Litigation of Rule 144 Restrictions: Beyond Rattling the Saber

If you want a primer on how Rule 144 works, Google it, because this is not the article for you. This is for the CEO and real big time shareholder who knows enough is at stake that they will do more than make veiled threats, and do more than get their transfer agency to freeze something for the usual 30 day period awaiting a court order to proceed one way or the other. If all you have been willing to do is threaten to that point, then please leave the room, or grow a pair and learn a little. If all the kids have left the room, I will proceed. Here is a tip, if you think you can call the SEC to resolve a legend removal, well think again (and actually read their position that they do not get involved). It is up to state law as far as the SEC is concerned. That means judges, evidence, pleadings, and convincing evidence at either the Federal or State level.

What you will learn in this article is several important key points for the potential litigant of a Rule 144 matter. This article assumes the holding period is met for the type of company involved. We also assume the shares were issued to you and you have them. Most important you will learn the mindset you will need to go the rest of the way. Most essential and up front, calculate the maximum cost of the fight vs. the cost of giving in and letting the shares hit the market or not cashing in if you had them to sell. Sometimes you have to let things lie as they are, or be prepared for what could become years of litigation and great expense.

This is about the rubber meeting the road and convincing courts across the country of why they should side with you and keep a restriction of shares on, or take them off. At this point the gloves come off, the check books open, and the fight is on for real, in court, with real litigation, not just an opinion letter about what you should be entitled to by Mr. X, Esquire in Topeka. By the way, if you consult with counsel who is definitely seeing your side, ask for their qualifications in fighting (and winning) Rule 144 related litigation. Also ask him or her if they actually have been inside the courthouse since law school so he can tell you where to park.

Every CEO has had the problem of what to do about shares of stock that he wants to keep out of the market. Whether it was a bad consultant, bad PR guy, or just someone you don’t want to be able to get their shares freed up because he is your ex brother-in-law or that oh so special someone they hold so dear for taking them for a ride. It all comes down to Rule 144.

Just as bad is being on the other side, the holder of the shares, who may very well, without question (at least in their mind) be totally entitled to the exemption from registration under Rule 144 in order to be able to deposit and sell the shares. They have met all the qualifications of holding time, are an outsider, and did all the services or paid for the shares and just know they are entitled to sell them as they want without further restrictions.

Recently as an example, while involved in a plethora of litigation around the removal and anti-removal of Rule 144 restriction I am involved in, I won a decision against a Company who was attempting to keep stock restricted by throwing all sorts of allegations at the shareholder. It was everything short of “he did my dog while I was not looking” defenses against my client. In a fairly quick decision in my clients favor (two months), the United States District Court in Los Angeles, California effectively handed the shares over, when the Court denied the Company’s preliminary injunction to continue to lock up the stock (i.e. not remove the legend); thus we won, and the transfer agent, to their credit, removed the legend immediately. C’est la vie. War won, after massive litigation within 2 months. 44 documents filed, and dozens of exhibits later. Total cost, well enough to keep me in it with blood zeal.  Sell, sell, sell.

On the other hand, if you are a company, most usually you have some promoter or fundraiser who promised A and you think you got crap in return. Well, we can’t let them go ahead and get away with it can we?! Or, the more accurate answer is, do we owe it to our shareholders to spend X to stop them. So you better know several things before you do this litigation thingy. First, you cannot get a transfer agent to stop shares, without formally opposing the reissuance under Rule 144. That will usually buy you 30 days before the TA requires a “court order” or similar court simulated kerfuffle to stop them from freeing up the shares. I say kerfuffle, because sometimes filing the suit and trying to get dates for hearings even beyond the 30 days can keep the TA at bay. Winning of course is the next step. Any transfer agent worth their salt will not give you more time than 30 days to freeze things without a lawsuit. You need to actually file suit and get things done; quickly. Thus, comes 1) the check book for counsel and 2) an ability to know what the hell they are doing to get it done.

The Steps to Consider:

Cost (or How Not to Slay Windmills). It should be self evident that this is a business decision no matter if you are the issuer wanting to block the shares or the shareholder wanting to free the shares up. You should not go pay $20,000 in legal costs to stop $10,000 in stock issuance or pay that much to get the same freed up. In reality, you may just choose to suck it up, take the hit of the shares on the market, spread the bad word about the miscreant who took the shares and move on with your business. As a thumbnail, you likely will not get even a preliminary injunction for less than $10,000 in legal fees.

Counsel considerations. In selecting counsel, get one with a pulse who knows the before mentioned parking spaces. Other than that, make sure you get a maximum fee written into the contract, and make sure they know issues involved and have the experience. This is your biggest decision in the Business Decision part of the equation. You are past the bluffing stage at this point. Be prepared to pay for it. Don’t hire the most expensive counsel, but the most keyed into your situation. Also, your general counsel may be a choice if they have the litigation expertise. By the way litigation means actual court room experience, not transactional. Make sure they know the evidence issues and what is or is not admissible short of testimony.

