Tag Archives: Affiliate Under Rule 144

What is Tacking Under Rule 144?

Tacking under Rule 144 allows a holder of restricted securities to aggregate the separate holding periods of prior holders in order to meet the Rule 144 holding period requirement.

Rule 144 Holding Periods:  Either Six Months or One Year

The holding period for mandatory SEC filers is 6 months.  These are fully reporting Issuers filing 10-K, 10-Q and 8-Ks and “subject to” the requirements of the Securities Exchange Act of 1934.

In contrast, the Rule 144 holding period for voluntary SEC filers and non-reporting Pink Sheets is 12 months.

Rule 144 Tacking is Allowed for Restricted Stock and Convertible Debt

Tacking is used for both restricted stock, and for convertible promissory notes, as well.

For example, if a Note is documented at over a year old, the Rule 144 holding period is likely met even if the Note holder converts into common stock immediately prior to seeking a Rule 144 legal opinion.  This is because the Note holder is allowed to tack the age of the Note onto the age of the newly issued stock to meet the 12 month holding period.

Tacking Under Rule 144 is Only Permitted to Non Affiliates

By permitting tacking, the SEC allows a selling security holder to include the holding period of a prior non-affiliate holder.   However, if the securities were purchased from an affiliate, tacking is not permitted and the holding period starts over.

For example, if a non affiliate shareholder who owned stock in an SEC mandatory filer for seven months sells stock in a private Stock Purchase Agreement to a new non affiliate shareholder today, the new shareholder has already exceeded the 6 month holding period.

Removing the restricted legend on the stock will require the new shareholder to provide documentation which shows the origin and history of the shares, including the prior holder’s purchase date and non affiliate status.

OTC Securities Lawyer Answers Rule 144 Questions on Tacking

Shareholders with questions regarding tacking under SEC Rule 144 or Section 4(a)(1) can contact OTC Bulletin Board and OTCMarkets securities attorney Matt Stout at (410) 429-7076 or mstout@otclawyers.com.

When is an Amendment to Form 144 Needed?

Affiliate Shareholders of OTC Markets and Bulletin Board public companies are those serving as Officers, Directors, control persons or owners of more than 9.99% of the Issuers voting securities of any class (“Affiliates”).

Affiliates Submit SEC Form 144 When Selling Restricted Stock

Affiliates of OTC companies know that in order to clear and sell restricted stock, they need to fill out a Form 144 and submit that to their broker, which will allow them to sell up to 1% of the total issued and outstanding common stock of the Issuer within a 90 day period.

Increasing the Number of Shares Sold Requires an Amendment to Form 144

Under Rule 144(h), an amendment to SEC Form 144 needs to be filed if the Affiliate wishes to sell more securities during the 90 day period than was originally declared for sale on the original Form 144.

For example, if an Affiliate files a notice on SEC Form 144 for the proposed sale of less than the full amount of shares that could be sold under the volume limitations set forth in Rule 144(e), but then decides to sell up to 1% of the issued and outstanding, an amendment is needed.  For this reason, it may be wise for Affiliates to consider simply using the 1% number in the original Form 144 filing.

No Form 144 Amendment is Needed if the Affiliate Shares are Unsold

Under Rule 144(h), if the Affiliate filed a Form 144, but does not sell all of the securities referred to during the 90 day period, no amendment needs to be filed with the SEC.

No Form 144 Amendment is Needed Due to a Stock Split

If after an Affiliate’s filing of Form 144, the OTC Issuer declares a stock split,  no new Form 144 filing is needed within the 90 day period to sell the correct number of post-split shares which equate to the number of pre-split shares the Affiliate had already declared on Form 144.  The broker will simply make the adjustment and inform the Affiliate of the new maximum to be sold under the Rule 144 volume trading limitations.

No Form 144 Amendment is Needed to Change Brokers

Individual brokerages may have their own policies on this, but the SEC does not require a new Form 144 or amendment to be filed when an Affiliate uses more than one broker, since it is the share number and trading volume limitation which governs trading, and not the brokerage used to execute the trades.

