Who Should be the Trustee of Your Grantor Retained Annuity Trust?
A grantor retained annuity trust or GRAT is a very common estate planning tool. However, when a public company insider creates a GRAT using the public company stock, the insider needs to consider the Section 16 implications to the structure of the GRAT.
GRATs and Public Company Officers
Under Section 16(b) of the Securities Exchange Act, an insider (such as a director or officer) of a public company can be required to disgorge profits resulting from that insider’s purchase and sale of the public company’s securities within a six-month period, known as a short-swing profit. This mechanism was developed to deter insiders from using confidential corporate information for personal trading gain. While there are certain exceptions to the rule, insiders need to be careful whenever engaging in transactions involving the public company’s stock to make sure that they do not inadvertently trip up on Section 16.
Generally, a GRAT provides that the trustee makes an annuity payment to the grantor each year as defined in the GRAT. Often, the primary asset held in a GRAT is stock of the public company of which the grantor is an insider. Frequently, the trustee of the GRAT pays the annuity by distributing a portion of the stock held by the GRAT back to the grantor. The GRAT can have the grantor/insider as the trustee of the trust or it can provide for a separate trustee. The parties to the GRAT need to carefully consider the expected action by the GRAT in making the decision on who should be the trustee. This is where the Section 16 issue can arise.
Grantors as GRAT Trustees
If the grantor is the trustee, then generally when he or she contributes the stock to the GRAT it is only a change of form of beneficial ownership and the grantor is still considered the beneficial owner of the stock held by the GRAT. If, on the other hand, the grantor is not the trustee, then when the grantor contributes the stock to the GRAT, the Securities and Exchange Commission no longer deems it owned by the grantor/insider and any transactions in the stock by the GRAT is not deemed a transaction by the grantor.
Third Party Trustees
If one of the purposes of the GRAT is to diversify the grantor’s holdings, then having a separate trustee should be considered. If the GRAT intends to sell the company’s stock in the market and there is a separate trustee, the SEC would not deem such sales by the GRAT to be sales by the grantor/insider. However, in the event the GRAT has a separate trustee, the transactions between the grantor and the GRAT need to be considered carefully. If the grantor is not the trustee, then when the stock goes into the trust, the SEC no longer deems it owned by the grantor and instead considers it a gift to the GRAT. This is generally not a problem, because as a gift, it is exempted from Section 16 and is not deemed a sale. However, if any of the annuity from the GRAT to the grantor is settled in the stock of the company to which the grantor is an insider, then the SEC deems it a purchase by the grantor. The SEC deems the purchase price to be the grantor’s basis in the stock prior to giving it to the GRAT and as a purchase it is matchable against any sale of the company’s stock by the grantor in the six months before and after the distribution.
In addition, if there is a separate trustee, the grantor needs to be very careful that the trustee is independent of the grantor and that the grantor does not tell the trustee when to sell the stock. If the grantor tells the trustee whether and/or when to sell the company’s stock, it could lead to issues of tipping or insider trading and maybe even a challenge of whether the trustee was in fact separate from the grantor. Public company officers with GRATs should review their plan details with a securities lawyer to ensure there are no Section 16 violations. Questions about this article can be directed to Susan Sidwell at 615.251.1083 or susan.sidwell@h3gm.com.
