Checks & Balances in Asset Management

Posted on: March 5th, 2013

In the world of institutional investing where boards are held accountable for the management of pension and foundation assets, it has become standard (although not universal) practice to separate the functions of investment advice, investment management and custodial services. The purpose of this separation is to ensure the objectivity of the advice given to the decision-makers and to incorporate certain critical checks and balances into the investment process. Those checks and balances exist to protect assets against theft, or misappropriation, and to ensure a full and proper accounting of holdings and performance. At Seaside National Bank & Trust we have incorporated many of the same checks and balances into our structure and process.

We use only external investment managers that have no economic or other relationship with Seaside. If we recommend a particular manager as part of our investment advice, it is solely because we believe that manager can deliver excellent performance at a good price and not because we have an economic interest in any ensuing transaction. This would not be the case if we were to recommend a fund managed by an affiliate or a portfolio managed by one of our colleagues. In order to maintain this objectivity, we also do not share in any fees or commissions paid to any investment manager or broker involved in the investment management process. We have a single source of revenue: our clients. Unfortunately, this degree of economic autonomy is still the exception, rather than the rule, in the delivery of investment services to individuals.

As investors, we tend to focus on the advice and management aspects of the investment process. A less examined, but equally important role belongs to the custodian. At Seaside, our Wealth Management clients’ assets are held in custody accounts titled in their names (or in the name of a designated Trust). This means that, unlike loans and deposits, those assets are never incorporated into the balance sheet of Seaside National Bank & Trust, or commingled in any way with its corporate assets. No creditor of Seaside would ever have a claim against our clients’ assets held in custody. This would remain true, even in the unlikely event of an insolvency proceeding. As a nationally chartered bank, regulated by the Office of the Comptroller of the Currency, Seaside is fully responsible for its Wealth Management clients’ assets, but it is responsible for those assets in its capacity as custodian. We may serve in other roles, such as Trustee or investment advisor to our clients, but in safekeeping and accounting for their assets, we serve as custodian.

The role of a custodian is to safe keep and accurately account for assets, verify and settle trades, account for dividend and interest income due on those assets and perform all of the operational functions necessary to support those activities. Because these activities are operationally intensive, and require the support of complex systems, Seaside has partnered with BMO Global Asset Management to provide superior custody services and trust accounting to its clients at a competitive price. BMO is one of the largest Banks in the US and enjoys an excellent reputation in the outsourcing of trust accounting systems and custody services. In a very real sense, the safekeeping and accounting of our Wealth Management clients’ assets are supported and verified by two independent banks.

In Seaside’s structure and Wealth Management process, the role of the custodian is separate and distinct from that of any of the asset managers we employ. Furthermore, our utilization of the custodial services of BMO means that an independent bank is verifying the assets we hold on our client’s behalf. The separate and independent status of the custodian is an important assurance that our clients’ assets will be protected and that the accounting for those assets will be accurate.

None of these safeguards will prevent the loss of value in a declining market. But the essential function of the custodian is too easily underestimated. Recent headlines describe a “Ponzi scheme” that defrauded investors of up to $50 billion of their hard-earned money. One simple way Bernard Madoff ’s victims could have prevented this deception would have been through the use of an independent custodian. A third-party custodian would have had to account for the cash, the trades and the resulting security positions. A separate custodian would have had to value the holdings using public pricing services. Such a custodian would have had to independently verify the inflated claims of asset appreciation so essential to the ruse. Madoff was able to pull off his scheme because he controlled the cash, he controlled the asset management, he had custody of the assets and he generated the statements accounting for those assets.

The role of an independent custodian may be the least glamorous of all the roles involved in the investment process, but it is an essential role in the safeguarding of assets and a critical part of the checks and balances we use at Seaside National Bank & Trust in the investment of our client’s assets.

Investments are:
Not FDIC insured
Not guaranteed by Seaside National Bank & Trust
Subject to risk and may lose value