Posted On: FEBRUARY 2023
Do your assets include unregistered securities, such as restricted stock or interests in hedge funds or private equity funds? If so, it’s important to consider the securities law implications of various estate planning strategies.
Securities laws in a nutshell
The federal securities regulation regime consists of four main laws:
To avoid the time and expense of registering a securities offering with the SEC, many companies take advantage of an exemption that allows them to raise capital in an unregistered offering. The most commonly used exemption is Regulation D, Rule 506, which exempts offerings of an unlimited amount of securities, provided several conditions are met, including limiting purchasers to 1) any number of “accredited investors” (see below), plus 2) up to 35 nonaccredited, “sophisticated investors.” Purchasers in these transactions receive “restricted securities,” sales of which are subject to holding periods, volume limitations and other restrictions.
Potential estate planning issues
Transfers of unregistered securities, either as outright gifts or to trusts or other estate planning vehicles, can raise securities law issues. For example, if you gift restricted securities to a child or other family member, the recipient may not be able to sell the shares freely. A resale would have to qualify for a registration exemption and would likely be subject to limits on the amount that can be sold.
If you plan to hold unregistered securities in an entity — such as a trust or family limited partnership (FLP) — be sure that the entity is permitted to hold these investments. The rules are complex, but in many cases, if you transfer assets to an entity, the entity itself must qualify as an “accredited investor” under the Securities Act or a “qualified purchaser” under the Investment Company Act. And, of course, if you plan to have the entity invest directly in such assets, it will need to be an accredited investor or qualified purchaser.
Accredited investors include certain banks and other institutions, as well as individuals with either 1) a net worth of at least $1 million (excluding their primary residence), or 2) income of at least $200,000 ($300,000 for married couples) in each of the preceding two years.
A trust is an accredited investor if:
FLPs and similar family investment vehicles are accredited if 1) they have at least $5 million in assets and weren’t formed for the specific purpose of acquiring the securities in question, or 2) all its equity owners are accredited.
Qualified purchasers include individuals with at least $5 million in investments; family owned trusts or entities with at least $5 million in investments; and trusts, not formed for the specific purpose of acquiring the securities in question, if each settlor and any trustee controlling investment decisions is a qualified purchaser.
Federal securities laws and regulations are complex, so a full discussion of them is beyond the scope of this article. If your assets include unregistered securities, consult with us to be sure your estate planning strategies comply with applicable securities requirements.
Sidebar: Watch out for short-swing profit rule The insider trading laws generally make it unlawful for insiders — such as officers, directors and more-than-10% shareholders — to trade the company’s stock for their benefit (or recommend such trading to others) on the basis of material nonpublic information (MNPI). Insiders are required to report their holdings and certain transactions involving the company’s securities to the SEC.
In addition, under the short-swing profit rule, an insider’s profits generated by the purchase and sale of the company’s securities within a six-month period may be recovered by the company.
The rule is intended to discourage insider trading, but it applies regardless of whether the insider possesses any MNPI. The rule may affect certain transfers for estate planning purposes. For example, if you sell securities to a trust for which you’re the trustee and certain immediate family members are the beneficiaries, then transactions by you or the trust within the following six months may be subject to the rule, placing your profits at risk.