The recent surge in popularity of the trust company as a vehicle for the delivery of professional investment management services is not surprising.
- Money. A vast pool of investable assets of public and private retirement plans, charitable foundations and endowments, as well as individuals and families, amounting literally to trillions of dollars, is held in trusts.
- More Money. Trusts require a wide range of potential revenue-generating services, including investment management, custody, and administration, among others. Moreover, because trusts are used and widely recognized as highly flexible vehicles for protecting and managing property and transmitting wealth on a long-term basis, they offer opportunities for relatively "permanent" service relationships.
- Professional Trustees Needed. Trust investment principles have progressed far beyond traditional rules focusing on preservation of principal to encompass modern portfolio theory and sophisticated and innovative management techniques. Recognizing that investment management is critical to the achievement of trust objectives, federal and state laws require trustees to have or to hire professional investment expertise.
While professional trust services traditionally have been provided primarily through trust departments of large "full service" commercial banks, non-bank institutions, such as investment advisory firms, broker-dealers, and insurance companies are establishing trust company affiliates to provide one-stop, full service fiduciary and investment management services without the need for a third-party trustee. Banks for their part have found that consolidating trust operations in a trust company affiliate sometimes offers advantages over the traditional trust department/branch structure.
This Client Alert provides a general overview of the regulation and activities of trust companies in a question and answer format. Anyone interested in additional information about this Client Alert or the Firm's extensive background and experience in providing services to trust companies should contact Bill Wade in Los Angeles at (213) 683-6228, David Hearth in San Francisco at (415) 835-1607, or any other member of the Firm's Investment Management Practice Group.
What is a Trust Company?
Simply put, a trust company is a corporation authorized to act as trustee or in other fiduciary capacities. It is somewhat of a historical accident that corporate trustees are regulated as banking institutions, but a trust company does not necessarily have to be a "bank" in the normal sense of the term. This Client Alert focuses on stand-alone trust companies that do not take deposits or make loans and which may or may not be affiliated with a bank. (Many banks, of course, exercise trust powers directly through trust departments.) Three alternative forms of trust company charters currently are used:
- State-Chartered Trust Company. The laws of approximately 40 states, including California, allow the establishment of a stand-alone trust company that does not take deposits or make loans and is not affiliated with a bank. (See Footnote 1.) The California Department of Financial Institutions ("DFI") licenses trust companies in California.
- National Trust Company. The Office of the Comptroller of the Currency ("OCC"), which charters and regulates national banks, may authorize the creation of a "national trust company," i.e., a bank that limits its activities to the exercise of trust powers.
- Thrift Limited to Trust Powers. The Office of Thrift Supervision ("OTS"), which charters federal savings associations (commonly called "thrifts"), recently has begun to issue charters for federal thrifts limited to trust powers.
Who Can Establish a Trust Company?
While particular regulatory requirements and limitations have to be examined on a case-by-case basis, practically anyone can establish, own, and operate a trust company. This includes natural persons, financial services institutions, such as broker-dealers, investment advisory firms, insurance companies, and national or state- chartered banks and savings associations (or their holding companies), and non-financial commercial or industrial firms.
What Can a Trust Company Do?
The fundamental trust company franchise is the legal authority to engage in the business of holding and managing other people's money for compensation. Technically, this means acting in a fiduciary or representative capacity (e.g., trustee, executor, guardian, conservator, investment adviser or manager, agent, custodian, and similar capacities) and providing services necessary or incidental to carrying out responsibilities imposed by fiduciary laws. The specific nature and scope of trust company business activities are defined by state law. (Federally-chartered trust institutions are authorized to engage generally in activities co-extensive with those permitted to competing state-chartered institutions.)
Trust company statutes are often broadly worded and susceptible to flexible or expansive interpretation. California trust companies, for example, may "engage in any business activity not prohibited by [California laws applicable to trust companies]." In addition to acting in various fiduciary capacities and generally conducting a trust business, California-chartered trust companies are specifically authorized to "buy and sell securities for account of customers." Trust companies operating under statutes of this kind have a high degree of flexibility in designing fiduciary products and services.
Although trust company charters are very broad, an important point that should not be overlooked is that trust companies are not required to exercise all of the powers granted them. Some concentrate on products and services amenable to standardization and relatively low overhead (e.g., common and collective funds, employee benefit trusts, assets allocation programs). Others seeking individualized "relationships" and long-term cross-selling opportunities focus on labor-intensive personal trust administration. Still others choose the full-service route.
What about Capital Requirements?
Yes, capital is required. No, there is no particular dollar amount that will suffice in all cases. Statutory and regulatory minimums for state-chartered institutions vary widely, ranging from as low as $100,000 to as high as $8 million. (See Footnote 2.) Applicants for federal charters can expect minimums in the vicinity of $3-5 million. The amount required also will depend on the nature and scope of the trust company's business activities.
