CHAPTER XV

THE NATURE AND FUNCTIONS OF TRUST COMPANIES

[91]The trust company supplements the bank. Through a long process of evolution the bank has developed as a means of facilitating the exchange of commodities. The trust company is a still further step in the same process, and, in a highly organized society, it meets needs which the bank is not able to supply.

In a new community the general store forms the centre of the business life of the place. With growth and increasing trade, the private banker sees room for the profitable employment of his funds. The state or national bank meets the needs of further growth. Success and the accumulation of wealth pave the way for the trust company. The bank is organized primarily to serve the needs of active commercial life; the trust company handles funds in less active circulation.

It is customary for the courts to designate or approve certain trust companies as depositories for funds paid into court, and the effect of such designation or approval would be to relieve executors, trustees, or others acting in a fiduciary capacity and depositing with these companies from liability for loss through their failure. A person charged with due care in the selection of a depository could not be held to have been wanting in such care in choosing as a depository a trust company which the court has itself approved.

The powers of trust companies vary in different states, and when they are created by special legislation, local companies are found with different charter privileges. The capital and surplus of these institutions are liable for their acts in fiduciary capacities, and in some states they are required to deposit with one of the state departments a fund as a special guarantee. The liability assumed is generally accepted by the courts in lieu of the bonds which individuals acting in similar capacities are required to give.

The development of trust companies in the United States has been remarkably rapid. Since 1882, when the first legal authority was given for the exercise by corporations of fiduciary powers, they have steadily grown in number until there are now more than fifteen hundred, distributed as follows:

Alabama 30 Arizona 9 Arkansas 38 California 24 Colorado 16 Connecticut 31 Delaware 12 District of Columbia 5 Florida 9 Georgia 25 Idaho 10 Illinois 75 Indiana 108 Iowa 29 Kansas 4 Kentucky 42 Louisiana 22 Maine 39 Maryland 21 Massachusetts 56 Michigan 6 Minnesota 4 Mississippi 19 Missouri 49 Montana 7 Nebraska 13 Nevada 1 New Hampshire 4 New Jersey 86 New Mexico 10 New York 78 North Carolina 38 North Dakota 5 Ohio 60 Oklahoma 10 Oregon 20 Pennsylvania 260 Rhode Island 11 South Carolina 17 South Dakota 12 Tennessee 73 Texas 52 Utah 9 Vermont 26 Virginia 19 Washington 20 West Virginia 22 Wisconsin 9 Wyoming 5 Hawaii 5 ---- Total 1555

Their business in all departments has shown a steady increase, and the trust companies of the United States to-day carry deposits amounting to over $3,858,300,000. Net deposits in the 7397 national banks aggregate $5,891,670,000.

In some states commercial banking and trust powers are exercised by the same companies. In such cases, separate departments are maintained for the various classes of business. Another method is for the same individuals to organize a national bank and a trust company, the former under national and the latter under state laws.

The securities company or trust company organized under state laws and controlled by a national bank with the stock interest in the former distributed among the owners of the stock of the bank and evidenced by indorsement on its certificates is still another expedient which has been resorted to in order to enable a closely affiliated and controlled organization to exercise legitimate functions which are, however, outside the province of a national bank.

The earning power of trust companies has equalled and even exceeded that of the banks, and the stock of those companies which are well established and doing a flourishing business sells at such a premium that investment in it at its market value gives a very low return.

Trust company failures have been few and far between, and where they have occurred they can be traced to a disregard of sound banking principles and to the assumption of unwarranted risks. Even in the case of companies which have failed there is no record of any impairment of trust funds, whatever loss there was having been borne by the stockholders and, to a less degree, by the depositors. This fact, the result of the absolute separation of trust assets from assets belonging to the company, is the strongest argument for the employment of trust companies in fiduciary capacities, and explains their rapid growth in popular favor.

The literature put out by these institutions invariably recites the advantages to be gained by dealing with them instead of with individuals. The following is a good example of such reasoning:

THE ADVANTAGES OF A TRUST COMPANY AS TRUSTEE

A trust company is preferable to individual trustees, because it possesses every quality of desirability which the individual lacks, to wit:--

(1) Its permanency: it does not die.

(2) It does not go abroad.

(3) It does not become insane.

(4) It does not imperil the trust by failure or dishonesty.

(5) Its experience and judgment in trust matters are beyond dispute.

