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By Eric Altstadter, CPA, Goldstein Golub Kessler & Company, P.C.

Congratulations. Today, the company you and your partner created one special evening at a restaurant became a reality! The dream you both shared, nurtured, conceived, developed, and planned for has come full circle. Today, at 9:00 a.m. your company's symbol flashed by on the computerized quote board at the New York Stock Exchange, and a price, equal to the initial public offering price, went with it. That price, and the number of shares you, your partner, and your key management people hold was determined during intense negotiations, some longer, harder, and more intense than others, with your underwriter.

Establishing the Initial Stock Value

To say that the pricing of a company's stock is a difficult experience is an understatement. Usually the underwriter feels that the owners have placed too high a valuation on their company. Conversely, the company believes that the underwriters' valuation is too low. Miraculously, both parties come to an amicable agreement and settlement. Included in that agreement and settlement is the number of shares you hold upon completion of the initial public offering. Persons who purchased their stock in the initial public offering typically have purchased newly issued, registered shares. As such, those registered shares are freely traded by those purchasers in the open market. Because your shares were not purchased in any public offering, the shares you retain in the company are known as unregistered shares, or restricted shares. Quite often, those shares are subject to an agreement with the underwriters that prohibits their sale for a specified period of time. This is commonly referred to as a "lock-up" agreement. Absent a lock-up agreement, the unregistered shares can be sold into the marketplace over a period of time, and the rule which governs their sale is known as Rule 144.

Definition of Rule 144

The general interpretation of Rule 144 of the Securities Act of 1933, which was amended on February 20, 1997, requires a person to hold restricted stock for a continuous period of one year. Prior to this amendment, the old rule required that the restricted stock be held for a continuous two-year period. The holder is then entitled to sell during any three month period, one percent of the total amount of shares outstanding during that three month period, or the weekly average trading volume during the four calendar weeks preceding the filing of Form 144, which form is required to be filed with the Securities and Exchange Commission whenever restricted shares are offered for sale. This sale of restricted securities is commonly referred to as "leakage." Leakage is the term that signifies when an individual who has owned the company's restricted stock for a continuous period is able to attempt to sell that stock. The company must then send a letter to the transfer agent confirming that the sale of the restricted shares conforms to the Securities and Exchange Commission's rules and regulations. Purchasers who are not control persons, as defined by the Securities and Exchange Commission's rules and regulations, are generally free of most limitations, provided they have held their shares for a continuous two-year period. Prior to the recent amendment, the old rule for noncontrol persons required holding the stock for a continuous three-year period. Restricted stock generally carries a legend on the actual certificate stating that these shares are restricted. Restricted stock may not be offered for resale without the filing of a registration statement or without an exemption from registration.

Other Perspectives of Rule 144

The sale of shares under Rule 144 can be viewed as more than a legal issue; it also is an emotional issue. Sellers must understand that the sale of shares is reported to the Securities and Exchange Commission and is, therefore, information available to the general public. With technology available today, this information is seen, digested, projected, and acted on instantaneously by the financial community. Rule 144 aside, any person is prohibited from selling shares if they are aware of any adverse information that has not been disseminated to the general public. Sometimes these sales, since they come from company insiders, are regarded as a harbinger of negative results on behalf of the company. The financial community may see the sales as an attempt by management to "bail out" or "cash out" while the going is still good. It is important to understand that these transactions may impact the sales volume or sales price of the company's stock. Certain decisions made by management in its day-to-day business operations might therefore be affected. Sometimes the fact that management has spent a great deal of time nurturing a company, perhaps over three to five years, is lost by the fact that today they wish to get out, even if the getting out is only partial.

Additionally, Rule 144 does not protect that person, if that person is an insider, from the exposure to short-swing profits. Short-swing profits are profits realized on the sale of stock within a six-month period regardless of what the investment decisions were based on. The profits are recoverable to the company, and may be asserted by any shareholder of the company, for the benefit of the company.

The final amendments to Rule 144 were released on February 20, 1997, effective April 29, 1997. The revised holding periods apply to securities whether purchased before or after the effective date. There are additional proposed amendments outstanding. Some of the proposed amendments include an increase in the threshold requirements for filing Form 144 from the current 500 shares or $10,000 sales price test to a 1,000 shares or $40,000 sales price test, further revisions to the one-year and/or two-year holding periods and elimination of the two trading volume tests that limit the amount of securities that can be sold, and relying on the percentage of shares outstanding test. *

Gary Illiano
Grant Thornton LLP


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