On December 22, 2020, the Securities and Exchange Commission (the “SEC”) announced proposed amendments¹ to Rule 144 (“Rule 144”) under the Securities Act of 1933, as amended (the “Securities Act”) to revise the holding period determination for certain market-adjustable securities of an issuer that does not have a class of securities listed (or approved to be listed) on a national securities exchange. If adopted as proposed, the amendment would effectively eliminate “tacking” for securities “acquired upon the conversion or exchange” of certain market-adjustable securities.² The SEC defines a “market-adjustable security” as “a convertible or exchangeable security that provides for a conversion rate, conversion price, or other terms that, in each case, would have the effect of offsetting, in whole or in part, declines in value of the underlying securities that may occur prior to conversion or exchange.” For example, a convertible note that converts into common stock based on the market price of the common stock at the time of conversion would be deemed a “market-adjustable security” under the proposed amendment.  

In addition, the proposed amendments would: (1) require electronic filing of all Form 144 notices related to the resale of securities of issuers (“reporting issuers”) subject to the reporting requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”); (2) eliminate the Form 144 filing requirement related to the sale of securities of non-reporting issuers; (3) amend the Form 144 filing deadline so that Form 144 may be filed concurrently with related Form 4 filings under Section 16 of the Exchange Act (“Section 16”) by persons subject to both filing requirements; and (4) amend Forms 4 and 5 to add an optional check box to indicate that a reported transaction was intended to satisfy Rule 10b5-1(c) under the Exchange Act (“Rule 10b5-1(c)”).

The proposed amendments are subject to a 60-day comment period through March 22, 2021.

Rule 144 - Background 

Rule 144 provides a non-exclusive safe harbor from the statutory definition of "underwriter" to assist security holders in determining whether the exemption from registration under Section 4(a)(1) of the Securities Act for “transactions by any person other than an issuer, underwriter, or dealer”³ is available for the proposed resale of “restricted” or “control” securities they hold. Restricted securities are securities acquired pursuant to one of the transactions listed in Securities Act Rule 144(a)(3), such as securities issued in a private placement.⁴ The term “control securities” is not defined but generally refers to securities held by an affiliate of the issuer, regardless of how the affiliate acquired the securities.

A security holder purporting to rely on Rule 144 for the resale of restricted securities must hold the subject securities for a specified period of time prior to resale. The Rule 144 “holding period” for the resale of restricted securities is six months from the date of sale for securities issued by a reporting issuer or one year from the date of sale for securities issued by a non-reporting issuer.⁵ The SEC explains in the release accompanying the proposed amendments (the “Release”) that the purpose of the holding period is to help “ensure that a holder who claims an exemption under Section 4(a)(1) has assumed the full economic risks of investment and, therefore, is not acting as a conduit, directly or indirectly, on behalf of the issuer for the sale of unregistered securities to the public.”⁶

Under Rule 144(d)(3)(ii), initially promulgated in 1972 and existing in its current form since 2007, securities acquired from an issuer solely in exchange for securities from the same issuer “shall be deemed to have been acquired at the same time as the securities surrendered for conversion or exchange, even if the securities surrendered were not convertible or exchangeable by their terms”⁷ In effect, this rule allows the holder of a security, such as a bond, note, or preferred stock, to convert or exchange such security for another security of that same issuer, and subsequently treat that new security as if it were acquired on the date the original security was acquired. This process of calculating the Rule 144 holding period of a new security by utilizing the date the original security was acquired rather than the date of issuance of the new security is known as “tacking.”

Rule 144 - Proposed Amendments to the “Tacking” Rule for Certain Market-Adjustable Securities

A standard term of convertible or exchangeable securities is that the conversion or exchange price and/or the number of securities received upon conversion or exchange are fixed at the time of an initial transaction. Straightforward examples include either a series of preferred stock which is convertible into common stock at a later date at a fixed price or a warrant exercisable at a fixed price. Convertible securities which have a conversion feature that is based on future market prices of the underlying stock can, however, become convertible at dramatically lower prices. The prospect, or actual triggering, of this dilution can cause further stock price decline and have other severe negative effects on an issuer. Financings with these features have variously been called "floorless", "toxic," "death spiral," and "ratchet" convertibles.⁸   The SEC has become increasingly concerned with these types of "toxic" convertible securities.⁹ The proposed amendment to the “tacking” provisions of Rule 144 is intended to address this concern by limiting the ability of shareholders to quickly sell newly issued securities into the public market when the shareholder acquires such securities through a conversion or exercise of market-adjustable securities. 

