What is a Restricted Stock?

Published by Thomas Herold in Investments, Laws & Regulations, Trading

'Restricted Stock' is explained in detail and with examples in the Trading edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.

Restricted Stock refers to those company stock shares which prove to be unregistered. These are typically issued out to affiliates of the corporation such as the directors, board, company insiders, and company executives. Because this stock class is non-transferable, it can only be traded as those SEC special regulations set out. This stock class is often referred to as letter stock or Section 1244 stock. It commonly becomes available for sale under the guidelines of certain vesting schedule provisions which transpire over a few years’ time in most cases.

Companies have two different types of such awards they can make in reward for faithful service which goes above and beyond the call of corporate performance and duty. These are restricted shares of stock and restricted stock units. The difference is that the units could be offered either as cash or stock shares. This will always be spelled out in the award letter or agreement. The units which are converted to stock do so at a typical one for one ratio. The underlying shares do not actually become issued until the unit fully vests. This means that the voting rights on the shares underlying the units will not yet be available. Units are also not paid dividends as they are not yet physical shares of stock. There are plans though which credit the dividend equivalents for the underlying stock to the account in any case. Taxes become due on such awards only when they fully vest.

It was actually in the years of the middle 2000s that such restricted stock shares grew in popularity and practice with companies. Corporations were made to expense out stock option grants. Insiders of the company receive restricted stock following merger and acquisition transactions, affiliate ownership, or underwriting activity to keep them from advance selling shares which could negatively impact the firm. When executives choose to leave the company, they could forfeit all shares of their non-vested restricted stock. Failing to attain set standards of performance or to measure up to corporate and personal goals are other reasons for inadvertently forfeiting their stock shares. If they run afoul of the Securities and Exchange Commission and its stringent trading restrictions, they might similarly lose their promised shares.

This matters enormously since the SEC’s regulations which govern all restricted stock trading and transactions are contained within the SEC Rule 144. It lays out very clearly and specifically the ways and means for registering and publically trading any stock shares that are restricted as well as the limits placed upon volume and holding periods.

Restricted stock is also taxed under the Internal Revenue Service codes which are laid out in Section 1244 of their IRS Code. The computations and regulations are quite complicated. Holders of such stock which is restricted will have to pay capital gains or losses tax which is figured up based on the difference from the value of the underlying shares at the time of vesting and the date where the holder sells the shares. Such restricted stock shares become taxed in the year in which they vest as ordinary income. In other words, the share awards are treated as compensation. Those amounts which holders must declare to the government as income are the fair market value of the vesting date less the original exercise price of the underlying shares.

Those restricted stock share awards can be forfeited by the recipient if he or she were to leave the company earlier than their vesting. This would happen regardless of whether the separation was voluntary or involuntary in the end. Any taxes which were prepaid to the IRS on shares that had not yet vested would be non-refundable, making the matter more complicated still.

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The term 'Restricted Stock' is included in the Trading edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.