Under the Securities Act of 1933, all offers and sales of securities must be registered with the Securities and Exchange Commission (SEC) unless an exemption applies. One of the conditions of the Regulation D safe harbor from SEC registration is that the issuer must take reasonable care to ensure the issued securities are not bought by Section 2(a)(11) underwriters. If a shareholder’s resale of stock is considered a “distribution,” the shareholder is considered an underwriter. Therefore, including a restrictive legend on securities helps establish that the issuer took reasonable care to comply with the conditions of Regulation D.
It is possible for shareholders to resell their securities in a way that would jeopardize the issuer’s original exemption from registration. One way for a startup to create mechanisms to prevent this is a stock legend. Thus, when a security is initially issued in an unregistered transaction, the company will typically include a restrictive legend on the security to:
- Identify the restricted nature of the security;
- Make clear the shareholder’s inability to freely resell; and
- Demonstrate the company’s attempted compliance with the exemption requirements.
When it comes time for a holder of shares to consider selling, the same principle of finding a security exemption for an unregistered offering will apply and most holders rely on the safe harbor of Rule 144. If the shareholder resells its shares in accordance with Rule 144, the resale is considered exempt from registration under Rule 4(a)(1) of the Securities Act.
For questions about resales or ensuring that your offering is compliant as an unregistered offering, please contact us at info@bendlawoffice.com or (415) 633-6841.
Disclaimer: This article discusses general legal issues and developments. Such materials are for informational purposes only and may not reflect the most current law in your jurisdiction. These informational materials are not intended, and should not be taken, as legal advice on any particular set of facts or circumstances. No reader should act or refrain from acting on the basis of any information presented herein without seeking the advice of counsel in the relevant jurisdiction. Bend Law Group, PC expressly disclaims all liability in respect of any actions taken or not taken based on any contents of this article.