Written by The Wealth Advisors Trust Advantage
Trust & Estates Magazine is the primary periodical for the fiduciary industry and is considered "must reading " for bank trust officers. The February 2012 edition contained a "Perspective" entitled "Emerging Directed Trust Company Model." (Joseph F. McDonald III, "Emerging Directed Trust Company Model," Trusts & Estates (February 2012)
The author of the "Perspective" is Joseph F. McDonald III, an attorney at McDonald & Kanyuk PLLC in Concord, New Hampshire. McDonald's "Perspective" clearly makes the point that directed trust companies represent a superior trust model for today's affluent clients. The ability to create "multi-participant trust" governance structures (or what are more referred to as directed trusts) in trust friendly states has threatened to topple the bank trust departments' market share among affluent clients. The "Perspective" infers that a "tipping point" has arrived in the fiduciary business in favor of financial advisors who now have the ability to align their services with a growing group of directed trust companies who operate under a new trust model free from embedded constraints and cost structures of the "traditional" trust model.
Financial advisors and other estate planning professionals should understand the extent of this fundamental change within the fiduciary business and the potential benefits directed trust companies can provide to the affluent clients. The time has arrived to conduct a search for one or more firms providing directed trust services. The small investment of time and effort expended in the due diligence process of selecting a directed trust provider will be rewarded several fold in terms of increased AUM and client service.
The "Perspective" describes the inherent risk management and cost issues facing the bank trust departments as they attempt to provide comprehensive trust services to customers. The "traditional model" assumes the trustee is liable for any and all activities undertaken as trustee and, as a result, a cumbersome, multi-disciplined, multi-layered, and expensive administrative process is required to mitigate risk and exposure to litigation.
"A large bank trust department designed to deliver bundled trust services requires elaborately structured risk management policies and procedures to allow the bank's personnel to perform the multiple fiduciary responsibilities inherent in the role and limit the bank's exposure for claims of breach of fiduciary duty. The directors, officers, and support personnel are compensated commensurate with their experience, expertise, and level of responsibility.
"The classic regulated corporate trustee collects from each of its trusts annual fees of between 50 and 120 basis points, depending on the value of the trust's principal. These fees have historically been adequate to cover the trust department's extensive overhead..."
"Before directed trusts became popular, the high costs of operating in a regulated industry with significant barriers to entry for alternative business models gave the incumbent bundled service providers significant pricing power and created an almost infinitely elastic demand for their services."
Unlike the traditional bundled model, directed trusts typically involve the inclusion of an "investment advisor" to manage the trust assets, a trust protector, a co-trustee, and potentially, a "distribution advisor" responsible for providing the trustee with directions concerning discretionary distribution powers. The adage "less is more" clearly applies to directed trusts in terms of reduced and greater control by grantors and beneficiaries. Financial advisors seeking to transfer existing trusts from banks should communicate to prospective clients the inherent distinction between the traditional and directed trust model. Prospective clients are far more likely to accept the logic of the structural distinctions as opposed to the traditional argument that banks are poor money managers.
In addressing demographic trends, McDonald states "Several demographic, industry, and legal trends have coalesced to drive the increasing demand for directed trusts and the [Directed Trust Companies] that serve them."
"Unlike in previous generations, when wealthy families were more conservative investors and looked to the institutional stability of banks as their trustee and investment advisor/manager of choice, today's affluent prefer a specialized approach that gives them the flexibility to choose their own investment professionals. They increasingly reject the notion that a jack-of-all-trades can be a master of any. That's particularly the case in the modern world of complex dynasty trust administration involving layers of discretionary distribution powers and wide-open trust investment standards. The new directed trust structures offer the best of both worlds."
This "best of both worlds" is described as the family's ability to have the comfort of selecting a state regulated and adequately capitalized financial institution to serve as administrative trustee at a reasonable fee. While on the other hand, the family has access to a much broader universe of investment options and contrasting investment styles which are not generally offered by, or available through, bank trustees. Financial advisors seeking to transfer large trust relationships should focus on the increase of overall governance by the family, including, but not limited to, control of the investment management process. The increase of overall family control is beyond question or debate. A prospective client can easily see the benefits inherent in a directed trust arrangement and make the trust transfer decision accordingly.
Six Progressive States: Birds and Trusts Migrate to Better Climates
In the area of directed trusts there are progressive and regressive state laws. States such as South Dakota, Delaware, Alaska, Nevada, New Hampshire, and Wyoming have adopted laws favorable to creation of directed trusts for the purpose of creating a robust trust industry within the state. Fortunately for the affluent, and their advisors, trusts may be " moved" to favorable trust states. The change of trust situs, or place of administration, can be accomplished through a number of methods including decanting, application of local trust modification statutes, non-judicial settlement agreements, virtual representation, and court approval. The ease of trust migration varies widely from state to state. There is a strong trend among the states in favor of decreased court involvement and the ability to modify trusts by agreement of the interested parties, particularly with regard to administrative matters under which the appointment of a successor trustee is often included in the state statute.
McDonald states "these progressive states recognize that the popularity of long-term (even perpetual) trusts as wealth management, asset protection and wealth transfer tax avoidance structures, combined with tremendous concentrations of fungible financial wealth, liberal choice and conflict-of-law principals, as well as the relaxation of interstate banking restrictions, have created a national market for directed trust services. A family living in a regressive state needn't move to a progressive state to secure the benefits of a directed trust established and administered in that jurisdiction."...
Expectations Regarding Directed Trust Companies
Financial Advisors and their prospective directed trust clients need to recognize the distinctions between directed trust providers and traditional trust providers. Directed trust providers are by definition "upstart" companies whose services and infrastructure are tied to the present and future as opposed to the past. The following excerpt from the Trusts & Estates article illustrates the point.
"[Directed Trust Companies] can operate lean and mean in inexpensive, highly utilitarian ,Class B office space, with more manageable risk management policies and procedures, less high-priced management personnel, no investment professionals, and an appropriate number of administrative personnel to handle their accounts."
Despite the realities described in the excerpt above, financial advisors and prospective customers often fall into the practice of using the same due diligence inquiries regarding a directed trustee as they would a traditional bank trustee. Questions regarding staffing levels, years in business, number of accounts, and assets under management all require an analysis which incorporates a fundamental understanding of the directed trust model which is non-investment management, non-custodial and often non-discretionary with regard to distributions. Prospective trust clients need to be informed that the directed trustee is engaged to discharge limited duties in a "multi-participant trust".
Recent changes in state trust laws, customer demographics, and technology have coalesced to bring fundamental changes to the trust marketplace. The traditional bank trust department model suffers high embedded costs, inflexible policies and procedures regarding risk management, and customer demands for increased participation in the management and control of trusts.
The emergence of the directed trust model has dramatically changed the trust marketplace by empowering the affluent with increased control of the trust's investment management, distributions, and overall governance. Financial advisors, attorneys and CPAs should fully understand the distinction between traditional and directed trust models and create appropriate client expectations regarding directed trust providers.