Revision of Holding Period Requirements in Rule 144; Section 16(a) Reporting of Equity Swaps and Other Derivative Securities

SECURITIES AND EXCHANGE COMMISSION

17 CFR Part 230

[Release Nos. 33-7187; 34-35896; File No. S7-17-95]

RIN 3235-AG53

Revision of Holding Period Requirements in Rule 144; Section

16(a) Reporting of Equity Swaps and Other Derivative Securities

AGENCY: Securities and Exchange Commission.

ACTION: Notice of proposed rulemaking.

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SUMMARY: The Commission is proposing to amend the holding period

requirements contained in Rule 144 (d) and (k) to permit resales of

``restricted'' securities after a one-year, rather than a two-year,

holding period, if the sale complies with all of the other provisions

of Rule 144. Securities held by non-affiliated shareholders could be

resold without restriction after a holding period of two, rather than

three years. In addition, the Commission is requesting comment on

whether Rule 144 should be revised to address new trading strategies,

such as equity swaps, and is reminding persons subject to reporting

under Section 16 of the Securities Exchange Act of 1934 (the ``Exchange

Act'') that reporting of these transactions is required under the

current rules.

DATES: Comments must be submitted on or before September 8, 1995.

ADDRESSES: Comments should be submitted in triplicate to Jonathan G.

Katz, Secretary, Securities and Exchange Commission, 450 Fifth Street

NW., Washington, DC 20549. All comment letters should refer to File No.

S7-17-95 and will be available for public inspection and copying in the

Commission's Public Reference Room.

FOR FURTHER INFORMATION CONTACT: Richard K. Wulff, Office of Small

Business Policy, Division of Corporation Finance at (202) 942-2950.

SUPPLEMENTARY INFORMATION: The Commission is proposing to shorten the

holding periods in Securities Act of 1933 (the ``Securities Act'')

1 Rule 144,2 the non-exclusive safe harbor for resales of

``restricted'' securities 3 and securities held by affiliates of

the issuer. Under the proposal, the holding period for resales of

limited amounts of securities by any person would be reduced from two

years to one year, and the holding period for resales by non-affiliates

without compliance with any provisions of the rule would be reduced

from three years to two years.4 This release also includes a

discussion of whether Rule 144 should be amended to reflect new trading

strategies, such as equity swaps, and a reminder to persons subject to

reporting under Section 16 of the Exchange Act 5 that reporting of

these transactions is required under the current rules.

\1\ 15 U.S.C. 77a et seq.

\2\ 17 CFR 230.144.

\3\ ``Restricted securities'' are defined in Rule 144(a)(3). See

infra Note 7.

\4\ The Commission has established the Advisory Committee on the

Capital Formation and Regulatory Processes (the ``Advisory

Committee''), chaired by Commissioner Steven M.H. Wallman. The

Advisory Committee is considering fundamental issues relating to the

regulatory framework governing the capital formation process,

including whether the current system of registering securities

offerings should be replaced with a company registration system. The

recommendations of the Advisory Committee may result in rule

proposals or legislative recommendations that, if endorsed by the

Commission, ultimately may address the matters discussed in this

release. Under some of the company registration models now being

considered by the Advisory Committee, many of the legal distinctions

between publicly offered and privately placed securities would be

eliminated, including the concept of restricted securities.

Securities issued by a company registered with the Commission would

be freely tradeable, regardless of the public or private character

of the transaction.

\5\ 15 U.S.C. 78p.

[[Page 35646]]

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I. Background and Proposal

The Commission adopted Rule 144 in 1972 6 to provide an

objectively determinable safe harbor for resales of ``restricted''

securities and ``control'' securities. ``Restricted'' securities

generally are securities issued in private placements; 7

``control'' securities are securities owned by affiliates of the

issuer. The rule provides that a person that complies with its terms

and conditions will not be engaged in a distribution of securities and,

thus, not be an underwriter 8 for purposes of the Section 4(1)

exemption from Securities Act registration for ordinary trading

transactions.9

\6\ Release No. 33-5223 (January 11, 1972) [37 FR 591].

