From the July 2002 issue of Investment Advisor • Subscribe!

July 1, 2002

In Independents We Trust

Whether you build your own or find a partner, an i

If we had conducted our survey of independent trust companies a decade ago, to receive a dozen respondents from a universe not much larger than 12 would have been significant. Today--and beginning on page 47--you'll find 68 survey respondents, spread across the nation. That the number of independent trust companies continues to grow in pace with the spread of financial advisory firms is no coincidence, for the virtues of one can be of benefit to the other. As we'll see, more and more advisors are making use of these independents--for a host of laudable reasons--or starting trust companies of their own.

Some of the independent trust companies in our survey, such as Santa Fe Trust in New Mexico and Commonwealth Trust Company in Delaware, provide administrative trust services only, eschewing investment and advisory services entirely. They generally "partner" with financial advisors--as opposed to competing against them--as well as with attorneys, CPAs, insurance professionals, and broker/dealers. Other independent trust companies specialize, such as Denver-based First Trust Corp's focus on self-directed retirement plans. Still others offer ? la carte services, or do it all--everything from court-created and personal trusts to estate administration and financial planning--whether as trust companies offering advisory services or as advisory firms offering trust services through their own trust companies.

Regardless of client base, corporate structure, and services, what these trust companies have in common, and their reason for being, is their independence from big-bank trust departments and the trust divisions of large brokerage firms and insurance companies. What does this mean to financial advisors? Through either their own independent trust company or by utilizing the services of another, advisors will be able to address the trust needs of their clients while allowing the advisor to retain control over the management of client trust assets that might otherwise go to or remain in a large bank trust department, thus diminishing the advisor's fee. Advisors taking the independent route stress the importance of being able to maintain a seamless client relationship, and say they are able to provide their clients with better and more flexible trust services.

While Commonwealth Trust was launched in 1931 solely as a trust company and claims the honor of being the oldest independent in America, the majority in our survey didn't get started until the 1990s. (Some that are listed with "ancient" start dates actually began their lives as law firms.) When the ban on interstate banking fell in the early 1980s and big banks began to morph into mega banks, concerns were raised in some corners of the financial services world regarding the ability of these new institutions to provide trust clients with true personal service and local market servicing options. David Roberts, president and CEO of advisor-owned National Advisors Trust Company, in Overland Park, Kansas, and a former executive VP at UMB Bank's personal trust division, encapsulates these sentiments thusly: "Financial advisors and their clients have often felt intimidated, ignored, or handcuffed by large, impersonal brokerage firms or trust companies."

Also being called into question are issues of fiduciary responsibility. "When a trust company is owned by a bank or by another financial institution, there are inevitably some pressures brought to bear in the operation of the trust company from the entity that owns you," says Tom Batterman, president of Vigil Trust & Financial Advocacy, an independent trust company and advisory firm in Wausau, Wisconsin. "This may influence the judgments you make as a fiduciary." For example, the urge to invest trust assets in a bank's mutual funds can be irresistible when the bank operates both a trust company and a mutual fund affiliate. Being independent, Batterman maintains, leaves a trust company free to make totally objective decisions about how it is going to execute its fiduciary duties. As for quality of service, Jim McMackin Jr., VP and director of marketing for Commonwealth Trust, says that "the vehicle of service gets lost in a bureaucracy, whereas here, we live on service."

McMackin feels that the proliferation of new independent trust companies (he notes that most are not purely administrative operations like Commonwealth's) "clearly tells you that people are unhappy with bank performance and large trust companies." He likens the phenomenon of independent trusts to the growth of small community banks, which continue to spring up across the nation, despite research indicating that the number of banks in general should be dwindling because there already are too many of them. People flock to these new small banks for the personal, friendly, "community" service they seem to offer. This comparison prompts Batterman to characterize his trust company "as the community bank of the trust industry."

All In the Family

Membership in the Naperville, Illinois-based organization AITCO (Association of Independent Trust Companies) has shot up 20% over the past five years, according to Batterman, who serves as AITCO's president. Involved in the association's formation in 1989, he notes that there were "seven of us at that first meeting." Today, AITCO boasts some 200 members, among them trust companies, those considering setting up a trust company, trust departments of community banks, financial advisors (offering investment recommendations and other services), and vendors providing services to the industry. Independent trust companies are governed by the same state and federal requirements applicable to the trust departments of large banks.

