If you're an estate planner, you're probably not an expert in securities laws. But you may have clients who are “insiders” of publicly held companies or who own restricted securities — and these clients may be subject to federal securities laws and have certain reporting obligations or disclosure requirements that could impact how you structure their estate-planning transactions. Before you develop gifting, sales or transfer strategies for such clients, avoid the unintended consequences of making a mistake by knowing the basics of potentially applicable federal securities laws and how they operate.

Restricted Securities

Rule 144 of the Securities Act of 1933 (1933 Act) governs the sale or transfer of restricted securities and provides a safe harbor from the statute's registration requirements if certain conditions are met. Securities may be restricted for many reasons, but investors most often receive restricted securities through a merger or acquisition, employee benefit plan or in a private placement in exchange for providing start-up capital or services to a company. In the context of estate planning, it's important that gifts, sales and transfers of restricted securities comply with Rule 144.

Even otherwise unrestricted securities may be subject to transfer restrictions because of the status of their holder. For example, “control securities” are those held by an affiliate (sometimes referred to as an “insider”) of the issuing company and resale of such securities is restricted absent registration or the availability of a safe harbor such as under Rule 144. An “affiliate” is a person in a relationship of control with the issuing company (for example, an executive officer, a director or a shareholder with 10 percent or more control). The definition of “affiliate” also extends to family members living in the same home as the insider and trusts or estates in which the insider has an interest or in which the insider serves as trustee or executor.1

Holding Period

Generally, Rule 144 requires that restricted securities be held for either six or 12 months after a person acquires and fully pays for the securities. The holding period and resale restrictions depend on whether the shareholder is an affiliate and whether the issuing company is publicly traded. In most cases, non-affiliates can freely sell securities after six months, but sales by affiliates must satisfy the holding conditions of Rule 144.

In certain instances, a shareholder can make a gift or transfer of restricted or control securities and the donee or transferee will assume (tack on) the holding period of the previous holder (although the securities will remain restricted if they were restricted prior to the donation or transfer). Prior to any transfer, the shareholder should review the terms of any registration rights granted to him to confirm that the transferee will assume those registration rights.

In the following situations, a transferee should be able to tack on the transferor's holding period for Rule 144 purposes:

  1. gifts of restricted securities to a family member;
  2. transfers to a private foundation (PF) or public charity;
  3. transfers to a revocable or irrevocable trust;
  4. an inheritance of restricted securities from an estate, except that no holding period is required if the estate or the beneficiary isn't an affiliate of the issuer;2
  5. transfers to a limited liability company (LLC) or limited partnership (LP) wholly owned by the transferor;
  6. gifts of LLC or LP interests (if an LLC or LP owns the restricted securities) to a family member; and
  7. a division of community property between spouses.

The transferee will probably not be able to tack on the transferor's holding period in the following circumstances:

  1. an installment sale in which the transferor sells shares to a trust for the benefit of his family members; and
  2. certain reorganizations of LLCs or LPs that hold restricted securities.

Volume Limitations

In addition, Rule 144 imposes volume limitations when selling restricted or control securities, such that the amount of securities that may be sold during any three-month period is generally limited to the greater of (1) 1 percent of the outstanding class of stock, or (2) the average weekly reported trading volume in the stock for the prior four weeks. In a planning context, sales by affiliates may be aggregated for purposes of applying the volume limitations. For example, sales by a donor and donee, and sales by a grantor and a trust, each will be aggregated for six months or one year, depending on the reporting status of the issuer company.3 In addition, because an estate may be subject to the volume limitation rules, these restrictions can create difficulty if an executor needs to sell assets to create liquidity to pay estate taxes. Before an affiliate sells restricted or control securities, he should consult a corporate or securities attorney to determine if other sales by any related parties would be aggregated with the affiliate's proposed sale, thereby reducing the number of shares otherwise eligible to be sold by the affiliate.

Who Must Disclose?

The Securities Exchange Act of 1934 (1934 Act) requires certain insiders and shareholders to disclose their ownership in publicly held companies and to report certain changes in ownership. Generally under Sections 13(d) and (g) of the 1934 Act, any person who acquires or holds beneficial ownership of more than 5 percent of a class of voting stock of a public company must disclose the ownership to the Securities and Exchange Commission on a Schedule 13D or 13G, depending on the circumstances of ownership. Subsequent increases or decreases in ownership must also be reported. For purposes of Section 13, “beneficial ownership” refers to the shared or sole power to vote or exercise investment power over the securities. Accordingly, a trustee of a trust that owns more than 5 percent of the voting stock of a public company generally will need to file a Schedule 13D or 13G, but the beneficiary won't (unless the beneficiary shares voting or investment power).