Likewise, under Rule 144(h), an Affiliate filing Form 144 who indicates that the Affiliate may sell shares through more than one broker is not required to allocate a specific number of shares to each broker on Form 144.

OTC Securities Lawyer Helps Affiliates Sell Restricted Stock

Management and control persons of OTC Markets and Bulletin Board public companies can contact Matt Stout for referrals to OTC brokers and assistance filling out SEC Form 144.   Securities lawyer Matt Stout reviews certificates, filings and documents at no cost to determine if a Rule 144 legal opinion can be issued.   Shareholders can email Matheau J. W. Stout, Esq. at mstout@otclawyers.com or call (410) 429-7076.

Rule 144(c) Current Public Information Requirement

Shareholders familiar with Rule 144 know that for the Rule 144 Six (6) Month holding period to be used, the public company’s mandatory SEC filings under the Securities Exchange Act of 1934 must be current.  When an SEC filer’s Exchange Act reports become delinquent, the One (1) Year holding period under Rule 144 applies (if the company was never a “shell”).

Affiliate Sales of Restricted Stock Using Rule 144

Is this true for Affiliates, who have filed a Form 144 with the intention of selling up to 1% of the public company’s issued and outstanding shares of common stock during a 90 day period?

Yes, the Rule 144 “current public information” requirement must be met in order for the Affiliate to sell shares under the Rule 144 safe harbor.  The public company’s filings must remain current in order to meet his requirement at the time each sale is made.

Rule 144 Attorney Drafts Affiliate Legal Opinions

Affiliates of OTC Bulletin Board and OTC Markets companies can contact Rule 144 lawyer Matt Stout for assistance with completing Form 144 and selling restricted stock at (410) 429-7076 or mstout@otclawyers.com.

 

 

 

What are Convertible Securities?

Convertible securities include bonds and preferred stock.  For OTC Markets and Bulletin Board companies, the term usually means a debt secured by a Promissory Note, which can be converted into common stock.  These are known as Convertible Notes or simply Convertible Debt.

Convertible Debt in OTC Markets Companies

Most convertible promissory notes issued by OTC Markets public companies include provisions that allow the debt holder to decide if and when to convert a Note into common stock.  SEC Rule 144 usually allows a debt holder to trace their holding period to the date of the Note, rather than the date of conversion, which could be months or years after the Note was issued.

Why Do OTC Markets Companies Issue Convertible Debt?

OTC Markets companies issue Promissory Notes primarily to raise capital or to pay for services. It is a fact of life for services providers that OTC public companies often lack the cash to pay their vendors.

Why Do Debt Holders Convert Promissory Notes into Stock?

Statistically, experienced OTC lenders and service providers accepting Convertible Notes in lieu of cash know that microcap companies quoted on the over-the-counter markets will probably default on their obligation to pay.  Given that probability, drafters of Convertible Promissory Notes must take into consideration that the debt holder will later need to convert a defaulted Promissory Note into common stock after the Rule 144 holding period has been satisfied.

9.99% Blocker Clauses in Convertible Promissory Notes

Convertible Promissory Notes issued by OTC Markets  companies usually include “blockers” which are clauses preventing the debt holder from owning greater than 9.99% of the OTC company’s issued and outstanding shares of stock at any one time.  This blocker is intended to prevent the debt holder from being classified as an Affiliate, which would cause Rule 144 Affiliate volume trading limitations to be applicable under Rule 144.

Exceeding 9.99% ownership in an SEC reporting company also brings the obligation of filing SEC Forms 3, 4 and 5.

Institutional financiers that specialize in providing capital to OTC Markets Pink Sheets and Bulletin Board companies using convertible debt typically do not convert a Note again until they are “flat.”  Being “flat” means that the common stock in their brokerage account from the prior conversion has all been sold, such that it is easy to verify with the Company and Transfer Agent that the debt holder has complied with the 9.99% blocker.

4.99% Blocker Provisions in OTC Markets Convertible Debt

For SEC reporting companies filing under the Securities Exchange Act of 1934, sometimes the blocker clause will specify a maximum of 4.99% if the debt holder also wants to avoid the additional obligation of filing a Schedule 13d or Schedule 13g.