(6) It never neglects its work or hands it over to untrustworthy people.

(7) It does not refuse to act from caprice or on the ground of inexperience.

(8) It is invariably on hand during business hours and can be consulted at all times.

(9) Its wide experience of trust business and trust securities is invaluable to the estate.

(10) It is absolutely confidential.

(11) It has no sympathies or antipathies and no politics.

(12) It can be relied upon to act up to its instructions.

(13) It does not resign.

(14) All new investments of value suitable for trust estates are offered in the first instance to trust companies, and in that way it has a choice of valuable security; and as its purchases are on a scale of magnitude, it can usually buy at a rate which is lower than that at which the individual trustee can purchase.

The most common objection to the appointment of corporate trustees is thus stated by Augustus Peabody Loring, Esq.:

The trust companies, which have of late years become so numerous, to a considerable extent do away with the element of personal risk attaching to an individual trustee; but they lack the advantages of personal management. These companies sometimes fail from improper management as utterly as individuals do, and as a rule the lack of personal management results in securing the minimum return only on the amount invested, and lacks the great advantages often secured by the able personal oversight of individual trustees.

The question, after all, comes back to the personal qualifications of corporate officers and individuals. If the former are less capable than the latter, the fault is with the particular company--not the system, and if interest returns are sometimes less under corporate management, this fact is more than equalized by the added safety to the corpus of the estate.

A "Trustee Company" has been suggested as a proper title for the company doing a legitimate trust business, and is the name used in Australia and in New Zealand. In some states the use of the word "trust" in corporate titles is now regulated by law. Confusion has arisen in the popular mind between the trust company and the trusts or industrial combinations.

The usual functions of a trust company are: banking in a more or less limited form, execution of corporate trusts, execution of individual trusts, care of securities and valuables. In addition, other functions are sometimes exercised, such as life, title, and fidelity insurance, and the business of becoming surety. The earlier companies in the United States were chartered to manage individual estates only and to act in certain fiduciary capacities; the recent development of the trust company has been in the direction of banking functions and corporate trust business.

It is worthy to note that the life insurance companies which originally secured trust powers have, with but few exceptions, given up their life insurance business, and that most of the fidelity insurance and surety business is given over to companies which now make a specialty of such risks. The fact is being recognized that the assumption of vast risks contingent on future occurrences is not compatible with the absolute security which is essential in the transaction of legitimate trust business.

BANKING

The banking functions of trust companies may include any or all of the following:

The receipt of money deposits payable on demand and subject to check, or payable at a fixed date, or according to special agreement. Interest is usually allowed on all deposits above a fixed maximum amount or on the total sum.

Money advances secured by the hypothecation of stocks, bonds, life insurance policies, bonds and mortgages, or other personal property.

Real estate loans, secured by bond and mortgage. It is customary to loan not over two-thirds of the value of improved property; when the property is unimproved, not more than half.

Discounting paper is engaged in principally by companies transacting a commercial banking business. The purchase of unsecured paper is permitted in some states where discounting is not allowed.

The purchase and sale of securities.

Trust companies sometimes guarantee issues of bonds, or at least set their stamp of approval upon them.

The issue or guarantee of letters of credit, and the transaction of a foreign exchange business.

The care of savings deposits. For this purpose a separate department is usually maintained.

CORPORATE TRUSTS

Among the most important functions of a trust company are those relative to the business of other corporations:

Of late years the trust companies in the Eastern cities have been selected as trustees instead of individuals whenever the law of the State where the property was situated allowed such selection. Trust companies have manifold advantages over individuals in such a relationship; they do not die; the large amount of financial business which they daily transact provides them with the machinery for such purposes; while their well-known names stand as evidence to the purchasing public that at least the necessary formalities have been complied with. Beyond that responsibility the trustees of corporation mortgages usually assume none.

In recent years the trust companies have shown a tendency, when acting as mortgage trustees, to recognize a greater moral responsibility than they at first were willing to bear. Trust companies did not, of course, intend to appear as in any way guaranteeing the bonds to which they certified, though that seems often to have been the erroneous opinion of the unthinking; but trustees now acknowledge themselves bound within the limits of the mortgage to use their influence to protect the interest of the bondholders. A trust company which should now allow the issue of unsecured bonds because of some glaring defect in the language of the mortgage, would not longer be morally excused by financial opinion, though perhaps held technically innocent.[92]

As trustee under corporate mortgages and trust deeds, the trust company acts for the bondholders. It is customary for it to authenticate each bond issued subject to the provisions of the mortgage, to represent the bondholders in case of default, and to exercise such other functions as may be provided in the mortgage.

