done through a registration statement filed with the SEC, ensures that potential investors can make informed decisions.

Prevention of Misrepresentation and Fraud

By setting strict guidelines about the information that must be disclosed, the '33 Act deters companies from using misleading or untrue statements. This creates a more level playing field for all investors.

For companies and startups, complying with the '33 Act is not just about avoiding legal pitfalls—it's about building trust with investors. When potential stakeholders know that a business is transparent about its financial standing and risks, they're more likely to invest with confidence.

5 Conditions for Resale of Rule 144 Securities

When your startup or company grows and the time comes to consider selling your securities, the path isn't just a straightforward "sell" button. The Securities and Exchange Commission (SEC) has outlined certain conditions under Rule 144 that ensure both transparency and fairness in the resale of securities. Here are those:

1. Holding Period

One of the foundational aspects of Rule 144 is the stipulation of a minimum holding period. Why? This period allows for a buffer, preventing knee-jerk sales based on immediate non-public information. If the issuer of the securities is a reporting company, familiar with the periodic disclosures under the Securities Exchange Act of 1934, your holding period stands at a minimum of six months. However, if the issuer isn’t regularly reporting, you need to hold onto those securities for at least one year before considering resale.

2. Current Public Information

Imagine making a significant investment decision without all the data. Unsettling, right? Rule 144 mandates the availability of current public information about the issuer. This can typically be found in the form of regular SEC filings. By ensuring this information is readily available, the rule empowers potential buyers with the insights they need to make informed decisions.

3. Trading Volume Formulas

The market thrives on balance. Rule 144 aids in maintaining this equilibrium by limiting the volume of securities you can offload. For any three-month period, you're restricted to selling an amount that doesn't exceed 1% of the outstanding shares of the same class being sold. This provision prevents a flood of sales, which could drastically affect the stock's price and market stability.

4. Ordinary Brokerage Transactions

Any sale under this rule should resemble routine trading transactions. This means you can’t go out of your way to solicit or arrange for the sale—it should be as organic as any other market transaction.

5. Filing a Notice with the SEC

Transparency is key. If you happen to be an affiliate of the issuer and are selling a considerable amount—specifically, more than 5,000 shares or securities worth over $50,000 within a three-month period—you're required to let the SEC know. By filing Form 144, you're effectively announcing your intent to sell, ensuring that all market players are aware of potential shifts.

For startups and established businesses, these conditions are not just regulatory hoops to jump through. They're guidelines to ensure that the securities market remains a trustworthy space for all involved. By adhering to them, you champion fairness and transparency in every transaction.

How Rule 144 Thwarts Insider Trading

When we speak of insider trading, we often envision shadowy deals and covert whispers about non-public company information. And rightfully so. Insider trading, where privileged information is used for personal gain in the stock market, is a breach of trust, eroding faith in the fairness of financial markets. So, where does Rule 144 come into play in preventing such unethical maneuvers?

Time as a Barrier

The holding period condition of Rule 144 is a masterstroke in preventing hasty decisions based on insider knowledge. By mandating insiders to hold onto their securities for a specified duration, Rule 144 ensures they can't immediately capitalize on non-public information. This time frame acts as a cooling-off period, reducing the allure of making a quick buck through insider knowledge.

Mandatory Disclosure

Rule 144's emphasis on ensuring the availability of current public information adds another layer of protection. Ensuring essential information about the company is available to the public narrows the information gap between insiders and regular investors, thus reducing the advantage insiders might have.

Limiting Volume

The restrictions on the volume of securities that can be sold under Rule 144 are not just about maintaining stock prices and market stability. It also serves as a deterrent to large-scale insider trading. By capping how much can be sold, it prevents significant market movements based on inside information.

Public Declaration of Sale

For affiliates required to file Form 144, this is more than just paperwork. Declaring an intent to sell is similar to announcing one's moves on a chessboard. It informs the market, making it harder for insiders to clandestinely profit from non-public information.

For startups and companies, understanding and complying with Rule 144 isn't just about avoiding legal consequences. It's an affirmation of commitment to fair play. Rule 144 is a reminder that in the complex world of securities, trust is the most valuable commodity. Upholding it ensures not just individual success, but the overall health and credibility of the financial markets.

Can You Remove the Restricted Legend Before Selling Securities?

Seeing that “restricted” legend on your stock certificate may feel like an anchor weighing down your ability to deal freely with your securities. It essentially signifies that the security hasn’t met all the conditions for public resale, thus requiring certain restrictions. But is it forever? 

