Understanding Restricted Stock Transactions

On the following pages you will learn in great detail about the complexities and strict guidelines which govern the sale of restricted and control securities.

The enclosed concepts and information were designed for educational purposes only. While we have attempted to be a thorough as possible we suggest individuals consult with qualified legal counsel prior to making any final decisions regarding the sale, exchange, exercise, or use of their restricted securities.

IMPORTANT NOTICE

EVERY EFFORT HAS BEEN MADE TO ENSURE THAT THE INFORMATION CONTAINED HEREIN IS ACCURATE. HOWEVER, WE MAKE NO REPRESENTATIONS AS TO THE ACCURACY OR ADEQUACY OF THE MATERIAL, AND FURTHER, CHANGES IN SECURITIES RULES AND REGULATIONS MAY MAKE SUCH INFORMATION OBSOLETE.

CONTENTS

• INTRODUCTION
• RULE 144
• What is Restricted Stock?
• What is Rule 144(k) Stock
• What is Control Stock
• RULE 145
• REQUIREMENTS APPLICABLE TO RULE 144, 144(k), 145 SALES
• Sale of Restricted Stock
• Sale of 144(k) Stock
• Sale of Control Stock
• Sale of 145 Stock
• DEFINITION OF RULE 144/145 TERMS OF SALE
• Adequate Current Public Information
• Holding Period (Only Non-Registered Securities)
• Volume Limitations
• Manner of Sale
• The Required Notice of Proposed Sale (Form 144)
• RULE 144 DECISION CHART
• STOCK OPTIONS
• What are Incentive Stock Options
• What are Non-Qualified Stock Options
• INVESTMENT STRATEGIES FOR HOLDERS OF RESTRICTED SECURITIES
• Hedging Techniques
• Margin and Collateralization of Restricted Securities
• Utilizing Options Against Restricted Securities
• Exchanging Restricted Securities for Assets

INTRODUCTION

Under Federal securities laws, persons who have Restricted Stock, which they have acquired in private transactions, may resell in the public market only if the company that has issued the stock takes steps to register the stock, or if the stock is sold in accordance with the conditions of Rule 144. The same is true of persons who, because they are directors, officers or otherwise in a control relationship with the issuing company ("insiders"), are deemed to own control stock.

Rule 144 stock includes both Restricted Stock and Control Stock. In addition to Rule 144, insiders must also concern themselves with Section 16 of the Securities Act of 1934. Section 16 of the "Act of '34" applies to officers and directors of an issuer which has a class of equity securities registered with the Securities and Exchange Commission under Section 12 of the 1934 Act, and to beneficial owners of more than 10% of such a class (insiders).

Generally, Section 16 imposes reporting obligations on insiders and permits the issuer to recover profits made by its insiders on certain purchase and sale transactions occurring during any period of less than six months. In addition, insiders are prohibited from selling any of the issuer's equity securities "short" or entering a transaction which is deemed to be the equivalent of a short sale.

In the absence of other transactions affected by an insider that may be subject to Section 16(b) "short swing profit" liability, an insider who has held an employee stock option for at least six months will be able to exercise the option and immediately sell the underlying security without short swing profit liability.

RULE 144

What is Restricted Stock?

Restricted Stock is stock that has not been registered with the Securities and Exchange Commission (SEC) and is acquired from the issuing corporation or from a control person (also known as an affiliate of the issuer). Typically, restricted stock will have been acquired in one of the following ways:

Public Offering

When a company goes through the process of an Initial Public Offering (IPO), the original owners, who gave up a percentage  of their shares of stock in order to raise capital from public investors will, after the offering, own Restricted Stock. The shares sold to the public (or "registered shares") are not considered "Restricted" and are freely tradable.

Direct Purchase

This occurs when a purchaser buys the stock directly from the original owner, whose shares are Restricted. The restrictions carry over, although certain holding period restrictions may be "tacked on" by the purchaser.

Private Placements

These are transactions in which the security has been acquired directly from the issuing corporation by the buyer in a negotiated transaction.

Mergers and Acquisitions

When company decides to merge or acquire another company, the vehicle of barter or payment in many cases is Restricted Stock. (A typical example is when an acquiring company issues unregistered stock to the owners of a target company as an inducement to accept the takeover.

Stock Options or Stock Purchase Plans

In many cases public companies will issue stock options or stock purchase plans to key employees, or others deemed important to the company. Under certain conditions the options offered may be for restricted stock of the company, and therefore, once exercised, would require registration prior to sale.

What is Rule 144(k) Stock?