In addition, Section 16(a) of the 1934 Act requires “insiders” of public companies to file reports with the SEC disclosing changes in the amount of equity securities of their company that they beneficially own. For purposes of Section 16, “beneficial ownership” refers to an insider's pecuniary interest in the securities, or the ability, directly or indirectly, to share in any profit from a transaction in the securities.4 An insider is deemed to beneficially own securities held by members of his immediate family that share the insider's household and may include securities owned by a trust held for the benefit of an insider's family members.

The basic forms Section 16 requires are the Form 3 (filed upon initially becoming an insider), Form 4 (filed to report transactions that create changes in beneficial ownership) and Form 5 (an annual statement). Form 4 filings generally are due within two business days following the transaction. The insider may not need to immediately disclose on a Form 4 certain transactions that only affect a change in the insider's form of ownership of the securities (such as a transfer to the insider's spouse) but instead may disclose the change on the next required Form 5.

While the insider should always consult with his attorney to confirm the required disclosures for his particular situation, the following are common examples of reporting obligations for estate-planning transfers:

Transfer to a revocable trust

The insider will be deemed to beneficially own the shares in the trust and shouldn't need to disclose the transfer on a Form 4, but he should continue to report the shares as beneficially owned on subsequent Forms 4 and 5.5

Gifts

Gifts to family members, charities and PFs shouldn't trigger immediate reporting obligations (although some attorneys may recommend voluntary reporting on a Form 4) but should be reported on the next required Form 5 or otherwise required Form 4.6

Gifts to an irrevocable trust for the benefit of the insider's spouse and children

If the insider is the trustee or retains investment control over the trust assets, then the insider will continue to have beneficial ownership over the trust assets and should report the change on the next required Form 5 or earlier on a Form 4. If the trust has an independent trustee (that is, the insider doesn't retain investment control over the trust assets), then the transfer to the trust should be reported on Form 4. Moreover, if as a result, the trust owns 10 percent or more of any class of stock or 5 percent or more of any class of voting stock, the trustee will need to determine whether the trust, in addition to the trustee, must file reports under Section 16.

Charitable remainder trust

A contribution to or distribution from a charitable remainder trust of which the insider is the trustee and sole beneficiary shouldn't trigger immediate reporting obligations on a Form 4.7 The insider should continue to report the shares owned by the trust on the annual Form 5. If the trust sells the securities, however, then the insider should report the sale on a Form 4.

GRAT

Assuming the insider (grantor) is the trustee and sole annuitant of a grantor retained annuity trust (GRAT) during the initial term, the insider doesn't need to report the funding of the trust with issuer securities or the subsequent annuity payments, but instead may reflect his updated holdings on the next required Form 4 or Form 5. (If the insider isn't the trustee and has no control or investment authority over the trust, then he will not be deemed to have beneficial ownership of the trust assets for purposes of Section 16 and therefore should file a Form 4 to reflect the change in ownership.) If the insider (grantor) is the trustee, then any sale of securities by the GRAT should be reported on a Form 4 and any distribution of securities at the end of the annuity term may be reported as a gift on a Form 5 or the earlier required Form 4.8 If the grantor's children are the remainder beneficiaries, then the grantor should be able to continue to report the shares owned by his children as long as the children share his home.

Contribution to LLC/LP

A transfer of securities to an LLC or LP managed and controlled by the insider shouldn't trigger any immediate reporting obligation but should be reflected on the next required Form 4 or Form 5, unless the transfer changes the pecuniary interest of any person in the securities.9 Note that limited partners are generally not deemed to have a reportable interest in the partnership.

While some transactions may not technically need to be reported until the year-end Form 5 is filed, it may be a good idea to voluntarily disclose the transaction on a Form 4 to avoid the risk of late filing.

Short-swing Profit Liability

Section 16(b) of the 1934 Act provides that an insider is liable for any profits he realizes after engaging in “short-swing” transactions in the issuer's equity securities. Liability for short-swing profit is triggered if the insider engages in both a sale and a purchase (without regard to which transaction occurs first) of the company's equity securities within any six-month period. However, certain transactions may be covered by one of the several exemptions to the short-swing profits recovery provisions, such as transfers of securities through gift or inheritance.

