In the late 1980s, not long after I took my traditional bank-and-trust-companies practice to the new Chicago office of a mega law firm, Jay Hughes, generations-bridging counsel to wealthy families and one of my new partners, paid me a visit. “You know trust companies and I know the wealth-management needs of extraordinarily wealthy American families,” he said. “I believe that in the next decade there will be a great deal of interest in private trust companies, like the one the Rockefeller family just chartered. With our combined expertise, we may be able to respond to that interest.” Jay was prescient. But neither of us could know then how strong the interest in private trust companies would prove to be — nor how many legal obstacles would have to be overcome to attain his vision.

Statistics are hard to come by — after all, these are private trust companies. The available evidence, though, suggests that formation of private trust companies accelerated through the 1990s to what is now a rather rapid rate. Based on data from Family Office Exchange, Inc., a Chicago-based association of wealthy families and family offices, the 10 private trust companies I helped form from 1997 through 2001 represented at least a quarter of the private trust companies chartered in that period. Our two-per-year pace has increased since 2001 to more than five-per-year. The large number of client families now considering the private trust company suggests this pace could double again during the next two years. My discussions during the last year and a half with state banking regulators in 20 key states reveal our experience to be representative of a wider trend.

What has led to this geometric growth? Many of the most attractive elements of private trust companies (PTCs) were already in place when I last reported on PTCs, in the August 1997 issue of Trusts & Estates.1 But back then, no private trust company charter was recognizably distinct from those of public trust companies or bank trust departments.2 In addition, most states that offered attractive environments for private trust companies were geographically remote from most wealthy families' homes. This combination of legal and geographic barriers discouraged all but the wealthiest and most committed families from considering the PTC alternative to individual and institutional trustees.

Just six years later, a distinctive state PTC charter has emerged, dramatically reducing the cost of forming and operating private trust companies while enhancing their attractiveness. In key states, regulatory skepticism and legal barriers have been replaced with familiarity and formal support. The new private trust company charters crafted in those states are characterized by:

  • Modest capital and other charter requirements;

  • Flexibility to charter in one state while maintaining a full-service office in another;

  • Risk-appropriate levels of regulatory supervision and support for fiduciary policies tailored to the clientele of a private trust company;

  • Substantial protection for family and company privacy; and

  • Reasonable staffing, space and activities requirements for both chartered state and family offices.

These developments make the PTC charter more attractive and affordable. Coupled with a rapidly spreading awareness of the PTC's many advantages, they may have propelled the concept past the “tipping point,” to use the phrase popularized by author Malcolm Gladwell. At a minimum, it is a concept that strategic advisors should discuss with any wealthy clients. (See “What's the Attraction?” page 50).

HOW WE GOT HERE

In the past, there was no identifiable PTC charter. Even if state law recognized a private trust company, it was usually only for the limited purpose of exempting the PTC from burdensome requirements that would otherwise make it impossible for a family to obtain a charter. In my 1997 article, I cited two major legal disincentives to forming private trust companies:

  • Minimal understanding and acceptance of the concept among banking regulators; and

  • The inconvenience of chartering and operating a private trust company in a state distant from where the family lived.3

This historic lack of accommodation had serious implications for the cost structures and privacy of early adapters such as the Rockefeller family. First, most states required PTCs to be capitalized at levels comparable to banks, usually in the millions of dollars, even though the working capital needs of private trust companies have always been minimal. Second, burdensome regulatory regimes — designed for banks with federally insured deposits, but ill-suited to trust companies serving only the families of their owners — were applied indiscriminately to private trust companies. Third, most states required all trust company charter applicants to show they would meet the “convenience and needs” of a wide public, as opposed to a wealthy family. Finally, the privacy of private trust companies and their owners was generally granted no more consideration than that of state-chartered commercial banks — even though revealing PTC ownership or assets under management could expose wealthy family members and PTC employees to identity theft and physical harm.

These financial burdens, regulatory requirements and privacy concerns sharply limited the number of families able and willing to form private trust companies well into the 1990s. Of course, some families were motivated to form them anyway. But the financial burdens undoubtedly induced many of these pioneers to admit unrelated families as clients, thereby allowing them to spread their high mandatory costs over a larger client base. In fact, almost every regulated private trust company chartered before 1996 — including the Rockefellers' PTC that inspired Jay Hughes to predict the trend — has now admitted unrelated families.4

Another significant problem has been the distance between where wealthy families tend to center their residences and activities — mostly in populous states — and where the more favorable legal environments for trust companies are found. Typical populous income taxes, heavy regulation of financial institutions, and indifferent trust laws common to populous states make them unattractive places to charter private trust companies. This disparity has led many families to charter PTCs hundreds, even thousands, of miles away from where they lived their lives and managed their financial affairs, creating operational challenges.

