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Ready to cash in on that IPO? Make sure you understand Rule 144

In today’s highly profitable cannabis industry, we’re seeing a lot more companies go public. These IPOs raise capital for business interests, but they also might raise questions about private-placement stock, as well.

That’s understandable. After all, holders of these kinds of pre-IPO securities are eager to be rewarded financially once a company goes public. But the stock they hold is restricted and can’t be traded with the ease of calling a trader and placing the sale. So how can they profit if they can’t sell the stock?

They still can trade, of course, but they should temper their expectation of quick profit-making by understanding the importance of Rule 144.

Rule 144 is part of the U.S. Securities Act of 1933, the landmark investor-protection law passed in the wake of the stock-market crash of 1929. The act’s Rule 144 is what controls transactions in restricted securities, and it provides a way for individuals holding these kinds of stocks to sell them to the public.

Fundamentally, Rule 144 is part of the federal protections against companies that might attempt to manipulate single-day price movements by flooding the market with shares.

When a company is private, it can issue stock in what’s known as “private placements.” The shares of these securities in private placement are considered restricted. They typically are acquired in trades that are exempt from the registration dictates of Section 5 of the Securities Act.

They aren’t registered with the U.S. Securities and Exchange Commission and they can’t be publicly traded. The stock certificates of such shares even are stamped with a legend that denotes them as being restricted from sales or trades.

However, restricted stock can be resold to the public if the holder can attain an exemption to securities laws. And that’s where Rule 144 comes into play.

Consider this all-too-familiar situation, especially in today’s cannabis industry. A private company or start-up uses private stock to compensate consultants or, perhaps, even its own employees. But then that company goes public. And if that consultant or employee or anyone holding such a restricted security wants to sell or trade, they can rely on the safe-harbor provisions of Rule 144, as long as few conditions are met.

Those conditions include things such as the manner in how the stocks are sold, the company information that is disclosed and the allowed volume of sales, among other things. For typical holders of these kinds of securities, though, there really are only two primary considerations that will have the most immediate effect on their efforts to turn a profit after an IPO.

First, know that Rule 144 stipulates a mandatory holding period for restricted securities. For a public company reporting to the SEC (for at least 90 days), that period is six months. For private companies under no such SEC reporting constraints, the hold is for a year. For any restricted-stock holders, the period is identified as beginning when the securities are fully purchased. If a company relies on Rule 701 for issuances to employees or consultants who are individuals, stocks can be sold with no holding period (after the 90 day reporting period).

Aside from the holding-period requirements of Rule 144, holders of restricted stock also need to be aware of the rule’s requirements concerning the restriction labeling on stock certificates. Because even if all other requirements of the rule are met, shareholders still will need to have any restriction warnings removed from the stock certificates before they can be traded. For public companies, only so-called “transfer agents” can make this happen — meaning it’s a requirement for companies to get a legal opinion to confirm that the stock is “freely tradeable” under Rule 144.

It’s important to note that Rule 144 also provides the terms under which private securities are sold or traded, too. If the consultant in the above example receives private-company stock as compensation from a company that isn’t publicly traded, he or she can still seek to sell the stock, and Rule 144 provides a guide for accomplishing this.

IPOs can be exciting for shareholders, and there’s no reason holders of restricted securities can’t share in this excitement with their private-placement holdings.

But holders of these kinds of securities should understand that their profits won’t come immediately because of Rule 144’s requirement for holding periods. And they should know, too, that they will have to address the stock certificate legends by getting a legal opinion issued.

If patient and pragmatic in these aspects of Rule 144, though, investors will be better prepared for profit-making if and when it comes.

Julie Herzog

Julie Herzog

As head of the corporate/securities practice at Fortis Law Partners, Julie Herzog handles a wide variety of corporate, securities and merger and acquisition transactions. She has handled transactions valued at over $4 billion for major public companies and investment banks and enjoys working with a diverse clientele ranging from Fortune 100 corporations to startups, family offices, and venture capital and private equity funds. Since 2013, Julie negotiated and closed over 75 transactions valued at over $1.5 billion on behalf of our clients. Her clients represent a variety of industry sectors, including cannabis, energy, health care, technology, manufacturing, real estate, food and beverage, business consulting and other services. She has counseled several hundred companies from inception through initial public offerings or successful sales. For more information, contact [email protected].

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