What level of transparency does your Opportunity Zone fund provide? Is it verified by a third-party fund custodian?

Jeremy Christensen is director of fund custody at Millennium Trust Company, a custody firm that manages investment accounts, retirement funds, and alternative assets like Opportunity Zone funds.

Click the play button below to listen to my conversation with Jeremy.

Episode Highlights

• The role of a fund custodian.
• How the SEC Custody Rule comes into play with Qualified Opportunity Funds.
• When a fund is legally required to employ a third-party custodian.
• Why a fund that isn’t legally required to retain a fund custodian may still wish to have one.
• How a custodian can help with transparency and make investors more comfortable.
• The differences between a fund custodian and a fund administrator, and how they work together.
• The different service providers that every major Opportunity Zone fund should have — fund custodian, fund administrator, legal team, accounting team, and auditor.
• Protections and other benefits that a custodian provides to the general partners and limited partners.
• The fees that a fund custodian charges.

Featured on This Episode

• Jeremy Christensen on LinkedIn
• Millennium Trust Company
• SEC Custody Rule

Industry Spotlight: Millennium Trust Company

Established in 2000 and headquartered in Oak Brook, IL, Millennium Trust Company provides access to a wide range of unique custody solutions for managing alternative assets, investment accounts, or retirement funds.

Learn More

• Visit MTrustCompany.com
• Call Millennium Trust: (630) 368-5600

About the Opportunity Zones Podcast

Hosted by OpportunityDb.com founder Jimmy Atkinson, the Opportunity Zones Podcast features guest interviews from fund managers, advisors, policymakers, tax professionals, and other foremost experts in opportunity zones.

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Show Transcript

Jimmy: Welcome to the Opportunity Zones Podcast. I’m your host, Jimmy Atkinson. If you are an investor in Qualified Opportunity Funds, what level of transparency does your fund provide? And if you’re a fund sponsor, what are you doing to ensure third party verification of assets? And what type of transparency are you providing to your investors and potential investors? That’s where the concept of a fund custodian starts to take shape.

Joining me on the podcast today is Jeremy Christensen, director of fund custody at Millennium Trust Company. Jeremy joins us today from his home office in Oklahoma City. Jeremy, welcome to the show.

Jeremy: I certainly appreciate it, Jimmy. Glad to be on the show.

Jimmy: You bet, Jeremy, looking forward to this conversation today. So to start us off, what can you tell us about fund custody? Can you give us an overview of what exactly it is?

Jeremy: Yeah, absolutely. So, just to give you the basics of fund custody, let’s say you have a fund that’s set up that holds 10 different assets inside of there. So, the fund custodian would set up an account on behalf of the fund itself. They would be titled name and trust company, in this case, Millennium Trust Company FBO fund itself. And then the custodian would hold the actual assets that are inside of the fund, and then the cash as well in some cases.

And then the custodian would distribute money as directed by the manager. So, they would make a purchase on behalf of the manager whenever they direct them. They would make a distribution whenever the manager directs them, they would pay expenses as the manager or the administrator directs them. So, what this allows the custodians to do is, they have a trail of what’s going on throughout the quarter, throughout the year.

And the custodian will send a quarterly statement that will say basically, you get 10 assets inside of here. You know, each one’s worth $10 million total funds worth $100 million. There were new subscriptions of $1.2 million inside of here, new purchase of $20 million, dividends of $5 million, distributions of $2 million inside of there. And then they’ll put that in a statement on a quarterly basis and send it out to the investor.

So, the investor gets the statement at the fund level, that gives them an idea of what’s going on inside of the fund itself. So, they’re not blind as to what happens inside of that fund. They get transparency into the fund, and that’s the role that the custodian serves.

Jimmy: And I think the other important role that the custodian serves is that it’s a third party, it’s not coming directly from the fund. It’s coming from a third party. I don’t know if administrator is the right word or not, but is that right?

Jeremy: It would be because you would consider custodian not administrator, because the administrator is gonna play a different role. They’re gonna play the role on the individual’s investment part of it, whereas the custodian plays the role at the fund level.

