Are securities issued through an employee stock benefit plan or as compensation for professional services considered "restricted securities?"

Nasdaq’s Rule 5005(a)(37) provides the framework for determining when securities are considered “restricted securities,” including those issued through employee stock benefit plans or as compensation for professional services. One key aspect of this rule is its connection to Rule 701 under the Securities Act of 1933, which governs the issuance of securities under certain compensation plansIf a company issue shares in accordance with Rule 701, those shares may be classified as restricted securities under U.Sfederal securities laws, affecting how and when they can be traded. 

Understanding how Nasdaq applies these regulations to companies issuing stock as part of compensation packages or stock benefit plans is crucial, as these types of issuances are common among major publicly traded companiesThis process typically involves regulatory guidelines that ensure such shares cannot be freely sold on the market without meeting certain conditions, such as holding periods or specific exemptions. 

Securities Issued Under Rule 701 and Their Restricted Status 

Rule 701 of the Securities Act of 1933 allows private companies to issue shares to employees and certain other individuals as compensation without the need for SEC registrationWhen a company like Palantir Technologies (PLTR), prior to its public listing, issued shares as part of an employee compensation plan under Rule 701, these shares were considered restricted securitiesThis classification arises because Rule 701 provides an exemption from registration but still subjects the securities to specific limitations, particularly regarding resaleThese securities remain restricted until the company either becomes publicly traded or the holding period and other conditions are met. 

For instance, companies such as Coinbase Global (COIN), which utilized stock options and grants to reward employees prior to going public, often relied on Rule 701Under this rule, shares issued to employees would not be immediately tradable upon issuanceIf a company later goes public, as was the case with Coinbase, these previously issued shares would continue to be restricted under federal securities laws until the conditions set forth in Rule 701 are satisfiedThese restrictions protect the market from sudden influxes of shares and ensure compliance with regulatory requirements, which aim to prevent excessive volatility. 

Compensation for Professional Services and Stock Issuances 

In addition to employee stock plans, companies often issue securities as compensation for professional servicesThis practice is common in sectors such as technology, biotech, and other high-growth industries where companies like Tesla (TSLA) or Snap Inc(SNAP) may offer stock compensation to consultants, advisors, or other service providers in lieu of cash paymentsThese stock-based compensations are also governed by federal securities laws and Nasdaq regulationsIf the securities are issued under Rule 701 or similar frameworks, they will be considered restricted until certain criteria are met. 

For instance, in the case of Uber Technologies (UBER), early-stage advisors and consultants who helped the company during its rapid growth might have received stock as part of their compensationIf these shares were issued under Rule 701 or another exemption, they would be subject to restrictions on resaleThese restrictions ensure that the shares cannot be freely traded until certain holding periods have passed or other legal requirements have been fulfilledNasdaq's classification of these shares as restricted further regulates how they enter the public market, maintaining market stability and preventing any unregulated or excessive dilution of the company's stock. 

Resale Restrictions Under U.SFederal Securities Laws 

When securities are considered restricted under U.Sfederal securities laws, this classification is rooted in the regulatory framework designed to protect public markets from excessive volatility and to ensure compliance with established lawsFor instance, Rule 144 under the Securities Act of 1933 sets the conditions under which restricted securities can be resoldThis rule establishes criteria such as holding periods, volume limits, and the requirement for certain disclosures, particularly for affiliates and insiders. 

For a company like Robinhood Markets (HOOD), which went public with significant employee and insider stock ownership, shares issued to employees prior to the initial public offering would likely be considered restricted securitiesUnder Rule 144, these shares would be subject to a holding period, generally six months to one year, before they could be resold on the open marketAdditionally, insiders or affiliates of the company, such as executives or large shareholders, would need to comply with volume limitations and other regulatory conditionsThis ensures that the resale of restricted securities happens in a controlled manner, preventing a sudden and disruptive influx of shares into the market. 

Similarly, Airbnb (ABNB), after its highly publicized IPO, faced similar challenges with restricted securities issued to employees and service providers under compensation plans prior to going publicMany of these shares were subject to Rule 144's conditions before they could be freely traded, ensuring that the company complied with federal securities laws while maintaining control over its stock liquidity and price stability. 

Lockup Agreements and Their Intersection with Restricted Securities 

Restricted securities issued under compensation plans or Rule 701 can also be subject to lockup agreements, which further restrict the resale of these shares following a company’s initial public offeringLockup agreements are commonly employed in IPOs, where insiders, employees, and other significant shareholders are prohibited from selling their shares for a specified period, typically 90 to 180 days. 

For example, Snowflake (SNOW), after its IPO, subjected many of its employees and insiders to lockup agreements that restricted the sale of their stock for several monthsThese shares, already classified as restricted securities under Rule 701 or other compensation plans, could not be traded until the lockup period expiredOnce the lockup agreement expired, the restricted shares still had to meet the requirements of Rule 144 before they could be resold in the market. 

Impact of Restricted Securities on Market Dynamics 

The classification of securities issued under employee stock benefit plans or as compensation for services as restricted can have significant implications for a company’s stock liquidity and market behaviorFor companies like Lucid Group (LCID) or Rivian Automotive (RIVN), which went public through SPAC mergers, the presence of restricted securities limits the number of shares immediately available for trading, reducing liquidity in the early stages of public tradingThis limitation on tradable shares can lead to price stability but may also contribute to volatility once the restrictions are lifted. 

The resale of restricted securities is typically monitored closely by both Nasdaq and federal regulators to ensure that a sudden influx of shares does not overwhelm the marketCompanies that issue significant amounts of restricted securities as part of compensation plans or other non-cash arrangements must carefully manage the timing and volume of share releases to avoid destabilizing their stock price. 

Conclusion 

Nasdaq’s Rule 5005(a)(37) and the corresponding federal securities laws provide a detailed regulatory framework for managing restricted securities, particularly those issued through employee stock benefit plans or as compensation for professional servicesCompanies like Palantir Technologies (PLTR), Tesla (TSLA), and Robinhood Markets (HOOD) have all utilized stock compensation plans that result in the issuance of restricted securities, which are subject to resale limitations under Rule 701 and other U.Sfederal securities laws. 

These restrictions, along with lockup agreements and the requirements of Rule 144, ensure that the sale of restricted securities happens in a controlled and regulated manner, preserving market stability and protecting investorsBy adhering to these regulations, companies maintain compliance with Nasdaq listing standards and federal securities laws while managing the distribution of their stock in a way that aligns with market expectations and protects the value of their publicly traded shares.