\7\ ``Restricted'' securities include those acquired from the

issuer or an affiliate in a transaction or chain of transactions not

involving a public offering; those acquired from the issuer and

subject to resale limitations under Regulation D, 17 CFR 230.501-508

or Rule 701, 17 CFR 230.701; those subject to the Regulation D

resale limitations and acquired in a transaction or chain of

transactions not involving a public offering; and those acquired in

a transaction or chain of transactions meeting the requirements of

Rule 144A, 17 CFR 230.144A.

\8\ See Section 2(11) of the Securities Act.

\9\ Section 4(1) exempts transactions by persons that are not

issuers, underwriters or dealers.

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The rule includes holding periods for ``restricted'' securities to

establish that the holder did not purchase with a view to an

unregistered public distribution. Under the rule, all ``restricted''

securities must be held at least two years before any can be resold,

measured from the time the securities were purchased from the issuer or

an affiliate. For ``restricted'' securities held between two and three

years, other provisions of the rule require that the issuer be

providing certain current information about itself, that limited

amounts of securities are resold, that the resales are effected in

ordinary brokerage transactions or directly with a market-maker, and

that a notification of the resale is filed with the Commission. After a

three-year holding period, ``restricted'' securities may be resold by

non-affiliates without compliance with any of these provisions.

The length of the holding period for ``restricted'' securities

significantly impacts the costs of raising capital in private

placements since investors require that the price of the securities be

discounted commensurate with the market risk during the holding period.

In each of the past four years, the small business community has asked

the Commission through the annual Government-Business Forums on Small

Business Capital Formation to consider shortening the Rule 144 holding

period.10 The two-year holding period has been in place since the

rule was adopted in 1972; the concept of ``free'' resales for non-

affiliates after three years was adopted in 1981.11 In 1990, the

rule was revised 12 to permit the holding period to be measured

from the time that the securities were purchased from the issuer or an

affiliate, so that holders may tack each other's holding periods,

rather than requiring the entire holding period for each holder.

\10\ Final Reports of the SEC Government-Business Forum On Small

Business Capital Formation (June 1992) (June 1993) (June 1994)

(February 1995). The Small Business Investment Incentive Act of 1980

directs the Commission to host this annual meeting for the purpose

of reviewing ``the current status of problems and programs relating

to small business capital formation.'' Pub. L. No. 96-477, Section

503, 94 Stat. 2275, 2292-93 (1980).

\11\ Release No. 33-6286 (February 6, 1981) [46 FR 12195].

\12\ Release No. 33-6862 (April 23, 1990) [55 FR 17933].

Based on the Commission's experience with Rule 144 in the 20 years

since adoption, the Commission believes that it is appropriate to

enhance the utility of the safe harbor, and reduce costs for private

capital formation, by shortening the holding periods. Consequently, the

Commission is proposing that the holding period applicable to limited

Rule 144 resales be reduced from two years to one 13 and the

holding period for ``free'' resales by non-affiliates reduced from

three years to two. The Commission believes that these proposed holding

periods are sufficiently long to establish that the securities were not

purchased with a view to a public unregistered distribution.

\13\ Conforming changes also are proposed to be made in

paragraph (e)(3) relating to determining the limitations on the

amounts resalable by pledgees, donees and trusts, reducing the

period from two years after the event of pledge default, donation or

trust acquisition, to one year.

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Comment is requested as to whether the proposed revisions to the

holding period are appropriate. Are these periods sufficient to assure

that persons relying upon Rule 144 are not engaged in a public

distribution of securities inconsistent with the Section 4(1) ordinary

trading transaction exemption? Should the periods be retained, or

should the proposed periods be changed to be shorter or longer? If

other holding periods are suggested, the basis for the selected holding

period should be indicated.

II. Equity Swaps and Other Like Investment Strategies

A. Treatment Under Rule 144

In 1990 when the Commission amended Rule 144 to allow tacking of

the holding period between investors, the Commission also deleted the

provision that previously tolled the holding period if the holder

engaged in short sales, puts or other options to sell

securities.14 The intervening 5-year period since implementation

of the holding period revisions has evidenced the growth of a variety

of investment strategies associated with separating the bundle of

rights that make up a security: strategies that are used in both the

private and public securities markets. Through the use of equity swaps,

forward contracts, derivatives and other financial tools, holders of

restricted and control shares are selling interests in such shares

while retaining legal title to the ``underlying'' security. Today,

record or beneficial ownership does not necessarily reflect who holds

the voting, investment or income interests of a security.15

\14\ In 1990, the Commission rescinded former subdivision (d)(3)

of Rule 144, which generally tolled the holding period while a

holder had a short position in or an option to sell securities of

the same class as the restricted securities.

