Unregistered shares, also known as restricted stock, are securities not registered with the Securities and Exchange Commission (SEC). They are usually issued through private placements, Regulation D offerings, or employee stock benefit plans as compensation for professional services, or in exchange for funding a startup company.
For example, a privately-held company might issue unregistered shares to its executives and board members as part of their compensation package.
Key Takeaways
- Unregistered shares are any form of company stock that does not have an effective registration statement on file with the SEC.
- Unregistered shares have fewer investor protections and pose higher risks so certain criteria—such as being a high-income investor—are usually required in order to be sold these shares by a company.
- Investors can avoid being scammed through unregistered securities by verifying if a security is registered in the SEC’s EDGAR database online.
Understanding Unregistered Shares
Unregistered shares have fewer investor protections and pose different kinds of risks compared to registered securities. As a result, companies can only sell unregistered shares to “qualified investors.”
To be considered a “qualified investor,” one must be a high-net-worth individual (HNWI) or a high-income investor. Typically, a high-net-worth individual must have liquid assets in the six to seven figures. A high-income investor generally has an annual income of at least $200,000 individually or $300,000 for married couples.
In the past, soliciting or advertising unregistered shares was prohibited. However, the SEC adopted Rule 506(c) as part of the Jumpstart Our Business Startups (JOBS) Act in 2013, allowing certain unregistered securities to be solicited and advertised.
Selling unregistered shares is typically considered a felony, but there are exceptions to this rule. SEC Rule 144 specifies the conditions under which unregistered shares may be sold:
- They must be held for a prescribed period.
- There must be adequate public information about the security’s historical performance.
- The sale must be less than 1% of shares outstanding and less than 1% of the previous four weeks’ average trading volume.
- All normal trading conditions that apply to any trade must be met.
- Sales of more than 5,000 shares or more than $50,000 worth of shares must be preregistered with the SEC. An exception to this condition occurs if the seller is not associated with the company that issued the unregistered shares (and has not been associated with it for at least three months) and has owned the shares for more than one year.
Avoiding Unregistered Stock Scams
Sometimes investors can be taken advantage of through unregistered securities scams. These scams usually advertise the sales as private offerings with little to no risk but with high returns.
The SEC advises investors to be aware of the following red flags of potential fraud when considering unregistered offerings:
- Claims of high returns with little or no risk
- Unregistered investment professionals
- Aggressive sales tactics
- Problems with sales documents
- No requirements on net worth or income
- Only a salesperson seems to be involved
- Sham or virtual offices
- The company is not in good standing or not listed
- Unsolicited investment offers
- Suspicious or unverifiable biographies of management or the promoters
Investors can also verify if a particular security is registered by checking the SEC’s EDGAR database online. Stocks traded by the average investor will typically be registered in the database.
Related Terms: Restricted Stock, Regulation D, High-Net-Worth Individual, JOBS Act, Rule 144.
References
- U.S. Securities and Exchange Commission. “SEC Approves JOBS Act Requirement to Lift General Solicitation Ban”.
- U.S. Securities and Exchange Commission. “Investor Alert: 10 Red Flags That an Unregistered Offering May Be a Scam”.
- U.S. Securities and Exchange Commission. “EDGAR | Company Filings”.
