Let market forces prevail to address charity trustee gouging claims

Rather than capping fees, introducing competition may be the way to deal with disquiet over fees charged by trustee companies managing charitable trusts. Flickr

The current review over the regulation of trustee companies has revealed significant problems with how trustee companies are paid for managing charitable trusts.

Submissions to the review claim that the reforms that went through in 2009 have seen some annual management fees increase from $29,000 to over $160,000.

Given that the 2009 reforms were intended to expose trustee companies to greater competition, which should drive down prices for services offered, such claims beggar belief. This would indeed be the case had genuine competition been introduced in 2009. But the current regulations are a demonstration of what happens when market forces are not allowed to operate properly, despite platitudes to the contrary.

To put the issues into context, charities perform valuable social services, in many cases performing work that would otherwise be expected to be done by the government. As I have written previously, this not only justifies the special tax concessions that many charities enjoy, but allows market forces to direct privately donated funds to their preferred altruistic use. The alternative is to open up funds obtained under compulsion to be caught up in a system of patronage and special interests.

The charitable sector, therefore, can be seen as one in which activities undertaken are governed by a strong sense of altruism. This would seem to be antithetical to the stereotypical “dog eat dog” world of the market. But the market is all about efficiency and, in the case of the charitable sector, allowing market forces to operate unimpeded will see funds go to the purpose where they can do the most good.

The present situation regarding trust management fees is a striking example. Every dollar that is paid to a trustee company is another dollar that is not feeding the hungry, healing the sick or sheltering the homeless. Of course, if the trust property needs to be managed professionally so that a superior return can be generated on investments, which in turn funds these good works, then paying a professional manager a sufficient fee maximises the money that can serve charitable purposes.

But the rapid climb in fees suggests that other forces are at work, unless charitable trusts have been suddenly managed in a much better way (in which case, what was happening before?). More likely, given that the increase coincided with a regulatory change, parties are exploiting some aspect of the new regulation to their own benefit. It is here that it is elements of the law overlap that produce anomalous results.

First, management of charitable trusts, in particular, is premised on a strong degree of altruistic obligation. Lawyers call these obligations “fiduciary duties” and they are a departure from the usual legal position that everyone is entitled to act in their own self-interest.

Secondly, these trustee companies are now part of profit-seeking enterprises, which owe a duty to their shareholders to maximise profits. A trustee company was typically appointed by a benefactor many years ago but has since been absorbed by a larger profit-seeking entity.

The new regulations cap the fees that trustee companies can charge, but, as the submissions demonstrate, the cap has been somewhat generous and has resulted in substantially greater fees being levied. No suggestion has been made that the trustee companies have acted illegally; rather, they are asserting entitlements they may not otherwise have been inclined to do (or could not do) previously.

A third element of the law creates the present problem. Traditionally under trust law, the wishes of the party that established the trust are given primacy. In the present situation, a charitable trust may have been set up specifying a particular trustee company. At that time, the trustee company was vested with appropriately altruistic motives and did not charge the sorts of fees that a similarly skilled entity in the profit-seeking sector would charge.

As discussed, this has changed over time. But it is very difficult for a trust to change trustee. It is here that market forces are hobbled, creating the present problems. The submissions focus heavily on the formulae used to calculate the maximum fee that may be charged. But it is really the inability of charitable trusts to change trustee, particularly when that trustee is specified in the trust deed.

As any economist will predict, put up high barriers to entry and you can expect to see prices increase without any necessary corresponding increase in quality. The lack of portability here effectively protects trustee companies from the market forces that would push fees to a more efficient level as the 2009 reforms claimed as their objective. Any response from a trust to a trustee company that had just increased its fees would rightly be regarded as an idle threat.

If the government is serious about ensuring that trustee company fees are set efficiently, they would be better served by ensuring that market forces in the form of competition can operate unhindered, rather than trying to set some predetermined formula that will inevitably be inappropriate in some circumstances.

This should be done by allowing trusts to change the trustee company in as simple a fashion as possible. There is no need to legislate a maximum fee that trustee companies can charge. Let the market operate and setting the cap at the right level will be done.