The modern trust company; its functions and organization

Front matter

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Preface To The First: Edition

To a correspondent asking, “ What book or books will best give me a working knowledge of trust company and banking methods; particularly regarding the work of the various departments of the trust companies?” the New York Evening Post recently replied that so far as it was aware no such book had been published.

A search in library catalogues confirms the almost equally discouraging statement of the Chief Bibliographer of the Library of Congress that ‘“‘ there is not much literature on trust companies appearing in separate book form.” On the other hand, much has been

ritten about the functions, organization, and methods of the banks.

The reason is easily given. The development of the “trust company idea” is a recent one, and only within the past twenty years have these corporations become a prominent factor in the financial world. Until the organization of the Trust Company Section of the American Bankers’ Association in 1896, the only publications in reference to trust companies were short chapters in works on banking and an occasional magazine article. Since that time the transactions of the Trust Company Section and articles in banking periodicals and the financial press have constituted the most important contributions to the subject; but in spite of all that has been written on special lines of trust company work, it is still difficult to obtain a general knowledge of what a trust company is and how it does its business.

The aim of the present volume is to describe the functions and organization of the trust company as it exists in the United States to-day. Its history, which dates from the granting of the first trust company charter in 1822, has already been told in a number of interesting papers and addresses, and is therefore not repeated. Practical experience, consultation of all available literature, the examination of trust companies in various parts of this country, and conferences with their officers, have helped to make a composite

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Vill PREFACE picture. The forms and systems described are those which have commended themselves to the authors’ judgment as best adapted to the needs of the average trust company. It does not follow that many others are not equally good. The methods outlined in the following pages, although not complete in every detail, are, it is believed, representative of the best systems now employed.

Free use has been made of books and papers on various parts of the subject. To the officers of many trust companies grateful thanks are due for uniformly courteous treatment and much appreciated opportunities of studying their methods.

Special mention must also be made of valuable help rendered by Parker S. Williams, Esq., of the Philadelphia Bar, and by Miss Elizabeth B. Kirkbride.

Bo Bak OES.

SEPTEMBER 25, 1905.

Preface To The Third Edition

SINCE the first edition of “ The Modern Trust Company” was ' published in December, 1905, the subject has been one of ever increasing public interest. To this fact must be attributed the general circulation of so technical a book; it has even been reported among the “ miscellaneous books most in demand ”’ on the shelves of a public library.

During this time laws have been passed in many states, tending toward the proper control and regulation of trust companies. Renewed emphasis has been given to the necessity for the maintenance of substantial cash reserves by all companies doing a general banking business. The relation of trust companies to the clearing houses has received a thoughtful consideration which bids fair to bring about better understanding between the trust companies and the banks.

In the present edition all references to laws and to clearing house and stock exchange rules have been brought up to date. New titles have also been added to the bibliography.

The panic of 1907, with its immediate demand for corporate vigilance, has driven home the conviction that sound banking principles must be the basis of success in all trust company operations.

F. B. K.

ES: NEw York, FEBRUARY 25, 1908.

Preface To The Fourth Edition

The third edition of “The Modern Trust Company ” appeared shortly after the panic of 1907. The fresh realization, caused by the panic, of the need for conservative banking methods, has since borne fruit in considerable legislation and many improvements in practice.

The last five years have witnessed a steady and healthful growth of the trust companies of the United States, together with a more insistent demand for rigid integrity, sound banking, and cooperation between all classes of financial institutions.

The fourth edition appears at a time when the need for a scientific currency system is more generally realized than ever before. The trust companies can take an important part in the creation of an intelligent public opinion.

The new edition of this volume has been brought up to date, and the bibliography has been rearranged and amplified; otherwise the book is unchanged.

F. B. K. apy a oS New York, OCTOBER I, IQI3.

Preface To The Fifth. Edition

The great war put the Federal Reserve system to an early and severe test and during it many trust companies entered the system from motives of patriotism. The strain of war developed the strong points of the system convincingly. Inherent weaknesses and wrong practices were likewise made manifest. Congressional action and regulations of the Federal Reserve Board are in some respects correcting early mistakes and setting new standards of practice.

The rapid assumption of trust powers by national and state banks is a development of no little importance to the people of the United States. All state and national banks to-day have the power to serve their communities in every phase of fiduciary banking. To the trust companies a broader banking field has simultaneously opened larger possibilities for usefulness and profit. If the trust companies have in the past been “ department stores ” of credit, the term can now be applied more truthfully than ever before.