A generation ago it was customary for a railroad to name one or more individuals as trustees of the mortgages executed to secure bond issues. The development of trust companies and their manifest advantages over individuals in such a capacity has resulted in their absorbing almost all this business. Trust companies are now generally appointed as trustees in corporation mortgages, and are also often named to succeed individuals who have died or resigned. The appointment is one of the most important and far reaching which the trust company can accept. Its name and reputation serve as an assurance that the transaction is a regular one, and entered into in good faith. Although the modern corporation mortgage is usually explicit in its terms to the effect that the trustee in no way guarantees the value of the security and assumes no liability except for its own negligence, yet the intimate connection between the trustee and the borrowing corporation in the minds of investors makes it necessary that care be taken not to assume trusteeships which may lead to a wrong use of the name and credit of the trust company.

As trustee under mortgages securing bond issues, the title to the mortgaged property is vested in the trust company for the benefit of the security holders. The corporation owning the mortgaged property retains physical possession of it so long as the terms of the obligation are complied with, except in the case of securities pledged, which are usually lodged with the trustee. In case of default, however, it devolves upon the trustee to protect the interests of the bondholders, and this may necessitate the foreclosure of the mortgage and sale of the property.

As fiscal agent it dispenses coupon and interest payments on bond issues, and dividends on stock. It receives sums set aside as sinking funds to provide for the retirement of obligations at maturity, or when bonds are subject to redemption, draws the specified amount by lot and pays the principal.

As registrar the trust company authenticates certificates of stock and bonds in order to prevent an over-issue, and to reduce the chance of loss or theft. As transfer agent, the company attends to perfecting transfers of ownership for stock and bond issues or parts thereof.

The New York Stock Exchange, like most other stock exchanges, in its constitution requires that all active listed stocks must be registered. This Exchange also requires that a trust company or other agency shall not at the same time act as registrar and transfer agent of the same corporation. In the popular mind, and even in the minds of some trust company officers, the difference between the duties of the two positions has been more or less confused. Both have been created to safeguard and facilitate the passing of title to shares of stock, but the duties of a transfer agent and a registrar are not synonymous; they are distinctive. One is called upon to examine and give clear titles to property transfers, and the other is merely to record such transfers.

As manager of underwriting syndicates, the trust company issues the prospectus and markets the securities of corporations which are being launched, or of established companies which are putting out new securities.

In railroad and other reorganizations, the trust company takes a prominent part, acting both as a depositary for, and as a representative of, the committees which formulate and execute the plans of reorganization. Its officers often have a large share in the preparation of such plans.

As assignee and receiver, the trust company acts in the same capacity for corporations as for individuals and firms or partnerships, assisting in winding up insolvent businesses and in conducting embarrassed ones.

INDIVIDUAL TRUSTS

The execution of individual trusts is the function originally assumed by trust companies. The various other forms of business which are now engaged in, have, with the exception of life insurance, been later developments of the trust company idea. The earliest power granted these companies was to receive moneys or other property, real or personal, in trust. The trust company now also acts as executor and administrator of the estates of decedents.

As executor appointed by the will of a decedent, it takes out letters testamentary upon probate of the will, advertises, files inventory and appraisement, pays debts, collects claims, makes the requisite accounting to the probate or orphans' court, and makes distribution of the estate in accordance with the terms of the will and the court's decree.

As administrator acting under appointment of the register of wills or probate court, it performs similar duties, distributing the estate in accordance with decedent's will if there is one, or if there is none, in accordance with the intestate laws of the state, which specify the order of succession and distributive shares in the case of estates of decedents leaving no wills. There are different kinds of administrators, in any of which capacities a trust company may be called upon to act.

As trustee under will, the trust company carries out the provisions of the will, investing and managing the estate or particular fund in accordance with the directions of the testator. As such it may hold real and personal property.

As trustee under deed or private agreement, a contract is entered into between the company and the owner of the property, by which the title to the property is vested in the corporation subject to the terms recited in the instrument. Such deeds of trust may be revocable or irrevocable. Marriage settlements are frequently made in this way.

