Release No. 33-7187

Release No. 34-35896

60 Fed. Reg. 35645 - July 10, 1995

Revision of Holding Period Requirements in Rule 144; Section 16(a) Reporting of Equity Swaps and Other Derivative Securities

ACTION: Notice of proposed rulemaking.

SUMMARY: The Commission is proposing to amend the holding period requirements contained in Rule 144 (d) and (k) to permit resales of ''restricted'' securities after a one-year, rather than a two-year, holding period, if the sale complies with all of the other provisions of Rule 144. Securities held by non-affiliated shareholders could be resold without restriction after a holding period of two, rather than three years. In addition, the Commission is requesting comment on whether Rule 144 should be revised to address new trading strategies, such as equity swaps, and is reminding persons subject to reporting under Section 16 of the Securities Exchange Act of 1934 (the ''Exchange Act'') that reporting of these transactions is required under the current rules.

DATES: Comments must be submitted on or before September 8, 1995.

ADDRESSES: Comments should be submitted in triplicate to Jonathan G. Katz, Secretary, Securities and Exchange Commission, 450 Fifth Street NW., Washington, DC 20549. All comment letters should refer to File No. S7-17-95 and will be available for public inspection and copying in the Commission's Public Reference Room.

FOR FURTHER INFORMATION CONTACT: Richard K. Wulff, Office of Small Business Policy, Division of Corporation Finance at (202) 942-2950.

SUPPLEMENTARY INFORMATION: The Commission is proposing to shorten the holding periods in Securities Act of 1933 (the ''Securities Act'') ¹ Rule 144,² the non-exclusive safe harbor for resales of ''restricted'' securities ³ and securities held by affiliates of the issuer. Under the proposal, the holding period for resales of limited amounts of securities by any person would be reduced from two years to one year, and the holding period for resales by non-affiliates without compliance with any provisions of the rule would be reduced from three years to two years.⁴ This release also includes a discussion of whether Rule 144 should be amended to reflect new trading strategies, such as equity swaps, and a reminder to persons subject to reporting under Section 16 of the Exchange Act ⁵ that reporting of these transactions is required under the current rules.

[[Page 35646]]

I. Background and Proposal

The Commission adopted Rule 144 in 1972 ⁶ to provide an objectively determinable safe harbor for resales of ''restricted'' securities and ''control'' securities. ''Restricted'' securities generally are securities issued in private placements; ⁷  ''control'' securities are securities owned by affiliates of the issuer. The rule provides that a person that complies with its terms and conditions will not be engaged in a distribution of securities and, thus, not be an underwriter ⁸ for purposes of the Section 4(1) exemption from Securities Act registration for ordinary trading transactions.⁹

The rule includes holding periods for ''restricted'' securities to establish that the holder did not purchase with a view to an unregistered public distribution. Under the rule, all ''restricted'' securities must be held at least two years before any can be resold, measured from the time the securities were purchased from the issuer or an affiliate. For ''restricted'' securities held between two and three years, other provisions of the rule require that the issuer be providing certain current information about itself, that limited amounts of securities are resold, that the resales are effected in ordinary brokerage transactions or directly with a market-maker, and that a notification of the resale is filed with the Commission. After a three-year holding period, ''restricted'' securities may be resold by non-affiliates without compliance with any of these provisions.

The length of the holding period for ''restricted'' securities significantly impacts the costs of raising capital in private placements since investors require that the price of the securities be discounted commensurate with the market risk during the holding period. In each of the past four years, the small business community has asked the Commission through the annual Government-Business Forums on Small Business Capital Formation to consider shortening the Rule 144 holding period.¹⁰ The two-year holding period has been in place since the rule was adopted in 1972; the concept of ''free'' resales for non- affiliates after three years was adopted in 1981.¹¹ In 1990, the rule was revised ¹² to permit the holding period to be measured from the time that the securities were purchased from the issuer or an affiliate, so that holders may tack each other's holding periods, rather than requiring the entire holding period for each holder.