But the growth of and interest in independent trust companies aren't simply the result of feelings of community togetherness. Nor are they strictly centered around issues of control, service, and fiduciary responsibility. There are other factors at work, and it is at their juncture that financial advisors enter the picture.

Jeffrey Lauterbach is chairman, president and CEO of The Capital Trust Company of Delaware. While Capital Trust was created by charter over 100 years ago, the company exercised its trust powers in 1999, and opened for trust business in 2000. Like Commonwealth Trust, it is located in Wilmington, Delaware. (See "Wealth-Friendly Delaware" sidebar on p. 42). While Capital Trust's primary business is trust administration--serving as a back office for more than 100 advisors while, with some exceptions, allowing them to manage the trusts--it is the trustee of the U.S. Charitable Gift Trust, a national donor-advised fund distributed through advisors by Eaton Vance. The company also has a separate line of business pursued primarily through attorneys.

Demographic-Fueled Growth

According to Lauterbach, much of the growth of independent trusts is driven by demographics, a causal factor shared with independent financial advisors. "You not only have the Bob-Hopers dying off and passing wealth to the Baby Boomers, you have this group of independent advisors that didn't exist to serve the Bob-Hopers until the last 20 years," says Lauterbach. "And they have matured [along] with both of these groups of people."

Naturally, it is in the advisor's best interest to align himself with an independent trust in order to maintain control of client assets and personal relationships that otherwise would be lost. Commonwealth Trust's McMackin says that a good 95% of his company's new business is in personal trusts, and that 75% of that business is brought in by attorneys--McMackin calls them gatekeepers--"who get more actively involved in long-term planning and estate issues than advisors." This happens because advisors, often unfamiliar with the trust business, are not always comfortable establishing trust services for clients. "The next step is to go to the attorney," he says, "and the attorney then controls the process, which gets it out of the hands of the advisor."

The Urge for Going

Commonwealth's typical experience with financial advisors is that of an advisor with a client or potential client who has an existing trust somewhere, "and wants to move the trust to Delaware and pick up the investment side as well as having us become the trustee." It's a scenario that represents 75% of Commonwealth's interface with financial planners and advisors. But he sees more and more planners getting, or trying to get, involved with independent trust companies, especially over the past five years.

"They see, first of all, the risk to their existing portfolio if something happens to Pop [the head of a client family], and the money goes into a trust over which the planner has no input or control," says McMackin. "And second of all, the baby boomers are getting older and closer to transferring assets, and it gives a planner that knows the business and knows how to do effective estate planning a real opportunity to add incremental service to their clients." In this regard, retaining control over a client's trust assets isn't solely about an advisor levying fees on assets. Batterman at Vigil Trust, for example, notes that 90% of his income comes from advisor services as opposed to trust services--which is just the way he wants it.

National Advisors Trust Company's Roberts finds an inherent problem in "putting your best customers, who are typically your trust customers, into an entity that has basically an investment advisory service built into it." Sooner or later, he says, "someone's going to look at it and say, 'Hey, that's where the profitability is,' and someone else is going to say, 'Maybe they should talk to us [for financial advice]? It's difficult for both entities to maintain perspective on that relationship, and I don't think that either one of them ever gets real comfortable with it.

As for big-bank trust departments, not all disallow input from advisors, but they're not about to share a client's asset fees. Batterman points out, however, that some clients and advisors are better served by going to large banks and their large trust departments, just as others are better served by going to smaller banks and their independent trust companies.

The approach an advisor takes regarding his involvement with trust companies and their services is dependent on how serious the advisor is about being in the trust business. For the advisor who has an occasional client with a trust need, who is comfortable with his state regulatory environment, who is confident that his client's bank trust department is not amenable to keeping the advisor around to advise on client assets, a good alternative, says Batterman, would be to hook up with an independent trust company willing to act as an administrative trustee only. In this capacity the independent trust would handle all the legal and accounting issues, including trust interpretations and distributions, while allowing the advisor to invest client assets and keep the fee revenue stream flowing smoothly.

What's it cost? Naturally, fees vary depending upon the services, and from company to company. For example, at The Capital Trust Company of Delaware, which works exclusively with advisors, for managed accounts the net of advisor fees (there is a fee minimum of $3,000) is 1.0% for the first $500,000, with 0.35% as the trustee fee. For the next $500,000 the net is 1.0% with a 0.25% trustee fee, with a downward sliding scale thereafter.

