Written by: Eliana Cotton and Peter Dzuba Esq.
Part II of a two‑part series examining the real‑world mechanics of Rule 144, including legend removal, legal opinions, and compliance pitfalls that shareholders and companies must manage during secondary transactions.
I. The SEC’s Anti-Evasion Warning: “Plans or Schemes”
In the SEC’s “Preliminary Note” to Rule 144, we find the following caveat: “The Rule 144 safe harbor is not available to any person with respect to any transaction or series of transactions that, although in technical compliance with Rule 144, is part of a plan or scheme to evade the registration requirements of the [Securities Act].” Examples of problematic patterns include: pre-arranged buyers, sham transfers among related parties, sellers attempting to reset a holding period artificially, and myriad of other fact patterns. Because the SEC generally looks at substance over form, startups should always consult experienced securities counsel before any secondary transaction.
II. Why Rule 144 Does Not Automatically Make Shares “Free Trading”
A common misconception is that once Rule 144 is satisfied, the shares become unrestricted or “free trading.” This is not true. Startup stock certificates (or electronic book entries) will generally carry the following restrictive legend:
“THE SECURITIES REFERENCED HEREIN HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AND HAVE BEEN ACQUIRED FOR INVESTMENT AND NOT WITH A VIEW TO, OR IN CONNECTION WITH, THE SALE OR DISTRIBUTION THEREOF. NO SUCH SALE OR DISTRIBUTION MAY BE EFFECTED WITHOUT AN EFFECTIVE REGISTRATION STATEMENT RELATED THERETO OR AN OPINION OF COUNSEL IN A FORM SATISFACTORY TO THE COMPANY THAT SUCH REGISTRATION IS NOT REQUIRED UNDER THE SECURITIES ACT OF 1933.”
In practice, the restrictive legend, not Rule 144 alone, governs the process. Whether the company uses an outside transfer agent or handles its own transfers internally (as most startups do), the entity performing the transfer-agent function faces potential liability under Section 5 of the Securities Act if it registers an unlawful transfer. As a result, the legend is treated as a strict instruction not to transfer or reissue the shares unless the issuer verifies compliance and authorizes the removal.
To proceed with a Rule 144 transfer, the holder must provide a legal opinion confirming that the proposed sale is exempt under Section 4(a)(1) of the Securities Act and that the conditions of Rule 144 have been satisfied. The issuer (or its counsel) reviews the opinion and, if satisfied, issues a written authorization directing that the restrictive legend be removed. If the company uses an external transfer agent, the agent will act only upon the issuer’s instructions. If the company serves as its own transfer agent, as is common in early-stage startups, it processes the legend removal directly upon approving the exemption.
Put differently, Rule 144 is necessary but not sufficient. Compliance with Rule 144 does not itself remove the legend; it merely entitles the holder to request removal. Only after the issuer authorizes removal does the transfer-agent function, whether performed internally or by a third-party agent, become purely ministerial and obligated to register the transfer.
Note: While many startups use only the standard SEC restrictive legend above, founder, employee, and early investor shares often carry multiple legends (e.g., rights-of-first-refusal, lock-up restrictions, contractual transfer limitations). These additional legends do not disappear under Rule 144 and typically remain in place until the applicable agreement expires or the company formally waives the restriction.
III. Practical Implications for Startups and Early Holders
Rule 144 is straightforward in principle but highly procedural in practice. For startups and early shareholders, several practical considerations arise:
- Plan Ahead for Secondary Liquidity: Startups should anticipate founder liquidity, employee secondary transactions, early investor exits, and establish internal processes for reviewing Rule 144 compliance.
- Maintain Accurate Cap Table and Issuance Records: Rule 144 analysis often turns on accurately tracking points in time, including “date of purchase,” “fully paid,” and “date issued.” Ambiguous or sloppy records create real problems.
- Communicate Clearly with Holders: Misunderstandings around “free trading” status frequently frustrate employees and investors. Clear policies and guidance help prevent friction.
- Coordinate Closely with Counsel and Transfer Agents: Every Transfer agent has its own procedures, timelines, and required documentation. Having experienced counsel ready to help guide the process is essential.
Conclusion
Rule 144 is a powerful mechanism for enabling shareholder liquidity in private companies, but its requirements, particularly for affiliates, are highly technical and easy to misapply. Although the rule provides a safe harbor that removes sellers from “underwriter” status, the real-world process of legend removal, transfer-agent coordination, and exemption analysis demands careful navigation. Startups should plan ahead and engage trusted securities counsel early to navigate these nuances and mitigate avoidable delays or compliance risks.
Peter Dzuba is an attorney at Barakat + Bossa PLLC. He advises clients on complex corporate transactions, including mergers and acquisitions, financings, fund formations, and regulatory compliance. Peter brings a multifaceted background in corporate law, immigration, and cross-border investments. He may be reached at pdzuba@b2b.legal.
Eliana Cotton is a law clerk at Barakat + Bossa PLLC and a third-year law student at the University of Miami School of Law. Her interests lie at the intersection of business, real estate, and emerging regulatory frameworks, with a focus on securities regulation, cryptocurrency, and fashion law. She may be reached at ecotton@b2b.legal.
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