Based on the Commission's experience with Rule 144 in the 20 years since adoption, the Commission believes that it is appropriate to enhance the utility of the safe harbor, and reduce costs for private capital formation, by shortening the holding periods. Consequently, the Commission is proposing that the holding period applicable to limited Rule 144 resales be reduced from two years to one ¹³ and the holding period for ''free'' resales by non-affiliates reduced from three years to two. The Commission believes that these proposed holding periods are sufficiently long to establish that the securities were not purchased with a view to a public unregistered distribution.

Comment is requested as to whether the proposed revisions to the holding period are appropriate. Are these periods sufficient to assure that persons relying upon Rule 144 are not engaged in a public distribution of securities inconsistent with the Section 4(1) ordinary trading transaction exemption? Should the periods be retained, or should the proposed periods be changed to be shorter or longer? If other holding periods are suggested, the basis for the selected holding period should be indicated.

II. Equity Swaps and Other Like Investment Strategies

A. Treatment Under Rule 144

In 1990 when the Commission amended Rule 144 to allow tacking of the holding period between investors, the Commission also deleted the provision that previously tolled the holding period if the holder engaged in short sales, puts or other options to sell securities.¹⁴ The intervening 5-year period since implementation of the holding period revisions has evidenced the growth of a variety of investment strategies associated with separating the bundle of rights that make up a security: strategies that are used in both the private and public securities markets. Through the use of equity swaps, forward contracts, derivatives and other financial tools, holders of restricted and control shares are selling interests in such shares while retaining legal title to the ''underlying'' security. Today, record or beneficial ownership does not necessarily reflect who holds the voting, investment or income interests of a security.¹⁵

The Commission is examining whether it may be appropriate to revise Rule 144 to reflect the economic realities of these transactions. For example, is it appropriate to treat securities as ''held'' in the private markets if the economic risk of the investment has been shifted to the public markets? If not, should this be addressed through reintroducing holding period tolling concepts for periods when the holder is not at risk, or should the rule be revised to require compliance with the rule when the risk shifting transaction to the public markets occurs? If Rule 144 were to be revised to address these questions, what changes would best ensure that the economic benefits and risks of investment are not shifted during the prescribed holding period? Also, should any possible revisions distinguish between companies that are and are not widely followed in the market and, if so, why? In addressing the question generally, commenters should provide their views as to the need to have a fungibility doctrine underlie Rule 144 to assure that the safe harbor in fact protects resales that are not part of the distribution and that are consistent with investment intent.

B. Reminder of Requirement To File Section 16 Reports

Questions are being raised as to the adequacy of information to the markets about the securities transactions effected through equity swaps and similar

[[Page 35647]]

strategies.¹⁶ In August 1994, the Commission's release proposing revisions to rules under Section 16 of the Exchange Act ¹⁷  included a discussion of reporting obligations arising from equity swaps and similar risk-shifting transactions. In that release, the Commission stated that Section 16 insiders must report equity swaps and similar transactions in equity securities of the issuer,¹⁸ unless the swap relates solely to interests in securities comprising part of specified market baskets or indices of stocks.¹⁹

The release provided the following example of an equity swap required to be reported. An insider agrees to pay to the counterparty for a period of three years the value of dividend payments on 100,000 shares of issuer common stock, in exchange for payment of a fixed interest rate based on the market value of the 100,000 shares of stock at the commencement of the swap term. The parties also agree that at the end of the swap term, the insider will pay to the counterparty the cash value of any appreciation on the shares during the term, or, conversely, the counterparty will pay to the insider the cash value of any depreciation. The insider retains title to and any voting rights in the securities.

