For The Alaska Journal of Commerce

As you rummage through your files at the close of this year to gather information for preparation of your tax return and with the resolve of being more organized in 2004, you may come across a stock certificate. It's for a company in which last summer you were encouraged to invest by your brother-in-law. It clearly displays a "restrictive legend," the text of which centers on a terse warning that transferability of the stock is severely limited. What does the legend mean? Are you allowed to offer and sell the certificate to your next door neighbor? The starting points for answers to these questions are federal and state securities law.

Under the Securities Act of 1933, as amended ("Securities Act"), an offer of a security must be registered with the Securities and Exchange Commission before the offer may be made, with limited exceptions. These exceptions are registration exemptions which center on either the nature of the security or the nature of the transaction in which the security is offered. A similar approach is taken in the securities laws of most states, including Alaska.

For example, a bond issued by the State of Alaska is a security. However, by its nature, such a bond is exempt from the registration provisions of the Securities Act. Conversely, a stock issued by a for-profit Alaska corporation is a security and is not by its nature exempt from those registration provisions.

If the stock is offered in a private transaction, the offering may be exempt from registration under the Securities Act. However, the stock issued in that transaction is considered "restricted stock." That is, it was offered and sold without benefit of prior registration.

The SEC has required, in the context of such a private transaction, that the certificate or other evidence of ownership of the stock must include a prominently displayed disclosure of the restrictions on transferability which attach to such a security. This disclosure is referred to as a "restrictive legend."

Many states (including Alaska) have subscribed to a policy of requiring a similar legend regarding securities issued without registration under state law.

In either case, the restrictive legend applies regardless of the form of security. For example, it applies to a common stock, preferred stock, debenture or other security of a company, or units of a limited partnership. In short, it applies to any form of security as set forth in the Securities Act (or in the case of a state legend, the corresponding state law) which is offered and sold without benefit of registration under that act.

Typically, a restrictive legend includes a statement that the security has not been registered under the Securities Act. It may also make reference to the lack of registration under state securities law.

The restrictive legend includes a disclosure that the security has been acquired for investment and may not be sold or transferred in the absence of an effective security registration under the Securities Act, with limited exception–when the transaction is ex-empted from registration under that act. The restrictive legend may include a similar statement applying to required registration under state securities law, except when exempted from such state requirements.

The Securities Act private transaction exemption is silent as to whether the restricted nature of a restrictive legend ends after passage of time. For a company not having publicly-traded securities, this limitation on transferability is formidable and difficult to overcome. Here, the only means of transfer in compliance with the Securities Act (or state law), and short of an expensive registration process, may be a private sale to an existing security holder of, or buy-back by, the issuer-company. There simply is no public market for the restricted security.

Similarly, for a company having publicly-traded securities (a company whose securities are listed on an exchange or stock market such as the New York Stock Exchange or the Nasdaq Stock Market), the exemption does not specifically extinguish the transferability limitation with the passage of time. However, Rule 144 adopted by the SEC pursuant to the Securities Act, in part, addresses this issue and allows transferability under limited conditions and subject to the provisions of the rule.

Rule 144 is characterized as a "safe harbor," in part, for a public sale in ordinary trading transactions of limited amounts of restricted securities owned by a prospective seller. While not an exclusive means of satisfying the federal private offering exemption, the rule provides specific steps which, if followed, allow the seller to conclude the requirements of the exemption have been satisfied.

The requirements of Rule 144 include that current public information is available on the company, e.g., that appropriate company reports are filed with the SEC. The requirements also include that the security has been held by the seller for a requisite time period, that only up to a specified volume of securities are sold within a stated period of time, that sales only occur through properly licensed broker-dealers, that appropriate seller reports are filed with the SEC and that the seller has a bona fide intent to sell the security.

The provisions of Rule 144 are detailed. Suffice it to say that a seller of restricted securities of a publicly-traded company may, in satisfying the provisions of the rule, have the Securities Act restrictive legend removed. However, to avoid state registration, an appropriate exemption must separately be found under state securities law in order to remove the state restrictive legend.

Removal of a restrictive legend may be necessitated to accommodate a timely sale of the security. For example, the prospective seller may wish to transfer the securities into the name of the seller's broker-dealer for the benefit of the seller and to accomplish a faster response to a possible purchase of the securities in the public market place.

In summary, a security bearing a restrictive legend will, as a practical matter, at best impede the transferability of the security and at worst prevent it. This limitation should be taken into consideration by a prospective security holder before accepting such a security, especially for a security that is not publicly-traded. However, such a holder may look to Rule 144 as a safe harbor, at least in the context of a publicly-traded security and the Securities Act restrictive legend.

*Mr. Brecht is managing shareholder and an attorney in private practice with the law firm of Wohlforth, Vassar, Johnson & Brecht, A Professional Corporation, with offices in Anchorage, Alaska. Mr. Brecht's concentration of practice is in state and federal securities law, corporate, and financial law. The content of this article was not prepared as, and must not be construed as, legal or investment advice to anyone. He may be reached via email at jbrecht@wvjb.com.

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