The “tacking” provisions allow the holder of a convertible security to “tack” the period of ownership of an underlying security post-conversion or exercise to the period of ownership of the original convertible security, pre-conversion or exercise. Convertible securities often provide for adjustments to the number of underlying shares and the conversion price to protect the investor, and may also include anti-dilution provisions designed to protect the holder’s economic interest if the issuer subsequently issues shares of the underlying securities at a price below their current market value or below the holder’s original purchase price.

The convertible securities and other arrangements subject to the proposed amendment (including transactions involving the exchange of a non-convertible security for another security where the original security was not convertible by its terms) are not “typical” convertible instruments, but involve one or more “toxic” features. The SEC’s proposed amendment aims to address situations where the discounted conversion or exchange features in market-adjustable securities provide security 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. The SEC explains their view that when a holder of market-adjustable securities purchases those securities with a “view to [distribute]” the underlying securities post-conversion in order to profit from the difference in purchase price of the underlying securities and the market price of those same securities, specifically caused by the built-in “toxic” feature of the convertible securities, the holder has effectively acted as an underwriter.¹⁰ As an underwriter, such a holder could not rely on the Section 4(a)(1) exemption from registration.”¹¹

Under the proposed amendment, the holding period for securities acquired upon the conversion or exchange of market-adjustable securities would not begin until the conversion or exchange of those securities, which would thereby eliminate “tacking” for those new securities. However,¹² the proposed amendment would apply only to convertible securities where:

• the securities acquired upon conversion or exchange were acquired from an issuer that, at the time of the conversion or exchange, did 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 declines in the market value of the underlying securities occurring prior to conversion or exchange.

The SEC explains the proposed amendment would be limited to issuers not listed on a national securities exchange “because national securities exchanges registered pursuant to Section 6 of the Exchange Act have certain listing requirements, such as requiring shareholder approval of an issuance of 20 percent or more of a company’s common stock,”¹³ rationalizing that shareholder approval would be withheld in highly dilutive transactions the amendment is meant to address. The SEC further states it has observed that issuers able to satisfy the listing criteria of the exchanges “have generally not engaged in these transactions ” but do not provide any additional information to verify this statement.

Rule 144 - Potential Impact of Proposed Amendments

It is unlikely that the proposed amendments would dramatically impact the ability of most issuers to obtain financing options on favorable terms.

The proposed amendment to Rule 144(d)(3)(ii) as drafted would not apply to securities issued by companies listed on a national securities exchange, and based on research performed by the SEC during the drafting of the proposed amendments, the use of “toxic” convertibles “[is] concentrated in the subpopulation of issuers who are unable to issue additional equity or fixed-rate convertibles, such as financially distressed firms, other low- or no-revenue firms, and those approaching bankruptcy.”¹⁴ These issuers generally utilize “toxic” convertibles because no other option is available. If investors cannot structure transactions to utilize downside protection provided by market-adjustable securities due to the adoption of the proposed amendments as drafted, these investors may be more likely to demand substantial concessions from issuers, including but not limited to, creative financial covenants, fixed deep discount conversion or exercise prices, additional collateral, and in extreme situations, personal guarantees from management. In addition, investors may be more likely to demand greater registration rights in transactions involving convertible securities, specifically where an issuer is not listed on or is at risk of being delisted from a national securities exchange.  

It is worth noting the SEC’s proposed definition of a “market-adjustable security” hinges on whether the adjustment relates to a “decline in value,” without explicitly stating whether value is determined in terms of the underlying security’s market price, or by transactional or other means. Based solely on the definition itself, convertible securities featuring typical “full ratchet” and “volume weighted” anti-dilution protection could arguably be deemed to be a “market-adjustable security.”  However, the proposed amendment suggests convertible securities featuring typical “full ratchet” and “volume weighted” anti-dilutions protection would not fall within the definition of “market-adjustable security” by differentiating between typical adjustments and anti-dilution provisions and “market-adjustable securities.” The proposing release describes a “market-adjustable securities” as having protections that “go beyond typical adjustments and anti-dilution provisions…and protect the holder against general decreases in market value of the underlying securities.” We expect that the definition of “market-adjustable security” in the final rule would provide clarity on this distinction. 