Jimmy: Gotcha. Yeah, I want to ask you a little bit more about those differences between a custodian and administrator in a few minutes here. But first, I wanna ask you about the SEC’s custody rule, because that comes into play here with regards to what types of funds or what size funds are required to have a custodian, is that right? Can you tell us a little bit more about the custody rule and how did that come about?

Jeremy: Absolutely. So, the custody rule came about right after the Madoff scam. So the SEC took a look after that and wanted to be, you know, on top of things a little more, they wanted to have a little more controls in place. So the custody rule 206(4) basically state that under the Investment Advisers Act of 1940, registered investment advisers that have custody of client funds or securities, they’ve got to maintain those with a qualified custodian.

So, the intent of doing that was to put more controls in place, so they didn’t have another Madoff type situation where you’ve got one person that’s receiving the money, investing the money and then reporting on the money. By having a custodian in place, you know, the money is going to a separate third party, and then you have a third party that is reporting on the money at the fund level.

So,it shows where that money is going from point A to point B, you know, so on and so forth. So the investor has that transparency inside of the fund. And that was the overall goal of the custody rule that the SEC came out with.

Jimmy: And getting to Opportunity Zone Funds now, if I am an Opportunity Zone fund sponsor, at what dollar level do fund sponsors or advisors need to start complying with the fund custody rule?

Jeremy: Sure, absolutely. There’s a couple different criteria that go into that. If you’re just strictly a fund sponsor, it’s typically $150 million before you’re required to comply with the actual rule. If you are an SEC registered RIA, which you typically have to register at $100 million, that’s when you’d have to comply. There are a few exceptions out there where the RIA does have to register earlier than that.

And if they are not registered with the SEC, then it depends on the state rules that they have. So there’s a few different components that go into answering that question.

Jimmy: Got it. So if you’re not an RIA, then your minimum is $150 million. You’re subject to the fund custody rule once you hit $150 million in assets, but if you’re an RIA, it may kick in much sooner, is that the gist of it?

Jeremy: That is typically the case. And there’s a few nuances that go in there. Obviously you need to talk to your counsel and make sure when you need to meet everything, but that’s the general idea behind it.

Jimmy: Got it. Okay. Thanks for clarifying that. Let’s focus now on Opportunity Zone specifically. So I think at a high level I understand what fund custodian does for all types of private equity funds. What exactly does a custodian do for an Opportunity Zone Fund?

Jeremy: So, most of the investments that you have inside of an Opportunity Zone, the vast majority of them aren’t going to be direct real estate purchases, they’re gonna be truly formed into an LLC. So you have the opportunity to get more money from different investors inside of there. And once you form it into an LLC, a lot of times it is considered a security at that point in time and there has to be a custodian on and especially if it’s over the $150 million mark that we talked about, and it’s a registered investment advisor running it..

So, once you get to that point, you have to have a custodian on there from a custody rule standpoint. And the other thing that comes into play is a lot of times, people want it to…even if they don’t hit that $150 million, or what they have inside of there is not truly considered a security, so by definition, they don’t have to have a qualified custodian on there. They still want one because they create transparency for the investor themselves.

So, the investor has a look into the actual fund, they can see the money movement. And like I said before, it’s a third party. So, it’s not the same person receiving the money, investing the money, and reporting on the money. So ultimately, at the end of the day, the transparency makes the end investor feel more comfortable. And as we all know, the more comfortable that an investor feels, the more likely they are to make an investment into the fund, and the more likely they are to make a larger investment.

They might be going after an investor, you know, that would have invested a million dollars because they work with you as an advisor, but since you have a custodian in place, and they can see the transparency in the fund, you know, maybe they’re willing to invest $2 million instead of a million dollars. So, we see a lot of people, even when it’s not required to have a custodian, they will have a custodian just because they know it’s best practices. It provides the transparency and it makes it a little easier to attract that money.

So, we see a lot of that, not only just in Opportunity Zone Funds, but we see it in all of the funds that we deal with as far as private equity, private debt, and that type of stuff. I will tell you within Opportunity Zone Funds, you know, anytime something is new, you know, it’s a spin-off of real estate, obviously, and we do a lot of real estate funds, but it’s the new Opportunity Zone programs, that is new.