Rule 144(k) stock is Restricted Stock that has been: (i) held at least three years, and (ii) the owner is not and has not been an affiliate of the issuer for three months preceding the sale.

What is Control Stock?

Control Stock is stock that is owned by persons who control the business affairs of the issuing corporation. In most cases, corporate directors and senior officers are considered control persons. Also, under certain conditions, close relatives, related trusts, estates, corporations, and partnerships may be considered control persons. (The terms "affiliate" and "insider" are used interchangeably with control persons)

In determining who is a control person, the SEC presumes anyone owning 10% or more of the outstanding shares of a corporation, whether he or she is a trustee or executor, or an officer or director, is usually considered a control person. Such a presumption may be rebutted by facts which establish that the person is not in a control position, or part of a control group.

RULE 145

What is 145 Stock?

Rule 145 applies to stocks or other securities which are issued to stockholders in connection with a plan of reorganization which has been submitted to the stockholders for their approval. Such types of reorganization include:

Reclassification

a reclassification of the securities of a corporation other than a stock split, reverse stock split or change in par value, which involves the substitution of one security for another;

Mergers or Consolidations

a statutory merger or consolidation, or similar plan of acquisition in which securities of one corporation become, or are exchanged for, securities of any other corporation (except where the sole purpose of the transaction is to change the issuer's domicile);

Transfers of Assets

a transaction in which the stockholders of a corporation, which sells or exchanges its assets, receive stock in the acquiring corporation as a result of the sale or exchange. In a registered merger of two companies - "Company A" takes over "Company B" - there are three types of shares that can result: Clean shares, Rule 145 shares, and Rule 144 shares.

Clean Shares

A non-insider of Company B who has registered or non-registered shares in Company B, but does not become an insider of Company A gets clean shares. These shares are saleable in the open market with no restrictions.

Rule 145 Shares

An insider of Company B who has registered or non-registered shares in Company B but does not become an insider of Company A, gets shares subject to resale pursuant to Rule 145.

Rule 144 Shares

An insider of Company B who has registered or non-registered shares in Company B and becomes an insider of Company A, gets fully registered shares in Company A. These shares are "control shares" and are subject to sale under Rule 144 but are not subject to the two year holding period.

REQUIREMENTS APPLICABLE TO RULE 144, 144(k), 145 SALES

Sale of Restricted Stock (non-registered stock only)

The requirements applicable to the sale of Restricted Stock under Rule 144 depend upon the length of time the stock has been held. If a minimum of one (1) year has elapsed since the later of the date of acquisition of the securities from the issuer (or an affiliate of the issuer), and the giving of the full purchase price or other considerations, it may be sold if the seller complies with the following conditions:

• Adequate current public information concerning the issuer is available;
• The amount of stock which may be sold in any three month period is limited;
• The stock is sold in a "brokers transaction" or directly to a dealer who is a market maker in the securities;
• Notice of the proposed sale on Form 144 is transmitted to the SEC and to the principal exchange (if any) on which the stock is listed;
• The holder transmitting the Notice has a bona fide intention to sell the securities referred to in the Notice within a reasonable time.

NOTE: If the stock has not been fully paid for and held for at least one year, it may not be sold unless the original owner has died and the sale is being made by his or her estate, or by a beneficiary. In such a case, it may be sold under Rule 144 (assuming the estate itself is not an affiliate of the issuer) if the following conditions are met:

There is adequate current public information concerning the company available; notice of the proposed sale on Form 144 is transmitted to the SEC and to the principal exchange (if any) on which the stock is listed; the holder transmitting the Notice has a bona fide intention to sell the securities referred to in the Notice within a reasonable time.

Sale of Rule 144 (k) Stock (non-registered stock)

If the time period described in the second paragraph of "Sale of Restricted Stock" above is at least three years and the owner of such stock is not, nor has been, an affiliate of the issuer for three months preceding the sale, the stock may be sold publicly without condition. This is pursuant to paragraph (k) of the Rule.

Sale of Control Stock (stock held by insiders)

Stock which a control person has acquired in a private placement (or other non-public transaction) is restricted stock and therefore subject to a one-year holding period. These shares may be sold only in accordance with the conditions applicable to the sale of restricted stock described above.

