What is Rule 144A?
Rule 144A modifies the Securities and Exchange Commission (SEC) restrictions on trades of privately placed securities so that these investments can be traded among qualified institutional buyers, and with shorter holding periods—six months or a year, rather than the customary two-year period. While the Rule, introduced in 2012, has substantially increased the liquidity of the affected securities, it has also drawn concern that it may help facilitate fraudulent foreign offerings and reduce the range of securities on offer to the general public.
The Impetus for Rule 144A
Before a security can be offered to the general public, the Securities Act of 1933 stipulates that the issuer must register it with the SEC and provide extensive documentation through a filing with the agency.
- Rule 144A modifies SEC restrictions so privately placed securities can be traded among qualified institutional buyers with much shorter holding periods and no SEC registration in place.
- The idea is that sophisticated institutional investors don’t need the same levels of information and protection that individuals require.
- Critics have noted a lack of transparency and unclear definitions of what constitutes a qualified institutional buyer.
- Concerns endure that Rule 144A may give unscrupulous overseas companies undue access to the U.S. market without SEC scrutiny.
Rule 144A, however, was drawn up in recognition that more sophisticated institutional investors may not require the same levels of information and protection as do individuals when they buy securities. The Rule provides a mechanism for the sale of privately placed securities that do not have—and are not required to have—an SEC registration in place, creating a more efficient market for the sale of those securities.
Rule 144A Holding Requirements
In addition to not requiring that securities receive SEC registration, Rule 144A relaxed the regulations over how long a security must be held before it can be traded. Rather than the customary two-year holding period, a minimum of a six-month period applies to a reporting company, and a minimum one-year period applies to issuers not required to meet reporting requirements. These periods begin on the day the securities in question were bought and considered paid in full.
Public Information Requirement
A minimum level of public-accessible information is required of the selling party. For reporting companies, this issue is addressed as long as they are in compliance with their regular reporting minimums. For nonreporting companies (also called non-issuers), basic information regarding the company, such as company name and the nature of its business, must be publicly available.
Trading Volume Formula
For affiliates, there is a limit on the number of transactions, referred to as the volume, that cannot be exceeded. This must amount to no more than 1% of the outstanding shares in a class over three months or the average weekly reported volume during the four-week period preceding the notice of sale on Form 144.
The sale must also be handled by the brokerage in a manner deemed routine for affiliate sales. This requires no more than a normal commission be issued, and neither the broker nor the seller can be involved in the solicitation of the sale of those securities.
To meet filing requirements, any affiliate sale of over 5,000 shares or over $50,000 during the course of a three-month span must be reported to the SEC on Form 144. Affiliate sales under both of these levels are not required to be filed with the SEC.
Concerns Over Rule 144A, and Responses
As the Rule succeeded, as intended, in increasing non-SEC trading activity, concern rose at the number of trades that were all but invisible to individual investors, and even murky to some institutional ones, as well. In response, the Financial Industry Regulatory Authority (FINRA) in 2014 began to report Rule 144A trades in the corporate debt market. "We're excited to increase transparency in this opaque market. The information will help professional investors and contribute to more efficient pricing of these securities, as well as inform valuation for mark-to-market purposes," said Steven Joachim, FINRA executive vice president, Transparency Services.
Also, in 2017 the SEC itself responded to questions about the definition of “qualified institutional buyers” allowed to participate in Rule 144A trades, and how they calculate the requirement that they own and invest on a discretionary basis at least $100m in securities of unaffiliated issuers.
Still, some concerns endure about the effects of Rule 144A, including how it may allow unscrupulous overseas companies to fly under the regulatory radar when offering investments in the U.S. As Dan Caplinger put it in Motley Fool, "many [Rule 144A] transactions involve securities of foreign companies that don't want to subject themselves to SEC scrutiny, and that exposes U.S. institutions to the potential for fraudulent representations from those foreign issuers"