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This asset-class requires special planning

When it comes to estate planning, addressing all of your assets is a priority. However, some assets require greater attention than others. For example, if your assets include unregistered securities, such as restricted stock or interests in hedge funds or private equity funds, you must consider the securities law implications of various estate planning strategies.

Securities laws 101

The federal securities regulation regime consists of four main laws:

  • The Securities Act of 1933, which is designed to protect investors by imposing registration and disclosure requirements on public offerings of stock. Several exemptions from the requirements exist, including private placements that meet certain specifications.
  • The Securities Exchange Act of 1934, which applies to trading of securities in the secondary market and prohibits some activities, including insider trading, fraudulent trading and market manipulation.
  • The Investment Advisers Act of 1940, which requires investment advisers to register with the U.S. Securities and Exchange Commision (SEC) and comply with certain regulations designed to protect investors.
  • The Investment Company Act of 1940, which obligates investment companies (such as mutual funds, closed-end funds and unit investment trusts) to register with the SEC and comply with applicable regulations. There’s an exemption from these demands — typically relied on by hedge funds and private equity funds — for companies that don’t make public offerings of their securities and limit participation in the fund to either 1) no more than 100 investors, or 2) qualified purchasers.

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.

Transferring securities

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:

  • It’s revocable, the grantor is an accredited investor, and certain other requirements are met,
  • The trustee is a bank or other qualified financial institution, or
  • It has at least $5 million in assets, it was