Stock held by a control person which is not restricted (for example, stock which a director has purchased through or from a broker-dealer on an exchange, or on the Over-The-Counter market, is not subject to a one year holding period and may be sold provided the following conditions are met:

• Adequate current public information concerning the issuer is available;
• The amount of stock which may be sold in any three month period is limited;
• The stock is sold in a "brokers transaction" or directly to a dealer who is a market maker in the securities;
• Notice of the proposed sale on Form 144 is transmitted to the SEC and to the principal exchange (if any) on which the stock is listed;
• The holder transmitting the Notice has a bona fide intention to sell the securities referred to in the Notice within a reasonable time.

Sale of Rule 145 Stock

Stock received by a person who was a director or other affiliate of the acquired company before the reorganization, but who does not become a director or the affiliate of the acquiring company, or stock acquired from such person by a non-affiliate in a private transaction, may be sold within a period of one year of the Rule 145 transaction by complying with the following requirements of Rule 144:

• Adequate current public information concerning the issuer is available;
• The amount of stock which may be sold in any three month period is limited;
• The stock is sold in a "brokers transaction" or directly to a dealer who is a market maker in the securities;
• Notice of the proposed sale on Form 144 is transmitted to the SEC and to the principal exchange (if any) on which the stock is listed;
• (No holding period or Form 144 is required)
• After one year, as determined in accordance with paragraph (d) of Rule 144, sale of such stock is permitted if the current public information requirement is satisfied. The other requirements are not applicable. After three years, such stock may be sold without any limitations or conditions.

DEFINITION OF RULE 144/145 TERMS OF SALE

Adequate Current Public Information

This requirement is satisfied, in the case of issuers, subject to the reporting obligations of the Securities Exchange Act of 1934, only if the issuer has been subject to such reporting obligations for at least 90 days and, in addition, has filed all reports required to be filed under the Act during the preceding twelve months. If the issuer has failed to file the report within the required time (whether or not it has obtained an extension), the sale must be deferred until the report has been filed.

If the issuer is an insurance company, timely filing of the annual convention statement with appropriate state insurance authorities fulfills the public information requirement. The seller must determine whether or not the appropriate reports have been filed.

In the case of issuers that are not subject to the reporting requirements of the Securities Exchange Act of 1934, the public information requirement is satisfied only if certain prescribed data is publicly available.

Holding Period (unregistered securities only)

A minimum of one year must elapse between the later of the date of the acquisition of the securities from the issuer (or from an affiliate of the issuer) and of any resale of such securities in reliance on Rule 144 for the account of either the acquiror or any subsequent holder of those securities. If the acquiror takes the securities by purchase, the one year period shall not begin until the full purchase price or other consideration is paid or given by the person acquiring the securities from the issuer (or from an affiliate of the issuer). A promissory note, installment contract or other obligation to pay the purchase price will not be deemed full payment unless the note, contract or obligation provides for:

Full recourse against the purchaser of the security;

Collateral (other than the security purchased) having a fair market value at least equal to the purchase price of the security purchased; and

Discharge by payment is made in full prior to the sale of the security.

This one year holding period applies to sales of restricted stock by both affiliates and non-affiliates. However, in the case of estates or beneficiaries, there is no holding period requirement as long as there is no control relationship with the issuer.

In order to meet the one year holding requirement, the Rule permits tacking of holding periods between persons standing in certain relationships, such as pledgor-pledgee, donor-donee, settlor-trust-beneficiary and decedent-estate-beneficiary. In addition, tacking is permitted if the shares are acquired from a non-affiliate in a private transaction. Stock acquired as a stock dividend or pursuant to a stock split, reverse stock split, or recapitalization, is deemed to have been acquired when the stock to which it relates was acquired. Stock acquired from an issuer upon surrender for conversion of other securities of the same issuer without payment of any additional consideration is deemed to have been acquired when the stock surrendered from conversion was acquired. Stock issued as a contingent payment in a stock-for-stock or stock-for-assets acquisition is deemed to have been issued at the time of the acquisition, if the acquiring company was then committed to issue the stock subject only to conditions other than the payment of further consideration.

Volume Limitations

The number of shares of stock which may be sold during any three month period may not exceed the greater of the following:

One percent (1%) of the shares of the class outstanding as represented in the most recent report published by the issuer; or

The average weekly trading volume during the four calendar weeks preceding the filing of notice as reported on all national securities exchanges or through the automated quotation system of a registered securities association; or,

The average trading volume reported in the consolidated reporting system during the previous four week period.