So, anytime something’s new, people always realize that they need to put in a few extra pieces to make people feel comfortable, and that’s where transparency really comes in being on the Opportunity Zone side of things. So, we see more and more of that all of the time, people coming to us because of the transparency especially on Opportunity Zones, because it’s new to investors, and it makes them feel more comfortable.

Jimmy: I got you. I think that makes sense to me. You know, if you’re approaching an investor, and the investor may not be very comfortable with Opportunity Zones or the Opportunity Zone program, maybe it’s the first time that the investors even hearing about it. You might be able to make the investor more comfortable if you say, “Hey, I have a third party custodian here who’s gonna verify all of the cash flows and report on this quarterly.” I think that’s what you’re getting at there, just providing another level of comfort to the investor, even if the fund does not fall into the category of needing a custodian under the custody rule, that might be a reason why the fund may want to engage a custodian anyway.

Jeremy: That’s absolutely right. And to go just a little bit further on that, it’s not just the custodian. Anytime you have, you know, the proper people in place, people are gonna feel more comfortable. You know, so, let’s say you have the custodian, the administrator, the auditor, the accountant in place, people are gonna feel more comfortable investing in that fund, versus the fund that does self custody, they do self-administration, they’ve got an auditor that’s their next-door neighbor that nobody’s ever heard of.

Anytime you have those, those correct providers in place, it’s gonna make investors feel a lot more comfortable. It doesn’t just stop with one person, the custodian.

Jimmy: Absolutely. So yeah, the custodian is just one piece of the puzzle that a fund who is looking to raise capital might need to have in place. Getting back to that issue of the administrator and the custodian, can you explain what the difference is between those two, between a fund custodian and a fund administrator?

Jeremy: Absolutely. So the custodian and the administrator typically work pretty closely together. And the custodian, I always say the simplest way to explain it is the custodian works at the fund level and the administrator works at the individual level. And what I mean by that is the custodian as far as the cash management, the asset management that they do and the reporting that they do is the entire fund itself.

So if you have $100 million fund, it’s gonna show the hundred million dollar fund the number of an investments that are inside of that fund, and the cash flow that happens throughout that on the statements, whereas the administrator is gonna show statements for the individual’s investment into the fund. So let’s say you, Jimmy are an investor inside of $100 million fund, you have a million-dollar investment inside there. The administrator is gonna report that your million dollars is now worth $1.1 million. You hold 1.1% of this fund. Whereas the custodian is gonna report to you that, “Hey, you have…here’s the $101 million fund, and here’s what comprises this fund. So, custodian fund level, administrator, individual level.

Jimmy: Gotcha. That makes sense to me. And if I’m an investor, and there’s any sort of login platform for me to see what my investment is doing, that would go through the administrator, whereas the fund custodian…the fund custodian is also going to provide some sort of reporting there, you said on a quarterly basis? Does that go to investors as well?

Jeremy: That is correct. So, the quarterly statements that the fund custodian provide, that’s gonna go to the manager. And the manager report is a little bit different because it’s gonna show details. Like for instance, let’s say two new investors come in per quarter and one of them is you and one of them is not. So, it’s gonna show I invested a million dollars, you invested a million dollars inside of this one that have our names listed out there. And then it will show the assets, the dividends, and then same thing for distributions. Let’s say there’s two people that take a distribution. It will show John Smith distribution of a million dollars, Sally Smith distribution of a million dollars.

So, the manager gets that that shows all of the detail. What the investor is gonna get is it’s gonna show $2 million went in as new subscriptions, but it’s gonna be rolled up, it just shows $2 million. And of course, it doesn’t show any names or anything of that nature. Same thing on the backside of $2 million went out. It shows $2 million went out but it doesn’t show the name. So, the manager gets the detail, whereas the investor gets a view into the cash flow of the fund, but they don’t get details as far as names and stuff like that.

Jimmy: Gotcha. Okay, so the custodian provides high-level cash flow reporting and balance sheet as well, I think, is that right? It’ll show the actual assets that the fund holds.

Jeremy: It sure will. It sure will. So, it will show the assets, you know, dividend, new purchases, sales, anything of that nature.

Jimmy: And then the administrator shows what’s going on with just my particular personal investment in the fund. I think I…

Jeremy: That is 100% correct.

