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Rule 415's Slim Pickings - Investors Stuck with Restricted Securities Face Holding on Private Sales

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By: Joe Gose | April 30, 2007

The SEC's interpretation of Rule 415 is forcing PIPE investors to prepare for the possibility that they'll be stuck with restricted shares longer than they had planned.  Unfortunately, outside of privately selling the restricted securities to another investor or waiting for a year to take advantage of the Rule 144 exemption to registration, few if any options exist. ...

Issuers, investors, transfer agents broker dealers, and attorneys for investors and issuers must prepare, review and substantiate dozens of documents to clear a Rule 144 sale.

Investors who want to shed restricted stock before the one-year holding period expires can seek buyers in a private transaction, though they face the potential of losing money.  Still, that may be preferable to the possibility of losing an even larger sum while waiting for Rule 144 to kick in.  In fact, Barry Silbert, CEO of Restricted Stock Partners (RSP) in New York, says his firm has seen an increase in activity in conjunction with the SEC's attitude shift on Rule 415.

"It's pretty clear that it has had a very positive effect on our business," says Silbert, whose firm matches up buyers and sellers of restricted stock through the company's Restricted Securities Trading Network (RSTN).  "We're seeing a increase in the number of positions being listed with us, as well as the number of investment banks and placement agents doing business with us.  I don't want to call it a vulture mentality, but we also have a lot of buyers now who, I think, have recognized that there are a number of situations out there that aren't going to get better soon where a private sale is the only alternative."

Since opening shop about three years ago, RSP has facilitated some 400 transactions, Silbert adds.  Rule 415's fallout, however, has yet to significantly influence discounts in the sales of restricted securities, says Espen Robak, president of Pluris Valuation Advisors in New York.  Pluris, an affiliate of RSP, provides valuation data on illiquid securities through its LiquiStatÔ database by tracking RSTN deals.  Early this year, Pluris completed a white paper that compared restricted security illiquid discounts in RSTN transactions with discounts from past private placement studies.

The white paper, "Discounts for Illiquid Shares and Warrants: the LiquiStat Database of Transactions on the Restricted Securities Trading Network," studied 61 common stock transactions from April 2005 to December 2006 – no warrants were included and cash was the only consideration that changed hands.  Among other findings, Pluris reported an average discount of 32.8% to current share prices in the transactions, with a minimum discount of 10.1% and a maximum discount of 65.7%.  Additionally, discounts gradually shrunk as the time period for Rule 144 eligibility shortened: They ranged from roughly 15% to 25% with about 30 days remaining, compared with a range of about 30% to more than 55% with close to a year remaining.

Moreover, Silbert suggests that discounts in general are a little tighter today compared with two years ago, regardless of Rule 415 pain, as the demand for restricted securities has kept up with supply.  "We've developed a buy side over the last 12 to 18 months and have a pretty good handle on where the discounts should be," he says.  "There's not a lot of uncertainty associated with the pricing of these transactions, whereas two or three years ago, we were just a couple of guys with phones and didn't have the experience under our belt." ...