SEC Proposal Addresses Legend Removal Process

The SEC recently proposed updates to rules and forms applicable to transfer agents, including a new rule addressing the process to remove restrictive legends.¹ Comments should be received on or before November 3, 2026.

Proposed Exchange Act Rule 17ad-31: Restrictive Legends

Restricted securities are generally securities acquired in unregistered issuances from an issuer or in unregistered private transfers from affiliates. Typically, these securities bear legends indicating that they may not be resold without compliance with the registration requirements of Securities Act of 1933, as amended (Securities Act) unless an exemption from registration is available. Placement and removal of such legends are often the responsibility of transfer agents. Public resale of these securities typically requires removal of the legend, and transfer agents typically require an opinion of issuer’s counsel stating that the proposed sale is being made under a valid exemption from Securities Act registration before removing the legend. These opinions are often given by an issuer’s in-house counsel. However, in order to take advantage of the safe harbor provided by the proposed rule (described below), such opinions would have to satisfy specific substantive requirements, and could no longer be provided by in-house counsel; issuers would need to retain independent outside counsel to provide them.

As noted in the proposal, Securities Act violations “facilitated by the removal of restrictive legends have remained a perennial issue.” To address this concern, under proposed Exchange Act Rule 17ad-31, transfer agents would be required to:

• maintain a current list of issuer employees authorized to give instructions to the transfer agent on the placement and removal of restrictive legends (and may not act on instructions from anyone else); and
• refrain from facilitating (processing or recording) any “unregistered securities transaction” unless it has a “reasonable basis” to believe that the transaction does not violate, or is not part of a chain of transactions that would violate, Section 5(a) of the Securities Act.

“Unregistered securities transactions” include, but are not limited to: (i) an unregistered original issuance of securities; (ii) a request to remove a restrictive legend or stop order on any security; or (iii) the purchase, sale, or transfer (including a non-sale transfer) of a security by an affiliate, officer, or director of the issuer.

To establish the required “reasonable basis,” transfer agents should ensure that they are not aware of any “red flags” that may indicate that the transaction is “fraudulent, illegal or otherwise problematic.” Examples cited in the proposal include: “trading suspensions, concentration of ownership of the majority of freely tradeable securities, large reverse stock splits, companies whose assets are large but revenue is minimal, a shell company acquisition of a private company, incomplete or nonexistent issuer filings with the Commission, a sudden spike in investor demand for a thinly traded or low priced security, suspicious documents such as inconsistent financial documents or altered certificates of incorporation, an issuer with several recent name changes, business combinations, or recapitalizations, and receipt of similar documents from different issuers with certain characteristics, such as involvement of the same attorney.” Red flags should trigger reasonable further inquiry, and the transfer agent should proceed only if it has a reasonable basis to believe that the transaction will not facilitate a violation of the registration requirements of the Securities Act.

The proposed rule also includes a nonexclusive safe harbor which provides two methods by which transfer agents can establish that a “reasonable basis” for an unregistered securities transaction exists: (i) obtaining and reviewing an opinion of counsel with specified substantive requirements; or (ii) making their own determination that the transaction qualifies for a specific registration exemption. In order to rely on the safe harbor, the transfer agent must also not be aware of circumstances indicating that the transaction may violate, or is part of a chain of transactions that may violate, Section 5(a) of the Securities Act. This is intended to ensure there will be no “blind reliance” on opinions of counsel when there are “red flags” or “other circumstances that have alerted or should alert the transfer agent to potential problems with the transaction.”

The opinion of counsel must: (i) be from counsel who is not an affiliate, officer, director, or employee of either the issuer or the individual or entity seeking to resell shares of the issuer;² (ii) identify the documents and information reviewed and relied upon; and (iii) analyze the applicability and validity of a specific registration exemption and, based on that analysis, opine that the specific transaction may be conducted pursuant to the identified exemption.

Alternatively, a transfer agent may make its own determination (supported by written documentation reviewed and approved by management), that: (i) identifies the specific registration exemption for the transaction; (ii) identifies the documents and information reviewed and relied upon; and (iii) identifies and analyzes the specific facts, including the documents and information that establish and support such facts, that support the transfer agent's determination.

Potential Consequences

As noted in the proposal itself, the new rules may “cause transfer agents to spend more time performing due diligence of issuers and transactions, which may increase compliance costs, slow down the speed of transactions, and increase processing time.” The definition of “unregistered securities transactions” extends beyond legend removal for resellers of restricted securities (reaching, inter alia, private placements and unregistered equity compensation), and the “red flag” analysis may create time-consuming roadblocks for legitimate transactions. In addition, the opinion-based safe harbor does not permit opinions from in-house counsel. Issuers that would prefer to avoid the involvement of outside counsel in this process may wish to comment on the proposal.