Restricted securities: Overview, definition, and example
What are restricted securities?
Restricted securities are securities that cannot be freely traded or sold in the open market due to certain legal or contractual restrictions. These restrictions typically apply to securities issued by private companies, or those acquired through private transactions, such as in an employee stock option plan or through a private placement. These securities are subject to a holding period or other conditions that limit their transferability until certain criteria are met.
For example, shares issued to company executives as part of a stock compensation plan may be classified as restricted securities, meaning they cannot be sold until a certain period has passed or other requirements have been met.
Why are restricted securities important?
Restricted securities are important because they protect the issuer, prevent market manipulation, and ensure compliance with securities regulations. They also allow companies to maintain control over the timing and manner in which securities are sold or transferred, which can help stabilize the market and prevent sudden fluctuations in stock prices.
For investors, understanding the nature of restricted securities helps them assess their ability to sell or transfer the securities and plan accordingly.
Understanding restricted securities through an example
Imagine an employee of a private company is granted 1,000 shares as part of their compensation package. These shares are classified as restricted securities, meaning the employee cannot sell or transfer them for a set period, typically one year, as per the terms of the stock option agreement. After the holding period expires, the employee may then be allowed to sell the shares on the open market.
In another example, a company raises funds by issuing restricted securities through a private placement. The investors who purchase these securities are prohibited from selling them on the public market until they have held the securities for a specific period, typically six months or a year.
An example of a restricted securities clause
Here’s how a restricted securities clause might look in a contract:
“The Shares issued under this Agreement are classified as restricted securities and may not be sold, transferred, or otherwise disposed of except in compliance with the applicable securities laws and the terms of this Agreement. The Buyer agrees to hold the Shares for a minimum of [Insert Time Period] from the date of issuance before attempting to transfer or sell them.”
Conclusion
Restricted securities are subject to legal and contractual restrictions that limit their transferability, helping to ensure compliance with securities regulations and maintaining market stability. These securities play a key role in private company offerings, stock compensation plans, and other investment arrangements.
By understanding the terms of restricted securities clauses, businesses and investors can manage expectations around the timing and ability to sell or transfer securities, ensuring compliance with applicable rules and regulations.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.