Jimmy: Okay. I think I got a good grip on it now. So, in addition to a fund administrator, and a fund custodian, you also mentioned an auditor and an accountant. What other service providers does a fund sponsor typically needm and maybe you can just briefly go over the roles of each one. I think we’ve got a good grip already on custodian and administrator, but if you can go over some of the other roles, that would be great.

Jeremy: Sure, absolutely. So I think the first one that anybody’s gonna look into is the legal side of things, especially when it comes to Opportunity Zone. You’ve got the tax advantages, you want to make sure that the fund is created in a way that it takes advantage of everything. So, you want to make sure that you have a good legal group on the front side, to form all of those documents.

That key from there it goes typically to the auditor, the custodian, and the administrator, obviously we talked about the administrator and the custodian. The auditor can serve a couple different roles. The auditor can do a surprise exam that goes along with the custody, or the auditor can do a full exam at the end of the year and they could distribute financial statements with that full exam.

You know, in having no names inside of there, you know, as far as all of those providers I think makes a big deal as we talked about, as far as the best practices just makes people feel more comfortable. The other one that comes into play is the accountant. A lot of times the auditor and the accountant are the same, sometimes different, but that’s a big piece as well. And then sometimes you’ll see like a portfolio management piece inside of there as well. But I think the big ones, legal, administration, custodian, auditor, accountant, are the big ones that our investors look for.

Jimmy: Good. Right, no, I think you’re right about that. And like you said before, you know, if you’re doing everything in house, and you don’t have any third party legal verification or third party custodianship, it makes it a little bit tougher to raise capital. Certainly, I think if you were a very small fund, maybe you only have one or two investors, maybe it’s just a self-invested fund, you may not need all of these layers, but if you’re a larger fund and you’re seeking outside capital, absolutely, you’re gonna want to have all of these different players involved with your fund to give the investors more confidence in you and your fund.

Jeremy: Absolutely. I think, you know, friends and family fund like you said it’s not as big a deal. But when you get outside, you’re looking for outside money, it makes a huge difference. It’s kind of one of those things. It’s like the old Quaker State commercial, pay a little now or a lot later. You can pay a little now and raise a lot more money, or you can cheap out and probably not raise as much money.

Jimmy: That’s right. I think that’s a good analogy. So in addition to, you know, some of the levels of transparency that we’ve discussed already, what additional protections does a fund custodian offer both to the funds general partners, and to the limited partners?

Jeremy: Sure, absolutely. You know, one of the things that we haven’t talked about is from a general partner standpoint, obviously, it takes a little burden off of their plate. You’ve got somebody that’s holding the assets reporting on the assets. It’s all in the same place. So, it makes things easier for that GP. It also makes things typically easier for the auditor and the accountant, as far as they have, you know, at the end of the year, if they’re doing the books on it, they have one single place that they can go to, the custodian, and get all of that information.

So it takes some of that burden away from the GP. I think that’s the piece that often gets overlooked whenever you’re talking about the two big ones of transparency and meeting the custody rule that often gets overlooked, but it’s a pretty big piece that needs to be considered.

Jimmy: Right. That makes sense to me. So, you know, a couple questions I have coming up here. I think we’ve already answered a little bit, so you may repeat yourself here, but I think that’s okay, because I think this is important just to drive this point home. Can you tell us again, who needs a fund custodian? You said $150 million level or if you’re an RIA, but could you clear that up exactly who needs a fund custodian, and then also who would not need a fund custodian, or who would not be required to have a fund custodian but might still want one?

Jeremy: So you get to that. From a SEC custodian rule you get to the $150 million rule. You really need the fund custodian and it’s got to be a qualified custodian that’s doing that. So that’s just from a, you know, true need standpoint. From a transparency standpoint, from the standpoint of trying to reach best practices, it’s almost anybody that’s trying to raise outside money, even if you don’t hit that $150 million. We work with a lot of funds, that will be startup funds and, and basically they formed a registered investment advisory just to start up this fund.

And of course, when they start, you know, they’re…you know, startup to small fund and truly, you know, from a custody rule standpoint, they don’t need a custodian, but they use a custodian for the transparency because they want to raise money as quickly as they possibly can. And they certainly plan on getting over that $100 million mark at some point in time.

