The Restricted Securities Market utilizes privately negotiated transactions to provide access to liquidity in the $10 trillion dollar public securities market. A privately negotiated sale allows buyers and sellers to trade registered and unregistered securities, pursuant to certain guidelines and conditions pursuant to the Securities Act of 1933.

Privately Negotiated Sale - Section 4(1-1/2) Exemption.  The so-called Section 4(1-1/2) exemption is a hybrid derived from Section 4(1) of the Securities Act, which provides an exemption for resale transactions “by any person other than an issuer, underwriter or dealer,” and Section 4(2), which provides a private placement exemption for issuers.

The Section 4(1-1/2) exemption contemplates a private resale that is similar to an issuer’s Section 4(2) sale.  “This is a hybrid exemption not specifically provided for in the 1933 Act but clearly within its intended purpose,” according to the SEC (Act Release No. 6188, 1980 WL 29482).

Best practices associated with Section 4(1-1/2) transfers include:

• Placing a legend on the securities alerting the buyer about any restrictions.
• Arranging for the issuer to issue a stop-transfer order that allows any subsequent resale only after counsel issues an opinion about the legality of the resale.
• Making basic inquiries about the identity of the buyer and the buyer’s qualifications.
• Securing acknowledgement that the buyer is aware of the restrictive character of the securities and intends to hold the securities for investment.

Privately Negotiated Block Trade  By definition, a block trade is usually at least 10,000 shares of stock. Block positions can seriously affect the supply and demand for a security and be detrimental to its price if placed directly into the market. As a better alternative, holders of large equity positions may sell their entire position at a discount to the market. This is advantageous to both the buyer and the seller: the buyer has access to large size at a discount to market and the seller is able to sell the position more efficiently than exercising several transactions over a period of time. Buyers and sellers can execute trades through a privately negotiated transaction.

Restricted Securities. Restricted securities in publicly traded companies are a $1+ trillion asset class which is growing (the current financial markets notwithstanding) because of the many purposes restricted securities serve.  For example, restricted stock may be issued in connection with:

• Private placement transactions (PIPES)
• Mergers or acquisitions
• Management and employee compensation
• Corporate restructuring or reorganization
• Compensation for outside professionals such as consultants and bankers

Restricted Securities Basics

Restricted securities are stocks, warrants, debt or other securities that are:

• Generally acquired, either directly or indirectly, from public companies or company affiliates in transactions that are not registered with the U.S. Securities and Exchange Commission (SEC) or
• Registered with the SEC, but held by a “control” person and cannot be sold publicly without meeting certain requirements.

As the name implies, restricted securities cannot be freely traded and are, therefore, less liquid than publicly traded stock.  That does not mean restricted securities cannot be bought and sold. It does mean, however, that certain guidelines must be followed and rules adhered to.

Selling Restricted Securities

Along with a privately negotiated transaction, restricted securities may be sold through Rule 144 or a Prospectus Resale.

Rule 144 (Safe Harbor).  The purpose of Rule 144 of the Securities Act is to ensure that the owner of restricted securities assumes the economic risks of the securities before selling them.  It requires availability of information about the issuer and compliance with requirements governing manner of sale.  In addition, the seller may, depending on their status as an affiliate, have to adhere to holding periods and other manner of sale requirements such as volume limitations and public disclosure before the exemption becomes available.

Prospectus Resale.  A holder who acquired restricted securities through private placement can resell them to the public if the resale is registered with the SEC via an effective registration statement filed by the issuer.  Section 5 of the Securities Act requires the filing of a registration statement with the SEC and requires that a prospectus be delivered to each investor.

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