December 30, 2020
Authored by: R. Randall Wang and Vicki Westerhaus
Last week the SEC proposed to amend Rule 144 in order to:
- Eliminate tacking for shares underlying market-adjustable securities of unlisted companies
- Update and simplify certain filing requirements, including mandating electronic filing of Form 144s
Elimination of tacking for shares underlying market-adjustable securities of unlisted companies
The proposals would amend Rule 144(d)(3)(ii) to eliminate “tacking” for securities acquired upon the conversion or exchange of the market-adjustable securities of an unlisted company – that is, a company without any securities listed, or approved for listing, on a national securities exchange. As a result, the holding period for the underlying securities — either six months for securities issued by a reporting company or one year for securities issued by a non-reporting company — would not begin until the conversion or exchange of the market-adjustable securities.
In the SEC’s view, the change is needed because applying Rule 144 “tacking” provisions to market-adjustable securities undermines one of the key premises of Rule 144, which is that holding securities at risk for an appropriate period of time prior to resale can demonstrate that the seller did not purchase the securities with a view to distribution and as a result is not an underwriter for the purpose of Securities Act Section 4(a)(1).
In transactions involving market-adjustable securities, the discounted conversion or exchange features in these securities typically provide holders with protection against investment losses that would occur due to declines in the market value of the underlying securities prior to conversion or exchange. Often, the conversion formula does not contain a floor, leading the securities to be viewed as “toxic” because of the large amount of shares that may be issued. As a result, in the view of the SEC, holders of these securities are not at significant economic risk upon conversion with respect to the underlying security, in contrast to holders of typical convertibles where the conversion price is fixed.
After the Rule 144 holding period is satisfied, holders can convert the market-adjustable securities and quickly sell the underlying securities into the public market at prices above the conversion price. This creates an incentive to purchase the market-adjustable securities and immediately sell the underlying securities to capture the difference between the built-in discount and the market value of the underlying securities. Therefore, under Rule 144’s current formulation, holders can purchase market-adjustable securities with a view to distribution – and therefore act as an underwriter — while still satisfying the holding period requirements and tacking period provisions of Rule 144.
The proposed amendment would not affect the use of Rule 144 for most convertible or variable-rate securities transactions. It would apply only to market-adjustable securities transactions in which:
- The newly acquired securities were issued by a company that, at the time of the conversion or exchange, does not have a class of securities listed, or approved for listing, on a national securities exchange; and
- The convertible or exchangeable security contains terms, such as conversion rate or price adjustments, that offset, in whole or in part, declines in the market value of the underlying securities occurring prior to conversion or exchange, other than terms that adjust for stock splits, dividends, or other issuer-initiated changes in its capitalization.
The proposals would not apply to listed companies because of stock exchange rules which require shareholder approval of issuances of 20% or more of outstanding stock. The SEC believes that shareholders are unlikely to approve the types of highly dilutive transactions the amendments would address; moreover, it believes that listed companies have generally not engaged in such transactions.
Forms 4, 5, and 144 Filing Requirements
The proposed amendments would also update and simplify certain filing requirements for Forms 4, 5, and 144 by:
- Mandating the electronic filing of Form 144 – with paper filings no longer permitted and eliminating the requirement to send copies to stock exchanges
- The SEC noted that many exchanges no longer require physical copies of documents companies have filed on Edgar
- Eliminating the Form 144 filing requirement related to the sale of securities of non-reporting companies, i.e., issuers that are not subject to the reporting requirements of Section 13 or 15(d) of the Exchange Act
- With very few filings relating to non-reporting companies made, the SEC believes the benefits do not justify the burden on filers
- Extending the Form 144 filing deadline to the second business day following the trade, so as to allow Form 144s to be filed concurrently with Form 4s, when applicable
- The SEC noted that Form 144s would generally become publicly available earlier than physical copies that are mailed to the SEC at the time of the trade
- Amending Forms 4 and 5 to add an optional check box to indicate that a reported transaction was intended to satisfy Rule 10b5-1(c), which provides an affirmative defense for trading on the basis of material non-public information
The SEC plans to make an online fillable Form 144 available to simplify electronic filing and to streamline the electronic filing of Forms 4 and 144 reporting the same sale of a company’s securities – with an option to file both forms through a single user interface. The proposal would provide a six-month transition period to give Form 144 paper filers who would be first-time electronic filers sufficient time to apply for codes to make filings on Edgar.
The public comment period will remain open for 60 days following publication of the proposing release in the Federal Register.