The release suggested a method of reporting entering into and closing out the swap using stock appreciation and depreciation rights and deemed acquisitions and dispositions of the underlying securities. In setting forth this analysis, the Commission specially noted in the release that it was not suggesting that previously filed forms reporting swap transactions in another manner needed to be revised, or that swap transactions reported differently would be subject to disclosure pursuant to Item 405 of Regulations S-B or S-K.²⁰ The release solicited comment on whether the Commission's approach reflects economic reality and whether a separate reporting code for equity swaps is needed. The Commission wishes to remind Section 16 insiders that reporting at the time these transactions are entered into and when they are closed out is required.²¹

III. Summary of Initial Regulatory Flexibility Analysis

The Commission has prepared an initial regulatory flexibility analysis in accordance with the Regulatory Flexibility Act.²² The analysis notes that the amendments to Rule 144 are being proposed as a result of recommendations developed at the SEC Government-Business Forums on Small Business Capital Formation. The purpose of the revisions is to remove unnecessary restrictions in the resale of securities while maintaining important protections to the investing public.

A copy of the initial regulatory flexibility analysis may be obtained from Twanna M. Young, Office of Small Business Policy, Division of Corporation Finance, Securities and Exchange Commission, 450 Fifth Street, NW., Stop 7-8, Washington, DC 20549, (202) 942-2950.

IV. Statutory Basis, Text of Proposal and Authority

The amendment to the Commission's rule is being proposed pursuant to sections 2(11), 4(1), 4(4) and 19(a) of the Securities Act.

List of Subjects in 17 CFR Part 230

Reporting and recordkeeping. Securities.

For the reasons set out in the preamble, title 17, chapter II of the Code of Federal Regulations is proposed to be amended as follows:

PART 230--GENERAL RULES AND REGULATIONS, SECURITIES ACT OF 1933

1. The authority citation for Part 230 continues to read in part, as follows:

Authority: 15 U.S.C. 77b, 77f, 77g, 77h, 77j, 77s, 77sss, 78c, 78l, 78m, 78n, 78o, 78w, 78ll(d), 79t, 80a-8, 80a-29, 80a-30, and 80a-37, unless otherwise noted. * * * * *

2. Section 230.144 is amended by revising paragraphs (d)(1), (e)(3)(ii), (e)(3)(iii), (e)(3)(iv) and (k) to read as follows:

Sec. 230.144  Persons deemed not to be engaged in a distribution and therefore not underwriters.

* * * * *

(d) Holding period for restricted securities. * * *

(1) General rule. 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 any resale of such securities in reliance on this section for the account of either the acquiror or any subsequent holder of those securities, and 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. * * * * *

(e) Limitation on amount of securities sold. * * * * * * * *

(3) Determination of amount. * * * * * * * *

(ii) The amount of securities sold for the account of a pledgee thereof, or for the account of a purchaser of the pledged securities, during any period of three months within one year after a default in the obligation secured by the pledge, and the amount of securities sold during the same three-month period for the account of the pledgor shall not exceed, in the aggregate, the amount specified in paragraph (e)(1) or (2) of this section, whichever is applicable;

(iii) The amount of securities sold for the account of a donee thereof during any period of three months within one year after the donation, and the amount of securities sold during the same three-month period for the account of the donor, shall not exceed, in the aggregate, the amount specified in paragraph (e)(1) or (2) of this section, whichever is applicable;

(iv) Where securities were acquired by a trust from the settlor of the trust, the amount of such securities sold for the account of the trust during any period of three months within one year after the acquisition of the securities by the trust, and the amount of securities sold during the same three-month period for the account of the settlor, shall not exceed, in the aggregate, the amount specified in paragraph (e)(1) or (2) of this section, whichever is applicable; * * * * *

(k) Termination of certain restrictions on sales of restricted securities by persons other than affiliates. The requirements of paragraphs (c), (e), (f) and (h) of this section shall not apply to

[[Page 35648]]

restricted securities sold for the account of a person who is not an affiliate of the issuer at the time of the sale and has not been an affiliate during the preceding three months, provided a period of at least two years has elapsed since the later of the date the securities were acquired from the issuer or from an affiliate of the issuer. In computing the two-year period for purposes of this provision, reference should be made to paragraph (d) of this section. * * * * *

Dated: June 27, 1995.

By the Commission.

¹ 15 U.S.C. 77a et seq.