And then you’ve got the guy that’s, you know, perfectly happy with the $100 million fund, and that’s as high as it’s gonna go, and he’s still using the custodian, even though he doesn’t need it from the custodian rule because he needs the transparency. So, it’s really anybody that wants to raise outside money, I always say, because it makes their life a little bit easier. And it’s a pretty nominal expense, to get the benefits that a qualified custodian provides.

The people that don’t need a custodian, it’s gonna be the smaller funds, their friends and family. You know, you might have a single asset fund that you know, is got one large investor that goes inside of there. You know, so, those types of situations, probably not gonna need all of the services that a custodian provides, you know, even administrator, you know, accountant. So, they might do away with some of those pieces. But I would say from what we see probably, you know, 75% of the funds out there are gonna look to utilize custodian administrator, you know, all the best service providers that they can out there.

Jimmy: I gotcha. Yeah. So, just to reiterate, you know, someone with a $5 million or $10 million friends and family project, especially if it’s a single asset project, does not legally need a fund custodian and probably doesn’t really want one either. Somebody with $150 million or more fund is legally required to have a fund custodian. And then that middle group. Say, someone with $100 million fund in your previous example, that funding is not legally required to have a fund custodian, but probably wants one, especially if they’re raising a significant amount of outside capital and wants to show that transparency to their potential investors.

Jeremy: You’re absolutely right.

Jimmy: So, you mentioned a nominal cost a minute ago, that phrase, how much does a fund custodian cost and what does Millennium charge its private fund clients?

Jeremy: So, everything that we deal with is a little bit different. So, we’ll take a look at all of the opportunities and we’ll review them, we’ll price them out. And we price them out based on, you know, number of investors that are inside of their number of investments, the size of the fund, basically the overall work that can go into it. And as a fund gets larger, obviously there’s fixed costs on the front side of the fund. As it gets larger, costs go down, and we charge everything via basis point.

So, a fund might start at the very highest we would have a fund started 15 basis points, and then it might trail down to three basis points. You know, an average fund probably starts at 10 basis points and trails down to three basis points. But like I said, it could possibly get up to the 15.

Jimmy: Depends on the amount of assets under management, I suppose, right?

Jeremy: Absolutely. Absolutely. It all depends on the work that’s gonna go into it. And that’s dictated by the different nuances of the fund as far as assets, types of assets, that kind of stuff.

Jimmy: Good. Now, the Opportunity Zones industry, being a new industry that it is I’ve met you and some of your colleagues at Millennium Trust at a few of the conferences that have been taking place around the country over the last year or so. And I know you guys have put out a lot of educational material because it’s such a new industry. Can you talk to us a little bit about the educational efforts and the white papers that you’ve come out with?

Jeremy: Yeah, absolutely. We’ve got quite a few different pieces that are out there some that we’ve done solely by ourselves and, you know, some that are out with other service providers. And then we’ve even got a few with clients that we’ve got out there. Just kind of raising the awareness of what the custodian does, how the custodian can help the general partner and how the custodian can benefit the actual investor.

So, it kind of goes through the nuts and bolts of how we operate and what the benefits are that we provide to everyone in the puzzle.

Jimmy: Good. And so, where can our listeners go to learn more about Millennium Trust Company and about you and read some of the educational materials that you’ve created?

Jeremy: So the best place to go, is to go to our website, and our website is mtrustcompany.com and then the company itself as far as the phone number is 630-368-5600. And then we have actually…we’ve got sales reps strategically placed throughout the United States and different regions. So depending on where GP might be located, if they’re in California, we’ll have somebody in California. If they’re in Texas, we have somebody in Texas. You know, if they’re a New York, Boston area, we’ve got somebody out there in that area as well. So as a company, we have kind of geographically spread ourselves out to best serve the clients out there.

Jimmy: Perfect. Okay, Jeremy, this has been great. Thank you for taking the time today to speak with me and my listeners and tell us a little bit more about what an Opportunity Zone Fund needs in terms of services on the back end, and especially in terms of the role of a fund custodian. This has been great. I appreciate it. Thank you.

Jeremy: Yeah, have a good one, Jimmy.