The trustee's duty in investing the funds is a double one; namely, to invest them securely so that the principal shall be preserved intact, and to invest them as productively as possible under his powers, so that they shall yield the best rate of interest obtainable for the benefit of the person or persons entitled to the income. He must hold the scales evenly, regarding scrupulously his duties to all beneficiaries. The popular idea that security is the only consideration is erroneous, as the trustee is equally bound to invest the funds as profitably as possible and cannot neglect one duty more than the other. The mistaken impression that the corporate trustee, even more than the individual, is mindful only of the safety of the principal and entirely loses sight of the question of income, has arisen from the restrictions as to investments imposed by law, and frequently also by the will or trust deed, and from the fact that the individual executor or trustee, rightly or wrongly, sometimes assumes risks and personal liability which the proper rules of a trust company would not permit it to assume.

The executor or trustee is governed, as to the kinds of investments, by the directions of the will or deed of trust. This may require the purchase of "legal investments" only, or state that the trustee is not to be confined to securities prescribed by law, or give specific directions as to the classes of securities which are to be bought. The terms of such documents are always strictly construed by the courts; if no directions are given, the trustee is expected to buy only "legal" securities, and when he exceeds his powers he is held responsible for any loss. Administrators and guardians without broader powers given by will are obliged to invest, except at their personal risk, in such securities as are sanctioned by law or directed by the court.

Some states prescribe by statute the securities in which a trustee may invest. "Where there is no statute or decision of the highest court fixing the class of securities in which a trustee may invest, he can safely follow the rule prescribed for the investment of the funds of savings banks." In general, city, State, and United States bonds, first mortgages secured on improved real estate with ample margin, are among the investments sanctioned by law. As to real estate, stocks, and first mortgage bonds of railroad, manufacturing, and other corporations, the practice varies in the different states. Loans on personal property, second mortgages, and other investments subject to prior liens or of a speculative character are excluded. All investments must possess "intrinsic" value; the courts hold trustees liable for any losses from speculative risks--but any gains accrue to the trust estate.

OTHER FUNCTIONS

The trust company acts as guardian, curator, or committee of the estates, and in some states, of the persons of minors, those who are insane or mentally incompetent, spendthrifts, drunkards, and any other persons not legally qualified to take charge of their own affairs. In the case of a minor, the trust terminates on the ward's becoming of age; in other cases, when the disability is removed, or in accordance with a decree of court. These appointments are frequently made by order of court, and to it accounting must be made. In some states the company is styled "conservator" when caring for the estates of persons of unsound mind.

When acting as attorney in fact, the company obtains its authority by virtue of a letter of attorney which usually is or can be recorded, conveying certain definitely specified powers. This may be either to perform a single act--such as to satisfy a mortgage--or may be broader and continuing, granting authority to sell and transfer securities and collect income. A general power of attorney, as the term indicates, is a delegation to another of the general powers of the person appointing--as to payments, collections, transfers of property, and all transactions of a business nature.

As agent merely, the company takes charge of property, real or personal, for its owner, but such agency does not imply nor ordinarily include authority to sell or convey title. Moreover, trust companies as agent often take up lines of business which they either cannot or would not engage in on their own account. Thus, a trust company can act as agent for fire or life insurance companies, for water, gas, and other public service corporations. In new communities and where it is difficult to find responsible representatives, the trust company can often render efficient service and secure a steady income without risk by assuming agencies of various sorts.

As assignee the trust company takes possession of the property assigned for the purpose of carrying out the terms of the deed of assignment in the interest both of the assignor and the creditors of the assignor. The deed of assignment is an acknowledgment of an embarrassed or insolvent condition, and the efforts of the assignee are directed to realizing as much as possible from the assets intrusted to its management.

As receiver, the duties may be very similar to those of assignee, although they are usually broader in scope. The business may not be insolvent, and the application for the appointment of a receiver may be due to temporary difficulties only. By such an appointment the property is preserved intact and equal treatment is afforded creditors. An able receivership often results in the adjustment of difficulties and the return of the property to its owners on a paying basis. While in the case of assignee the appointment is by the individual, partnership, or corporation executing the deed of assignment which specifies the powers and duties of the assignee, in the case of receiver the appointment is by a court and the company so appointed acts as an appointee or ministerial officer of the court, and as such is directly subject to the court's orders.

