Free trading shares: how restricted stock becomes tradable

Free trading shares has nothing to do with commission-free broking. In securities practice it means stock that can be resold into the market without a restrictive legend: either because a resale registration statement covering it is effective, or because the Rule 144 holding period has run and Rule 144 is available to that issuer.

Key takeaways

• Restricted stock has two routes to free trading, and only two. An effective resale registration statement, or Rule 144 where it is available. Anything else called a route is one of those two renamed.
• Rule 144 is conditional, not automatic. Six months for restricted securities of an issuer that has been an Exchange Act reporting company for at least 90 days before the sale; one year if not.
• A shell company history changes the answer. Rule 144 is unavailable for securities initially issued by a shell company, or by an issuer that was ever one, except on the Rule 144(i) conditions.
• Legend removal is a five-party sequence. Holder representation, issuer counsel opinion, issuer instruction, transfer agent action, receiving broker review. Any one can stall it; none can compel the others.

Restricted, control and unrestricted stock

Three categories do the work, and conflating them is the usual reason an issuer misjudges when its investor can sell.

Restricted securities are securities acquired directly from the issuer, or from an affiliate, in a transaction not involving a public offering. They are legended. PIPE transactions, conversions into unregistered shares and private placements by public companies all produce them.

Control securities are securities held by an affiliate. They may be ordinary listed stock bought in the market; what restricts them is who owns them. An affiliate reselling under Rule 144 must satisfy the current public information, volume, manner-of-sale and Form 144 notice conditions even where no holding period applies.

Unrestricted shares, which is what people usually mean by free trading shares, carry neither burden: no legend, no exemption analysis, deliverable on a normal settlement cycle.

The two routes out of a legend

An issuer negotiating a financing is really negotiating which route the investor is buying, and what it has undertaken to do to deliver it.

The registered route is what makes an equity facility usable at all, because a facility drawn in tranches cannot wait six months per tranche. That is the subject of S-1 resale registration and how the resale route works.

Legend removal, step by step

Nobody can simply declare shares free trading. The legend comes off through a sequence that involves five parties, and the issuer controls only part of it. The last of the five — the broker that receives the deposit — is outside the issuer's control entirely, which is why a legally unrestricted share can still fail to reach the market.

1. The holder establishes the basis

   A representation letter giving the acquisition date, the consideration paid, non-affiliate status where claimed, and the exemption relied on.

2. Issuer counsel gives an opinion

   Counsel opines that the legend may be removed. Counsel will not do that without the representations, and no transfer agent acts without the opinion.

3. The issuer instructs the transfer agent

   An instruction letter authorising removal, usually conditioned on the holder selling under the prospectus where registration is the basis.

4. The transfer agent reissues the position

   Unlegended shares are issued in book-entry form, or delivered electronically to the holder's broker where the depository and the agent support it.

5. The receiving broker runs its own review

   FINRA has told firms to treat large deposits of thinly traded stock as a reason to look harder.

Two things follow. The issuer's obligation in a financing document is almost never to make shares free trading — it is to file, to seek effectiveness, to instruct its transfer agent and to keep its reporting current. And the last step is outside everybody's control: a broker that will not accept the deposit, or a depository restriction, stops a legally unrestricted share from reaching the market. That is why DTC eligibility and deposit chills belong in diligence.

Related reading

• Rule 144 in full
• Rule 144(i) and former shells
• Resale registration (S-1)
• Who we fund

Primary sources

• U.S. Securities and Exchange Commission — Rule 144: Selling Restricted and Control Securities
• 17 CFR 230.144 — Rule 144 in full
• FINRA Regulatory Notice 09-05 — Unregistered Resales of Restricted Securities

Free trading shares: frequently asked questions

Is free trading shares the same thing as commission-free trading?

No. Commission-free trading describes a broker that charges no commission on a retail order. Free trading shares is a securities-law description of the stock itself: shares that carry no restrictive legend and can be resold into the market without a further exemption or registration. The two phrases share a word and nothing else.

How do restricted shares become free trading?

By one of two routes. Either a resale registration statement covering the shares is declared effective and the holder sells under that prospectus, or the Rule 144 holding period runs and the remaining Rule 144 conditions are satisfied. Rule 144 is not available for a current or former shell company except on the Rule 144(i) conditions, so on those facts the registered route may be the only one.

Who actually removes the restrictive legend?

The transfer agent removes it, but only on instruction. In market practice the holder delivers a representation letter, issuer counsel opines that the legend may be removed, the issuer instructs the agent, and the agent then issues unlegended shares or credits them electronically. No single party can complete the sequence alone.

Are shares issued in a PIPE transaction free trading at closing?

No. Securities issued in a PIPE transaction are unregistered, so they are restricted securities in the investor's hands and carry a legend. They become freely tradable only when a resale registration statement covering them is effective, or when Rule 144 becomes available. Securities sold in a registered direct offering are registered when issued.

How long does legend removal take?

There is no timeline an issuer or a capital provider can promise. It depends on issuer counsel, the transfer agent, the depositing broker's own review and on the security being free of any restriction at the depository. Timing is never guaranteed, and a counterparty who quotes a fixed number of days is describing a hope rather than a rule.