The mobilization of our gold reserve, the establishment of the rediscount privilege, the nation-wide par clearing of checks, the creation of an open market for bankers’ acceptances and prime commercial paper, the development of foreign banking and of dollar exchange have occurred simultaneously with the change in the position of the United States from a debtor to a creditor nation.

Abuse of the rediscount privilege, selfish opposition to par clearing of checks, and other difficulties will be corrected by a growing public opinion which can be counted on to demand sound practice and perfect banking machinery and service.

The authors are fortunate in having associated with them H. Parker Willis, who was “expert to the House of Representatives . Committee on Banking and Currency” during the formation, discussion and passage of the Federal Reserve Act and who was later the first secretary of the Federal Reserve Board. The chapters on ‘Membership in the Federal Reserve System,” “ Making Use of the

X1 xii PREFACE

Federal Reserve System,” “ Credits and Credit Department,” “ Operating Costs,” “‘ Foreign Banking ” and ‘‘ Commercial Paper” are by him. Other new chapters are on “ Tax Department,” “ Statistical Department ” and “Investments.” The text throughout has been revised and amplified. All legal references have been brought up to date. New legal and accounting forms have been included.

Free use has been made of original sources of information. Grateful acknowledgment is offered to the many bank and trust company officers who, through helpful suggestion and free access to their forms, have aided in the work of revision. Special mention must be made of the help rendered by Huch Satterlee, Fs1., of the New York Bar, and by Miss Elizabeth B. Kirkbride. The former has verified the legal references, while the latter has again revised the bibliography.

It is the hope of the authors that the book may continue to set a standard of sound and progressive banking and be of practical use to those who manage or work in banks and trust companies or who come in contact with them as counsel, client or student. | eee seed 5 JOSS.

New York, OCTOBER I, 1920.

Table Of Contents

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III MEMBERSHIP IN THE FEDERAL RESERVE SYSTEM. . . . 39

Chapter I Functions Introduction

MoberN industrial society has developed the bank as a means of facilitating exchange, while it has developed the trust company aaron change, on the one hand, and of lending to borrowers or facilitating the growth of industry, on the other hand — are distinct and separate. In some countries this separate character is fully recognized by law and custom. Commercial banking is there a profession apart, while the task of caring for and investing funds which are expected to yield an income is performed by institutions solely devoted to that purpose. Conditions in the United States have not fostered this separate development, but have rather tended to fuse the functions of banking and investment. Under the Federal Reserve Act provision has been made for the performance of fiduciary functions by national banks, while in most states trust companies have for many years exercised banking powers as ancillary to their investment functions. It is nevertheless true to-day and probably will continue to be true that a large number of institutions specialize in the performance of fiduciary and investment functions, and these are for _ the most part trust companies organized under state law. With the trust company as such, this book is especially concerned.

A trust company might be organized without any banking functions, and there are to-day companies at various points in the United states whose banking functions are either rudimentary or prac-

I tically non-existent. The early history of trust companies in the United States, however, showed the banking functions to be so desirable that they came to be regarded as a natural and integral part of the trust company’s work.

The modern trust company as a rule, therefore, includes as the two chief parts in its organization, the banking department and the trust department. The work of the banking department may be limited to the acceptance of deposits and the making of loans, or it may include all the varied activities of commercial banking. In either case its relation to the trust department is most important.

The advantages of combining the two functions are evident. A trust company without any banking department would have to. deposit with some other institution the funds which it holds in cash as a part of its fiduciary operations, and would also have to apply to other institutions for many kinds of assistance and recognition which its own banking department might furnish. The trust company can also serve the convenience of its clients by offering them banking facilities and can furnish trust facilities to its banking clients, thus making each department contribute to the success of the other.

The dangers of the system are equally clear. The first requirement of all sound trust business is the integrity of the trust estate. A distinction must therefore be maintained between the funds in the trust department and in the banking department. The trust company cannot allow its trust funds to be employed in the conduct of its general banking business, nor can it risk a loss of confidence in its trust department through hazardous undertakings in its banking department.

The special character of trust company banking has been recognized by law. The national bank is permitted to issue its notes, which become part of the currency of the country. Its funds are largely employed in making unsecured loans by discounting the notes of its customers. Trust companies, on the other hand, are not allowed to issue such notes, and are in some states prohibited from discounting paper. The national banks are allowed to make loans secured by real estate only within prescribed limits and subject to various restrictions,! while the trust companies invest a considerable

1 By Section 9763 of the Compiled Statutes (Act of December 23, 1913, Chap. 6, portion of their funds in mortgages, and are in other ways allowed to keep their assets in less liquid form. Subject to certain qualifications, national banks are not permitted to make loans exceeding onetenth of their capital and surplus to any person. The provisions in trust company charters have been more liberal and have enabled these institutions to make larger advances, and so to take part in the development of the resources of the country on a larger scale. National banks, as a rule, do not pay interest on the accounts of individuals or firms, but do extend credit to them. Trust company deposits tend to be less active than those of commercial banks. The trust companies are, therefore, able to allow interest and thus to attract those who seek some return on idle funds or on savings, but who are not in need of unsecured loans.

