When two companies merge, the larger company often will issue shares of restricted stock to give key employees and executives of the smaller firm a stake in the newly combined company. Restrictions on this type of stock are temporary. Once a restricted stock's holding period lapses, it can then be sold to other investors under certain conditions.
Purpose of Restricted Stock
Restricted stock is typically issued to key company employees and executives as an incentive. Sales restrictions on this stock exist for a few reasons. First, if a large number of people decide to sell their shares at once to cash in on gains they made from the company merger, it can have adverse effects on the price of the stock and harm other investors. Second, when people own stock in a company, they have a stake in its success, which can encourage them to work harder toward its success.
Restricted Stock Lapse
Restricted stock is regulated by U.S. Securities and Exchange Commission Rule 144, which states that certain conditions must be met before restricted stock can be sold. One usual primary condition is a holding period during which restricted stock shares cannot be sold. Holding periods can be either six months or one year, at the discretion of the company that issues them. Restricted stock lapses when the holding period expires. This does not mean, however, that it can be sold at will. Other restrictions might still apply.
Additional restrictions apply after shares lapse if you receive your shares as an affiliate. An affiliate company is the smaller company that receives shares of restricted stock during a merger. The smaller company takes a minority interest in the larger company when restricted shares are used to buy it out. Once shares lapse, non-affiliates may sell their shares at will, but affiliates must adhere to sales rules as outlined in SEC Rule 144.
If you received restricted shares as an affiliate, you can sell them once they lapse, but the way you sell your shares is still restricted. An affiliate may not sell more than 1 percent of total company shares outstanding in any three-month period. Before you sell your shares, you must file a notice with the SEC indicating your intention to sell. This allows other investors to see when affiliate members are selling shares in the company.
- U.S. Securities and Exchange Commission; Rule 144; Selling Restricted and Control Securities; August 2008
- Gimme Law: Rule 144 Opinion Letter, Restricted Stock Sales
- U.S. Securities and Exchange Commission. "Rule 144: Selling Restricted and Control Securities." Accessed Sept. 4, 2020.
- Internal Revenue Service. "Publication 550 (2019), Investment Income and Expenses." Accessed Sept. 4, 2020.
Donald Harder has been writing financial-related articles since 2000 when he founded the firm Securities Research Services. He has worked as a speech writer for the U.S. Department of Justice and written white papers and studies for the U.S. Department of Housing and Urban Development. Harder holds a Master of Arts in international affairs from George Washington University.