Technically Rule 144 provides a safe harbor from the definition of the term “underwriter” such that a selling shareholder may utilize the exemption contained in Section 4(1) of the Securities Act of 1933, as amended, to sell their restricted securities. In addition, Rule 144 is used to remove the restrictive legend from securities in advance of a sale. In layman terms, Rule 144, allows shareholders to either remove the restrictive legend or sell their unregistered shares.

Rule 144(i), as amended, provides in pertinent part that the Rule is unavailable to issuers with no or nominal operations or no or nominal non-cash assets. That is the rule is unavailable for the use by shareholders of any company that is or was at any time previously, a shell company. A shell company is one with no or nominal operations and either no or nominal assets, assets consisting solely of cash and cash equivalents or assets consisting of any amount of cash and cash equivalents and nominal other assets.

Form 10 Information

In order to use Rule 144, a Company must have ceased to be a shell company, be subject to the reporting requirements of section 13 or 15(d) of the Exchange Act; filed all reports and other materials required to be filed by section 13 or 15(d) of the Exchange Act, as applicable, during the preceding 12 months (or for such shorter period that the issuer was required to file such reports and materials), other than Form 8-K reports; and have filed current “Form 10 information” with the Commission reflecting its status as an entity that is no longer a shell company, then those securities may be sold subject to the requirements of Rule 144 after one year has elapsed from the date that the issuer filed “Form 10 information” with the SEC.

The Evergreen Requirement

Rule 144 now affects any company who was ever in its history a shell company by subjecting them to additional restrictions when investors sell unregistered stock under Rule 144. The new language in Rule 144(i) has been dubbed the “evergreen requirement”. The new Rule has the impact of punishing a company that was ever a shell in perpetuity and more importantly, its investors. Brian Breheny, deputy director of the Securities and Exchange Commission’s corporate finance division, referred to the so-called evergreen requirement in Rule 144(i) of the Securities Act, as an “unfortunate result” and said it was “probably not something that the commission intended.”

Going Public and Reverse Mergers

Under the so called “Evergreen Requirement”, a company that ever reported as a shell must be current in its filings with the SEC for 12 months before investors can sell unregistered shares. Here is the hitch. As a result, the restrictive legend can never be removed in advance of a sale. The rule affects all companies going public through a reverse merger or SPAC. Moreover, the Rule effects all companies that have ever been a shell, even if a reverse merger was completed decades ago. It paints a “scarlet letter” on all former shell companies, as this requirement continues literally forever – famous former shells like Blockbuster Entertainment, Texas Instruments and Berkshire Hathaway are now burdened by this restriction decades after their reverse mergers.

So basically, you have to register the shares to get the legend removed. Practitioners have requested that the SEC either amend the Rule or issue additional guidance removing this requirement from Companies that were no longer shells at the time the Rule was enacted. So far no such changes have been made.

Securities attorney Laura Anthony provides expert legal advice and ongoing corporate counsel to small public Companies as well as private Companies seeking to go public on the Over the Counter Bulletin Board Exchange (OTCBB). Ms. Anthony counsels private and small public Companies nationwide regarding reverse mergers, due diligence on public shells, corporate transactions and all aspects of securities law.

Ms. Anthony is the Founding Partner of Legal & Compliance, LLC, a national corporate, securities and civil litigation law firm based in West Palm Beach, Florida. The firm’s corporate and securities attorneys provide technical legal services to small and mid-size private and public (OTCBB) Companies, entrepreneurs, and business professionals nationwide. Contact us today for a FREE consultation!

Many clients seek to register convertible securities, such as convertible debentures, warrants, options or convertible preferred stock. The question most often asked is how many share need to be registered, and in particular, does the Company need to register the shares underlying the convertible security.

First, it is essential to review a few basic facts on what a convertible security is and how it works.

