Restricted & control stock

There are rules that govern transactions with certain types of stock. In this section, we’ll focus on Rule 144, which covers
restricted and control stock.

Restricted stock

Restricted stock is stock that is not registered with securities regulators. You’ll learn more about the registration process, later in
the rules & regulations unit. For now, assume most securities offered publicly are legally required to go through a time and cost-
intensive registration process. However, securities can sometimes be offered to investors without being registered if an
exemption, can be claimed. One example is Regulation D, which allows issuers to offer unregistered stock to private audiences
made up primarily of wealthy and large investors.

When an investor obtains unregistered stock, they are holders of restricted stock. Rule 144 requires restricted stock to be held by
its investors for 6 months before resale. After this time period, the investor can sell their shares.

Control stock

Control stock is stock held by an affiliate, which is an insider of the company. An affiliate is any officer, director, or 10%
shareholder. Basically, if you are an executive for the issuer or own a bunch of their stock, you’re considered an insider
(affiliate). Rule 144 regulates this type of stock and prevents insiders from selling significant amounts of their shares quickly.

This part of Rule 144 is referred to as the “dribble” rule. Insiders are the largest shareholders of their companies. Some CEOs
own 51% or more of their companies to ensure their vote always controls the direction of their organization. If insiders were to
liquidate all of their shares at once, it could significantly affect the price. A 51% shareholder selling all of their shares in one
trade is similar to a manufacturer dropping off 10,000 lawnmowers at a local Home Depot and asking for them to be sold
immediately. Dropping the price close to zero might be the only way to get this accomplished!

Affiliates (insiders) are subject to sales limitations to prevent this from happening. They are allowed to sell the greater of 1% of
the outstanding shares or the four-week trading average, four times a year. Referred to as volume limitations, this rule prevents
affiliates from selling significant amounts of shares in short periods of time.

You now know the definitions and rules of restricted and control stock. However, what happens if an affiliate owns unregistered
stock? This is a common occurrence, as many executives of privately held companies own stock in their company. Restricted
stock rules apply because the stock is not registered with the SEC. Control stock rules apply because they’re affiliate-owned
shares. When this is the case, both sets of rules apply simultaneously.

Filings

Regulators aim to create a transparent environment in the securities markets. One of the ways this is accomplished is by requiring
public filings of transaction reports related to Rule 144.

Form 144 must be filed when an investor (affiliate or non-affiliate) intends to trade control or restricted stock at any point in the
next 90 days. This form is typically filed electronically on the Electronic Data Gathering, Analysis, and Retrieval (EDGAR)
system. All that’s required for Form 144 to be filed is an intention to trade a control or restricted stock; there is no requirement
for a transaction to actually occur.

The Securities and Exchange Commission (SEC), which oversees the filing process and maintains EDGAR, allows investors
performing small control or restricted stock transactions to avoid filing requirements. In particular, Form 144 must only be filed
if an investor plans to sell more than 5,000 shares or $50,000 of total stock.

Form 4 must be filed when an affiliate actually trades control stock. Known as the form that reports beneficial changes in
ownership for insiders, Form 4 must be filed within two business days of the transaction. Many financial media outlets pay close
attention to these filings, especially forms filed by famous executives and investors. For example, this Form 4 filing was the
reason why Elon Musk’s $6.9 billion sale of Tesla stock November 2021 was widely reported.

Rule 144A

One last item to cover is Rule 144A, which relates to Rule 144 (obviously). If a sale of restricted or control stock occurs with a
Qualified Institutional Buyer (QIB), the requirements of Rule 144 do not apply. A QIB is defined as an institution with $100
million or more of investable assets. When a QIB is involved in the sale of control or restricted stock, the 6 month holding period
and volume limitations do not apply.

Key points
Rule 144 - Rule covering restricted and control stock

Restricted stock - Stock not registered with the SEC - Subject to a 6 month holding period

Control stock - Stock owned by an affiliate (insider)- Subject to volume limitations

Affiliate - Officer, director, or 10% shareholder - Security sales subject to volume limitations

Form 144 - Filed if control or restricted stock intended to be traded in the next 90 days - Only must be filed if more than - 5,000
shares, or - $50,000 total value sold

Form 4 - Filed if an affiliate trades control stock - Must be filed within 2 business days of trade

EDGAR - Electronic filing system for SEC forms - Form 144 and Form 4 are filed on this system

QIB (qualified institutional buyer) - $100 million or more of investable assets

Rule 144A - QIBs are not subject to rule 144 - QIBs avoid holding periods and volume limitations