Wealth Planning Q&A with Dan Lindley
As part of our GFO Pulse Q & A series, Jane Flanagan, Director of Family Office Consulting, sat down with Dan Lindley, Fiduciary Practice Executive, to discuss the merits of a Private Trust Company (PTC) relative to directed trusts.
Jane: So Dan, we have approximately fifty GFO clients that have chartered a Private Trust Company to manage their family trusts. What are some of the benefits of a PTC?
Dan: One of the most common questions I field from our clients is whether they should establish a private trust company to rationalize the management of their family trusts. All too often they have an individual trustee who is aging out, having health problems, concerned about the succession process or simply too preoccupied with other business to devote substantial time to the administration of the family trusts. PTCs have some definite advantages, particularly when it comes to control and continuity, privacy, and limiting personal liability for fiduciary decisions.
“Clients shouldn’t rush into setting up a PTC without undertaking a thoughtful cost-benefit analysis. A series of directed trusts may meet their family’s fiduciary management needs.”
Jane: How do you help clients analyze their fiduciary options?
Dan: My own approach is to view a PTC – or any other fiduciary option – through a RECCS – Risk Mitigation, Efficiency, Control, Cost and Sustainability – factor analysis.
Looking first at the Risk Mitigation factor, there isn’t any doubt that a PTC offers greater protection to individuals who serve as the PTC’s directors. As long as the directors adhere to the PTC’s rules of governance, thoroughly educate themselves before making discretionary decisions, and maintain their conduct free of conflicts of interest, they should be able to rely on the business judgment rule to shield themselves from personal liability for beneficiary claims. Put another way, if a beneficiary has a legitimate claim for mismanagement of a trust, liability for that claim should stop at the PTC level, without reaching the directors personally.
The operation of a PTC can be reasonably Efficient if the family office coordinating its administration and the family directors and committee members are eager participants in its management. A PTC requires a commitment of time and effort from the family, which may be the biggest tradeoff for greater control and risk mitigation.
In terms of Control, a PTC stands out because the family will have complete authority over trust investments, including operating businesses, concentrated positions, alternative assets and the like. Family control over distribution decisions is more limited, however. IRS Notice 2008-63 prohibits a director from participating in the approval of any discretionary decision for a trust that the director (or spouse) created, has a beneficial interest in, or has a descendant (or a spouse of a descendant) with a beneficial interest. Involvement in such decisions can lead to inclusion of the trust in the director’s estate.
The Cost of operating a PTC can be considerable, resulting from D&O insurance, occupancy costs in the situs state, local administrative services, audit expenses, licensing and examination fees, and travel for board meetings. A rough rule of thumb is that a PTC makes good economic sense at $500 million or more in trust assets.
Finally, with respect to Sustainability, a PTC can be an enduring family entity if the family makes the commitment – at each generation – to keep it operating. Without the active participation of family members in the management of the PTC and its trusts, a PTC is just as likely to become someone’s failed dream.
Jane: It sounds like PTCs offer some meaningful advantages for families with significant trust assets. Is there an alternative to a PTC that offers some of these advantages without the expense and complexity?
Dan: There is an alternative, Jane: the directed trust! Under the laws of Delaware, Nevada, and various other states, the instrument for a directed trust divides the trustee’s traditional duties (administration, investments and distributions) among the trustee and one or more trust advisors who have exclusive authority over a designated function such as investments. The trustee has no responsibility for any actions under the aegis of an advisor. With that background, let’s run the directed trust through the RECCS analysis. Northern Trust serves as a directed trustee in our trust companies in Delaware and Nevada. For simplicity, I’ll focus my comments on Delaware.
Risk Mitigation for a directed trust is well-controlled because Delaware law allows the trustee and the advisor to ring-fence their roles, without cross-liability for the other party’s actions. While an individual advisor has personal liability as a fiduciary for investment performance, nothing under Delaware law prohibits an investment advisor from acting through an entity to heighten its protection against personal liability.
A directed trust structure is highly Efficient because all actions flow through the trustee, who maintains the trust records, performs principal-and-income accounting, prepares tax filings, implements directed trades and coordinates communications.
The family maintains full Control over investments through the named advisor, much like an investment committee for a PTC. The directed trust is free of interference with investment decisions from the directed trustee.
The Cost of administering a family’s directed trusts is substantially less than the expense of operating a PTC. Since the trustee’s responsibility for investments is eliminated, the trustee does not have to price in the tail risk of investment performance. Additional staffing and the various ancillary expenses of a PTC are not a factor with directed trusts.
A directed trust is highly Sustainable because a corporate trustee acts as its hub. As long as the family has a mechanism for “replenishing” its investment advisor or committee, it can perpetuate its directed trust for multiple generations. It is an option, moreover, to name the directed trustee as a successor advisor in default of any successor within the family.
Jane: It’s helpful to know that there is a meaningful alternative to a PTC. Before we leave today, what is one piece of advice you would like our readers to consider?
Dan: Clients shouldn’t rush into setting up a PTC without undertaking a thoughtful cost-benefit analysis. A series of directed trusts may meet their family’s fiduciary management needs.
Jane: Dan, thank you very much for your time and your perspective.
To Learn More, Contact:
David C. Albright, Head of Client Development – Americas, EMEA & APAC Regions, 312-557-1900 or DCA2@ntrs.com
Jane Flanagan, Director of Family Office Consulting, 312-557-2025 or JPF7@ntrs.com