The problem of combining banking and trust functions has been met in several ways. Even before the adoption of the Federal Reserve Act, some states allowed the same companies to exercise commercial banking and trust powers in separate departments. Another method is for the same individuals to organize a national bank under national laws and a trust company under state laws. Still another expedient is the organization under state laws of a securities company or trust company 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. This enables a closely affiliated and controlled organization to exercise legitimate functions which are outside the province of a national bank. The practice in Illinois of allowing a banking company to qualify under the law granting trust powers, is based on a sounder principle than the close relation between institutions acting under separate charters, amenable to different laws, but controlled by identical interests. By a recent amendment of the New York statute the Superintendent of Banks may authorize banks applying therefore to act in any fiduciary capacity in which trust companies are permitted to act.

Sec. e4, as amended September 7, 1916, Chap. 461) national banks not situated in a central reserve city may make loans secured by farm lands and unencumbered real estate located within one hundred miles of the bank, but loans on farm lands may be made for no longer time than five years, and on other lands for no longer time than one year, and the aggregate of such loans shall not exceed 25% of the bank’s capital and surplus or one-third of its time-deposits.

Under the Federal Reserve Act national banks are permitted to exercise fiduciary powers, while the privilege of membership in the Federal Reserve system has been extended to trust companies.

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.

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 is 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 development of trust companies in the United States has been remarkably rapid. Since 1822,1 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 twenty-one hundred, distributed as follows :—

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1 April 17, 1822, The Farmers’ Fire Insurance & Loan Company of New York (now the Farmers’ Loan and Trust Company), incorporated on February 28, 1822, was granted trust powers by a supplement to its charter.

March 9, 1830, the New York Life Insurance & Trust Company was chartered.

February 26, 1836, The Pennsylvania Company for Insurances on Lives and Granting . Annuities of Philadelphia, incorporated as a life insurance company on March to, 1812, was granted trust powers by a supplement to its charter.

March 17, 1836, The Girard Life Insurance, Annuity & Trust Company of Philadelphia (now The Girard Trust Company) was chartered.

All these companies are still flourishing.

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 $8,776,347,000.1 Net deposits in the 7,785 national banks aggregate $11,981,132,000.”

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 June 30, 1919. Compiled from ‘Trust Companies of the United States,” published by the United States Mortgage & Trust Company, New York. 2June 30, 1919. Report of the Comptroller of the Currency, 1919.

(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. : 1 —

“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.”

Thomas Leaming, Esq., viewing the matter from the standpoint of the beneficiary, says, “ No doubt there are some objectionable features in having for a trustee a corporation, which has neither a body to be kicked nor a soul to be damned.” ?

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.

1‘ A Trustee’s Handbook,” p. 15. 2“ Trust and Title Insurance Companies,” Lippincott’s Magazine, Vol. XLII, p. 887.

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 many 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 of 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. In the same way, many title insurance companies transact a banking and trust business, but tend to confine themselves more and more to title insurance. In other words, 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 minimum amount or on the total sum.

The advancing of money secured by the hypothecation of stocks, bonds, life insurance policies, bonds and mortgages, or other personal property.

The making of 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.

The discounting of paper. This was formerly engaged in principally by companies transacting a commercial banking business.

The purchase of unsecured paper, permitted in some states where discounting is not allowed.

The discounting of paper eligible for rediscount with a Federal Reserve Bank. This is becoming increasingly important.

The purchase and sale of securities.

The guarantee of issues of bonds, or at least setting the trust company’s 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.

“Tn 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 interests 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.

“One way in which the sentiment attributing some sort of ethical responsibility to trustees of corporation mortgages manifests itself is through slight alterations in the wording of the mortgage itself. The old language was that the trustee was to be held harmless under all circumstances. Now the trustee is often found willing to assume responsibility at least for gross negligence of servants or clerks not carefully selected. If to some such phrase be added a more careful drawing of the mortgage as to its provisions against unauthorized issues of bonds, a better compliance with the ethics of the situation would be had; for it is undeniable that a part of the public complaint against the fraudulent issue of bonds should be directed against the inadequate safeguards imposed in the mortgage rather than against the trustee.” 1

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.

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.

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.

1“ Corporation Finance.” Thomas L. Greene, p. 59.

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.