² 17 CFR 230.144.

³ ''Restricted securities'' are defined in Rule 144(a)(3). See infra Note 7.

⁴ The Commission has established the Advisory Committee on the Capital Formation and Regulatory Processes (the ''Advisory Committee''), chaired by Commissioner Steven M.H. Wallman. The Advisory Committee is considering fundamental issues relating to the regulatory framework governing the capital formation process, including whether the current system of registering securities offerings should be replaced with a company registration system. The recommendations of the Advisory Committee may result in rule proposals or legislative recommendations that, if endorsed by the Commission, ultimately may address the matters discussed in this release. Under some of the company registration models now being considered by the Advisory Committee, many of the legal distinctions between publicly offered and privately placed securities would be eliminated, including the concept of restricted securities. Securities issued by a company registered with the Commission would be freely tradeable, regardless of the public or private character of the transaction.

⁵ 15 U.S.C. 78p.

⁶ Release No. 33-5223 (January 11, 1972) [37 FR 591].

⁷ ''Restricted'' securities include those acquired from the issuer or an affiliate in a transaction or chain of transactions not involving a public offering; those acquired from the issuer and subject to resale limitations under Regulation D, 17 CFR 230.501-508 or Rule 701, 17 CFR 230.701; those subject to the Regulation D resale limitations and acquired in a transaction or chain of transactions not involving a public offering; and those acquired in a transaction or chain of transactions meeting the requirements of Rule 144A, 17 CFR 230.144A.

⁸ See Section 2(11) of the Securities Act.

⁹ Section 4(1) exempts transactions by persons that are not issuers, underwriters or dealers.

¹⁰ Final Reports of the SEC Government-Business Forum On Small Business Capital Formation (June 1992) (June 1993) (June 1994) (February 1995). The Small Business Investment Incentive Act of 1980 directs the Commission to host this annual meeting for the purpose of reviewing ''the current status of problems and programs relating to small business capital formation.'' Pub. L. No. 96-477, Section 503, 94 Stat. 2275, 2292-93 (1980).

¹¹ Release No. 33-6286 (February 6, 1981) [46 FR 12195].

¹² Release No. 33-6862 (April 23, 1990) [55 FR 17933].

¹³ Conforming changes also are proposed to be made in paragraph (e)(3) relating to determining the limitations on the amounts resalable by pledgees, donees and trusts, reducing the period from two years after the event of pledge default, donation or trust acquisition, to one year.

¹⁴ In 1990, the Commission rescinded former subdivision (d)(3) of Rule 144, which generally tolled the holding period while a holder had a short position in or an option to sell securities of the same class as the restricted securities.

¹⁵ See Release No. 33-7190, which addresses other issues relating to equity swaps and similar transactions.

¹⁶ See Rocker, ''Short Interest: No More Bullish Bellow,'' Barron's, May 1, 1995.

¹⁷ Release No. 34-34514 (August 10, 1994) [59 FR 42449].

¹⁸ The term ''insider'' as used in this release refers to officers, directors and holders of more than ten percent of a class of equity securities who are subject to Section 16.

¹⁹ 59 FR 42449, 42457, footnote 101 and accompanying text. No Section 16 consequences would flow from a swap transaction to the extent the swap relates solely to interests in securities comprising part of a broad-based, publicly traded market basket or index of stocks, approved for trading by the appropriate federal governmental authority, that are deemed not to confer beneficial ownership for purposes of Section 16 pursuant to Rule 16a-1(a)(5)(iii) [17 CFR 240.16a-1(a)(5)(iii)] and/or are excluded from the definition of ''derivative securities'' pursuant to Rule 16a-1(c)(4) [17 CFR 240.16a-1(c)(4)].

²⁰ 17 CFR 228.405 and 229.405.

²¹ To the extent settlement of the parties obligations occurs on an interim basis during the term of the swap, such as quarterly, the insider's Section 16 obligations would arise with respect to each settlement.

²² 5 U.S.C. 603.