The difficulty of operating an office in a distant charter state was exacerbated by strict limits on trust activities in the state where the family office was located. In 1997, a PTC chartered in a state other than the family state could not legally “do a trust business” in the family state. This meant only administrative or back-office services were permitted in the family state; all discretionary trust decisions had to occur in the PTC's chartering state. Only families exceptionally motivated to operate PTCs accepted the burdens of such an arrangement.

NEW CHARTER

Fortunately the past six years have made all the difference. Numerous states have adopted the Conference of State Bank Supervisors' model State Trust Company and Trust Modernization Act (CSBS Trust Company Act)5 or comparable interstate trust office legislation or regulations. These new enactments allow a private trust company chartered in a legally attractive state6 to have a full-service trust office (not just a back office) in another state that has adopted similar measures. States that have adopted versions of the CSBS Trust Company Act and created attractive legal environments for private trust companies include: Alaska, Illinois, Nevada, New Hampshire, New Jersey, South Dakota, Tennessee and Texas. States with large concentrations of wealth that have adopted versions of the act (in addition to the populous states on the first list) include: Connecticut, Minnesota, New York, North Carolina, Ohio, Oklahoma, Pennsylvania, Virginia and Washington.

Altogether, more than 30 states have adopted the CSBS Trust Company Act or provided comparable interstate authority. Notably missing from these lists, though, are such important states as Alabama, California, Colorado, Florida, Georgia, Hawaii, Kentucky, Maryland, Massachusetts and Michigan. States with otherwise attractive trust company and trust laws that still do not provide interstate authority include Delaware and Wyoming.

As a result of this new interstate authority in so many significant states, most wealthy families can take advantage of some of the best trust-company and trust-law regimes available in the country, while engaging in a full range of fiduciary and family services in their home states.

ACCEPTANCE

The CSBS Trust Company Act, and the process by which it was developed, helped overcome another major obstacle to PTCs: the wariness of state banking regulators. The model act has a chapter recognizing PTCs and according them special treatment. Moreover, the involvement of all 51 state regulators in the act's development helped familiarize them with nondepository trust companies.

The change in regulatory attitude has been striking. In 12 of the above states, I have personally seen a willingness to give PTCs a fair hearing — resulting in a growing understanding by the regulators of the entitites, the reasons why families form them, the professionalism with which they operate, and their more limited risks compared to banks.

This familiarity and acceptance have been reflected in revised chartering and operational requirements. Today, such requirements are often tailored to the risk profiles of new private trust companies. Another vital and welcome change: Many states have done away with the charter requirement regarding the “convenience and needs of the public.” Now most of these states ask only that the PTC applicant show a good likelihood that the company will have economic success. Even where the company still must show that it will benefit the local community, it need not include local citizens in the target market; rather, a modest economic benefit to the local community, such as local expenditures or part-time employment, usually suffices. Another example of regulation and supervision tailored to the needs and realities of private trust companies is the acceptance of a customized PTC policy manual by regulators in at least nine states (as well as by the national bank regulator, the Office of the Comptroller of the Currency). Although derived from the manuals of commercial trust companies and bank trust departments, a good PTC manual requires extensive modification to reflect the risk profiles and other practicalities of private trust companies focused on the needs of extraordinarily wealthy families.

Another dividend of the familiarization process (and of the recent national concern for the financial privacy of all families): State regulators now are more willing to increase the confidentiality accorded both family-member clients of private trust companies and the companies themselves. Before 2001, regulators routinely made public not only the identities of owners, but also substantial financial information about the PTCs themselves — information of a type the Gramm-Leach-Bliley Act of 1999 protects as “nonpublic personal [financial] information.”7 Even though that act does not directly apply, several states' regulators recently complied with requests by our clients to keep such information confidential.

COSTS AND RISKS

All these changes have substantially decreased the cost of structuring a family office as a private trust company. Still a major cost that remains is the capital required.8 But families centered in the 13 populous states with some version of the CSBS Trust Company Act (all of which have high capital requirements for trust companies) now do not have to charter an expensive trust company in their family state in order to provide trust services there. Instead, they can charter a trust company in states like South Dakota, Nevada and others that have lower capital requirements (less than $500,000) and bring a full-service trust office of the PTC to the family state.

A new compact among state regulators also means that family state regulators will not examine that family state office except in very unusual circumstances.

In the past, there was great uncertainty about the minimum presence required for trust company offices in both chartering and family-office states. That uncertainty has been resolved in almost all the key states. Now, only reasonable local space, personnel and activity are usually required. A cottage industry of local companies and professionals, charging reasonable prices, now provides the required office space and personnel in most attractive chartering states.

