February 28, 2008

Amended Rules 144 and 145 May Benefit M&A Transactions

In an effort to increase the liquidity of restricted securities and broaden capital-raising opportunities for companies without compromising investor protection, the Securities and Exchange Commission (SEC) adopted late in 2007 several amendments to Rule 144 and Rule 145 under the Securities Act of 1933. The amendments—which significantly reduce the limitations on sales of restricted securities—will make private placements less costly for issuers and will likely result in an increased use of stock as currency in merger and acquisition transactions.

Issuers and investors can now take advantage of these changes, as the amendments were effective February 15, 2008 and apply to restricted securities acquired before or after the effective date.

This article provides background on Rules 144 and 145, highlights the changes brought by the amendments, and examines the implications for companies involved in M&A transactions.

Rule 144: Background

Rule 144 provides a nonexclusive safe-harbor for security holders who wish to sell privately issued securities that they hold without registration under the Securities Act. If the intended sale meets the requirements of Rule 144, it will qualify as an exempt transaction under Section 4(1) of the Securities Act, which applies to offers and sales not involving an issuer, underwriter or dealer. Compliance with Rule 144 effectively protects the selling security holder from being deemed an "underwriter" under the Securities Act.

Securities acquired from an issuer, or an affiliate of the issuer, absent a public offering are deemed "restricted" securities, and holders of such securities must comply with Rule 144 or another exemption under the Securities Act to resell without registration. Securities held by an affiliate of an issuer (i.e., an officer, director, or other person who directly or indirectly controls or is controlled by the issuer) are deemed "control" securities, whether or not they are restricted securities. Sales of control securities must also comply with Rule 144 or another exemption under the Securities Act.

The status of a stockholder as an "affiliate" or "non-affiliate" of the issuer, and the status of the issuer as a "reporting" or "non-reporting" company, are important factors in the newly adopted amendments to Rule 144 because the SEC has become more liberal in its treatment of non-affiliate sales of reporting company securities while keeping a shorter leash on sales of non-reporting company securities (due to limited public information) and sales by affiliates (due to their position of control).

Rule 145: Background

Rule 145 under the Securities Act previously provided that persons who are parties to a publicly registered exchange of securities in connection with a business combination, securities reclassification or asset transfer subject to shareholder vote, and their respective affiliates, are presumed to be "underwriters" under the Securities Act, and any resale made by such persons would be subject to the volume, manner of sale and other requirements of Rule 145(d), unless another exemption under the Securities Act is available or the resale is registered under the Securities Act.

As a result of the "presumptive underwriter" provision of the "old" Rule 145, affiliates of the target company in a Rule 145 merger or acquisition would have limited liquidity with respect to the securities received from the acquiring or surviving company as consideration, irrespective of whether such persons became affiliates of the acquiring company. Pre-amendment, the target's affiliates would have to comply with certain requirements (including Rule 144 requirements) to resell the acquired securities absent registration.

Amendments to Rule 144

Holding Period

The amendments to Rule 144 reduce the period during which affiliates and non-affiliates must hold restricted securities before resale. Prior to February 15, 2008, holders of restricted or control securities could not sell such securities under the Rule 144 safe-harbor until at least one year had elapsed from the date such securities were acquired. Now, both affiliates and non-affiliates of reporting companies will be able to sell their control or restricted securities after just six months, regardless of whether the securities were acquired before or after the February 15 effective date. Restricted and control securities of a non-reporting company will remain subject to the current one-year holding period, due to the limited availability of public information relating to a non-reporting company.

Sales by Non-Affiliates

The SEC has significantly reduced the limitations on non-affiliate sales of restricted securities. The amendments eliminate the volume, manner of sale and Form 144 filing requirements for non-affiliates of both reporting and non-reporting companies. Non-affiliates of reporting companies who elect to sell their restricted securities after the six-month holding period, but before one year has elapsed, are subject only to the public information requirements of Rule 144(c).

After one year, non-affiliates of reporting companies may sell their restricted securities without having to comply with any of the requirements under Rule 144. Because non-affiliates of non-reporting companies remain subject to a one-year holding period, such holders may not sell before one year has elapsed but may sell without restriction after the one-year mark.

Sales by Affiliates

Although sales of control securities by affiliates of both reporting and non-reporting companies remain subject to all of the requirements of Rule 144 after the applicable holding periods (six months for reporting companies and one year for non-reporting companies), the SEC has relaxed certain restrictions applicable to such sales.

The amendments expand Rule 144(f) to permit the resale of securities through riskless principal transactions, which are trades executed at the same price, exclude any explicitly disclosed markup or markdown, commission equivalent or other fee, and are permitted to be reported as "riskless" under the rules of a self-regulatory organization. The transaction must nevertheless meet all the requirements of a brokers' transaction under Rule 144(g), except the requirement that the broker only execute the order to sell the securities as agent for the person for whose account the securities are sold. Rule 144(g) is concurrently amended to expressly exclude the posting of bid and ask quotations in alternative trading systems from the notion of "solicitation" in the definition of "brokers' transactions."

The manner of sale requirements and volume limitations for resales of debt securities held by affiliates have also been significantly changed by the amendments. The manner of sale requirements have been eliminated with respect to debt securities, and the volume limitation has been altered from the volume limitation applicable to equity securities to 10 percent of the applicable tranche.

Finally, the amendments raise the thresholds for filing of a Form 144 by affiliates from 500 shares or $10,000 within a three-month period to 5,000 shares or $50,000.

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