First, it's important to grasp why the legend exists. It's more than just a label; it's a warning to brokers and potential buyers about the limitations and conditions surrounding the security's sale. It screams, "Handle with care!" emphasizing the legal ramifications tied to the immediate sale.

So, can you remove it? Yes, but under specific circumstances. Primarily, you must have satisfied all the conditions of Rule 144. This includes the mandatory holding period, having access to current public information about the issuer, ensuring that the sale doesn't disrupt trading volume limits, and conducting the sale in an ordinary brokerage transaction.

The process of legend removal isn't just about ticking off Rule 144 conditions. It's also procedural. Typically, you, alongside your broker, would approach the issuer’s transfer agent with a request to remove the restriction. A legal opinion from an attorney, indicating that the conditions of Rule 144 have been met, is often required. This opinion will clarify that the security can now trade freely.

While it may seem tempting to hasten the removal process, especially if you're eager to capitalize on market conditions, tread carefully. An ill-advised attempt to remove the restricted legend prematurely can attract regulatory scrutiny and even potential legal actions.

For startups and businesses, navigating the landscape of restricted securities is intricate. Recognizing the purpose behind the restricted legend and understanding the process of its removal not only ensures compliance but also fortifies the company's commitment to transparent and ethical practices. It’s not just about fluidity in trading; it’s about upholding the integrity of the securities market.

Are Cryptocurrencies Subject to Rule 144?

The intersection of traditional securities laws and the dynamic realm of cryptocurrencies is nothing short of fascinating. As digital assets redefine the financial landscape, there's an inevitable question: How do long-standing regulations like Rule 144 fit into this new-age paradigm?

At the heart of the issue is the very definition of cryptocurrencies. Are they securities? Commodities? A new asset class altogether? The U.S. Securities and Exchange Commission (SEC) has indicated that certain cryptocurrencies, especially those stemming from Initial Coin Offerings (ICOs), can be considered securities if they meet the criteria of the Howey Test. As such, if a cryptocurrency is deemed a security, Rule 144 can apply.

Now, let’s talk about tokens from ICOs for a moment. If these tokens are determined to be securities, the issuers, and those who hold them, might have to grapple with Rule 144’s restrictions. This means that the resale of such tokens, especially if they bear restricted legends, must comply with the stipulations we've previously outlined, such as the holding period.

The regulatory stance on cryptocurrencies is not static. As the market matures and understanding deepens, regulatory bodies might refine their interpretations. Startups and companies in the blockchain and crypto space must remain vigilant, keeping abreast of any regulatory shifts.

Engaging in the sale or transfer of tokens or coins without proper regard for securities regulations can lead to significant legal repercussions. Just as with traditional securities, the spirit behind these regulations is to ensure fairness, transparency, and the prevention of fraudulent activities.

For businesses operating within the cryptocurrency ecosystem, it's imperative to remember that innovation doesn't negate the need for compliance. Rule 144, though crafted in a different era, has implications that ripple into today’s digital asset frontier. It serves as a reminder that irrespective of the asset's form, the principles of trust, transparency, and investor protection remain paramount.

Final Thoughts

For you, as someone involved in a company or startup, understanding Rule 144 is more than just understanding a regulation. It's about knowing how to protect your interests, foster transparency, and maintain integrity in the market. By adhering to Rule 144 and its stipulations, you don't just comply with the law; you ensure that the financial market remains a place where trust and fairness prevail. Stay informed, stay compliant, and always strive for transparency.

If you’re a startup looking for a solid RSU plan or a crypto firm seeking to incentivize your tech employees, consider booking a demo today with Upstock to find out how its RSUs and RTUs (restricted token units) are changing the equity landscape toward a future-proof success.

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ABOUT THE AUTHOR

Casey Fenton

Founder, Upstock & Couchsurfing, AI and Equity Innovator

Casey Fenton, the founder of Upstock & Couchsurfing and an AI and equity innovator, has revolutionized how we perceive and implement equity in the workplace. His foresight in creating platforms that not only connect people but also align their interests towards communal and corporate prosperity has established him as a pivotal figure in technology and community building. Casey speaks worldwide on topics including ownership mindset, worker equity, With Upstock and Couchsurfing, he has demonstrated an unparalleled expertise in harnessing technology for the betterment of community interaction and organizational benefits.

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