CHARGED WITH MAGIC:
UNDERSTANDING OFFSHORE TRUST COMPANIES

 

 
Prudence, integrity and expertise are the essential trinity in the profession of trust management. The role of trustee is a function that is unlike any other and it is why the observation has been made that "there is a vast deal of magic in words and the word most highly charged with magic to be found in the world is "trustee"." Trustees must be scrupulously honest and prepared to devote sufficient time to the administration of the trusts under their control, some of which can last for years in the case of families. They must have enough common sense and business acumen for the task which involves both financial and human affairs, calling for careful management of both assets and relationships with beneficiaries and others. The trust is an ancient tool which has been continually adapted to changing times and its application in financial structures is, like its potential benefits, manifold. Although light has been shone on magic in recent years, the trust still maintains a certain mystique. Often its activities are secretive, and when it is transported offshore this can add intrigue to mystique.


The central business of offshore trust companies is providing trust services but their fiduciary role can present a blurred picture unlike the sharply defined image of other offshore activities such as banking and insurance. Many offshore jurisdictions appoint the same regulator to supervise both banks and trust companies and whilst the distinction between insurance policyholders and bank depositors is transparent, the difference between a bank’s obligations to customers and those of a trustee to beneficiaries is not. Nor is clarity advanced by the fact that, traditionally, some insurance companies and banks include trust administration as part of their services. There are, nonetheless, similarities between banks and trust companies in that both manage assets, but their fundamental difference is revealed in their respective balance sheets. A trust company isolates its trust activity from its balance sheet but, in the case of a bank, its audited accounts incorporate customers deposits and loans, because these have an intrinsic link with a bank’s financial health. The guidelines and controls introduced by the Basle Committee on Banking Supervision, especially concerning capitalisation and liquidity levels of banks, bear this out. Trustees, on the other hand, whether they are individuals or institutions, swap the Basle Committee’s banking principles for those of equity. If a bank does happen to engage in trust work, the auditors record such business as being off-balance sheet activity in recognition and confirmation of the difference between the two services.


Unfortunately, some bankers wore blinkers when they jumped on the offshore trust bandwagon that started rolling a few decades ago and many have since paid dearly for the folly of placing more emphasis on profit than precaution. They accepted nominations as trustee, without having fully qualified and experienced staff and stepped into a legal minefield. Numerous lawsuits were filed and countless out-of-court settlements were reached. A sharp lesson was taught about the difference between contractual obligations to specified parties and those which fell under equity when claims against the trustee came from beneficiaries previously only names in a trust deed. The shareholders of these banks soon understood, however, that although the trust business administered may not feature in the annual audited accounts, the related legal expenses most certainly did, and that the potential for an action being brought against a trustee for breach of trust was ever-present. More alarming, the bankers had to face the fact that even where a trustee has taken and has followed legal advice, it does not automatically excuse him from liability.


In the eagerness to introduce more regulation in the offshore financial services industry, particularly in the case of fiduciary activities, governments and their regulators must fully understand the distinctiveness of trust work and the importance of the trinity of qualities mentioned at the beginning of this article. Just because the applicant for a trust licence is a bank or large corporation, it is not sufficient reason to short-circuit essential elements of the licensing process. The same attention given to a bank’s capital by Regulators should be paid to the ability to provide an adequate level of expertise in trustee law, accounting and administration. Once a licence has been granted, if the degree of expertise subsequently drops below a certain level, then Regulators should insist on immediate remedial action, just as they would if a bank’s capital reserves were too low. Regulators do have an easier time supervising banks which must provide regular financial data that enables liquidity and other important financial statistics to be studied and which serves as a barometer for measuring whether or not the customer’s welfare is being protected. A trust company’s accounts, on the other hand, will not do this and impressive audited accounts can still mask poor trust fund management. It follows, therefore, that a trust company’s real strength lies in the reservoir of skills which it has at its disposal and unlike a bank, the fact that its capital is perhaps only $250,000, should not be of any significance. Financial propriety is still important for the smooth running of a trust company’s business, of course, and the prudence necessary for the stewardship of trust assets should be reflected in its own accounts.


