As the compliance deadline for family offices to register with the U.S. Securities and Exchange Commission (SEC) quickly approaches, the focus has shifted to alternatives to registration and the concomitant compliance requirements. According to the 2011 research study by the Family Wealth Alliance (FWA), 54.5 percent of single family offices (SFOs) lack clarity regarding the potential impact of the Dodd-Frank Act and the new rules.As SFOs struggle to comply with the new rules and attempt to avoid registration, private trust companies (PTCs) may provide one avenue of relief.
A Ticking Clock At the FWA Fall Forum in Chicago, family office industry experts estimated that as many as 80 percent of all SFOs haven’t yet addressed their obligations or exemption under the new rules. This lack of attention may prove problematic for those who don’t squarely fall within the SFO exception. Generally, family offices are required to comply with the new law on or before March 30, 2012. That date, however, is somewhat misleading since the SEC has estimated that it will take at least 45 days to process registrations, which would require a submission on or before Feb. 15, 2012. Moreover, as the SEC gets flooded with new registrations and exemption ruling requests, it’s highly foreseeable that the processing time will take longer, requiring even earlier submissions. Consequently, SFOs and their counsel should immediately assess their level of compliance with the new rules, thus providing time to register, seek an exemption order or restructure to avoid SEC registration.
SFO Concerns Private families and their advisors share some significant concerns despite the improvements made to the rules following the comment period. Many of these concerns stem from the relatively unrestrained power of the SEC coupled with onerous on-going requirements for registered investment advisors (RIAs). These requirements include submission and updating of filing obligations for the RIA entity (Form ADV) and each investment advisor (Form U-4). These filings are maintained in the investment advisor registration depository managed by the Financial Industry Regulatory Authority. The licensing period is annual and carries with it record keeping, custody disclosure, audit and possible fiduciary duty requirements. These requirements, in turn, highlight additional concerns relating to invasion of privacy and lack of confidentiality.
Action Items SFOs should immediately review their operations and structure to carefully assess their current compliance status. This is also an excellent opportunity to consider broader structural issues relating to privacy, asset protection, income tax issues, benefits and employee compensation. SFOs should also consider prophylactic steps designed to deal with tax authorities and the newly operational Internal Revenue Service wealth squad (that is, the ultra-high-net-worth specialty group focused on auditing affluent taxpayers). If the SFO concludes that it’s exempt, the SFO should establish procedures to document compliance now and on an on-going basis to prove the exemption and avoid inadvertent mistakes that would require registration. Similarly, SFOs should review and monitor compliance with state securities law requirements and other SEC rules. If the assessment is inconclusive, SFOs should consider promptly seeking an exemption order. SFOs that are required to register have several alternatives including: 1) registering after creating a captive investment firm or spinning off an investment subsidiary to limit SEC scrutiny to that enterprise alone; 2) outsourcing the investment function to a multi-family office (MFO), institutional trust company or other independent RIA; 3) moving (for global families) the investment function to an international SFO or, creating an international SFO to compliment the U.S.-based SFO; or d) forming a PTC, captive insurance company or private family bank. SFOs should be aware, however, that these approaches necessarily trade one set of government regulators for another.
PTCs Wealthy families have started to consider the benefit offered by creating the family’s own PTC. If an SFO restructures and implements a PTC, it can avoid the Dodd-Frank compliance burden. Certainly, not all families with an SFO will benefit from creating and maintaining a PTC. Nevertheless, given the right set of circumstances, the addition of a PTC can compliment an SFO. Because family needs differ, there’s no specific level of wealth that determines when the need for an SFO, MFO or PTC arises, but there are some general industry guidelines. Industry experts believe that the investable asset threshold is approximately $250 million for an SFO and $20 million for an MFO. While the MFO threshold is much lower, other factors are typically involved. A family will consider the services of an MFO when it feels it no longer can manage (or no longer desires to manage) the family wealth from a complexity perspective, and the family generally believes there’s enough accumulated wealth to outlast the controlling generation’s lifetime. A family should consider a PTC if it desires the advantages of an SFO, but wishes to have more control over the trustee and can handle the additional cost of implementing and maintaining a PTC. The family will seek to replace an existing corporate trustee with a captive, family-friendly trustee that will cater to the family’s needs while satisfying the requirements of a corporate trustee.
Why a PTC? Wealthy families create PTCs to act as an independent trustee for the family’s trusts. A PTC can be structured to meet the requirements of an independent fiduciary so that the trustee is a corporate trustee and the family retains greater control over the administration of the trust. This is especially common if the trust agreement (perhaps an older agreement) calls for a corporate fiduciary or the trustee succession has resulted in a successor corporate trustee. Note that a PTC tends to be a captive entity, because the family owns and controls it. For some families, this is the control feature they’re looking for over a traditional corporate fiduciary relationship.
Retention of Single Stock Holding One area in which control over the fiduciary decision-making function is critically important is the decision whether to diversify a single stock position. Some traditional corporate trustees may be hesitant to hold a single stock concentration at the request of the family. With a PTC, however, the decisionmakers are those same family members who benefited from the investment concentration or the advisors that those family members hire, and thus there’s a motivation to continue with the family’s long-term investment concentration philosophy. Therefore, in many situations, the single stock investment concentration is the driving force for the family to create a PTC, which insures the investment concentration will be retained in each of the family trusts.
Ease of Trustee Succession Continuity of trusteeship is another reason families consider a PTC. Long-term trusts established for multiple generations are common in affluent families. One issue that arises in the trust administration of long-term trusts is trustee succession. An inherent problem arises when the long-term trust outlasts the designated individual trustees. While many sophisticated trust documents provide for trustee succession provisions, not all documents for a family will necessarily have similar succession provisions, and suitable successors may be difficult to identify. Thus, the controlled management of trustee succession can be problematic.
Operation of the Trust Company A family’s PTC will be controlled by the family, but governed by the specific corporate governance provisions of the company. A common arrangement would be to have a board of directors for the company that’s comprised of a significant number of family members. That family-controlled board can then hire outside advisors to handle the trust company’s day-to-day operations. If a corporate fiduciary previously acted as the trustee and custodian over the family’s trust assets, that corporate fiduciary may very likely be retained by the PTC to serve in a custodial capacity or perhaps in an administrative capacity. Thus, the family maintains fiduciary decision-making control (a potentially uncomfortable role for the corporate fiduciary), yet continues to act in a custodial capacity (a routine function for the corporate fiduciary).