For advisors who want more serious involvement, setting up their own trust business is a feasible option, but there's much soul searching and legwork involved. Batterman offers these tips to help advisors get started: Figure out what you're going to do structurally. Are you going to maintain two entities by running a trust company and your RIA? If so, you must carefully define the relationship between the entities. Or are you going to merge the entities together and perform your RIA function inside the trust company?

Once the structure is defined, the advisor can consider starting up. Batterman says a traditional startup process calls for the advisor to choose which regulator he wants to work with--his state regulator or one of the two federal regulatory agencies that would issue a trust charter. The advisor must come up with the capital to meet the regulator's capital requirements. (Keep in mind that regulators take a dim view of commingling client funds with the capital of the independent trust company.) These requirements vary from state to state, and are generally in the $1 million to $2 million range. Capital requirements of the two federal agencies at present are at least $2 million, Batterman says. Then the advisor must go through the application process of applying for the charter. "You're basically applying for a bank charter as limited to trust services," Batterman explains. "In order to get the charter you're going to have to develop your operational capabilities, show that you've got the ability to discharge these functions that you're going to undertake, and that you've got the necessary expertise in your staff."

Money can be saved by utilizing a state trust charter, but doing so may not be worth it in the long run. When setting up advisor-owned National Advisors Trust Company, David Roberts found it advantageous to work with federal regulatory agencies rather than state agencies to form, what is in effect, a federal savings bank. There are two federal agencies that issue trust charters: The Office of Thrift Supervision (which issued the charter for NATCO), and a larger entity, the Office of the Comptroller of the Currency (OCC). Roberts explains that under federal law, financial institutions can offer their services on a national basis, obviating the need to become qualified in each of the states in which they wish to do business. "That's a big advantage of this type of charter versus a state charter," he says, adding that NATCO presently has representation in 38 states.

All this is not to imply that there is anything wrong with state charters, because there isn't--especially when the independent trust company has a single location. That's the case with Santa Fe Trust, in Santa Fe, which is chartered by the state of New Mexico. Karen Sayre, Santa Fe Trust's chief operations officer, says there are no major differences between state and federal trust charters in terms of requirements, and that her trust company falls under "basically the same types of rules" as it would under federal OCC rules. A client's trust assets are just as secure in a state-chartered independent trust company as in a federally-chartered company, she says.

Who You Gonna Call?

If the task of setting up your own trust company sounds daunting, rest assured that your fears are shared by others. AITCO, which we noted as being an association of independent trust companies, asset managers, and financial counselors, is a good resource for advisors--no doubt in part because the organization began, as Batterman explains, as a group of "guys and gals who were in the process of starting trust companies and shared war stories." At AITCO's annual convention there is a workshop called "How To Start A Trust Company."

Another organization helpful to advisors is NITC (National Independent Trust Company), founded in 2000 in partnership between Batterman's Vigil Trust (which Batterman launched in 1989) and the Trust Company of Louisiana, in Ruston, Louisiana. As a trust-only national bank, chartered by the OCC, NITC was created as a cooperative trust infrastructure with the goal of helping existing independent trust companies address concerns that inevitably arise after five or more years of operation and asset growth, such as improving operating efficiencies through economies of scale, along with exit strategies and new capital requirements.

NITC currently has 19 offices in eight states, serving more than 3,000 clients with assets totaling $1.2 billion. Since the founding of NITC, Batterman has worked with RIAs to help them convert from a registered investment advisor operation to a trust company operation. But NITC was created with three distinct user groups in mind. In order of prominence, they are: existing independent trust companies; trust entrepreneurs, or those considering creating their own trust companies; and advisors exploring trust options. Unexpectedly, the advisor group has shown the most interest in NITC, with many showing interest in starting their own independent trust companies within the NITC organization. NITC, like AITCO, also assists advisors who don't necessarily wish to set up their own independent companies but are seeking a "friendly administrative trustee" to work with them, explains Batterman. Batterman places U.S. Trust Corp. in the category of outsourced administrative trustee services which, like Santa Fe Trust or Capital Trust, allow advisors to maintain control of and advise on their clients' trust assets. Lauterbach says that Capital Trust often advises the advisors, especially with liquidity issues. Many advisors will assume, erroneously, that all money in a trust account should be invested, he says. "You have immediate liquidity needs. You've got distributions that go out. If you use mutual funds as your investment choice, you have to make sure that you don't reinvest dividends, because what you're doing there is converting income to principal, and when it comes time to pay out income, you won't have any left. We want to make sure advisors do all this correctly."