Jurisdiction (Be the Home Team). This is a big point; check with your counsel on the facts, but consider this in your discussion. To flat out have a no brainer, file in the county and state where incorporated. But who wants to litigate in Reno, Nevada, or Tallahassee, Florida, or god forbid, Dover, Delaware. If you have a contract on your side for jurisdiction, meaning in your back yard if written correctly, then file at home. If not then go to where they operate from; a Nevada company may very well be operating in Orlando, Florida, so you may  be able to file there. Also, consider, that you may be able to bring suit against the transfer agent, and only name them as a party if they are wrongfully acting against you. However, if you are the company, you normally will not sue your own transfer agent but can make them an interested party, since they are the home team for you. No matter where you are, if counsel for a company, make sure the judge knows that you are representing hundreds (thousands) of shareholders not just the CEO who shows up with you. That has a great effect on judges.

Knockout First Strategy. Many times this works well for my client, and if not, it at least places you much further down the road that much sooner than normal. Don’t just sue them with a complaint, go for the jugular with an immediate either temporary or preliminary injunction. If you are a company you can even get an injunction heard without notice to the other side, which is a temporary injunction to the TA to stop their freeing up the shares. But it is just that, temporary, until the court can hear more evidence. A temporary injunction will not work for a shareholder to free up shares since the company has a right to respond. However, a preliminary injunction can work to get the shares freed up, if you can present enough admissible evidence in the form of affidavits, documents which are certified to get into evidence under the rules of court, and otherwise can make your side look like it will be the ultimate winner at a trial should it occur. Several times I have won this type of action within two months or less. Maybe the company will not appear at all, (or as some do, try to appear without counsel, which cannot be done by a corporation), or the evidence I present is enough to just flat win since it is admissible evidence in the right form under the rules of evidence.

The “Google” Effect. I call it this because more than once, the threat of publicity can force an issuer (or shareholder for that matter) to back off in the face of a press release that they are now involved in litigation, citing just facts from the case filing, but none the less making it seem to all the world that someone is a wretch in one way or the other. Actually, most if not all litigation will show up on I-Hub anyway, so it is just not avoidable. Fair game? Sure, why not. As long as you are not threatening criminal actions or saying you have pictures of the CEO with a dead hooker or something, it is fair commentary on current litigation and can be made, or not made if you settle with my client. No CEO or consultant wants a bad read on Google.

Deeper Pockets- Attacking the Transfer Agent. Remember, the TA is on the hook for a “wrongful” failure to act, if they are doing so in the face of overwhelming evidence. They could be liable for your lost profits as a shareholder, so remember to invite them to the party (sue them) if at all possible and they seem liable. TA’s are not there to blindly do what a company wants, but as a company you want them on your side. In the end, they are the ones who remove the legend, either by court order, settlement or because they see the writing on the wall and decide it is in  their best interest (i.e. not be subject to a large judgment and insurance claim) because they backed the wrong horse. Get them involved and named from the start. As to jurisdiction, if they are a TA they usually would be subject to jurisdiction in the state where the corporation is domiciled since they are doing business within that state.

Evidence, Evidence or How to Deflate a Tire. All clients come in thinking they will win. Before the back slapping starts, realize what is and is not evidence and what is admissible in court. You have to get past hearsay (what others wrote or said) to get documents and statements into evidence. Make sure your counsel knows the business evidence exception, so that many of your 144 related documents can come in through just the client, including the resolutions for issuance, the contracts involved, the opinion letter related to it,  transfer agent forms, etc. Just because Mr. CEO told Mr. X something does not mean it is admissible in court (it could be or not). When considering a case, a competent lawyer views it through what will be admissible and how he gets it in, or how he blocks it. Make sure you have signed documents for everything you received related to the transaction. Filing these under oath in an injunction filing can win or partly win the case.

Defenses (and the “Sheep Slander”). If on the side of the plaintiff, be it the company or shareholder, I always know what is next from the defense. Yep, my side was fraudulent in representations to other side, and by the way they sleep around with farm animals. Best defense is offense, so if you are bringing the suit, the other side will say you either did not perform, or even if you did, you lied to get the shares. If, of course, you have a record of being a convicted felon of some sort for fraud, it makes your case “somewhat” [sarcastic understatement for don’t bother] more difficult to win if you have a past full of misdeeds. If you do not, then you need to grow thick skin and move on and defeat their allegations with proof of performance or payment or fill in the blank as applicable how you got the shares. If you are a consultant or funder you may not want the cloud out there that you have been accused of fraud, unless you are willing to explain it away to other potential clients and do so believably, because it will come up. (See Google Effect).

Discovery and Litigation (or War and Peace as light reading). If you find yourself so far down the road responding to interrogatories and requests for production of documents for the third time, you might want to reevaluate the business decision to begin with. If you can’t win in the first three rounds, do you really want to keep going at this pace of costs and expenses.

In summary, dealing a knockout blow quickly to a 144 action is important, if you do it as a wise business decision. Select knowledgeable and experienced counsel, and be prepared to hit and win fast in the forum of your choosing. Most important get your records straight and know how to practice Sun Tzu law. After all, it’s your stock, so why don’t you keep it, or sell it, whichever suits your side.

Toll Free: (888) 914-4144 or email: Craig@securuslawgroup.com