Investing for Attorneys - Using Blind Trusts
No one would want to buy a stock at $100/share and immediately have a $60/share cost basis, but that's what happens with mutual funds.
Many attorneys work at firms that have prohibitions against owning individual securities. This removes potential conflicts of interest that could lead to lost business or the appearance of impropriety.The result of this is that attorneys at these firms are often invested in high fee and tax-inefficient mutual funds. This is a mistake that can, and should, be avoided.There are at least two ways to avoid investing in mutual funds and still comply with firm by-laws:
- utilizing a discretionary separate account, or;
- investing through a revocable blind trust.
Many of the same firms that prohibit the ownership of individual securities by a partner will allow accounts managed on a discretionary basis to own individual securities.This offers a number of advantages for attorneys.First, owning individual securities is much more tax efficient. Loses can be harvested and the timing of gains can be tailored to the needs of the partner.With mutual funds, the investor loses control of the tax aspects of their investment. Indeed, perverse occurrences such as having a loss in the fund and still paying capital gains tax are possible.Furthermore, when a partner buys a mutual fund, they are buying into embedded capital gains because they are joining a pool of investments that have usually been in existence for years, if not decades.No one would want to buy a stock at $100/share and immediately have a $60/share cost basis. However, this is what happens when attorneys buy into a mutual fund, especially after a long bull market like the present record-setting run.Lastly, many mutual funds are “closet indexers” with low active share. This means an investor in the fund is paying an active management fee for a portfolio that is highly duplicative of the index, and unlikely to outperform.
If a partner’s firm does not have a carve-out for discretionary accounts, a fall-back is to use a revocable blind trust.Blind trusts have been used for decades by politicians to avoid the appearance of any conflicts of interest. Indeed, The Ethics in Government Act of 1978 created two types of blind trusts. Essentially, blind trusts work like the discretionary account described above, however, the investments are made in a trust where the settlor (the attorney) has no knowledge of its investments.As a revocable trust, funds can be added to or withdrawn from the blind trust at the settlor's discretion. However, beyond a broad investment policy guideline, such as the asset allocation, the settlor will have no knowledge of the trust's contents. Typically, a blind trust will have an independent trustee and a third party accountant to reconcile the cash flows and report the values of the trust to the settlor. The independent trustee will typically be an institutional fiduciary or the investment advisor.As with a traditional discretionarily managed account, the asset manager will have a limited power of attorney to make investment decisions, but not to transfer funds from the account. The costs to create a blind trust instrument are low because there is very little customization and most of the language is boilerplate. Likewise, the fees of a third party accountant to review the statements and report the values is de minimis. If the trustee is the investment advisor, those costs can be included with the asset management fee.
As I have discussed extensively in my Company Town Risk series, attorneys face particular risks and need to diversify their investments away from those risks. For instance, if a partner’s practice is devoted to transactional work in the technology space, they should significantly reduce, if not eliminate technology investments from their portfolio. This cannot be accomplished by investing in mutual funds or standard index funds. Technology stocks are currently 26 percent of the S&P 500. To voluntarily concentrate a partners financial assets in the same sector their income is derived from is an unforced error.Ideally, a partner's portfolio should be customized to reduce their risks and allow them to manage their assets in a low-fee, tax-optimized fashion.Bantam accomplishes this through the creation of low-fee, custom indexes.You can find more about our services for attorneys here.
 5 CFR 2634.401 – Overview; Available at: https://www.law.cornell.edu/cfr/text/5/2634.401; Accessed August 24, 2018.