If you are a trust company using or considering directed or delegated trusts — what you’re about to read is both urgent and important. It speaks to the very nature of directed and delegated trusts, and the consequences of mismanaging a critical landmine in accurately serving your clients.
To refresh your understanding of what directed trusts are, let’s define what we mean. A directed trust arrangement refers to a relationship where control over the assets (and the investment fees they generate) remains with the legacy advisor or whomever the client assigns, while the trustee administers the trust itself.
In a delegated trust model, the difference is that the trustee always remains legally responsible to oversee and approve the trust's investments, in all aspects.
The common thread between these two models is that both the trustee and investment advisor are thus free to do what they do best. The result is an alignment of interest of all parties with the grantors and beneficiaries themselves while minimizing potential conflicts.
Trust Accounting: Held to a Higher Standard
Trustees are held to the highest level of fiduciary standards by law. In order for the trustee to demonstrate that it accounted for and used trust assets appropriately, the trustee must use a designated trust accounting system.
A trust accounting system has the ability to segregate cash and assets into separate, distinct buckets called principal and income. Sometimes this functionality is called dual cash accounting. It is unique to trust accounting systems and is required to provide appropriate record keeping for trusts.
When trust accounting transactions are posted, it is mandatory for the trustee (the person responsible for running the trust) to select the appropriate bucket i.e. principal or income accounts. Small mistakes early in a trust’s existence can result in losses attributable to the trustee.
All trustees must have a trust accounting system and the capability of determining principal or income allocations for all accounting transactions - income and expenses.
If not handled properly, discrepancies set the company up for problems.
The Biggest Challenge with Directed and Delegated Trusts
Many with deeper experience in the industry are becoming increasingly aware of a core challenge facing the modern trust company: the ability to provide accurate, timely information and accounting to advisors and end clients.
Examined more deeply, we see that the reporting and accounting issues are most often caused by the differences between portfolio accounting and trust accounting creating a square peg in a round hole conflict.
A common workaround to address this conflict is the use of a technology bridge - interfaces to automatically post-transaction activity between the advisor/broker and the trust accounting platform. And while interfaces greatly improve efficiencies and reduce manual shadow posting, some transactions will not automatically post and will require manual “shadow posting.”
These transactions—due to their exceptional and highly variable nature—require special treatment.
Some examples of transactions that often require manual treatment are corporate actions, disbursements, buys of new securities, and fees.
Part of the reason these often trigger manual exception processing and “shadow posting” is because the exact timing of their posting is not 100% pre-determined like many other financial transactions, or they need special handling due to their variable nature.
If a technology bridge is not available, limited, or fails you for any reason—manual “shadow posting” is the only way to accurately post account activity.
The bottom line reality of this distinction means that it’s VERY difficult to have these systems be 100% accurate and “in sync”—without some degree of manual oversight and activity.
The 4 Consequences of Doing Nothing
If your firm doesn’t have systems and a trained team (internal or outsourced) in place to handle the small but highly critical percentage of manual transactions involved in trust accounting—you’re all but guaranteed to have errors in your statements provided to clients.
We’ve seen cases where the statements created by trust companies were incorrect. It’s not hard to see how these could be perceived as defalcations and the associated risks with that perception.
Sadly, when it comes to directed/delegated trust accounting—many trust companies tend to ignore despite the following consequences:
· Consequence #1: Dramatically Increased Costs — when exceptions become errors, the cost of fixing the problem can become significant.
· Consequence #2: Significantly Lost Time/Opportunity — the time and resources it takes to correct errors on top of normal daily processing requirements can grind your organization to a halt.
· Consequence #3: Reputational Harm — incorrect statements aren’t just expensive in terms of direct costs, or indirect costs (lost time)—they pose an even bigger threat: damage to your reputation.
· Consequence #4: Legal/Compliance Risk — mishandling the problem of manual shadow posting and client statements is a liability. All trust activity (including accounting and disbursements) is highly regulated and protected by laws of the state the trust is established in.
How Trust Companies Can Ensure 100% Accurate Accounting and Compliant Statements
Given the severe consequences of this problem, you might wonder why trust companies haven’t figured out a better solution for handling automated and manual shadow posting. The challenge is that even with the best technology platform (some trust technology solutions are far superior to others)—the variable and often unpredictable nature of this small class of transactions makes some degree of manual oversight necessary. Therefore, having the right people in place to process these transactions correctly is paramount.
Understanding that there is a shortage of reliable seasoned trust talent in the industry and aligning with the correct technology solution will greatly enhance your ability to focus on what you do best - growing your business and serving your existing clients.
It’s for all these reasons and more, we’ve created a NEW whitepaper called, HIDDEN RISKS USING DIRECTED AND DELEGATED TRUSTS FACING THE MODERN TRUST COMPANY.
It’s available to download, free of charge, and will walk you through an in-depth overview of this challenge—and the optimum solution.
You will discover why aligning with the correct technology will create efficiencies, reduce costs, and compliment your organization’s strengths - instead of hampering them. You will be armed with the most important questions to ask technology vendors - cutting through the sales spin.
You will also discover how having a strong back office goes far beyond just avoiding these negative consequences; and how it allows the leadership in your firm to focus more resources (time, personnel, capital) on client service and growth. You will learn why outsourcing is often key to maintaining 100% accuracy in all your client statements, and why it’s often a good idea EVEN if you have a strong, talented internal team.
Go here to download, HIDDEN RISKS USING DIRECTED AND DELEGATED TRUSTS FACING THE MODERN TRUST COMPANY.
