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Take the inspiration of Delaware state law that allows hedge funds to segregate and manage their assets in separate “silos.” Add in the lessons earned over many years developing succession plans for closely held businesses. And the result is a new multiclass investment management device useful to wealthy individuals looking out for the next generation. A perennial challenge for high-net-worth individuals is how to ensure that family assets will be well-managed by their sons and daughters without unwisely tying the next generation’s hands. This new form of trading company permits the consolidation of portfolios of assets in order to expand investment options for its members and to teach the younger generation how to manage the family wealth. THE MAIN STRUCTURE The first step in establishing this kind of trading company is to create a limited liability company. The LLC investors make capital contributions in the form of cash, securities, real estate partnership interests, or other assets in exchange for membership interests. Typically, the members constitute multiple generations of a family as well as various trusts established to benefit the family. However, third parties might also be asked to participate, particularly if they have long-standing close affiliations with the family or if their services as asset managers are sought. The operating agreement for the company will establish separate classes for specific types of assets. In some cases, these classes will be sharply differentiated. For example, Class A may consist of investments in hedge funds; Class B, foreign bonds and currencies; Class C, real estate; Class D, fixed-income instruments; and Class E, equities. In other cases, the distinctions may be more subtle: large-cap stocks, small-cap stocks, emerging-market stocks, bonds, and alternative investments. The design of the asset classes is determined primarily by the members’ goals. Thus, a diverse group of assets may be administered as a single class if that grouping fulfills an ongoing investment objective of multiple members. Subtle distinctions between asset classes may be justified where the members desire to own similar assets in differing proportions. Members apportion their contributions among the asset classes in accordance with their own investment objectives. For example, an elderly member may wish to put much of his assets in fixed-income instruments, while a younger member may wish to place a large percentage of her assets in hedge funds. OPERATING INSTRUCTIONS The operating agreement will also set forth three levels of management, usually (although not necessarily) drawn from the membership of the trading company. There are individual asset managers for each asset class. There is a general manager, who may also serve as an asset manager. And there is a board, typically consisting of the asset managers, the general manager, and other qualified members of the trading company. The asset managers are authorized to make decisions regarding the day-to-day investment and management of their asset classes and to take all actions required to implement those decisions. For example, an asset manager could buy or sell specific stocks without first seeking approval from the general manager, the board, or the members of the company. The general manager handles the day-to-day management of the entire enterprise. The board makes decisions affecting the company’s overall direction, such as the amount and timing of distributions, the rebalancing of assets among various classes, the changing of asset managers, the admission of new members, and long-term strategic plans. The operating agreement typically sets forth requirements — for instance, age, education, and experience — for becoming a member of the board. Candidates may also be required to attend board meetings for two or three years before they are permitted to become voting members. For example, where asset managers are members of the same family, an aunt who has been a manager for decades will not accept a nephew as an equal until he has participated in board meetings for some years and become familiar with the intricacies of the family’s business. Clear withdrawal provisions will help decrease conflicts among members of the trading company. Typically, before a member can withdraw her investments, she must comply with certain notice and response requirements. For example, the member may be required to provide a written statement to the board expressing the nature of her grievance. The board will have 30 days to provide a written response. Within 30 days of receiving that response, the member may submit a counterproposal or elect to withdraw from the trading company. If a member decides to leave, the member and the board will have to agree upon the fair market value of her interest. If no agreement can be reached, we prefer to use the three-appraisal method, which averages the two closest appraised values to determine fair market value. A withdrawing member bears all costs associated with withdrawal, such as any surrender charges due upon liquidation of a private equity fund, legal and accounting fees, and tax liabilities incurred as a result of that withdrawal. WHAT IS GAINED A trading company set up along these lines provides both financial and legal benefits to its members. By consolidating ownership of a range of assets in one entity, it gives members access to more investment opportunities. Younger members especially can participate in otherwise unavailable private investments that require high minimum outlays. The larger pool of assets may also lead to reduced investment fees and higher investment returns. Equally important, a trading company helps younger members draw on the financial acumen and experience of older members. All members are invited to attend regular board meetings, where the general manager, asset managers, and financial advisers discuss investment strategies. Younger members learn how to make better investment decisions as they participate under the guidance of more experienced members. A trading company also provides a structure for succession when older managers become incapacitated or die. A well-trained younger generation is there to assume responsibility for investing the family’s assets. In our experience, the decisions that adult children make as a group are typically more conservative and better reasoned than the decisions they make as individuals. The assets of a trading company are protected from individual members’ creditors. In Virginia, Maryland, and the District of Columbia, a charging order is the sole means by which a creditor may satisfy a judgment against a member. Under a charging order, a creditor generally may attach only the member’s right to receive distributions. The creditor cannot exercise any management or voting rights. In addition, the creditor cannot force distributions. TAX ISSUES Finally, setting up a trading company may facilitate tax planning. Family limited partnerships have long been used to transfer assets from older to younger generations at substantially discounted values, which leads to lower taxes. But such partnerships must have an independent, compelling business purpose (other than wealth transfer). In recent years, the Internal Revenue Service has prevailed in a number of tax disputes largely by arguing that there was no compelling business purpose. By contrast, a properly organized and managed trading company should overcome any such attack by the IRS. Thus, when a member’s interest is transferred by gift or upon death, the value of that interest can be discounted due to lack of marketability and lack of control. A trading company is treated as a partnership for tax purposes, generally speaking. While a detailed tax analysis is beyond the scope of this article, each asset class should be accounted for separately, and their profits and losses should be allocated to the members in accordance with their percentage interests. A member who changes his ownership interests among the asset classes should, in most circumstances, be treated as receiving a deemed distribution from one class and making a deemed contribution to another. These transactions would be governed by the tax rules relating to partnership distributions. When assets are contributed to the trading company, the tax rules governing investment companies should be carefully followed to ensure that gains do not have to be recognized at that time. Last but not least, it is critical that the members respect the formalities of running a trading company by complying with the terms of the operating agreement. Follow the rules, and a multiclass trading company can help provide for the continued prosperity of its members.
James E. McNair is a partner, Kimberly Angott is an associate, and Eric C. Wang is of counsel based in the McLean, Va., office of Patton Boggs, where they focus on estate planning, wealth preservation, and tax issues.

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