When jurisdictions allow the use of the word "trust" (or a derivative of it) in a company’s name, they should do so fully recognising their responsibility to protect the public and if I assumed the role of Regulator in the imaginary Conch Islands, I would expect existing trust companies to be required by statute to inform me in advance of any changes in senior personnel. In effect, I would want the offshore trust company to have someone with a minimum of 10 years international experience at a senior level, backed by a professional trust-related qualification. Greater caution would be exercised in the case of a new independent trust company application, because besides studying the business plan and resumes, I would want the shareholders also to display a clear understanding and appreciation of the trust business, with all its demands and risks. Their motives should be closely examined: have they replaced Lord Langdale’s three certainties of a trust with their own, namely, a client, his cheque book and a pen? Unfortunately, although expertise can be gauged, business plans, resumes and motives cannot accurately assess the degree of prudence and integrity and here, a Regulator has to rely on his own experience, backed-up by circumstantial evidence and face to face meetings. It is true that strong clues can be found in professional backgrounds and references, but they come with no guarantees when considering acumen and probity. A flawed diamond can still sparkle.


Offshore financial services are big business today and the attractions of large fees have taken inexperienced domestic providers offshore into uncharted waters. The use of offshore trusts has become very popular and today, like transatlantic travel, they are packaged and promoted internationally. Advertising in leading international financial magazines offer for sale offshore trust companies that are "legal, legitimate and affordable". That tag can apply equally to firearms which, like trust companies, are potentially hazardous in the wrong hands. Amateurs managing trusts can be like children with matches in a fireworks factory, unable to perceive the dangers present. Critical errors can be made even before the administration of a trust begins. In some instances, corners are cut by cannibalizing precedent trust deeds and a defective document is presented to the inexperienced client as perfect for his needs. Concealed defects in a deed can have a long incubation period and might not become apparent for some years, by which time the problems may well have been compounded.


More dangerous than the enthusiastic amateurs are the sharks that swim these offshore waters and who have totally amoral intentions. Modern advances mean that it is possible for these unscrupulous individuals and companies to operate a large part of their business over the internet. Considerable amounts can be spent on a very impressive website and work, such as company and trust formations, can be outsourced. They have scant regard for the best interests of their victims and, whether their company has an issued capital of $2 or $2 million, by skilful presentation this electronic shop window can illustrate Bishop Berkeley’s maxim, "esse este percipi", (perception turns into reality).
The individual in search of safety, then, without the help of a guiding hand, should first look at the jurisdiction rather than the trust companies operating from it. If the regulatory regime consists of recovering an annual licence fee and little more, look elsewhere to a jurisdiction in which the Regulator has powers (particularly of inspection), requires audited financial statements and the law calls for a bond or professional indemnity insurance from the licensee. The size of the trust company, as I indicated earlier, does not necessarily have any correlation with the degree of safety or skill you can expect to find. A small, but well-established trust company which has been in business for many years, has had minimal staff changes – particularly at a senior level – and displays some permanence (perhaps by way of owning its premises) should not be automatically ruled out. Transient trust officers abound these days, particularly in large trust companies, and the interruptions in continuity are the bane of many a client’s life. But whether the trust company is big or small, a degree of insurance can be written into the trust deed. Alternative trustees can be appointed, for example, or a protector can be named whom the trustees must report to or take instructions from in respect of important aspects of administration.
I also think that the choice of trustee should be made after a personal visit to a short-list of trust companies. The initial meetings themselves send you positive or negative signals, although it is very important to look beyond pleasing personalities and smiles when trying to determine the quality of management. "What are your trustee qualifications and what is your experience?" This is a question which, in my view, is all too infrequently asked and its been known to remove a smile or two from the faces of some friendly trust company executives. Listen to the reply carefully.

 

 

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