When a debt holder converts a Note into 5% of the common stock in company subject to the reporting requirements under Section 12 of the Securities Exchange Act of 1934, the debt holder is required to file a Schedule 13D or 13G.

The rationale behind the 4.99% blocker is that the institutional financiers who provide capital to multiple OTC Markets and Bulletin Board companies tend to do many conversions.  Typically these lenders will only convert after the stock can be cleared using a Rule 144 legal opinion or Section 4(a)(1) opinion, and they will convert the debt in regular increments which are then immediately sold into the market, such that their accounts are flat before each subsequent conversion.

Such repeated and regular conversions in which stock is owned for perhaps only a few days at a time would cause an administrative burden to file multiple SEC forms each time the debt holder’s ownership in a particular OTC Issuer fluctuated above and below 5%.

Conversion Metrics and Formulas in OTC Convertible Debt

Convertible Promissory Notes issued by OTC Markets and Bulletin Board companies to raise capital or pay for services usually contain a conversion ratio based on fluctuating market prices.

Converting OTC Stock at a Discount to Market

That ratio or formula of a market price conversion is typically referred to as a “discount to market” which means that the debt holder will have the right to convert at a share price that is a particular percentage of the share price on the date of conversion or based on some average during a trailing conversion period.

Rule 144 and Section 4(a)(1) Legal Opinions for Debt Conversions

Management and Debt Holders of OTC Markets and OTC Bulletin Board companies can contact OTC Securities Lawyer Matt Stout for Rule 144 legal opinions and Section 4(a)(1) legal opinions at (410) 429-7076 or mstout@otclawyers.com.

 

 

What is Rule 144?

Rule 144 Safe Harbor for Clearing Restricted Stock

SEC Rule 144 is the most common safe harbor that Shareholders of restricted stock in OTC Markets companies use to sell their shares.

Rule 144 has three major questions that must be answered before it can be used to remove a restricted legend from a stock certificate.  These questions determine Affiliate Status, 144 Holding Period and Shell Status.

Is the Shareholder an Affiliate of the Issuer under Rule 144?

Under Rule 144, an Affiliate is a “control person” which is most often an officer, director, or owner of greater than 9.99% of the total issued and outstanding shares of any class of stock in the Issuer.

If a Shareholder is an Affiliate, or was an Affiliate within the past 90 days, then he or she is subject to trading volume limitations under Rule 144.

What are the Affiliate Trading Volume Limitations Under Rule 144?

Affiliate Shareholders of OTC Bulletin Board and OTC Markets OTCQB, OTCQX and Pink Sheets, can only sell up to 1% of the Issuer’s total issued and outstanding shares during any 3 month period, and such sales must be reported to the SEC on Form 144.

What is the Shareholder’s Holding Period under Rule 144?

Whether or not the Shareholder is an Affiliate, the restricted stock must be held for a certain period of time, known as the Rule 144 “holding period” after the Shareholder acquires the shares and before the Shareholder sells the stock.

What is the 144 Holding Period for SEC Reporting Companies?

For SEC reporting public companies, like those quoted on the OTC Bulletin Board (OTCBB) and the OTC Markets OTCQB and OTCQX, and for those listed on the NASDAQ or NYSE MKT, the Rule 144 holding period is a minimum of six (6) months.

In order to qualify, the public company must be “subject to” the reporting requirements of Section 12 of the Securities Exchange Act of 1934.  This is also known as a mandatory SEC filer.

Rule 144 Holding Period for Non Reporting Companies

For Non SEC Reporting Issuers, like those quoted on the OTC Markets Pink Sheets and filing OTC Markets Disclosure Statements, the Rule 144 holding period is twelve (12) months.

Voluntary SEC filers are also considered non reporting companies and have a Rule 144 holding period of twelve (12) months.

Voluntary filers are those which go public via S-1, but which have not yet filed an 8A-12g or 8A-12b or Form 10 under the 34 Act, so they are not yet technically “subject to” the reporting requirements of Section 12 of the Securities Exchange Act of 1934.

