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Should your wealth advisory firm offer trust services?

Feb 14, 2023

Over the next decade, the number of financial advisors could increase by 15%. Meanwhile, more fintech tools are becoming directly available to clients. The wealth services market is getting crowded — even commoditized.

In response, some advisors are adding trust services to their portfolios. On paper, it looks like a relatively simple way to differentiate their practice and appeal to high-net-worth clients. They can retain valuable accounts, keep more assets under management and create new sources of revenue. But it’s not simple at all.

Reward versus risk

For some advisors, they’ve begun accepting the role of trustee or successor trustee as part of the client’s trust. Additionally, some advisors are acting as de facto trust companies, offering some services traditionally offered by trust companies.

These types of activities come with fiduciary risks not normally associated with the role of an advisor. And if an advisor wishes to fully enter trust services, trust companies are beholden to an entirely different set of regulatory, operational and risk considerations. Advisors can’t be trustees in name only; they need specialized skills, internal control systems and infrastructure to avoid liability for both the firm and them personally.

Mistakes are easy to make if advisors don’t switch hats and clearly distinguish their roles. And the roles and rules are fundamentally different:

  • Advisors are focused on getting strong returns and growing wealth, while trustees’ ability to invest may be limited by the constraints of the trust document (a document that defines what and which types of investments the trustee has been granted).
  • Advisory firms have limited capital requirements, while trust companies have regulatory minimum and ongoing capital requirements, as determined by their regulatory body (e.g., state department of financial institutions).
  • Often, advisors have more latitude in working with clients to update plans, move money into different types of investments or shift allocations to capture new opportunities. Trustees may not have this flexibility and are bound to trust documents, which prescribe how assets can be operationalized.
  • Advisors have relatively limited scope: They plan and manage investments. Trust companies have ongoing account management responsibilities, including disbursements, record-keeping and regulatory reporting associated with trust activity.
  • Trustees must also understand the nuances of certain types of trusts. For instance, in a nondiscretionary trust, the trustee has no discretion in the management of the assets. The trustor specifies how the assets are to be distributed exactly.

Does it feel like advisors have their foot on the gas, while trustees are pumping the brakes? At times, advisors and trustees have contradictory responsibilities. That conflict can weaken internal controls and introduce irreparable risk.

Both parties have the interest of the client at heart, but very different perspectives about what that means and how to achieve it.

But is it wrong?

Let’s consider “Bob,” who is a financial advisor for the Smiths, a high-net-worth family. As the family’s long-time advisor, Bob has a deep understanding of the Smiths’ estate and financial goals.

Bob is also a trustee for the Smiths.

The question is: What’s wrong with this situation?

Legally, maybe nothing. However, it may present conflicts of interest. And one recent Financial Industry Regulatory Authority (FINRA) suspension case highlights the need for caution around this conflict of interest.

Trustees have fiduciary responsibilities that can create liabilities for firms that don’t consider the risks. And these risks could result in monetary damages surrounding fiduciary activities, such as improper investment management, compensation, fees, record-keeping and distributions management.

Getting it right versus getting into trouble

There are two strategic and risk-managed ways for an advisor to consider trust services. Advisors can:

  1. Establish a subsidiary: Setting up an independent trust company puts up important walls between the advisory and trustee functions.
  2. Outsource to a private label trust company: By outsourcing, advisors can offer trust services without taking on steep capital, infrastructure or IT requirements.

Both options allow advisors to expand services, retain control over client relationships and build their brand. Perhaps more importantly, they create clear separations between the two services and how they are administered.

Having a separate business structure for trusts also makes it easier to model the financial consequences, manage compliance risk and hire the right staff. Top-performing advisors and top-performing trustees may have divergent personalities, skills and motivations. Compensation structures are often different in advisory versus trustee relationships, too.

Responsibility to clients

It takes time to learn fiduciary duties. Trusteeship is not something an advisor can just step into, even if they’re an exceptional advisor. Advisors owe their clients focused proficiency. Wipfli can help you develop a strategy to add trust services and minimize risk. Together, we can weigh all the options and figure out how to do it right. Right for your clients, for regulators and for your firm.

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Author(s)

Robert H. Zondag, CTP
Principal
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