Form 144 - Proposed Amendments to Rules 101(a) and (b) of Reg S-T

Rule 144(h) requires an affiliate who intends to resell securities of an issuer in a transaction in reliance on Rule 144 that exceeds either 5,000 shares or has an aggregate sales price of more than US$50,000 during any three-month period to file a Form 144 concurrently with either the placing of an order with a broker to execute the sale or the execution of a sale directly with a market maker.¹⁵ Unlike the majority of SEC filings, Form 144 filings may be made electronically or on paper with the SEC’s offices in the District of Columbia.¹⁶ The Release notes that during the 2019 calendar year, nearly all Form 144 filings were submitted on paper (just over 200 out of over 31,000 filings were submitted electronically) and over 99% related to the resale of securities of issuers subject to the requirements of the Exchange Act.¹⁷

The proposed amendments to Rules 101(a) and 101(b) of Regulation S-T (“Reg S-T”) would require electronic filing of all Form 144 filings relating to securities of Exchange Act reporting companies and would eliminate Form 144 reporting for securities of non-reporting companies. The SEC states in the Release that “[m]andating the electronic filing of Form 144 would facilitate more efficient storage and retrieval of the transaction information and facilitate analysis of this information.” Any Form 144 filer who has not previously made an electronic filing on EDGAR would need to apply for EDGAR access in order to file documents on EDGAR. The SEC has proposed to provide Form 144 paper filers with a six-month transition period after the effective date of the amendments.¹⁸

Finally, the SEC has proposed to amend the Form 144 filing deadline (applicable to all Forms 144) as provided in Rule 144(h)(2) to coincide with the Form 4 filing deadline, such that all Form 144 filings would be due at the end of the second business day following the day on which the sale of securities has been executed.¹⁹

To facilitate compliance with the proposed amendments, the SEC has stated it plans to:

• make an online fillable Form 144 available to simplify electronic filing; and
• streamline the electronic filing of Forms 4 and 144 reporting the same sale of an issuer's securities.²⁰

To “streamline” the filing process for reporting persons required to file both a Form 144 and Form 4 to disclose a transaction, the SEC indicates it intends to give filers the ability “to file a Form 144 and a Form 4 through a single user interface.”²¹ This new system would use the information entered into digital fields to create separate Form 144 and 4 filings, after which a filer would be able to correct errors and verify the accuracy of the information before choosing to file one or both forms. EDGAR would then provide the filer with separate accession numbers for the Form 144 and 4 and copies of the filed forms.

As demonstrated by the statistics provided by the SEC, Form 144 filers strongly prefer to file paper forms, despite the relative ease and cost-savings of electronic submissions, likely due to the fact that a paper filing creates a potential layer of privacy not available for those who utilize the EDGAR filing system. If adopted as drafted, the proposed amendment would allow investors, including activist investors, to more easily monitor secondary trading of the significant security holders of Exchange Act registrants. In spite of the proposed improvements to the Form 144 electronic submission interface and the extension of the Form 144 deadline, such amendments may draw negative comments from investment funds who do not wish to publish their transactions, and potentially from registrants who believe public posting of secondary sales may create a negative inference as to such registrant’s future market value.

Form 144 - Potential Impact of Proposed Amendments

Typically, affiliates file a paper Form 144 disclosing the affiliate’s intention to sell securities during an upcoming three-month period, with the understanding that the information would not be electronically published on the EDGAR filing system. If electronic filing of Form 144 is mandated, affiliates may become more likely to file Form 144s disclosing a more conservative estimate of their intention to sell shares and file subsequent amendments on Form 144 on an on-going basis so as not to signal to the market the affiliate’s intentions of selling more shares that may never actually occur. 

A mandate for electronic filing of Form 144 would have an even greater change for affiliates of foreign private issuers.  Officers, directors and 10% or greater shareholders of foreign private issuers (unlike officers, directors and 10% or greater shareholders of domestic reporting companies) are not required to disclose transactions and changes in beneficial ownership under Section 16 of the Exchange Act, which requires officers, directors and 10% or greater shareholders to publicly disclose within two business days, any acquisition or disposition of the issuer’s securities, subject to very limited exceptions.  Absent special circumstances, officers, directors and 10% or greater shareholders are affiliates and are required to file a Form 144 whenever they sell a security of the issuer in reliance on Rule 144. Requiring affiliates of foreign private issuers to switch from paper Form 144s, which are accessible only through commercial databases on a delayed basis, to electronic Form 144s, which are publicly available on a real time basis, means that the market would become aware of sales made by affiliates of foreign private issuers in reliance on Rule 144 within two business days of when the sale is executed. This new and noteworthy disclosure requirement may impact the timing of sales for affiliates of foreign private issuers in ways they did not have to consider previously.  In addition, this could potentially motivate affiliates of foreign private issuers to demand issuers to register the affiliate’s shares on a resale registration statement, alleviating the affiliate’s reliance of Rule 144 and the requirement to file a Form 144.  

Section 16 Form Changes - Rule 10b5-1(c) Transaction Indication

Section 16 applies to every person who is the beneficial owner of more than 10% of any class of equity security registered under Section 12 of the Exchange Act²² and each officer and director (together, “insiders”) of the issuer of the security. Upon becoming an insider, or upon the Section 12 registration of that class of securities, Section 16(a) requires an insider to file an initial report on Form 3 with the SEC disclosing the amount of his or her beneficial ownership of all equity securities of the issuer. To keep this information current, Section 16(a) also requires insiders to report changes in such ownership on Forms 4 and 5. Under Rule 16a-3 of the Exchange Act,²³ insiders are required to report most changes in beneficial ownership, including purchases and sales of securities, on Form 4.

