Tag Archives: Beneficial Ownership

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.


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.

What is Cede & Co in Relation to DTC?

When Issuers of OTC securities are reviewing their Shareholder lists, the free trading securities held by Shareholders that have already “cleared” and are in “the system” are shown as owned by Cede & Co.  Because of this, Issuers often wonder what Cede & Co is and how it is related to DTC.

Cede & Co is DTC’s Partnership Nominee

Once a certificate has cleared and deposited deposited by Direct Participants with DTC, all subsequent transfers of those securities are registered in the name of DTC’s partnership nominee, Cede & Co.

Cede & Co Does Not Affect Beneficial Ownership

The deposit of Securities with DTC and their registration in the name of Cede & Co. does not change beneficial ownership.   However, DTC has no knowledge of the beneficial owners of the securities once they are in Cede & Co’s name.

Instead, DTC’s records reflect only the identity of the broker-dealer, bank, trust company, or clearing firm to whose accounts the securities are credited.

While DTC does not track beneficial ownership, it is still the responsibility of the Direct and Indirect DTC Participants to maintain an account of their holdings on behalf of customers.