\15\ See Release No. 33-7190, which addresses other issues

relating to equity swaps and similar transactions.

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The Commission is examining whether it may be appropriate to revise

Rule 144 to reflect the economic realities of these transactions. For

example, is it appropriate to treat securities as ``held'' in the

private markets if the economic risk of the investment has been shifted

to the public markets? If not, should this be addressed through

reintroducing holding period tolling concepts for periods when the

holder is not at risk, or should the rule be revised to require

compliance with the rule when the risk shifting transaction to the

public markets occurs? If Rule 144 were to be revised to address these

questions, what changes would best ensure that the economic benefits

and risks of investment are not shifted during the prescribed holding

period? Also, should any possible revisions distinguish between

companies that are and are not widely followed in the market and, if

so, why? In addressing the question generally, commenters should

provide their views as to the need to have a fungibility doctrine

underlie Rule 144 to assure that the safe harbor in fact protects

resales that are not part of the distribution and that are consistent

with investment intent.

B. Reminder of Requirement To File Section 16 Reports

Questions are being raised as to the adequacy of information to the

markets about the securities transactions effected through equity swaps

and similar

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strategies.16 In August 1994, the Commission's release proposing

revisions to rules under Section 16 of the Exchange Act 17

included a discussion of reporting obligations arising from equity

swaps and similar risk-shifting transactions. In that release, the

Commission stated that Section 16 insiders must report equity swaps and

similar transactions in equity securities of the issuer,18 unless

the swap relates solely to interests in securities comprising part of

specified market baskets or indices of stocks.19

\16\ See Rocker, ``Short Interest: No More Bullish Bellow,''

Barron's, May 1, 1995.

\17\ Release No. 34-34514 (August 10, 1994) [59 FR 42449].

\18\ The term ``insider'' as used in this release refers to

officers, directors and holders of more than ten percent of a class

of equity securities who are subject to Section 16.

\19\ 59 FR 42449, 42457, footnote 101 and accompanying text. No

Section 16 consequences would flow from a swap transaction to the

extent the swap relates solely to interests in securities comprising

part of a broad-based, publicly traded market basket or index of

stocks, approved for trading by the appropriate federal governmental

authority, that are deemed not to confer beneficial ownership for

purposes of Section 16 pursuant to Rule 16a-1(a)(5)(iii) [17 CFR

240.16a-1(a)(5)(iii)] and/or are excluded from the definition of

``derivative securities'' pursuant to Rule 16a-1(c)(4) [17 CFR

240.16a-1(c)(4)].

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The release provided the following example of an equity swap

required to be reported. An insider agrees to pay to the counterparty

for a period of three years the value of dividend payments on 100,000

shares of issuer common stock, in exchange for payment of a fixed

interest rate based on the market value of the 100,000 shares of stock

at the commencement of the swap term. The parties also agree that at

the end of the swap term, the insider will pay to the counterparty the

cash value of any appreciation on the shares during the term, or,

conversely, the counterparty will pay to the insider the cash value of

any depreciation. The insider retains title to and any voting rights in

the securities.

The release suggested a method of reporting entering into and

closing out the swap using stock appreciation and depreciation rights

and deemed acquisitions and dispositions of the underlying securities.

In setting forth this analysis, the Commission specially noted in the

release that it was not suggesting that previously filed forms

reporting swap transactions in another manner needed to be revised, or

that swap transactions reported differently would be subject to

disclosure pursuant to Item 405 of Regulations S-B or S-K.20 The

release solicited comment on whether the Commission's approach reflects

economic reality and whether a separate reporting code for equity swaps

is needed. The Commission wishes to remind Section 16 insiders that

reporting at the time these transactions are entered into and when they

are closed out is required.21

\20\ 17 CFR 228.405 and 229.405.

\21\ To the extent settlement of the parties obligations occurs

on an interim basis during the term of the swap, such as quarterly,

the insider's Section 16 obligations would arise with respect to

each settlement.

