How Technology is Transforming Wall Street and Financial Services

FINANCIAL SERVICES ARE a market basket of different things. We think about the brokers, bankers and insurers as the three communities of interest. We have the impact of the Internet and information technology as being transformational in those communities.
The Wall Street that I remember with guys in colored smocks at the Stock Exchange waiving their papers has changed. All of that is now done at a computer farm within fractions of a second. That has had ramifications on the way Wall Street conducts business. Policymakers are still trying to figure out how to regulate and moderate this properly so you don’t have people sneaking into the back door and taking advantage of the system— and I am not just talking about the traders, but also the customers.

big sum of money dollars - 3d illustrationThere is also the dimension of how to get more active and more diverse in terms of customer services. E-banking must be combined with response systems that have artificial intelligence so they are not just going through the basic “press 1 if you want to talk to a representative” process. We need much smarter and responsive systems. People are realizing that they cannot solve the problem by throwing more staff at it and doing it in a cost-effective way.

The value of data analytics is that if you are capturing all of the behaviors and all of the extremes that happen in that profile—and then you can match them to a pattern—that is certainly giving you a Newton’s Law of Motion without having to know what the law is. Now you can begin to reliably use that model as a way of predicting behaviors. That will help shape patterns that are contributing to the market for brokers and provide ways of understanding how to better service customer needs based on their past interactions. It’s also a way of getting beyond the statistical approach to actuarial predictions. The infusion of data analytics and big data into financial services is a big game changer.

The New Jersey Innovation Institute (NJII) Financial Services iLab is putting together a blockchain demonstration— Bitcoin is the cash transaction capability and blockchain is the delivery mechanism that provides for the secure and validated information transfer from buyer to seller. It’s essentially “bankless” banking. There is a lot of interest in understanding how it works, how it can be protected and how we can make a business out of something that, in some cases, can put businesses out of business. We are working on a real-world demonstration site where we have an operational ability with people coming in and finding out different ways they can use the block technology for providing secure transactions.

Donald H. Sebastian, Ph.D., is president and CEO of the New Jersey Innovation Institute (NJII), a New Jersey Institute of Technology (NJIT) Corporation.

Section 2704: Major Changes on the Way?

A Brief History of Section 2704

In 1990, Congress enacted section 2704 of the Internal Revenue Code, titled “Treatment of Certain Lapsing Rights and Restrictions,” in an effort to limit the valuation discounts for gift and estate tax purposes applicable in the case of intra-family transfers of interests in family-owned, or “closely held,” corporations and partnerships. Here is what it said:

  • Under section 2704(a) if an individual and the individual’s family hold voting or liquidation control over a corporation or partnership, the lapse of a voting or liquidation right shall be taxed as a transfer subject to gift or estate tax.
  • Under section 2704(b) when an interest in a family-owned corporation or partnership is transferred within the family, if a restriction limits the ability of the corporation or partnership to liquidate and that restriction can be removed by the family, that restriction is disregarded in valuing the transferred interest for gift or estate tax purposes.
  • Under section 2704(b)(4), Congress authorized Treasury to issue regulations providing “that other restrictions shall be disregarded in determining the value of the transfer of any interest in a corporation or partnership to a member of the transferor’s family if such restriction has the effect of reducing the value of the transferred interest for purposes of this subtitle but does not ultimately reduce the value of such interest to the transferee.”

For the last decade there has been an expectation of change to these regulations which were first adopted into law more than 25 years ago.

So What’s Finally Happened?

On August 2, 2016 newly proposed regulations were offered that would put into effect major changes to the valuation of interests in many family-controlled entities for estate, gift, and generation-skipping transfer tax purposes which would result in treating the lapse of voting or liquidation rights as an additional transfer while disregarding certain restrictions on liquidation in order to determine the fair market value of a transferred interest.

What Will the Changes Look Like?

As published by the IRS in the Federal Register on August 4 under 81 Fed. Reg. 51413-51425, if and when finalized, the regulations would:

  • Treat as an additional transfer the lapse of voting and liquidation rights for transfers made within three years of death of interests in a family-controlled entity, thereby eliminating or substantially limiting the lack of control and minority discounts for these transfers
  • Eliminate any discount based on the transferee’s status as a mere assignee and not a full owner and participant in the entity
  • Disregard the ability of most nonfamily member owners to block the removal of covered restrictions unless the nonfamily member has held the interest for more than three years, owns a substantial interest in the entity, and has the right, upon six months’ notice, to be redeemed or bought out for cash or property, not including a promissory note issued by the entity, its owners, or anyone related to the entity or its owners
  • Disregard restrictions on liquidation that are not mandated by federal or state law in determining the fair market value of the transferred interest
  • Clarify the description of entities covered to include limited liability companies and other entities and business arrangements, as well as corporations and partnerships

The Impact on Your  Business

When the regulations are finalized, if they are at all similar to the proposed regulations, taxpayers in corporations and partnerships, as well as in limited liability companies and other entities and business arrangements, will have lost a significant estate planning technique, and the tax cost of transferring interests in family-owned entities will increase.

Here are some of the areas of key concern:

  1. Lapse of voting or liquidation rights
  2. Disregarding certain restrictions on redemption or liquidation
  3. Restrictions imposed or required by law

Now What?

It is anticipated that there will be challenges to the proposed regulations being adopted in their present form raised at the public hearing scheduled for December 1, 2016 – especially because of the broad sweep of the proposed regulations. Therefore it is a safe guess that the earliest the regulations will not become final sometime in 2017.

So if you are considering transferring interests in family-controlled entities (that are not controlling interests and do not have liquidation rights) you might consider making the transfers soon.  There are, as always, mitigating circumstances that would need to be discussed by you and your trusted advisors to determine what is best for your company and your situation. To be prudent, you should always give careful consideration to your company’s existing and future operating agreements and other governing documents.


Photo Credit: MPI