Form 144 currently requires a selling security holder to represent, as of the date the form is signed, that he or she does not possess any material adverse information²⁴ in regard to the current and prospective operations of the issuer of the securities to be sold which has not been publicly disclosed. Rule 10b-5 provides that the purchase or sale of a security of an issuer is made “on the basis of” material nonpublic information about that security or issuer if the person making the purchase or sale was aware of the material nonpublic information when the person made the purchase or sale. Rule 10b5–1(c) establishes affirmative defenses that permit a person to trade in circumstances where it is clear that the information was not a factor in the decision to trade.²⁵

Pursuant to amendments to Rule 144 adopted in 2007, filers who satisfy Rule 10b5-1(c) by adopting a written trading plan or providing trading instructions may make that representation as of the date they adopt the plan or gave instructions, rather than the date they signed the Form 144.²⁶

With respect to Form 4 (and Form 5), if a transaction satisfies the affirmative defense conditions of Rule 10b5-1(c), and if the selling insider has not selected a date of execution, “the date on which the executing broker, dealer, or plan administrator notifies the insider of execution of the transaction is deemed the date of execution, so long as the notification date is not later than the third business day following the trade date.”²⁷

The SEC has proposed to add a “check box” to Forms 4 and 5, and to permit an insider, at the insider’s option, to indicate through the check box that a sale or purchase reported on the form was made pursuant to Rule 10b5-1(c). As proposed, “the check boxes on Forms 4 and 5 would permit [insiders] to indicate whether a transaction was made pursuant to a binding contract, instruction, or written trading plan for the purchase or sale of equity securities of the issuer that satisfies the conditions of Rule 10b5-1(c).” This affirmation is broader than the representation on Form 144, which refers only to written trading plans and trading instructions. Insiders may continue to provide additional information, such as but not limited to, the date of a Rule 10b5-1 plan, in the “Explanation of Responses” section of Forms 4 and 5.

Future Updates

We will provide additional information as the proposed amendments advance. 

^{1 Release Nos. 33-10911; 34-90773; File No. S7-24-20 https://www.sec.gov/rules/proposed/2020/33-10911.pdf (“2020 Release”).}

^{2 Id.}

^{3 See: Rule 144(a)(1).}

^{4 See: Rule 144(b)(2).}

^{5 2020 Release, citing: Revisions to Rules 144 and 145, Release No. 33-8869 (Dec. 6, 2007) [72 FR 71546 (Dec. 17, 2007)] (“2007 Adopting Release”).}

^{6 Id. citing Release No. 33-5223 (Jan. 11, 1972) [37FR 591 (Jan. 14, 1972)].}

^{7 Id.}

^{8 See: https://www.investor.gov/introduction-investing/investing-basics/glossary/convertible-securities.}

^{9 See: https://www.investor.gov/introduction-investing/investing-basics/glossary/convertible-securities.}

^{10 See 2020 Release.}

^{11 Id.}

^{12 Id.}

^{13 See, e.g., Section 312.03(c) of the New York Stock Exchange LLC Listed Company Manual and Nasdaq Stock Market LLC Listing Rule 5635(d).}

^{14 2020 Release.}

^{15 See Rule 144(h).}

^{16 “The paper filings of Form 144 are retained in the [SEC’s] public reference room for a period of 90 days. Investors or other interested parties wishing to access and review a Form 144 filed in paper must do so in person at our public reference room or subscribe to a third party information service that records and distributes the information electronically after a paper Form 144 is filed.” See: 2020 Release.}  

^{17 Id.}

^{18 Id.}

^{19 Id.}

^{20 Id.} 

^{21 Id.}

^{22 Id. citing 15 U.S.C. 78l.}

^{23 Id. citing 17 CFR 240.16a-3.}

^{24 Id. citing 2007 Adopting Release, supra note 19. Exchange Act Rule 10b5-1 defines when a purchase or sale of a security constitutes trading “on the basis of” material nonpublic information in insider trading cases brought under Section 10(b) of the Exchange Act [15 U.S.C. 78j] and Rule 10b-5.} 

^25Id.

^{26 Id.}

^{27 Id. citing See 17 CFR 240.16a-3(g)(2) (Exchange Act Rule 16a-3(g)(2)) and 17 CFR 240.16a-3(g)(4) (Exchange Act Rule 16a-3(g)(4)). “If the notification date is later than the third business day following the trade date, the date of execution is deemed to be the third business day following the trade date.”}