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New Markets for Unregistered Stock

July 1990

Recent actions of the Securities and Exchange Commission will make stock issued in private placements more marketable, stimulating capital formation and creating a new market in unregistered stock among institutional investors.

In order to avoid the high costs of registering stock with the SEC for public sale, companies seeking to raise capital often rely on exemptions from registration, frequently by offering securities privately to a select group of investors, rather than to the public generally. Until now, stock purchased in a private offering had to be held for at least two years before it could be sold. Some restrictions apply even after the holding period and are most severe for those in control of the issuer.

The SEC’s new Rule 144A does away with the holding period requirement for sales to qualified institutional investors and brokers. For example, an insurance company, bank or pension fund which meets the qualification requirements may purchase unregistered securities, either directly from an existing stockholder or from a broker, without waiting out any holding period and without subjecting the issuer or stockholder to additional regulation by the SEC.

The SEC has also approved rules of the National Association of Securities Dealers to establish a centralized market where qualified institutional investors can trade securities under Rule 144A. “PORTAL” (for “Private Offerings, Resales and Trading through Automated Linkages”) will provide a central database for quotations of listed, unregistered securities.

Taken together, Rule 144A and the PORTAL system will create a new market in unregistered securities. The existence of this market will increase the liquidity of unregistered stock and reduce costs associated with a long holding period. Investment should increase, both by large institutional investors who will now have access to an organized market for these securities, and smaller investors, such as venture capital funds and private “angels,” who will be able to sell unregistered stock without waiting for the holding period to expire.

TLB Comment : As a practical matter, Rule 144A will not be available to all issuers. Qualified buyers will have substantial existing portfolios and will be unwilling to invest either comparatively small amounts of money or the time and other resources necessary to monitor early stage companies. This will effectively limit Rule 144A to later-stage and fully mature companies in which a significant equity stake is available (depending on the buyer, probably a minimum of a few million dollars).

Rule 144A also r equires that potential institutional investors be able to get basic business and financial information of the issuer. Each holder of unregistered securities should be sure she has access to the information required to take advantage of the rule.