A Team Approach for Alaska Native Corporation Investors
Guest Author Bruce Edwards, Principal at Sorenson and Edwards
When Alaska Permanent Capital Management (APCM) approached me to write a guest blog about the benefits for Alaska Native Corporation investors of using a team approach to investing, I was excited because I am a firm believer in the team approach for most things, including an investment program. I have long been familiar with APCM, as several of our Alaska Native Clients have used APCM in one role or another since the 1990s, and I have definitely seen the benefits within our Clients’ portfolios from the multi-disciplined approach that APCM advocates for the serious long-term Alaska Natives investor. So, I am pleased to share my perspective with APCM clients on a team approach to investing.
As you read the rest of this blog, please don’t assume that what I lay out for your consideration is intended as the last and definitive word of the subject of a team approach to investing, because it is not. From long years as a lawyer assisting our Alaska Native Clients with their legal issues and concerns, I know that there are usually multiple ways to accomplish something. So, this blog is intended only to offer some general thoughts that should be considered when an investment program is being put together and/or operated. In a similar vein, because there are different ways to invest, some of my comments are intended only as generalizations to provoke further discussion as the reader decides how best to proceed. As a final word before we begin, none of this is intended as legal or investment advice, or to recommend how the reader should proceed. Every situation is different, and the reader should consult the reader’s own professionals in making decisions relative to a program of investment. With these preliminaries out of the way, let’s turn to the investment team.
Overview. For most of our Clients, the members of the investment team fall into four general categories. First and foremost, there is the Client itself. Second, there will be an investment adviser, and sometimes, more than one investment adviser. Third, the investment team should include an accountant, whether internal to the Client or an outside Certified Public Accountant. Finally, the investment team should include an attorney. So that’s the typical investment team. In some situations, there will be a fifth member, namely a custodian (typically a bank or similar institution) that will hold the Client’s funds and make investments. Not every investment team will include a custodian, as many investment advisors themselves (or through affiliates) can make investments, without the need for a third-party custodian.
In an ideal situation, the core competencies of the team members will overlap and mutually reinforce each other. Ideally, too, the team members will each understand and appreciate where their respective strengths and weaknesses lie, and rely more heavily upon the other team members who have a greater strength in a given area. Stated differently, it is very important that the members of the investment team work together and play nicely with each other. For example, although most team members will have a general understanding of how earnings from investments will be taxed and reported for financial purposes, there is simply no substitute for the expertise on these matters that a certified public accountant will bring to a discussion.
So here is a broader discussion of each of the team members.
The Client. The first and foremost member of the investing team is the Client itself. Everyone on the investment team should understand who (or more accurately, what) the Client is, what the Client wants to achieve, and who makes the internal decisions for the Client. This includes an understanding of the legal structure within which the Client must operate. Broadly speaking, this starts with understanding the type of entity, as the general law establishes different rules for different Alaska Native entities, the most common of which are Alaska Native Corporations, Alaska Native Settlement Trusts, Alaska Native 501(c) organizations such as Heritage Foundations, and Alaska Native tribal entities.
Moreover, each of these entities will also likely have their own customized rules that the entity has developed for itself. As relevant to the investment team, these customized rules include (in some form) where the decision-making power concerning investments is allocated within the entity (Board of Directors/trustees/tribal council or committee or management), the rules that govern investment decisions such as embodied in an investment policy statement and the manner in which disbursements are to be made from the funds within the investment program (for example, whether such disbursement are at the discretion of the Directors/trustees/tribal council or of a committee or determined by a pre-set formula).
The point of all this is that the members of the investment team should be as familiar as they can be with the Client. This includes the personnel of the Client itself who will function as a part of the investment team.
The Investment Advisor. For purposes of this blog only, I use the term “investment advisor” to indicate anyone who makes investment recommendations or conducts securities analysis in return for a fee, including through direct management of Clients’ assets. APCM, for example, is an investment advisor. A stock broker typically also is an investment advisor. There are important testing, licensing and disclosure requirements that apply to investment advisors and it is beyond the scope of this blog to describe these in any detail that does justice to what a person or firm must do to achieve the status of an investment advisor. These rules are in place to protect the investing public.
I mentioned above that some Clients have only one investment advisor, while others have several. The number of investment advisors is often a function of the size of the investment portfolio, but it can also be a function of the manner in which the Client chooses to invest.
The investment advisor is a fiduciary for the Client, and must always act in the Client’s best interest instead of their own. The standards by which the investment advisor’s performance will be judged as well as the fee arrangement by which the investment advisor is compensated are matters set forth in the investment advisory agreement between the Client and the investment advisor. A typical fee arrangement is that the advisor is compensated based upon the size of the investment portfolio, although other arrangements are possible.
The primary role of the investment advisor is to make specific recommendations to the Client as to how the Client’s funds should be invested. These recommendations are made based upon the specialized knowledge and expertise that the investment advisor has developed based upon training, research and experience. This can be done on a purely advisory basis, where the Client must make the ultimate decision, or, on a discretionary basis where the Client gives the investment advisor the discretion to make investment decisions.
Accountant. The role of the Accountant within the investment team is to provide perspective and guidance based upon tax and financial considerations, as well as to provide certain compliance functions such as the preparation of financial statements and tax returns. The Accountant can be either an employee of the Client, or an outside Certified Public Accountant. What is critical is that the person who functions as the Accountant has the skills and expertise necessary to provide financial and tax guidance to the Client.
The Accountant assists the investment process in many ways. If the purpose of the investment fund is to provide income in the form of distributions or dividends, the Accountant can function to provide an analysis whether the income payments are in compliance with state law (Alaska Native Corporations) or the requirements of the trust agreement (Alaska Native Settlement Trusts) and whether such payments are taxable to the recipients. Similar, in the Alaska Native 501(c) context, the Accountant can be critical in helping the Client navigate the intricacies of the federal Tax Code relative to expenditures of investment income derived by private foundations, where a misstep can result in penalties, exempt status disqualification, or in some cases, criminal liability.