Was the Issuer Ever A “Shell Company” under Rule 144?

Current Shells Cannot Use Rule 144 to Clear Stock

Rule 144 does not allow Shareholders of public companies that are currently classified as a “shell company” to use its safe harbor to clear and sell restricted stock.

This is true even if the Shareholder is not an Affiliate, and if the Shareholder has held stock for longer than the required holding period under Rule 144.

Can Former Shells Use Rule 144?

Former shell companies that now have assets and an operating business must wait one (1) year after the Issuer ceases to be a shell before their shares may be sold using Rule 144, and then only if the public company is an SEC filer and subject to the filing requirements of the Exchange Act of 1934.

The moment a public company ceases to be a shell is sometimes clear because it is found in an SEC filing, like a “Super 8-K” for instance.  This could be the date upon which the company acquired an operating business or assets, in a reverse merger.

The Evergreen Rule:  Rule 144 Applied to Former Shell Companies

Former shells that are fully reporting OTCQB, OTCQX and OTC Bulletin Board companies must have filed current SEC reports like the 10-Q, 10-K and 8-K for a minimum of one (1) year from the date they ceased to be a shell, and they must be current in their filings now, before its Shareholders can avail themselves of the exemption from registration offered by Rule 144.

The term “Evergreen Rule” refers to the requirement that former shell companies must remain current in their filings (forever) in order for Rule 144 to be used.  If a former shell becomes delinquent in SEC filings, Rule 144 cannot be used until the Issuer is current.

Non Reporting Pink Sheet Former Shells Cannot Use Rule 144

Former shell companies that are OTC Markets Pink Sheets cannot used Rule 144 even if they are “Pink Current” now meaning that they are up to date on their OTC Markets Quarterly Reports, Annual Reports and their Information & Disclosure Statements.

Section 4(a)(1) Can Be Used to Clear Stock of Pink Sheet Former Shells

If the shares are greater than Two (2) Year old, OTC shareholders in Pink Sheets or delinquent SEC filers may be able to use Section 4(a)(1) (also known as Section 4(1) or simply 4-1) to clear and deposit their restricted stock.

Section 4(a)(1) can only be used if the shareholder is not an Issuer, Underwriter or Dealer, and if the shareholder can document the origin and history of the Shares as dating back greater than Two (2) Years.

OTC Bulletin Board (OTCBB) and OTC Markets Issuers seeking a securities attorney with expertise in Rule 144 and Section 4(a)(1) can contact Matt Stout at (410) 429-7076 or mstout@otclawyers.com for further information.

Which Forms Do Corporate Insiders File with the SEC?

Insiders of Reporting Companies File SEC Forms 3, 4, 5

Since June 30, 2003, the SEC has required insiders to submit forms electronically through the SEC’s EDGAR system.  The SEC now also requires reporting companies with websites to post Forms 3, 4 and 5 by the end of the next business day after the forms are filed with the SEC.

Who Is a Corporate Insider?

Affiliates are also termed “corporate insiders.”  For the purposes of SEC Forms 3, 4 and 5, a corporate insider includes any officer or director, and any shareholder who beneficially owns greater than 9.99% percent of any class of the Company’s equity securities which are registered under Section 12 of the Securities Exchange Act of 1934 (the “Exchange Act”).

(Affiliates or insiders of Pink Sheets or non-reporting companies are not required to file SEC Forms 3, 4 and 5.  The requirements only extend to the insiders of  “mandatory SEC filers” which are subject to the reporting requirements of Section 12 of the Exchange Act.)

SEC Form 3 Reports Initial Beneficial Ownership by Insiders

An insider of an SEC reporting company that is registering equity securities for the first time under Section 12 of the Exchange Act must file this Form on or before the effective date of the registration statement.

If the public company is already registered under Section 12, Form 3 must be filed within Ten (10) days of becoming an officer, director, or beneficial owner of Ten (10%) Percent.

SEC Form 4 Reports Changes in Beneficial Ownership by Insiders

SEC Form 4 is used by insiders to report changes in ownership.  Form 4 must be reported to the SEC within Two (2) business days. Some limited categories of transactions not subject to the Two (2) business day reporting requirement.