Convertible Security Defined

A “convertible security” is a security that can be converted into a different security – typically shares of the company’s common stock. In most cases, the holder of the convertible determines whether and when a conversion occurs. In other cases, the company may retain the right to determine when the conversion occurs.

Companies that may be unable to tap conventional sources of funding sometimes offer convertible securities as a way to raise money more quickly. In a conventional convertible security financing, the conversion formula is generally fixed – meaning that the convertible security converts into common stock based on a fixed price. The convertible security financing arrangements might also include caps or other provisions to limit dilution (the reduction in earnings per share and proportional ownership that occurs when, for example, holders of convertible securities convert those securities into common stock).

Death Spirals

By contrast, in less conventional convertible security financings, the conversion ratio may be based on fluctuating market prices to determine the number of shares of common stock to be issued on conversion. A market price based conversion formula protects the holders of the convertibles against price declines, while subjecting both the company and the holders of its common stock to certain risks. Because a market price based conversion formula can lead to dramatic stock price reductions and corresponding negative effects on both the company and its shareholders, convertible security financings with market price based conversion ratios have colloquially been called “floorless”, “toxic,” “death spiral,” and “ratchet” convertibles.

Registration of Convertible Securities

Where convertible securities are being registered, the underlying securities must be registered where such securities are convertible within one year, or where the securities are convertible at the option of the Company. Where the securities are convertible or exercisable within one year, an offering of both the overlying security and underlying security is deemed to be taking place. If such securities are not convertible or exercisable within one year, the Company may choose not to register the underlying securities at the time of registering the convertible securities. However, the underlying securities must be registered no later than the date they become exercisable or convertible.

Timing of Registration

Where securities are convertible at the option of the issuer, the underlying securities must be registered at the time the convertible securities are registered since the entire investment decision that the investor will be making, is made at the time of purchasing the convertible security. That is, the security holder, by purchasing a convertible security that is convertible at the option of the Company, is in effect also deciding to accept the underlying security.

Securities attorney Laura Anthony provides expert legal advice and ongoing corporate counsel to small public Companies as well as private Companies seeking to go public on the Over the Counter Bulletin Board Exchange (OTCBB). Ms. Anthony counsels private and small public Companies nationwide regarding reverse mergers, due diligence on public shells, corporate transactions and all aspects of securities law.

Securities attorney Laura Anthony provides expert legal advice and ongoing corporate counsel to small public Companies as well as private Companies seeking to go public on the Over the Counter Bulletin Board Exchange (OTCBB). Ms. Anthony counsels private and small public Companies nationwide regarding reverse mergers, due diligence on public shells, corporate transactions and all aspects of securities law.

Ms. Anthony is the Founding Partner of Legal & Compliance, LLC, a national corporate, securities and civil litigation law firm based in West Palm Beach, Florida. The firm’s corporate and securities attorneys provide technical legal services to small and mid-size private and public (OTCBB) Companies, entrepreneurs, and business professionals nationwide. Contact us today for a FREE consultation!

The Securities Act of 1933 recognizes two broad types of exemptions to the registration requirements of Section 5, exempt securities and exempt transactions.

The Exempt securities are set forth in Sections 3(a)(1) – (8), (13) and (14) of the Securities Act. Exempt securities are continuously exempt from the registration requirements regardless of the nature of the transaction in which they may be offered, issued, sold or resold. Examples of exempt securities which may be publicly offered, issued, sold and resold by their issuers or any other person without registration include:

• Securities issued or guaranteed by the federal government;
• Any security issued or guaranteed by a bank;
• Commercial paper with a maturity of nine months or less;
• Securities issued by non-profit religious, educational or charitable organizations; and
• Insurance contracts

Exempt Transactions

The exempt transactions are set forth in Sections 3(a)(9), 3(b) and Section 4 of the Securities Act. Exempt transactions allow a security to be offered or sold in a particular transaction or circumstance or by a particular person or entity, although a subsequent offer or sale of the security could require registration under Section 5. Examples of exempted transactions include:

• Transactions by any person other than an issuer, underwriter or dealer (Section 4(1) – which permits most secondary trading of securities are form the basis for Rule 144)
• Transaction by an issuer not involving any public offering (Section 4(2) – often called the private placement exemption and is only available for use by the issuer and not for re-sale transactions)
• Brokers transactions (Section 4(3)); and
• An exchange of securities by an issuer with its existing security holders exclusively where no commission or other remunerations is paid or given (Section 3(a)(9) – conversion of convertible debt or equity securities and cashless exercises of warrants are typically accomplished using this exemption)

Examples of other common exemptions include:

• Offer or sales of a debtor through a bankruptcy court;
• Small offerings of less than $5 million under either Regulations A or D
• Offers and sales under written employee benefit plans (Rule 701); and
• Offshore offers and sales and Regulation S.

Of these exemptions the most commonly used are Regulations S, D and A. Regulation S is not technically an exemption but a jurisdictional provision regarding the reach of the Securities Act of 1933. In particular, Rule 901 provides “[F]or the purposes of Section 5 of the Act, the terms “offer to sell”, “sell”, “sale”, and “offer to buy” shall be deemed to include offers and sales that occur with the United States and shall be deemed not to include offers and sales that occur outside the United States.”

Regulation S

Regulation S covers (i) sales of securities to non-U.S. persons and to foreign securities markets by U.S. issuers, (ii) sales of securities to non-U.S. persons and in foreign securities markets by foreign issuers whose securities are not listed in the U.S. securities markets and which are non reporting companies under the Exchange Act, (iii) sales of securities to non-U.S. persons and in foreign securities markets by foreign issuers which are reporting companies under the Exchange Act, and (iv) resales of these securities.

Regulation D

Regulation D consists of eight (8) rules. Rule 501 through 503 contain definitions, conditions and other provisions that apply to Regulation D generally. Rules 504, 505 and 506 are the three current, specific exemptions from registration. Rule 504 provides an exemption for companies that are not subject to the reporting requirements of the Exchange Act of 1934 for the offer and sale of up to $1 million of securities in a 12 month period. Rule 505 exempts offers by companies of up to $5 million of securities in a 12 month period as long as offers are made without general solicitation or advertising, and there are no more than 35 unaccredited purchasers.

Rule 506

Rule 506 is a safe harbor under the private placement exemption (Section 4(2)). There is no limit on the amount of securities that can be offered or sold, so long as (i) offers are made without general solicitation or advertising, and (ii) the sales are made only to accredited investors or no more than 35 unaccredited investors and all investors must be sophisticated.

Accredited investors are generally defined to include:

• Banks, insurance companies and pension plans;
• Corporations, partnerships and business entities with over $5 million in assets;
• Directors, executive officers and general partners of the issuer;
• Natural persons with over $1 million net worth or over $200,000 in annual income for two years; and
• Entities, all of whose equity owners are accredited.

Regulation A

Regulation A permits a public offering of up to $5 million by issuers, including up to $1.5 million by selling stockholders, within any 12 month period. Regulation A is only available to issuers who are not subject to the reporting requirements of the Securities Exchange Act. Affiliate resales are not permitted unless the issuer has had net income from continuing operations in one of its last two fiscal years.

Securities attorney Laura Anthony provides expert legal advice and ongoing corporate counsel to small public Companies as well as private Companies seeking to go public on the Over the Counter Bulletin Board Exchange (OTCBB). Ms. Anthony counsels private and small public Companies nationwide regarding reverse mergers, due diligence on public shells, corporate transactions and all aspects of securities law.

Ms. Anthony is the Founding Partner of Legal & Compliance, LLC, a national corporate, securities and civil litigation law firm based in West Palm Beach, Florida. The firm’s corporate and securities attorneys provide technical legal services to small and mid-size private and public (OTCBB) Companies, entrepreneurs, and business professionals nationwide. Contact us today for a FREE consultation!