Can a Trust Company Contract with an Affiliate for Services?
Yes. Trust companies affiliated with financial services firms commonly use those affiliates to provide administrative, operational, and investment advisory support services. The trust company's regulators, however, will want comfort that the trust company itself has personnel and other resources adequate to fulfill its fiduciary obligations. While service arrangements with affiliates are common, trust companies also may obtain services from unrelated providers.
Can a Trust Company Manage Money on a Pooled or Parallel Basis?
Yes. While state and federal laws governing pooled or commingled investment activities are not clear or consistent and all proposals should be examined on a case-by-case basis, it is fair to say that trust companies have wide ranging opportunities in this area. Trust companies may provide investment advisory services to mutual funds registered under the Investment Company Act of 1940 (including open or closed-end funds), unregistered private investment funds limited to 100 investors or "qualified purchasers," and unregistered common and collective trust funds. Trust companies also may offer asset allocation and similar programs which, if designed to comply with SEC rules, permit investment of non-pooled client funds on a parallel basis.
How are Trust Companies Regulated?
Trust companies have two sets of legal and regulatory requirements to contend with:
- Federal and state laws applicable to particular fiduciary relationships govern a trust company's responsibilities as trustee or fiduciary. The Employee Retirement Income Security Act of 1974 (ERISA), for example, imposes standards and responsibilities on trustees and fiduciaries of private employee benefit plans. State laws, such as the Trust Law contained in the California Probate Code, govern fiduciary responsibilities to personal trusts and other non-ERISA trusts.
- A trust company also is subject to intersecting and sometimes inconsistent and overlapping laws governing the activities of the trust company itself as a business entity. As a result, choosing a trust company charter requires careful consideration of the applicable regulatory scheme in light of the organizers' business objectives. A few examples of these regulatory issues are referenced in a chart towards the end of this Client Alert.
Because trust companies are subject to regulation substantially similar to that applicable to banks, they enjoy many of the same exemptions from securities and other laws.
Are There Geographic Limits on Trust Company Operations?
Yes and no. The laws of many states are based on the notion that trust institutions are authorized to market and provide trust services only to citizens of the state in which the institution is based and chartered. While efforts are being made to ease barriers to interstate operations, these laws pose obstacles at least for state-chartered trust companies. The OCC and the OTS, on the other hand, have issued opinions to the effect that national trust companies and federal thrifts may establish limited purpose trust offices in any state that allows state-chartered banks and trust companies and other institutions the right to act as fiduciaries. Although federally-chartered institutions are subject to certain state requirements (e.g., security deposits with state treasurer), laws restricting or prohibiting out-of-state institutions from providing or marketing fiduciary services in or to the state are, according to the OCC and OTS, preempted.
In short, federally-chartered trust companies currently have a clear advantage over state-chartered trust companies in terms of interstate operations. Nevertheless, this is an evolving and still somewhat confused area. The OCC and OTS interpretations have not been tested in court, and several states have been reluctant to concede jurisdiction over out-of-state institutions, whether federal or state chartered. Institutions considering interstate operations thus should monitor current developments on a state-by-state basis. One thing, however, is clear: the modern mobility of customers, increasing competition from national financial services providers, and the communications revolution has made the trust and investment management business a truly national, indeed international, business.
1/ Source: Conference of State Bank Supervisors, "Profile of State Chartered Banking," Part IV (1998). return
2/ Source: Conference of State Bank Supervisors, "Profile of State Chartered Banking," Part IV (1998). return
For more information please contact either of the following two attorneys in the Investment Management Law Practice Group in our Los Angeles and San Francisco offices:
David A. Hearth - (415) 835-1607
- State Chartered Trust Company
- National Trust Company
- Federal Thrift Limited to Trust Powers
- Provide Investment Management and Advisory Services?
- Sponsor Common and Collective Trust Funds?
- Yes (state law, e.g., Uniform Common Trust Fund Act)
- Yes (OCC regulations)
- Yes (OTS regulations)
- Securities Law Exemptions for Common and Collective Trust Funds Applicable?
- "Bank" exemptions not available must rely on 100 investor/qualified purchaser exemptions
- Exempt From Advisers Act Registration?
- Subject to Glass-Steagall Act Restrictions on Bank Securities Activities?
- No (unless trust company opts to become member of Federal Reserve System)
- Yes (but disagreement between OCC and Fed re scope of restrictions)
- Subject to Bank Holding Company Act?
- No (unless parent is bank holding company)
- No (unless parent is bank holding company)
- No (but BHCA restrictions apply if parent is multiple thrift holding company)
- State Laws Restricting Entry Preempted?
Client Alert is published solely for the interest of friends and clients of Paul, Hastings, Janofsky & Walker LLP and should in no way be relied upon or construed as legal advice. For specific information on recent developments or particular factual situations, the opinion of legal counsel should be sought. PHJ&W is a partnership, including professional corporations.