SEC Form 5 Reports Changes Not Timely Filed on Form 4

SEC Form 5 is used by insiders to report any transactions that either a) should have been reported earlier on a Form 4 or b) were eligible for deferred reporting.  When Form 5 must be filed, an insider has Forty-Five (45) days after the end of the company’s fiscal year to file.

Supporting Documentation for Rule 144 Legal Opinions

One of the most common questions a securities lawyer receives is “What do I need to provide in order to have the restricted legend removed from my certificate?”   The best answer is always for the Shareholder to provide all of the documentation in his or her possession showing the origin and history of the shares.

Shareholders seeking Rule 144 legal opinions should first create PDF files of the stock certificates, and any other supporting documents which can show that the elements of Rule 144 are met.  Then email all of this to the securities lawyer.  The securities lawyer’s process cannot really begin until this information is reviewed and very few questions can be answered until then since most answers depend on the specific facts of the Rule 144 transaction.

SEC and OTC Markets Filings That Mention the Rule 144 Transaction

If the Shareholder is aware of a past SEC filing (10-Q, 10-K, 8-K) or OTC Markets filing (Quarterly Report, Annual Report, or Information and Disclosure Statement) that mentions their transaction, they should note this.   A reference in a public filing to their shares, or the transaction which originated their shares is perhaps the most helpful, and the most rare piece of documentation that can be provided.

Aside from documentation in the Issuer’s public filings, depending on the transaction which originated the shares, this documentation could include:

Documents in Support of a Debt Conversion Under Rule 144

Not all of these documents may be available to the Shareholder in every Rule 144 transaction, but in a best case scenario, all of these would be provided:

  1. Promissory Note; and
  2. Debt Purchase Agreement, if applicable; and
  3. Conversion Agreement signed by the Issuer, if possible; and
  4. Conversion Notice; and
  5. Board Resolutions in which the Issuer acknowledges the debt and the conversion; and
  6. Proof of payment via check or wire transfer; and
  7. Non Affiliate letters signed by the Shareholder and the Prior Debt Holder.

Documents in Support of a Private Stock Purchase Under Rule 144

Many of these documents may not be available, but they are helpful to establish the chain of ownership under Rule 144.  Since the Issuer is not usually involved, there are less Board Resolutions and documents provided:

  1. Stock Purchase Agreement (“SPA”); and
  2. Proof of payment via check or wire transfer; and
  3. Non Affiliate letters signed by Shareholder and the Prior Holder (unless the SPA clearly states this); and
  4. Documents showing how the Seller acquired the Shares in the first place.

Documents in Support of Shares Earned Under a Consulting Agreement Under Rule 144

Not all of these may be in a Shareholder’s packet, but more is better:

  1. Consulting Agreement between Shareholder and Issuer, which hopefully sets forth exactly when the Shares are considered fully “paid for” or earned under Rule 144; and
  2. Board Resolution acknowledging Consulting Agreement and confirming how and when the Shares were earned.  This essentially takes the place of “proof of payment” in the other examples; and
  3. Non Affiliate letter signed by Consultant unless non affiliate status is addressed in the Consulting Agreement.

It is rare when Shareholders have all of these documents handy when they go to sell restricted stock, since this is often years after the Shares were originally acquired.   On those occasions, a securities lawyer with expertise in drafting legal opinions under Rule 144 looks at the total picture and can request additional letters, affidavits and information when necessary.

Shareholders can contact securities lawyer Matt Stout with questions regarding Rule 144 legal opinions, Section 4(1) opinion letters and clearing restricted stock in general at (410) 429-7076 or mstout@otclawyers.com.

 

 

Beneficial Ownership Reporting Under Exchange Act Sections 13(d) and 13(g)

Many Affiliate Shareholders of OTC microcap companies are familiar with the Rule 144 reporting requirements and volume trading limitations for the beneficial owners of greater than 10% of an Issuer’s securities.

