Key family office personnel often serve as fiduciaries of family trusts and business structures, exposing them to significant personal liability while providing a workable, though limited, fiduciary solution to those families.
This arrangement is common in single family offices (SFOs), but SFOs have a fiduciary alternative—a private trust company (PTC). Unfortunately, as a result of burdensome Securities and Exchange Commission regulations, a single PTC isn’t an option for families in a multi-family office (MFO). The retail trust company model, however, may offer an efficient, long-term solution.
What’s a Family Office?
A family office is typically thought of as an entity created by a wealthy family that provides investment, fiduciary and other services to family members, as well as to trusts for their benefit and to family entities. Some family offices are very large and provide significant services while others are streamlined and provide limited services. An MFO generally provides family office services to two or more unrelated families.
Regulating Investment Advisors
Section 202(a)(11) of the U.S. Investment Advisors Act of 1940 defines an “investment advisor” as any person or firm that: (1) for compensation, (2) is engaged in the business of, (3) providing advice to others or issuing reports or analyses regarding securities. Most family offices fall within the definition of investment advisor and, absent an exclusion, would need to register as an investment advisor with the SEC.
In 2011, the Dodd-Frank Wall Street Reform and Consumer Protection Act set forth exemptions and exclusions from registration with the SEC. There are two common paths for family offices to avoid regulation under the Advisors Act. The “family office exemption” and the “bank exemption.”
A “family office” is a company (that is, any kind of entity) that: (1) provides investment advice only to family clients, (2) is wholly owned by family clients and controlled (directly or indirectly) exclusively by family members and/or family entities, and (3) doesn’t hold itself out to the public as an investment advisor. It’s clear, however, that the Family Office Rule doesn’t apply to MFOs. Family members must be lineal descendants of a common ancestor (including such family members’ spouses and spousal equivalents). MFOs, by definition, provide services to unrelated families.
Regulated banks also are exempt from Advisors Act registration. A “bank” is defined as: (1) a banking institution organized under the laws of the United States or a Federal Savings association, (2) a member bank of the Federal Reserve System, (3) any other banking institution, savings association or trust company doing business under the laws of any State or of the United States, and (4) a receiver, conservator or other liquidating agent of any institution or firm included in the above. An MFO isn’t a bank and doesn’t qualify as such under the Advisors Act.
States generally regulate MFOs with assets less than $25 million as well as most mid-size offices with assets between $25 million and $100 million. But, because an MFO doesn’t qualify for the family office exemption or bank exemption, absent another exclusion or exemption, an MFO with assets in excess of $100 million must register with the SEC and is generally known as a registered investment advisor.
Retail Trust Company Model
To escape this limbo, an MFO could explore a state-chartered retail trust company model. Such a retail trust company has full powers to act as a trust company and is authorized to provide services to the public. A retail trust company that’s regulated by the state should be considered a bank that qualifies for exemption from regulation under the Advisors Act.
There are two common structures for an MFO retail trust company. In the first, the independent principals of the MFO establish a retail trust company. In this structure, family office personnel are the sole participants. In the second, the core family served by the MFO establishes the retail trust company, and the other families serviced by the MFO elect to retain the retail trust company’s services. The second approach is attractive if one family is the driving force behind the MFO.
There are many practical considerations for the retail trust company structure, including:
- Will the non-core families participate in the new structure? In most cases, the decision makers will be the same: the family office personnel. However, if the core family creates the trust company, the core family could retain certain powers to remove and appoint trust company decision makers, which non-core families may find unattractive. From a practical perspective, however, non-core families may experience little difference between the retail trust company structure and a family office controlled by the core family and regulated under the Advisors Act.
- Which jurisdiction to choose? Laws governing retail trust companies and trust administration may not be attractive in the MFO’s state of operation, and the principals may wish to establish the trust company in an income tax-friendly jurisdiction with favorable laws. The selection of the trust company jurisdiction of operation could also create numerous administrative and logistical issues.
- Is the jurisdiction committed long-term to trust companies? While attracting trust companies to a jurisdiction may be beneficial from the jurisdiction’s economic perspective, local market banking competitors may voice concern. Depending on the jurisdiction, regulators may consider market saturation and competition when granting a retail trust company license.
- Can the trust company operate in a single jurisdiction? If fiduciary decisions or trust company administration occurs in a jurisdiction other than its jurisdiction of formation, the ancillary jurisdiction may impose some form of regulatory oversight, not to mention potential tax complications. It may be advisable to attempt structure trust company operations to avoid trust company activities in multiple jurisdictions.
Trust company laws are evolving and now provide MFOs an alternative to federally regulated investment advisor structures. The retail trust company solution provides flexibility in the delivery of investment advice to multiple families as well as enhanced fiduciary services. Further, it eliminates the need for the family office personnel to act as individual trustees of the family trusts and establishes a long-term governance framework for the administration of family trusts.
Although a retail trust company may add complexity, the benefits of the structure may be just the solution the MFO needs to be successful in the long term.
This is an adapted version of the authors’ original article in the February 2019 issue of Trusts & Estates.