The Accountant also can help structure a contribution of assets to an Alaska Native Settlement Trust so that the contribution is done in the most tax efficient manner. For example, most readers probably know that the federal 2017 Tax Cuts and Jobs Act permits an Alaska Native Corporations a deduction for contributions to an Alaska Native Settlement Trust. This deduction by the Native Corporation normally requires the recipient Settlement Trust to pay a 10% tax on the amount of the claimed deduction. However, what many readers may not know is that the 2017 Act permits a Settlement Trust to defer the 10% contribution tax if the contribution is “in kind,” that is, not in cash. That is, if the Native Corporation contributes securities to the Settlement Trust, the 10% contribution tax can be deferred. This contribution tax is deferred until the contributed securities are sold. The recommendation of which securities to purchase and contribute is the province of the investment advisor, but providing the advice whether this technique makes sense is an example of the value the Accountant adds to the investment team.
Finally, the advice of an Accountant can be instrumental in helping the Client avoid unnecessary tax costs. For example, certain types of investments outside of Alaska can trigger a state tax upon the investing entity and/or those who receive distributions from the investing entity. This is a particular problem for Alaska Native Settlement Trusts and their beneficiaries, as no state has a law that parallels section 646 of the federal Tax Code, which shields beneficiaries from income when a Settlement Trust distributes its after-tax income. In simplest terms, the consequence to certain investments outside of Alaska could be unnecessary beneficiary taxation. Pre-investment advice from the Accountant can avoid this problem.
Attorney. There are several roles for the attorney on the investment team. The attorney is in a unique position to provide recommendations and/or analysis of the legal structures that are involved. This includes not only who or what the Client is, and who has decisional authority, but also the legal requirements that apply to an investment program (including the distribution and/or expenditure of the funds within the investment program). Ideally, the attorney will be one who has worked with the Client previously, and so has familiarity with the Client and the law and documents which govern the Client.
The attorney is also in a unique position to review and/or prepare the various legal documents that are needed to put an investment program in place. This could range from drafting and/or reviewing an agreement to establish a settlement trust or captive investment vehicle, an investment advisory agreement or an investment policy statement (IPS). Most attorneys function well not only as draftsmen, but also as editors of what others have written.
So, for a document such as an IPS, a technique that works well is for various members of the investment team to initially draft those portions of the IPS that lie within their own respective areas of expertise. The Client, for example, might draft the portion of the IPS on governance, decision-making and overall objectives. The investment advisor, for example, might draft the portion of the IPS as to asset allocations and benchmarks to judge performance. The Accountant, for example, might draft portion discussing the tax and financial considerations that will apply to investments of the portfolio. Then, it would be up to the attorney to compile the draft portions of the Client, investment advisor and the Accountant into a workable draft document that can then be further reviewed and edited until an IPS is produced for the ultimate approval of the Client. This is a particularly appropriate role for the attorney, because at the end of the day, the IPS is a contractual document tied to the underlying investment advisory agreement between the Client and the investment advisor, because it supplies many of the metrics upon which the investment advisor’s performance will be judged.
Conclusion. The “best practice” for Alaska Native investors is to utilize a team approach whereby the skills and expertise of the Client’s personnel, one or more investment advisors, an accountant, and an attorney can be harnessed to maximize investment returns for the Client’s portfolio.
About Our Guest Author
Bruce Edwards is the Principal at Sorenson and Edwards. Learn more about his firm HERE.
Bruce is a member of the Alaska and Washington Bars. He earned law degrees from both the University of Washington (J.D.) and New York University (LL.M. Taxation) and clerked for a federal appellate judge at the U.S. Court of Claims. While at the Court of Claims, Bruce worked on the landmark case in which the Lakota Sioux sought the return of their sacred ancestral lands in the Black Hills of South Dakota. His tax practice includes both transactional and controversy work, as well as the drafting of Settlement Trust agreements and other tax planning documents unique to the Alaska Native Community.
Bruce has defended several multi-million dollar IRS audits (including mediation and “fast track” appeals) and also, has been lead tax counsel in over twenty IRS National Office private letter rulings, many of which have concerned either Alaska Native Corporations or Alaska Native Settlement Trusts.
Bruce is the author of the leading two law review articles concerning Alaska Native Settlement Trusts. The first (“Understanding and Making the New Section 646 Election for Alaska Native Settlement Trusts,” 18 Alaska Law Review 219 (Duke University 2001)) concerns Tax Code section 646, which is the primary provision that governs taxation of Settlement Trusts, while the second article (“The 2017 Tax Act and Settlement Trusts,” 35 Alaska Law Review 1 (Duke University 2018)) discusses the provisions that now permit an Alaska Native Corporation to deduct contributions to a Settlement Trust, which in turn permits that Trust to pay tax-free distributions and other benefits to its beneficiaries (typically, the shareholders of the Native Corporation that established the Trust).
Bruce has also written extensively about nationwide federal tax topics for Bloomberg BNA Tax Management. His most recent work for Bloomberg BNA is Income Taxation of Native Americans (including Alaska Natives), which was published in 2019 and is the only comprehensive treatise on the federal income taxation of indigenous peoples residing within the United States. His other writings for Bloomberg BNA include treatises on Involuntary Conversions, Home Ownership and Timber Transactions and seven chapters of Bloomberg BNA’s Tax Practice Series.
Bruce has served previously as the New Decisions Editor of the Journal of Taxation and has been a Fellow of the American College of Tax Counsel since the early 1990s.