Most private trust companies are formed by a family office, and families correctly focus on the incremental costs that forming and operating a private trust company will add to the costs of a well-managed family office. When assisting in that evaluation, I stress the need to compare the private trust company with a professionally managed, adequately resourced family office — and not some lesser configuration. In particular, a PTC's costs should not be compared to those of a family office with no system for managing family risk.

Private trust companies are required by regulators to adopt and follow formal risk management policies and procedures. These are embodied in manuals modeled on those of commercial trust companies, but tailored to reflect the risk profiles, clientele and services of a private trust company focused on the needs of an extraordinarily wealthy family. Family offices involved with significant assets need similar policies and procedures.

Many family offices recently have recognized that they effectively act as their families' trustees, investment advisors and other fiduciaries (even if others formally have the titles). Such family offices carry a risk profile that is indistinguishable from a private trust company's. The good news is that today's private trust company provides a state-of-the-art risk management model for the family office. The bad news may be the need for a family office to upgrade its risk management systems to the PTC standard whether or not it moves to the private trust company structure.

Unlike other organizations, a family office's risk management objective is not just to protect the company, its owners and management: the goal is to protect the entire family served by the family office. When the family includes multiple trusts, charities and other enterprises served not only by the family office but also by individual and corporate trustees and advisors who are also friends, managing the risks of errors can be quite challenging.

Many advisors are now recommending that families compound these existing complexities with trust protectors and trust advisors (individuals or companies), and investment and distribution committees — essentially parceling out fiduciary duties and responsibilities. The risk management implications of such structures are obvious, and someone, preferably the family office, must see that all the actors within the complex structure are wisely chosen, given clear responsibilities, and performing them well. This involves substantial management costs. An alternative, of course, is to integrate all fiduciary and other family office services within a private trust company, under the PTC's risk management umbrella.

In any event, the cost of a formal risk management system is one every prudently managed family office should incur no matter how it structures its affairs. It is not, therefore, an additional cost imposed by the move to adopt a private trust company structure.

SOME PRECAUTIONS

Since 1997, I have been chronicling the birth of a new form of financial institution. While the emergence of the private trust company charter as sui generis has taken me by surprise, the brief time frame over which this has occurred has amazed me in light of the extensive legislation and changes in regulatory attitudes and practices that was necessary to bring it about.

As with any youthful endeavor, though, there are challenges ahead and dangers requiring vigilance. Among the challenges is the need for families to take care that they not obtain such control over trust distributions within their trust companies as to bring assets or income into the estates of grantors or beneficiaries, or cause other adverse tax consequences.9

Foremost among the potential dangers is that a private trust company fail to adequately manage its affairs, resulting in significant losses. Such an event could well lead to a decline in critical regulatory support for the charter. I recently have seen how the unfortunate failure of Independent Trust Corporation, Orland Park, Illinois (not a private trust company) has lead to substantial increases in minimum capital requirements for trust companies in Illinois as well as other states. A similar problem with a private trust company could do substantial harm, not just to the hopes of new entrants, but also to regulatory attitudes toward even well-managed, existing private trust companies.

Hopefully, these few words of caution will help assure a robust future for this young and promising new charter.

Endnotes

1. “Forming a Private Trust Company: Elements and Process,” Trust & Estates, August, 1997 at 36.

2. Ibid.

3. Ibid at p. 36-37.

4. Rockefeller Trust Company. Others include (in order of formation): Bessemer, Laird Norton, Legacy, Pell-Rudman (now Atlantic), Pitcairn, Glenmede and Whittier Trust Companies. Besides sharing costs, there are other, still-valid incentives for a private trust company going multi-family, including the wherewithal to have more wealth-management specialists on staff, to create products in-house, and to attract and retain high-powered executives with financial incentives. Of course, adding non-family clients creates managerial challenges not present in a truly private trust company.

5. CSBS, Statutory Options for Multi-state Trust Activities, March 1997. The author served as principal draftsman.

6. Based on our survey of some 40 state tax, trust company and trust law issues in each state identified in this article.

10. For example, Bank of Crestwood v. Gravois Bank, 616 S.W.2d 505 (Mo. 1981); Jackson v. Valley National Bank of Eagan Township, 152 N.W.2d 472, 474 (Minn. 1967); “Discussion of the ‘Public Necessity’ et al. Standard,” by the Indiana Department of Financial Institutions, 1995; Georgia Department of Banking and Finance, Statement of Policies (March15, 2001, Revised, 2001 GA Bank. LEXIS 2); In re Application of Dorsey, 623 N.W.2d 468, 473 (SD 2001); In re Rockingham County Trust Co., 485 A.2d 700, 702 (N.H. 1984).