As with Section 16(a), an insider is deemed to beneficially own stock held by certain members of his family or owned by trusts or partnerships. Accordingly, sales and purchases by certain related parties or entities may be attributed to the insider and create liability under Section 16(b). For example, if an insider purchased issuer stock in January and his spouse sold issuer stock in May, the transactions would be matched and the insider would be liable for any profits.

Because each estate-planning situation is unique and seemingly minor facts may result in unintended consequences, it's important to consult with an attorney prior to any person, trust or entity related to an insider engaging in any transactions involving securities of an issuer. The following are some examples of estate-planning transactions and the potential Section 16(b) implications:

Gift

A gift generally isn't treated as a purchase or sale for purposes of Section 16(b).10 However, a net gift (when the donee agrees to pay the gift tax generated by a gift of issuer securities) may be treated as a purchase and sale since the donee's payment of tax is considered a partial sale for tax purposes.

Sale of securities owned by a trust

If a trust whose holdings are deemed beneficially owned by an insider sells securities of the insider's company, the insider should avoid any purchases of the company's stock within six months of the sale. In addition, because purchases and sales by a trust (of which the insider is trustee) may be linked to the insider's own purchases and sales, the insider may want to consider using an independent trustee to avoid the issue.

GRAT

The SEC has taken the position that contributions to and annuity payments made from a GRAT (of which the insider is the grantor and trustee) are deemed to be mere changes in beneficial ownership and shouldn't be deemed to be a sale or purchase for purposes of Section 16(b).11 However, the Southern District of New York has held that a distribution of issuer securities from a GRAT to a grantor (after the grantor exercised the power to substitute property of an equivalent value into the trust) constituted a purchase for purposes of Section 16(b).12 Although this decision has been widely criticized, insiders should use caution if considering a sale of insider securities within six months of the receipt of GRAT annuity payments. Further, if the trustee of the GRAT is independent of the insider and the insider doesn't control investment decisions of the GRAT, the insider won't be deemed to be the beneficial owner of the securities inside the trust. Purchases and sales of issuer securities by the GRAT, therefore, shouldn't be attributable to the insider.13

LLC

A contribution or sale of securities to an LP or LLC (if the insider has investment control of the entity) shouldn't be treated as a sale or purchase.14 However, a sale of LLC interests in which the LLC owns issuer securities, should be treated as a sale for purposes of Section 16(b).

PF

A PF that owns issuer securities should be treated separately from the insider for purposes of Section 16(b), if the insider isn't an officer or director of the PF.15 Accordingly, if the PF sells issuer securities, the sale shouldn't be attributed to the insider.

This article is for informational purposes only and is not intended as a basis for decisions in specific situations. UBS Financial Services Inc. does not provide legal or tax advice.

The author would like to thank C. Alex Bahn, of Hogan Lovells in Washington, and her dad, Jack Bjerke, of Baker Hostetler in Columbus, Ohio, for their review and comments.

Endnotes

  1. Rule 144(a)(2) of the Securities Act of 1933 (1933 Act).
  2. 1933 Act, Rule 144(d)(3)(vii).
  3. 1933 Act, Rule 144(e)(iii) and (iv).
  4. Rule 16(a)-1 of the Securities Exchange Act of 1934 Act (1934 Act).
  5. 1934 Act, Rule 16a-8(a)(2).
  6. 1934 Act, Rule 16b-5(a).
  7. Munger, Tolles & Olson, SEC no-action letter (Dec. 10, 1991).
  8. Peter J. Kight, SEC no-action letter (Oct. 16, 1997).
  9. 1934 Act, Rule 16a-13.
  10. 1934 Act, Rule 16b-5(a).
  11. Kight, supra note 8.
  12. Morales v. Quintiles Transnational Corp., 25 F. Supp. 2d 369 (S.D.N.Y. 1998).
  13. Dreiling v. Kellett, 281 F. Supp. 2d 1215 (W.D. Wash. 2003).
  14. 1934 Act, Rule 16a-13.
  15. A.L. Williams, SEC no-action letter (Jan. 21, 1987).

Ann D. Bjerke is a director and trusts and estates consultant at UBS Financial Services, Inc. in Chicago

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