Common Issues Related to the Sale of Gifted Stock

by Saul Ewing Arnstein & Lehr LLP

One of the more challenging aspects of managing a development office at a college or university is managing the sale of a gift of company stock.  While there is no set criteria for determining when to accept such a gift, or for managing a gift of company stock once received, we have seen a number of issues recurring.  This article provides a brief overview of the common issues colleges and universities face in dealing with the complexities of gifted company stock.

To Sell or To Hold?

An institution must decide whether to sell or hold the gifted stock.  While holding the stock of a hot public company may seem appealing due to its potential appreciation in value, development offices are generally not in the business of stock speculation, and not surprisingly, many institutions have an investment policy that calls for immediate liquidation of stock holdings.  This also ensures that the value of the gift can be realized and immediately deployed into more conservative investments.  With the increased volatility of the stock market, an excessive delay in resale can reduce the ultimate value of the gift.  For example, suppose the gift received is 100,000 shares of PubCo stock that is trading at $60 per share on the gift date.  If it takes 60 days to complete the resale and the price drops to $50 per share in that time, then the value realized on resale will be $1 million less than it was on the date of the gift.  Accordingly, a common strategy is to liquidate this stock as soon as possible after its receipt.

What are the obligations of owning a private company’s stock?

While it is generally possible to liquidate public company stock, private company stock, on the other hand, often has no resale market and the donee is forced to hold the stock until the sale or merger of the issuer or the potential initial public offering of the issuer’s common stock.  Holding private stock may create additional obligations or burdens for an institution.

For example, in a private company, an owner is often required to sign contracts that regulate ownership of the equity.  In a limited liability company, this contract is an operating agreement and in a corporation it is generally a shareholders’

agreement.  Institutions must be wary of restrictions on resale, additional capital contributions for future funding requirements or acquisitions, restrictive covenants such as non-competition agreements, and voting requirements.  The development office would be well-served in conferring with legal counsel about these additional obligations.

Is the stock of a public company registered or restricted stock?

The first step in the sale process of public company stock is to identify the status of the stock as either registered or restricted.  In order to resell stock in the United States, the resale either needs to be registered with the Securities and Exchange Commission ( “SEC”), or the seller must have some exemption from registration that applies to the sale in question.  The donor should be able to determine the status of the gifted stock.  If not, an inquiry to the issuer should provide the answer.

Registered Stock

Stock that has already been registered will generally only require the donee to (1) sign a seller’s representation letter and stock power covering the stock, and (2) deliver these executed documents to the issuer’s transfer agent.  However, when the stock has registration rights and the issuer completes the registration of the resale of the stock, the process becomes more complex.  In that scenario, the donee is listed as a selling stockholder on the registration statement and must comply with the securities laws or risk liability for failing to do so.  In addition, the donee will need to verify the accuracy and completeness of disclosure information listed in the selling stockholders section of the registration statement.  This information usually includes a brief description of how the institution acquired the stock and how it plans to dispose of the stock.  Once the shares are registered, the donee can sell the shares through a stock broker on the open market, to a market maker, or to another investor in a private transaction. 

In addition to these disclosures, the donee will also be required to sign an underwriting agreement that commits it to register the resale of the shares in the registration statement.  The underwriting agreement will contain various representations and warranties that the donee will be required to make to the issuer.  It is important for the donee to have its legal counsel review these representations and warranties to ensure that they are not overly broad.  In addition, counsel should verify that the underwriting agreement does not include any unreasonable covenants or obligations applicable to the donee.  Notably, the donee is expected to pay any commissions and legal fees that it incurs in connection with the sale of the stock.  Other than those commissions and fees, all other expenses related to the resale registration are generally paid by the issuer.

Restricted Stock

For restricted stock, the most common exemption from registration is Rule 144 promulgated under the Securities Act of 1933, as amended (“Rule 144”).  Rule 144 provides a safe harbor from classification as an underwriter for all parties that comply with its applicable requirements.

The first step in the resale of restricted stock under Rule 144 is to identify the status of the donor and to verify whether or not the donor is an affiliate of the issuer of the stock.  An affiliate is a party that has the ability to control the issuer and generally consists of either an officer, director or greater than 10 percent stockholder of the issuer.

For non-affiliates, as long as the shares have been held for at least six months, all of the shares can be sold.  In calculating this holding period, the donee will generally be able to include or “tack” the holding period of the donor.  In order to sell the shares, the non-affiliate will need to deliver a seller’s representation letter to the issuer’s transfer agent which confirms that the donee is a non-affiliate and has held the stock for the requisite holding period.  Affiliates must also comply with sales volume limitations, file Form 144 with the SEC reporting the proposed transaction, and adhere to a number of insider trading rules and requirements.  A development office will generally find counsel’s assistance necessary to navigate and satisfy these requirements.

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While the receipt of a stock gift is generally a win for a development office, such a gift presents a host of compliance issues and strategic considerations that will require the attention of the institution’s officers and legal counsel.  The ability to navigate these issues in an efficient manner is essential to liquidating the gifted stock in a manner that allows the institution to best use the funds to further its educational mission, just as the donor intended.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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