A trust company acting as receiver is better able than an individual to furnish additional capital, if amply secured, and thus successfully to meet the difficulties which withdrawal of credit and restricted capital have temporarily brought upon an otherwise prosperous business. The courts authorize the issue of receivers' certificates to provide funds for purchase of equipment and the proper maintenance of the property and conduct of the business when the creditors are benefited by such expenditures. Such certificates may be made a first lien on all assets, taking precedence even of mortgages and other secured obligations. The receiver thus secures the capital necessary to make the property more productive and to secure the largest return from the business.

As custodian or depositary, the trust company sometimes holds property the title to which is in dispute, delivering the same when the ownership is legally determined.

In taking charge of escrows or conditional instruments or deeds delivered to a third party until the condition is performed, the trust company acts in a similar capacity, as the joint representative of both parties.

The trust company acts as the representative of both the living and the dead in practically every legal relation in which an individual is qualified to act. Its function is not only to keep intact the estate of which it has charge, but to look to and safeguard the interest of every beneficiary.

CARE OF SECURITIES AND VALUABLES

The functions already recited have resulted in the assumption of the duty of caring for property other than that of the estates held in the trust department. In the safe deposit department, individual safes are rented, bulky packages--not containing stocks or bonds--are received on storage, certificates of deposit covering securities are issued, and provision is made for access to, and examination of, the property so deposited. For personal property received on storage, the charges are either according to bulk or value. Wills are usually receipted for and kept without charge.

INSURANCE

The examination and insurance of real estate titles is a later development often found in connection with the usual trust functions.

Fidelity insurance and suretyship providing against loss by reason of the dishonesty of individuals and the non-performance of obligations, contracts, etc., have often been combined with the various forms of trust company activity. They are, however, largely passing into the hands of corporations especially organized for the transaction of such business.

COMPENSATION

When acting as trustee under corporation mortgages, a definite charge may be made for accepting the trust, and a fixed amount per annum thereafter for paying coupons and performing other duties. For the certification of bonds it is usual to charge fifty cents per bond in the case of large issues, and one dollar for small issues. The figures, however, vary in different places. The charge for certifying the bonds may be the only one, although an additional charge is usually made for counsel fees. In case of default and consequent foreclosure of the mortgage, extra payment is made to the trustee covering all services incident to the foreclosure.

For the disbursement of sinking funds, interest, or coupons, the temporary use of the money may be considered adequate compensation, if the amount involved is large. A commission on the sum distributed or a fixed amount is charged when acting as fiscal agent, apart from duties in other capacities. For acting as registrar or as transfer agent it is usual to make a fixed charge per annum, based on the amount of labor involved. The transfer agent is usually paid about twice as much as the registrar. Compensation for acting as manager of an underwriting syndicate may be a fixed sum or a commission, according to the provisions of the underwriting agreement. For acting as depositary under plans of reorganization, assignee, or receiver, a lump sum is usually paid covering all services. Agency work of various sorts is paid for in accordance with the usual practice in the business which is undertaken; a fixed sum, or a fixed sum and a commission, or a commission only, may be received.

The trust company is in a position to render valuable, and often indispensable, aid to its corporate clients. Large amounts being involved, the great railroad and industrial corporations are willing to pay well for such services. Corporate trust business has, consequently, been a profitable field for the trust companies.

GOVERNMENT REGULATION

An examination of the laws of the various states is interesting as showing the attempts which are being made at regulation. Most of these laws have been enacted within recent years and to-day there are but few States which do not have such statutes on their books.

The step which Massachusetts first took in requiring a legal reserve to secure deposits has been followed by similar action in other states. In general, the wisdom of prohibiting companies which engage in the care of estates from assuming excessive risks is becoming better recognized. The promotion and underwriting of commercial ventures and the assumption of unknown risks are functions not compatible with the proper exercise of the duties of trustee or executor.

The supervision of trust companies by the separate states provides an elastic system to supplement the rigidly guarded powers of the national banks, and can adapt itself to changing conditions and enlarging needs, leaving for solution according to the requirements of each section of the country such questions as proper functions, reserves, and the authority to establish branch offices.

FOOTNOTES:

[91] Adapted from Kirkbride and Sterrett, _The Modern Trust Company_, pp. 1-13, 113, 114, 127, 143-146, 204, 205, 208. The Macmillan Company. 1913.

[92] Thomas L. Greene, _Corporation Finance_, p. 59.