Legal Definitions - restricted security

Restricted Security

A restricted security is an investment, such as a stock or bond, that cannot be freely bought or sold on public markets without meeting specific conditions or waiting for a certain period. These restrictions typically arise because the securities were acquired through a private sale from the issuing company, rather than through a public offering registered with regulatory bodies like the U.S. Securities and Exchange Commission (SEC). The purpose of these limitations is often to ensure that investors have access to sufficient information about the company before the securities are widely traded, protecting the public market from potential fraud or manipulation.

Examples:

• Example 1: Startup Employee Stock Options
  Imagine Sarah, an early employee at a tech startup, receives stock options as part of her compensation package. When she exercises these options, she acquires shares directly from the company. These shares are typically considered restricted securities because they were not sold to her through a public market offering. She might have to hold them for a specific period, perhaps six months or a year, before she can sell them on a public exchange, and even then, she might be subject to volume limitations on how many shares she can sell at once.
  Explanation: Sarah's shares are restricted because they were acquired directly from the company in a private transaction, not through a public offering. The restrictions ensure that the market isn't flooded with shares from insiders without proper disclosure.
• Example 2: Private Placement to Institutional Investors
  A growing biotechnology company needs to raise capital quickly but doesn't want to go through the lengthy and expensive process of a full public offering. Instead, it conducts a "private placement," selling a large block of its stock directly to a few large institutional investors, such as hedge funds or pension funds. The shares purchased by these institutions are restricted securities. They cannot immediately resell these shares to the general public; they must hold them for a specified period, often a year, before they can be sold on a public exchange, or they might only be able to sell them to other qualified institutional buyers.
  Explanation: The shares are restricted because they were sold directly to a limited number of sophisticated investors in a private transaction, bypassing the public registration process. This limits their immediate resale to the broader public market.
• Example 3: Shares Acquired by a Company Executive
  John is the Chief Financial Officer (CFO) of a publicly traded manufacturing company. As part of his compensation, he receives a bonus in the form of company stock directly from the company, rather than buying it on the open market. These shares are considered restricted securities because they were acquired directly from the issuer by an "affiliate" (an executive with control over the company). Even though the company's stock trades publicly, John's specific shares are subject to restrictions, meaning he cannot sell them immediately or in unlimited quantities. He must typically hold them for a certain period and then sell them under specific rules, often involving volume limits over a set timeframe.
  Explanation: John's shares are restricted due to his status as an affiliate of the company and how he acquired them (directly from the issuer). This prevents insiders from unfairly profiting or manipulating the market by quickly offloading large amounts of stock without public scrutiny.