Recent years have seen a dramatic increase in the number of Private Trust Companies (“PTCs”) established by wealthy families. PTCs are used to consolidate the trustee function of multiple trusts within a family, and because these trusts are often invested in family-controlled investment vehicles they implicate various federal securities laws. For instance, the Investment Company Act of 1940, which regulates mutual funds and other pooled investment vehicles (the “1940 Act”) may require significant review and planning for large families considering considering use of a PTC. Compliance with 1940 Act registration and ongoing regulatory requirements can be extremely burdensome, and therefore we, as advisers, are often faced with the challenge of navigating the maze of exceptions available under the 1940 Act.
As a general rule, there is an exception to the registration and other requirements of the 1940 Act for investment vehicles (such as partnerships or limited liability companies) which have fewer than 100 investors, or whose owners are all “qualified purchasers” (generally a person with over $5 million of investments). While the 100 investor limit would seem generous in a family context, it is not out of the question that a multi-generational family could have in excess of 100 investment accounts after counting all trusts and individual family members having separate accounts, and therefore fail to qualify for this exception. Likewise, it is not often the case that all investors are qualified purchasers. In these situations, a family must seek another exception from the 1940 Act.
For a family that has established a PTC to manage its pooled investments, it is possible that the so-called “Common Trust Fund Exception” could be available, but only in limited circumstances. There are three primary requirements to qualify for the Common Trust Fund Exception. First, the exception is available only to a banking institution or trust company supervised by a state or federal regulatory body. Many PTCs are formed as regulated entities subject to state supervision and therefore do meet this criteria (although certainty on this point in the form of a SEC no-action letter is not available). Second, the Common Trust Fund must be “maintained by” the PTC. The SEC has interpreted this to mean the PTC must exercise substantial investment responsibility over the Fund. The PTC may hire investment professionals to assist with investment management, but the PTC must make all final investment decisions. This requirement may prove to be difficult to meet for a PTC that intends to delegate investment responsibility. Third, the PTC must use the Common Trust Fund for a “bona-fide fiduciary purpose”. Based upon available SEC guidance, this means, essentially, that the Fund is to be used exclusively for the collective investment of moneys contributed by the PTC to the Fund while acting in a fiduciary capacity as trustee of one or more trusts, and therefore, the Fund would not be open to contributions by individual family members for collective investment. This restriction has been interpreted by the SEC to also exclude revocable trust accounts because the grantor of the trust typically would have the right to direct the investments of his/her own revocable trust—thus defeating the “bona fide fiduciary purpose“ requirement.
In sum, the Common Trust Fund exception may provide needed relief for certain family collective investments maintained by a PTC, but because of the several limitations it is not likely that the exception will find wide application.