Section 13 Applies to Exchange Act Reporting Issuers

However, many are unaware that all owners of greater than 5% in any Issuer which has registered a class of its equity securities under Section 240.13 of the Securities Exchange Act of 1934 (“Exchange Act”), are supposed to file Beneficial Ownership Reports with the SEC.

Investors Owning Greater than 5% Must File Schedule 13 Reports

Under Regulation 13D-G, beneficial owners must continue to file these Schedule 13D or the more abbreviated 13G reports as long as their holdings exceed 5%. These Beneficial Ownership Reports provide the SEC with certain background information as well as the investor’s “intentions” which is why these Schedule 13 reports are filed in connection with a tender offer.

Investors seeking further information on the reporting requirements in connection with a tender offer, or with questions on securities law compliance in general, can contact Matt Stout, securities lawyer at (410) 429-7076 or mstout@otclawyers.com.

 

How Do Stock Splits and Reverse Splits Affect Trading Volume Under Rule 144?

Affiliates of OTC Issuers Can Sell 1% Every 3 Months under Rule 144

Under Rule 144, Affiliates of OTC Bulletin Board (“OTCBB”) and OTC Markets OTCQB, OTCQX and Pink Sheet Issuers are only allowed to sell 1% of the total issued and outstanding shares during any 3 month period.

Affiliates of Exchange Listed Issuers Have a Choice Under Rule 144(e)

Affiliates of Issuers listed on national exchanges like the NASDAQ or NYSE MKT are allowed to sell either

  1. 1% percent of the issued and outstanding shares; or
  2. The average weekly trading volume during the 4 weeks before the Affiliate filed Form 144.

Stock Splits Do Not Affect the Affiliate’s Percentage of Ownership

Whether the Issuer is quoted on the Over-the-Counter markets or listed on a stock exchange, neither forward stock splits nor reverse stock splits will affect the trading volume limitations under Rule 144(e) since a forward or reverse split would not change the percentage of the Issuer’s stock that the Affiliate is allowed to sell during the time period chosen.

Calculate Available Volume Under Rule 144 Following a Stock Split

To calculate available trading volume following a forward stock split or reverse stock split, an Affiliate should measure the trading volume as if the split had occurred on the 1st day of the 3 month period, even if it occurs at some later point during the 3 months.

Affiliates of OTC, NASDAQ and NYSE MKT Issuers with questions regarding selling restricted stock under SEC Rule 144 can contact securities lawyer Matt Stout at (410) 429-7076 or mstout@otclawyers.com.

What is Beneficial Ownership Under SEC Rule 144?

Beneficial Ownership under Rule 144 essentially means that although a Shareholder doesn’t legally own the Shares in his or her own name, the Shareholder can nevertheless exercise control over them.

Affiliates Are Those Who Beneficially Own Greater Than 10%

Rule 144 considers Shareholders who “beneficially own” greater than 10% of an Issuer’s outstanding stock, of any class, to be an Affiliate, or Control Person, which subjects them to volume trading limitations.

Being an Affiliate means that the Shareholder must file Form 144 every time he or she sells securities, and worse still, that the Affiliate may not sell more than 1% of the Issuer’s issued and outstanding shares during any three month period.

How to Avoid Being Classified as an Affiliate

With that in mind, many large Shareholders wonder how they can avoid being classified as an Affiliate.  The answer is clear under Rule 144.

Affiliates are those who occupy positions of control in an Issuer, such as an officer or director, and those who beneficially own greater than 10% of the issued and outstanding.

So the key, then, is to ensure that the Shareholder does not beneficially own greater than 10%.  This sounds simple, but in practice is often difficult for many Shareholders, especially those who may exercise debt conversions that inadvertently bring their ownership above 10% by not including “blocker” provisions.

Beneficial Ownership Under Rule 144 is a Test of Substance Over Form

To say that the concept of beneficial ownership is a matter of substance over form, means that the SEC cares about who actually controls the Shares rather than who might appear to control them. For this reason, it is much better to own 9.99% than to try and hide ownership through relatives or corporate entities.

Owning Shares in the Names of Corporate Entities and Relatives?

