Wednesday, February 19, 2014

Rule 144 -- Are You an Affiliate?

This is from the SEC website:

“Control securities are those held by an affiliate of the issuing company.  An affiliate is a person, such as a director or large shareholder, in a relationship of control with the issuer. Control means the power to direct the management and policies of the company in question, whether through the ownership of voting securities, by contract, or otherwise.  If you buy securities from a controlling person or "affiliate," you take restricted securities, even if they were not restricted in the affiliate's hands.”

Unfortunately, the 1933 Act does not define the terms "control person" or "control relationship". However, the SEC in Rule 405 sets forth a definition of control as follows:
"The term "control" (including the terms "controlling," "controlled by," and "under common control with," means the possession, direct or indirect, of the power to direct or cause the direction of the management and policies of a person, whether through the ownership of voting securities, by contract, or otherwise.”
The SEC staff and the courts utilize two rather imprecise tests in determining who is a control person, or - using the terminology of Rule 144 - an "affiliate.
First, does the person in question have the power to direct corporate management and policies?
Second, does the individual have the power to compel the Issuer to file a 1933 Act registration statement covering a proposed sale?
Obviously these tests are largely subjective. Most securities lawyers take the position that, generally, all corporate directors as well as senior officers of a corporation are control persons of that corporation for 1933 Act purposes. Corporate officers below that level, as well as officers and directors of subsidiaries are, generally, not presumed to be control persons. The identity and number of 1933 Act control persons will vary from company to company.
With regard to 1933 Act control status, it is clear that corporate officers or directors positions are not the only defining characteristic in determining whether or not one is considered a control person. Large share ownership is also indicative of control status.
However, again, there is no precise test such as the 10% test applied to certain insiders under the Securities Exchange act of 1934. It largely depends upon the conditions surrounding each case.
For example, persons occupying a certain relationship with a control person may themselves be treated as control persons. A relative or spouse of a control person living in the same home is also a control person. Any relative of a control person's spouse -- for instance, a mother-in-law sharing the same home -- may also be found to be a control person.
Therefore, you may or may not be considered a control person depending upon your ongoing relationship with the company, your relationship with other control persons, or your continued ownership of a large block of the company's shares.
The SEC advises that beneficial ownership of more than 10% percent of an issuer’s outstanding equity securities generally gives rise to presumptive affiliate status.

In addition, affiliate status could be attributed through other indicia of control, such as board representation and negative control rights. 

Although the presumption is rebuttable, a person who claims that he is not an affiliate in order to use the exemption from registration has the burden of proving the availability of the exemption.

While there is not a substantial body of law surrounding this issue for Rule 144, there are a number of cases discussing this issue under Sections 15 and 20(a) of the Securities and Exchange Act.

In looking at these cases, we are concerned here only with what fact patterns establish control.

Actual control or the ability to control is certainly enough. In some cases, the courts have ruled that indirect means of discipline or influence is enough.

Some cases have found possession of potential power, to control is enough, not actual use of that control.

Inaction by a defendant is enough where it is willful or done intent to further some misconduct.

Outside directors have on occasion found to be liable. Outside directors who own stock have been found to be liable.

Officers and directors have been found to have control, naturally. Officers and directors with significant stock holdings obviously have control. People who make or sign misleading statements may be found liable. Other employees of an issuer have been found to have control, as have persons acting in disguised capacities, nominal, figurehead or de facto office holders.

 Rule 405, by its language, refers to control broadly as "the possession, direct or indirect, of the power to direct or cause the direction of the management and policies of a person whether through ownership of voting securities, contract, or otherwise."

Control depends in part on the influence of an individual.

Control can be inferred from a result. For example, one court held that where the controlling persons so dominated those controlled as to be able to gain upwards of 90% of the stock from the owners, those facts demonstrated control.

We suggest that if you own at least 10% of the stock or if you are a director or are in senior management you should consider yourself to be a control person and an affiliate. If members of your immediate family are any of the foregoing you are an affiliate or control person.


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