In determining the amount of stock which may be sold under these limitations, not only Rule 144 sales by the prospective seller, but also Rule 144 sales made by certain other persons within the preceding three months must be aggregated to determine the volume limitations. These include sales by:

any relative or spouse of the seller or any relative of such spouse who resides in the same home as the seller;

any trust or estate with respect to which the seller or any such relative serves as trustee, executor in any similar capacity or in which the seller and all persons specified above collectively own 10% or more of the total beneficial interest;

any corporation or other organization, other than the issuer, in which the seller and such relatives collectively own beneficially 10% or more of any class of equity securities or 10% or more equity interest.

In determining the applicable volume limitations under Rule 144, certain other requirements apply:

where two or more persons agree to act in concert for the purpose of selling stock of an issuer, all stock sold under Rule 144 by any such persons during any period of three months must be taken into account.

The Rule requires aggregation of sales of convertible securities with sales of the stock into which they are convertible.

If the one year holding requirement is met by tacking a prior owner's period of ownership, in some cases, the aggregated amount sold by the current owner and by prior owner(s) may not, for one year after the security changes hands, exceed the volume limitation. This applies to securities acquired through pledge or gift and securities acquired by a trust from the settlor or by beneficiaries from a trust.

Stock sold pursuant to an effective registration statement, in a Regulation A offering or in a private placement, may be excluded in determining amounts subject to the volume limitations.

Sales may be made in successive three month periods, but share which could be sold in one three month period, but may not be carried forward and added to the amount which could be sold in a later three month period.

Manner of Sale

Both the seller and the broker (sometimes referred to as a stockbroker or registered representative of a brokerage firm) are prohibited from soliciting or arranging for the solicitation of orders to buy the security in anticipation of, or in connection with a Rule 144 sale. A broker who has a Rule 144 sell order may, however, make inquiries of other brokers or dealers who have indicated an interest in the security within the preceding 60 days and for customers who, on an unsolicited basis, have indicated an interest in the security within the preceding ten business days.

If the sell order is executed by the broker as agent for the seller, the broker may receive from the seller no more than the usual and customary broker's commission. The seller is prohibited from making any payment in connection with the offering or sale to any person other than the broker who executes the sale.

Agency transactions which comply with the foregoing requirements are considered permissible "Broker's Transactions" under Rule 144. As an alternative, the seller may sell under Rule 144 directly to a broker-dealer who is a regular "market-maker" or "block positioner" in the stock.

The Required Notice of Proposed Sale (Form 144)

To be entitled to the benefits of Rule 144, one signed original and two copies of Form 144 (the Notice of Proposed Sale) must be mailed to the Securities and Exchange Commission either prior to, or concurrently with, the placing of the sell order with the broker. This is not required if the amount of stock to be sold during any period of three months does not exceed 500 shares, or units and the aggregate sale price does not exceed $10,000. The original Form must be manually signed by the person for whose account the stock is being sold. If the stock is listed, a copy of the Form must also be sent, at the same time, to the principal exchange on which the stock is trading.

If the seller does not sell all the stock covered by the Form within 90 days after the filing, the filing process must be repeated before the commencement of further sales, except, of course, in cases where the passage of time has extended the seller's holding period beyond three years. In such cases the sale may therefore be made under paragraph (k) of the Rule. As noted, paragraph (k) sales may be made without restriction, i.e., without regard to the current public information, volume, manner of sale or notice requirements, provided the seller is not and has not been an affiliate of the issuer for at least three months preceding the sale.

Click Here to See Restricted Stock Decision Chart

STOCK OPTIONS

Stock Options are complex transactions that require a substantial expertise to complete. In addition to knowledge of governmental regulations and taxing authorities, there are several different types of stock options with major variations in their holding periods, manner of exercise, and tax consequences. Because of these and other factors, the strategies to utilize these stock options effectively must be developed based on both the specific plan and the needs of each individual owner. In addition, many sellers of stock acquired through the exercise of employee options are in a control relationship with their company and, thus, subject to Securities and Exchange Commission rules 144 and 16(b).

Incentive Stock Options

The primary advantage of an Incentive Stock Option (ISO) is that no taxable event occurs, either at the time of grant or exercise of the option. Furthermore, any gain resulting from the subsequent sale of the shares will be treated as a long-term capital gain provided such sale takes place more than one year after the exercise date and also more than two years after the date the option was granted. Failure to satisfy these holding period requirements will cause at least a portion of the gain, and in certain circumstances the entire gain, realized upon the disposition of the stock to be treated as ordinary income. Also, even though the difference between the exercise price and the market value of the shares on the date of exercise does not create a taxable event, the amount of such difference, which is sometimes referred to as the "bargain element", is treated as an adjustment in calculating the alternative minimum tax.