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III. Summary of Initial Regulatory Flexibility Analysis

The Commission has prepared an initial regulatory flexibility

analysis in accordance with the Regulatory Flexibility Act.22 The

analysis notes that the amendments to Rule 144 are being proposed as a

result of recommendations developed at the SEC Government-Business

Forums on Small Business Capital Formation. The purpose of the

revisions is to remove unnecessary restrictions in the resale of

securities while maintaining important protections to the investing

public.

\22\ 5 U.S.C. 603.

A copy of the initial regulatory flexibility analysis may be

obtained from Twanna M. Young, Office of Small Business Policy,

Division of Corporation Finance, Securities and Exchange Commission,

450 Fifth Street, NW., Stop 7-8, Washington, DC 20549, (202) 942-2950.

IV. Statutory Basis, Text of Proposal and Authority

The amendment to the Commission's rule is being proposed pursuant

to sections 2(11), 4(1), 4(4) and 19(a) of the Securities Act.

List of Subjects in 17 CFR Part 230

Reporting and recordkeeping. Securities.

For the reasons set out in the preamble, title 17, chapter II of

the Code of Federal Regulations is proposed to be amended as follows:

PART 230--GENERAL RULES AND REGULATIONS, SECURITIES ACT OF 1933

1. The authority citation for Part 230 continues to read in part,

as follows:

Authority: 15 U.S.C. 77b, 77f, 77g, 77h, 77j, 77s, 77sss, 78c,

78l, 78m, 78n, 78o, 78w, 78ll(d), 79t, 80a-8, 80a-29, 80a-30, and

80a-37, unless otherwise noted.

* * * * *

2. Section 230.144 is amended by revising paragraphs (d)(1),

(e)(3)(ii), (e)(3)(iii), (e)(3)(iv) and (k) to read as follows:

Sec. 230.144 Persons deemed not to be engaged in a distribution and

therefore not underwriters.

* * * * *

(d) Holding period for restricted securities. * * *

(1) General rule. A minimum of one year must elapse between the

later of the date of the acquisition of the securities from the issuer

or from an affiliate of the issuer, and any resale of such securities

in reliance on this section for the account of either the acquiror or

any subsequent holder of those securities, and if the acquiror takes

the securities by purchase, the one-year period shall not begin until

the full purchase price or other consideration is paid or given by the

person acquiring the securities from the issuer or from an affiliate of

the issuer.

* * * * *

(e) Limitation on amount of securities sold. * * *

* * * * *

(3) Determination of amount. * * *

* * * * *

(ii) The amount of securities sold for the account of a pledgee

thereof, or for the account of a purchaser of the pledged securities,

during any period of three months within one year after a default in

the obligation secured by the pledge, and the amount of securities sold

during the same three-month period for the account of the pledgor shall

not exceed, in the aggregate, the amount specified in paragraph (e)(1)

or (2) of this section, whichever is applicable;

(iii) The amount of securities sold for the account of a donee

thereof during any period of three months within one year after the

donation, and the amount of securities sold during the same three-month

period for the account of the donor, shall not exceed, in the

aggregate, the amount specified in paragraph (e)(1) or (2) of this

section, whichever is applicable;

(iv) Where securities were acquired by a trust from the settlor of

the trust, the amount of such securities sold for the account of the

trust during any period of three months within one year after the

acquisition of the securities by the trust, and the amount of

securities sold during the same three-month period for the account of

the settlor, shall not exceed, in the aggregate, the amount specified

in paragraph (e)(1) or (2) of this section, whichever is applicable;

* * * * *

(k) Termination of certain restrictions on sales of restricted

securities by persons other than affiliates. The requirements of

paragraphs (c), (e), (f) and (h) of this section shall not apply to

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restricted securities sold for the account of a person who is not an

affiliate of the issuer at the time of the sale and has not been an

affiliate during the preceding three months, provided a period of at

least two years has elapsed since the later of the date the securities

were acquired from the issuer or from an affiliate of the issuer. In

computing the two-year period for purposes of this provision, reference

should be made to paragraph (d) of this section.

* * * * *

Dated: June 27, 1995.

By the Commission.

Margaret H. McFarland,

Deputy Secreatary.

[FR Doc. 95-16390 Filed 7-7-95; 8:45 am]

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