Monthly Archives: October 2014

Can a Pink Sheet Use S-8 Shares to Compensate Consultants Who Raise Capital?

Exchanging Services for Rule 144 Restricted Stock is Common

Among OTCMarkets public companies, it is commonplace for Issuers to pay for consulting services using restricted shares of common stock.   For non-reporting companies, such as Pink Sheets, the usual way is for the CEO and the consultant to enter into a Consulting Agreement which specifies a certain number of shares for a specific scope of work.

This restricted stock is then held for the standard 12 month holding period under Rule 144 before being sold on the market.  Many times, the type of work for which restricted stock is awarded does include activities associated with raising capital, but Rule 144 is the mechanism for clearing the stock, not S-8.

S-8 Can Only Be Used By SEC Reporting Companies

Most Pink Sheets are not SEC filers, but are instead under the OTCMarkets’ Alternative Reporting Standard.  (Due to a recent change in OTCMarkets’ policies governing its OTCQB market tier, many SEC filers saw their OTCQB status change to Pink Sheet when their share price dropped below a penny.)   Because of this distinction, consultants providing services in exchange for true Pink Sheet stock are awarded Rule 144 restricted stock with a 12 month holding period, not S-8 stock, which is free trading.

S-8 Cannot Be Used for Capital Raising Activities

Even if a Pink Sheet was allowed to use S-8, the capital raiser would still be out of luck because stock issued to consultants in exchange for work associated with capital raising cannot be cleared using S-8.  There are no exceptions for this.  In fact, there are 8 requirements for an SEC reporting company to be able to use S-8, and all of them must be met.

Pink Sheet Stop Signs and Shell Status Under Rule 144

Sometimes shareholders cannot obtain a Rule 144 legal opinion letter from a securities attorney even though they have held shares in an OTC Markets public company for greater than one year. When this happens, the problem is usually a lack of current public information, which is required under Rule 144.

A Stop Sign Could Be a Shell Under Rule 144

How does a securities lawyer determine whether or not the Issuer is a Shell Company as defined under Rule 144 if the Issuer is a Stop Sign and has not published any public information? An OTCMarkets.com Stop Sign is technically a Pink No Information company under the Alternative Reporting Standard, and this implies that there is not enough information made available to warrant even a Yield Sign.

Simply put, regardless of the Issuer’s past filings, it doesn’t meet Rule 144’s current information requirement so Rule 144 cannot be used. Another way to look at this is that a securities attorney also cannot be sure the Issuer is not currently a shell if it is marked a Stop Sign.

Section 4(1) Legal Opinions Do Not Address Shell Status

When faced with an Issuer that fails to keep its filings current, a shareholder’s best friend could be Section 4(1). A Section 4(1) legal opinion is sometimes considered by experienced securities law counsel when the shares in question are greater than two (2) years old. This is a holding period twice as long as that required of a current Pink Sheet under Rule 144. If that holding period can be met, then “shell status” is not an element of a Section 4(1) legal opinion, since it concerns itself with whether or not the shareholder is an underwriter or dealer, rather than with the Issuer’s filings.

What is the “Evergreen Rule” Under Rule 144?

Rule 144(i), as amended, states that Rule 144 is not available for the resale of securities initially issued by a former shell company unless the following two requirements are met:

1. One (1) year has passed since the Issuer filed current “Form 10 information.” What is Form 10 information? It is the information that would be required if the Issuer were filing a general form for registration of securities on Form 10 under the Securities Exchange Act of 1934, or under an S-1, which reflects its status as an entity which is no longer a “shell”; and

2. The Issuer is current on all reports required to be filed with the SEC during the One (1) Year before the shareholder elects to sell shares.

The Evergreen Rule Requires Current Information Under Rule 144

The latter requirement, that the Issuer be current for the prior twelve months, is known as the “Evergreen Rule” and without that requirement being met, the former shell company’s securities can never be sold under Rule 144. As a practical matter, the Evergreen Rule means that the restrictive legend on the shareholder’s stock certificate cannot be removed in advance of a contemplated sale, since that could mean the actual sale might occur at a time when the Issuer’s filings are no longer current.

The Evergreen Rule as applied to former shell companies lasts forever, even if the Issuer ceased to be a shell long ago, and even if the required Form 10 information was filed many years ago.

For this reason, management of former shell companies should consult with experienced securities counsel when deciding how to respond to requests by shareholders for restrictive legend removal.

Matt Stout is a microcap securities lawyer representing OTCMarkets Issuers in a full range of securities legal matters including reverse mergers, DTC eligibility, securities legal opinions and SEC compliance. Mr. Stout can be reached at mstout@otclawyers.com or (410) 429-7076 with questions about Rule 144.