Many insiders of OTC public companies own shares not only in their personal names, but for estate planning purposes might also hold shares in the names of trusts, corporations, and LLCs, not to mention the names of spouses and other relatives.  There is nothing inherently wrong with this as long as this is disclosed by an Affiliate.   Rule 144 looks at all of this beneficial ownership to see who really owns greater than 10%.

Examples of Affiliate Status By Beneficial Ownership

So if a Shareholder owns 3% in his own name, controls 5% in a family trust, and owns another 3% in an LLC…the Shareholder is an Affiliate…in the aggregate.   3+5+3 = 11

If a Shareholder owns 8% and his mother owns 3%, the Shareholder might be an Affiliate….if his mom lives in the same household.   If the Shareholder does not live with Mom, he’s not an Affiliate.   This is checked against the Transfer Agent’s Shareholder List, which shows the addresses of residence.

Finally, if a Shareholder owns 5% in his own name, and his brother (who lives in another household) owns 6%, neither one of them is automatically an Affiliate.  But if the two of them formed an LLC that owned all 11% they would both end up classified as Affiliates.   Sound confusing?

A Special Caveat to Holders of Convertible Notes Without Blocker Clauses

Here is the most important example: if a Shareholder owns 9.99% in his own name, he is not an Affiliate.   And if that Shareholder sells stock this month, and then later converts more debt such that he replenishes what was sold….but never goes over the 9.99%, he is not an Affiliate, unless the Note from which he is converting does not contain a “blocker” clause which would prohibit conversion beyond 9.99%.

If a “blocker” clause is not inserted into the Note, a circumstance could potentially arise under § 240.13d-3 whereby the Shareholder would theoretically become the “beneficial owner” of greater than 10% even if he does not exercise his right to convert.   Specifically, paragraph (d)(1)(i)(B) states, in relevant part, that

A person shall be deemed to be the beneficial owner of a security, subject to the provisions of paragraph (b) of this rule, if that person has the right to acquire beneficial ownership of such security, as defined in Rule 13d-3(a) (§ 240.13d-3(a)) within sixty days, including but not limited to any right to acquire: (A) Through the exercise of any option, warrant or right; (B) through the conversion of a security;

What does this mean?   If a Note, for example, becomes “due on demand” and does not contain a “blocker” clause which prevents the Note Holder from converting beyond 9.99% ownership, then it would seem arguable that the Note Holder “has the right to acquire”….”within sixty days”….greater than 10%.

So by this reading, it is not enough for a Shareholder to simply pay attention to Rule 144 and make sure that he stays in compliance–the Note also needs a “blocker” clause, just in case the Issuer’s stock price drops enough that in theory it would be possible for the Note Holder to exercise a conversion taking stock ownership beyond 10%.

Beneficial Ownership Under Rule 144 Is a Broad Concept

Beneficial ownership includes not only those Shares held in the Shareholder’s own name, but also those in the name of a trust, corporation or LLC that the Shareholder controls, and Shares in the name of his or her spouse, and other relatives living in the same household. The list can also include those Shares owned by corporate entities controlled by the Shareholder’s spouse and other relatives living within the same household.   That is quite a long list.

Pink Sheet Issuers Must Disclose Owners of Greater Than 5%

Pink Sheet Issuers who want to maintain the OTC Markets Pink Current designation must disclose in their filings the names and addresses of all parties that “beneficially own” greater than 5% of their Shares, even though these Shareholders are not considered Affiliates under Rule 144 unless they own greater than 10% of the issued and outstanding.

With this in mind, large Shareholders that would rather not have their names and addresses in an OTC Markets Information and Disclosure Statement should stay at 4.99%.   Likewise, those who do not wish to provide the SEC with notice of their beneficial ownership, must also stay at 4.99%.

Affiliates of OTC Bulletin Board (OTCBB) and OTC Markets OTCQB, OTCQX and Pink Sheet Issuers with questions on Affiliate sales of stock under Rule 144, or how to draft debt conversion documents with “blocker” clauses to ensure that a Shareholder does not inadvertently go over 9.99% (or 4.99%) can contact Matt Stout, securities lawyer at (410) 429-7076.