7. Section 509(4), Chapter V, Privacy, Gramm-Leach-Bliley Act.

8. The lowest-cost PTCs are the (more properly named) “unregulated corporate fiduciaries” authorized by Wyoming and at least three other states. These companies must act as a fiduciary exclusively for one family. Because of limitations on their interstate activities and the securities advisory activities in which they may engage without registering with the Securities and Exchange Commission, these entities are not suitable for many families. But for appropriate candidates, they provide the least costly form of private corporate fiduciary. We advise our clients that for risk management and shareholder and management protection, even unregulated corporate fiduciaries should be well-capitalized and professionally managed and adopt formal trust company policies and procedures.

9. For a thorough discussion of this issue, see: Donald D. Kozusko & Miles C. Padgett, “Private Trust and Protector Companies: How Much Family Control?,” 43 Tax Management Memorandum 443 (Nov. 4, 2002).

WHAT'S THE ATTRACTION?

Families are chartering PTCs at record levels. Here's why

The primary purpose of a PTC is to provide fiduciary and other wealth management services to the family. Its attractiveness therefore lies in how well it performs based on the criteria by which wealthy families judge their fiduciaries:

  • Responsive and Flexible — Networks with third-party providers; offers choice of trustee contact personnel; welcomes settlor/beneficiary involvement; willing to amend trust instruments.

  • Loyal and Independent — Helps avert conflicts; avoids sales culture.

  • Multi-Competent — Handles trust administration, investment management, financial reporting and taxes; has specialized expertise.

  • Efficient — Controls overhead costs; provides economies of scale; has and uses leverage with third-party service providers.

  • Convenient and Accessible — Puts information online; delivers locally useful out-of-state trust/tax laws.

  • Secure and Private: Protects assets and family; provides quality fiduciary risk management; has adequate capital; provides adequate regulation and supervision; fosters a culture of privacy.

  • Supportive of Nonfinancial Objectives — Promotes family's succession planning and member development; has expertise in wealth issues; facilitates charitable objectives.

In the chapter I contributed to the recently published book Wealthy & Wise1, I describe these criteria in detail and apply them to the various types of trustees available to wealthy families: individuals, institutions, boutique companies and private companies. But the most important are the first two listed: responsiveness/flexibility and independence/loyalty. And in these, private trust companies excel.

But the key to the private trust company's appeal is not just that it meets families' short-term criteria, but also that it allows them to respond to changing needs and standards over the long term, even for generations.

The PTC can meet several other important needs of wealthy families:

  • Broad Powers — A PTC is the only form a family office can take to provide fiduciary services directly to family members rather than just supporting the family's individual trustees or unaffiliated corporate fiduciaries.

  • Trustee Succession/Continuity — Unlike individual trustees, private trust companies can be unlimited in duration, substantially aiding the resolution of trustee succession problems.

  • Legal Protection of Family Members and Advisors or Family Office Managers — Through both their corporate (or limited liability company) form and formal risk management, PTCs may be expected to protect family members and family office management from loss and personal liability and obviate the need for any individual to bear the risks and burdens of a trustee.

  • Federal Securities Law Exemptions — PTCs are exempt from registration as investment advisers with the Securities and Exchange Commission and may offer common trust funds, pooling devices exempt from registration under the Investment Company Act of 1940.

  • Tax Management — If properly managed, PTCs can facilitate siting trusts in states without state income or capital gains taxes and can provide maximum deductibility of trust administration fees and expenses.

  • Enhanced Family Governance — The governance process they require of families is both a boon and a bane of private trust companies. Organizing a PTC is a major step, usually requiring widespread support within a family. But the case for a PTC is often compelling, especially for a family already inclined to form or professionalize a family office. In addition to all its other benefits, a PTC may fill a void left by a departed family business, and I have seen families considering the concept develop a new cohesiveness. Ironically, because a PTC may have significant capital and, more importantly, will play the vital role of trustee of family trusts, the problem of keeping an asset within family control for generations (previously solved with the sale of the family business) may reassert itself around the PTC.

  • Family Member Development — Like other family offices, the private trust company can be a locus of family member education and generation succession planning. More uniquely, roles may be individually tailored in the PTC to match the skills and interests of family members as well as trusted family advisors.
    John P.C. Duncan

Endnote

  1. John Duncan, “Finding an Outstanding Trustee: What Wealthy Families Look for in a Trustee and How They Get It,” Chapter 16 of Wealthy & Wise, ed. Heidi L. Steiger, John Wiley & Sons, Inc., 2002.