ISOs are subject to a number of other conditions in addition to the holding period requirements. Among other things, they may not be granted with an exercise price of less than 100% of the market value of the stock on the date of grant. The Internal Revenue Code imposes certain other limitations on ISOs, and the issuing company may impose additional limitations as well.

Non-Qualified Stock Options

In the case of a non-qualified stock option, taxable events occur both at the time of exercise and upon subsequent sale. Additionally, under certain rare circumstances a taxable event may occur upon the granting of the option rather than at the time of exercise. Thus, tax liability may be incurred in connection with either the grant or exercise of the option although no sale has occurred to generate the funds to pay such tax liability.

Any appreciation occurring between the exercise and sale dates will be taxed at long-term capital gain rates (as opposed to ordinary income tax rates at the time of exercise), provided the shares are held for the requisite holding period prior to their disposition.

While Non-Qualified Stock Options receive less favorable tax treatment than ISOs, they do have certain attractive features. One of the most advantageous is the fact that they can be granted at a discount from the current market price.

Note: We emphasize that you should consult with your tax adviser to determine the effect of the exercise of options and the sale of stock (if applicable).

INVESTMENT STRATEGIES

Following the guidelines of Rule 144/145, the owners of Restricted Securities can liquidate their shares by "registering" the stock with the Securities and Exchange Commission through the procedures available, as outlined above. However, limitations under Rule 144/145 will typically prevent quick sales, and in many cases severely limit the flexibility of restricted stock owners normally afforded owners of non-restricted securities.

For example, unlike the owner of registered securities, it may take the owner of restricted stock a long period of time to liquidate his holdings. During the period of time the selling process is occurring, the stock could decline in price and the seller may have virtually no liquidity. Therefore, while he or she may show substantial assets on paper, the client may be "cash poor." Additionally, because the shares are restricted, and forms and procedures must be followed exactly, most owners of such stock will incur legal fees and extra costs as part of the liquidation process.

HOWEVER, UNDER RULE 144, AS AMENDED, RESTRICTED STOCK MAY BE EXCHANGED PROVIDED THE NEW OWNER OF THE STOCK IS WILLING TO ASSUME THE SAME RESTRICTIONS AS THE ORIGINAL OWNER.

This means that the owner of Restricted Stock may SELL, EXCHANGE, DONATE, OR USE AS COLLATERAL his stock under the 1% per quarter allowance, as long as the lender, or new owner is willing to maintain the restrictions, is not an underwriter, or doing it as a scheme for distribution.

Hedging Technique

The development of strategies designed to protect the value of the securities in the event of a decline in price.

Margin and Collateralization

The ability, under various rules and regulations instituted by the Federal Reserve Board and the various securities exchanges, to establish "credit" using control and restricted "marginable" securities.

Generally speaking, if a stock is saleable under Rule 144 or Rule 145 and its trading volume (liquidity) is adequate, most brokerage firms will allow a client to collateralize as much as - but not more than - 1% of the outstanding shares against a maximum loan of 45% of the stock value. (Note: The client will be required to provide the lending firm with a signed and dated Borrower's Letter documenting the loan arrangement. Finally, the client will provide a signed Form 144 and a signed Seller's Rule 144 Letter.)

In addition, many lending institutions including banks, finance companies, and others will allow a owner of restricted securities to "pledge" his or her holdings for a loan during the time of ownership, or until such time as the holder decides to liquidate the stock through registration.

Utilizing Options Against Restricted Securities

The ability to purchase, sell, write, or institute option spreads against their restricted stock equity positions in order to generate income, provide protection, or increase cash flow. While highly technical, and not for all investors, the use of options can provide increased flexibility to the owner to restricted securities.

Exchange of Barter Strategies

The ability under the guidelines of Rule 144/145, to exchange Restricted Stock for practically anything including tangible assets such as real estate, yachts, automobiles, planes, art, etc., or intangible assets such as Limited Partnerships, Private Placements, Loan Pools, Mortgage Pools, or other types of hybrid securities. It can also be gifted or used in a charitable contribution.

Note: Much of the confusion regarding exchange transactions centers upon whether an owner of Restricted Securities is an "Affiliate" or a "Non-Affiliate." For the purposes of transactions involving an exchange, the new owner, unless he or she is somehow connected to the original owner, or the issuer, would be considered a "Non-Affiliate." As such, the owner is likely entitled to sell, protect, or utilize Restricted Securities as previously described. Legal counsel should be contacted in order to determine whether he or she can claim themselves a "Non-Affiliate" for the purposes of the Rule.

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