Also indicative of the increased interest in and need for independent trust company services--and a resource for select advisors--is the National Advisors Trust Company, which bills itself as the nation's first advisor-owned trust company, and operates as a provider of administrative and custodial services for trust and brokerage accounts nationwide. Its genesis lies in National Advisors Holdings, Inc., also in Overland Park, Kansas, which was formed in 2000 to organize a federal savings bank. Towards this end, NAH raised more than $4 million from 75 financial advisory firms across the country. NATCO received its operating charter as a federal savings bank from the Office of Thrift Supervision last October. NATCO shareholders--there are now 82 of these member financial-advisory firms--collectively manage more than $20 billion in total client assets.

NATCO president and CEO Roberts explains that NATCO receives all its clients from the direct referral and recommendation of its shareholder group. "We don't really take clients off the street, so to speak," he says. "That's kind of the secret of our company. We support the client needs of our shareholder group, which makes us different from all the other trust models around." Interest in becoming involved with NATCO has grown steadily, Roberts says, and while he doesn't want NATCO to become "huge," expanding the group by a limited number is under consideration. "When we started this process almost three years ago, we were kind of having to talk firms into what the idea was and what we were about. Now we're turning people away. Awareness has certainly changed."

Convincing Your Client

The advisor may see myriad advantages about either starting his own independent trust company or utilizing the services of another in lieu of the big-bank trust department the client might consider or already be in. But can the client be expected to share in his enthusiasm over an independent trust company relationship?

For advisors wishing to use an independent trust company as an administrative trustee, or to outsource other services, the advisor's story to his client might go something like this, says Batterman. "We've had a long relationship, and you'd like to have me continue to manage your money. Well, eventually you're going to have some need for trust services, and we need to structure some arrangement where you can get your trust needs addressed that are still going to allow me to continue the relationship for money management. There's a limited universe of options we have for that from a trust standpoint. Independent trust companies are primarily focused on more personal, hands-on types of service and a more personal feel, like the community bank of the trust industry. So I think we'll get better service and more flexibility in those services by using an independent trust company."

If the advisor plans to create his own independent trust company as a sister to his RIA, or if he is going to convert the RIA into a trust company, the story to the client might be this, Batterman says. "Our RIA has done this [created or converted] in order to institutionalize its business. This will help to ensure that our ability to provide these services to you and your family continues on beyond the life of the advisor in an institutional type of format. You see, the banking industry, which our trust will be a part of, is more heavily regulated than an advisory firm. It will provide you with a greater level of security and comfort. To be a trust you have to have substantial capital to back the work you're doing on behalf of your clients. You get regularly examined, usually about every 12 to 18 months, as opposed to the five-year cycle that the SEC might be on. Substantial levels of insurance are required to protect clients in case something goes wrong. And I will continue working closely with you as before."

A Look Ahead

What's in store for the nascent independent trust-company industry? "I would say that the opportunity not only is pregnant now, but will get more pregnant in the future," comments Lauterbach.

Beyond the advantages inherent in independent trust companies, regardless of how they are structured, Batterman, who is a financial advisor first and "a trust company" second, stresses the importance of the function an independent trustee performs as a fiduciary, whom he considers "the premier fiduciary out there." It's a consideration of the significance that can often be overshadowed by attention devoted to planning services, trust or otherwise. There are a lot of people who don't necessarily need a trust, Batterman maintains, but would like a true fiduciary looking after their money for them. It is the focus of his business, he says, to help people understand what an independent trust company and a fiduciary do, and that they can use those services today. "They don't need to wait until they die to have somebody come in and protect the interests of their family."

The growth of independent trust companies and available trust services is a subject currently under discussion at AITCO, whose membership is booming. "There are a lot more trust options out there [for financial services professionals] than there were back in 1990, when people had little choice but to set up their own independent trust company" or lose clients to large banks. Today advisors can still do the former, or with less expense, hook up with an outsourced trustee for their trust administration needs or numerous other trust-related services. "I don't think the interest in coming up with some mechanism for providing trust services is going to be decreasing," says Batterman. "I think actually it's going to continue to increase, and that it's going to be a matter of what vehicle people are going to use to do that."

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