Death Care Compliance Law

Death Care Compliance Law

Preneed: A Pandora's Box of Problems

William Stalter is the founder of Stalter Legal Services and the Preneed Resource Company. Bill focuses his law practice on preneed and death care compliance, serving banks, funeral homes, crematories, and cemeteries. He has written multiple published articles

NPS Trustees: Pre-acceptance Due Diligence

Posted in Compliance, Fiduciary, Missouri - SB1, NPS/Lincoln

The Office of the Comptroller of the Currency (the OCC) supervises the fiduciary activities of national chartered banks, and in February, updated the guidelines used by its examiners.  The “Personal Fiduciary Activities” booklet includes a section on pre-acceptance due diligence that fiduciaries should conduct before agreeing to serve as trustee for an account.  Page 7 of the attached excerpt describes due diligence procedures banks should incorporate into their policies.  The Special Deputy Receiver has argue that the NPS trustees failed to perform sufficient pre-acceptance due diligence before accepting those accounts, and therefore breached this duty to the preneed consumers and funeral homes.  The expert report of Professor Hanna suggests that the SDR’s arguments include that the banks were too small to handle a preneed trust, did not understand the requirements of Chapter 436, and did not discover either Doug Cassity’s fraud conviction or the Consent Decree between NPS and the State of Missouri.

Too Small to Play

A fiduciary can breach its duties to a trust beneficiary if it accepts an account for which it lacks the resources or personnel to properly administer the account.  The fiduciary must be able to assess its own capabilities to handle the account.  The pleadings suggest that the SDR has attempted to prove that NPR targeted smaller banks with promises to keep the administration simple and to give the bank an opportunity to win all of NPS’ banking business.

Failure to Comprehend

With special purpose trusts, the fiduciary has a duty to familiarize itself with all applicable state laws and determine its ability to comply with those laws.  The SDR has asserted that a crucial error committed by the defendant trustees in 1989 demonstrated their failure to understand Chapter 436.  Before accepting the NPS trusts, one trustee eliminated from the trust agreement the requirement that NPS provide individual account data.  NPS moved the trusts from UMB Bank when that trusee threatened to cutoff income distributions when such data was not forthcoming.  Subsequent trustees did not require individual contract data, and instead relied upon NPS instructions regarding distributions.

Don’t Get in Bed with the Devil

The OCC guidelines state that a fiduciary has a duty to investigate the trust and its assets.  The SDR has asserted that the trustees also had a duty to investigate the preneed seller, which would have disclosed the Cassity conviction and the NPS Consent Decree.   If such due diligence had been performed, the trustees would either have refused to accept the trust or implemented additional safeguards.

Of these three arguments, the failure to comprehend Chapter 436 carries the greatest weight with this author.  While a small trust department may lack personnel and programming to provide investment or compliance services, those functions can be delegated.  The OCC guidelines recognize that a fiduciary may even have a duty to delegate functions when it lacks the necessary expertise.  That can be true even for the largest trust operations.  A trust department is more likely to breach a duty when it fails to comprehend what is required by applicable law that bank officers do not regularly interpret.

With respect to not getting in bed with the devil, the OCC guidelines do warn banks regarding reputation risk when agreeing to accept preneed funeral business.  However, OCC guidelines focus due diligence efforts on trust assets and administrative procedures, not so much on the trustor or an undisclosed party with ownership interests in the trustor.

Finding Fault with Chapter 436: The NPS Civil Trial

Posted in Fiduciary, Missouri - SB1, NPS/Lincoln

The NPS civil trial has completed its third week, and jurors probably face another four weeks of witness testimony.  First from the NPS receiver, and then from the defendant trustees, the jurors are hearing two very contrasting theories of what fiduciary duties were owed by the NPS trustees.   Up until a few weeks before the trial began, the defendant trustees defined their fiduciary duties as owed exclusively to the preneed seller (which for the most part was NPS).  But the court ruled in favor of the NPS receiver, and found that the consumers and funeral home providers were also trust beneficiaries, and therefore owed fiduciary duties.

Pleadings filed with the court suggest that the SDR’s arguments will be focused exclusively on duties owed to consumers and funeral home providers.  The defendant banks will seek to demonstrate that procedures were developed in compliance with the requirements of Chapter 436.  The elephant in the courtroom will be the failure of a billion dollar preneed company, and the exposure of tens of thousands of consumer contracts.   The receiver will argue to jurors that such a failure had to be the result of fiduciary negligence.  To an extent, the court has provided some support to this argument.   In an evidentiary ruling, the court held that the defendant banks could not introduce evidence for the purpose of showing that regulators bear some fault for the NPS collapse.  However, the court left open whether he will allow the introduction of evidence regarding regulatory actions for other purposes.   Consequently, we anticipate that the defendant banks will introduce evidence of regulatory actions for purposes of establishing standards that the trustees subsequently followed.   If regulators and bank trustees did all that was required by Chapter 436, preventing the Cassitys’ fraud was not a failure on their part, but rather a failure of Chapter 436.

Missouri trust treatise law was authored in part by Professor Francis Hanna.  Professor Hanna was qualified as an expert by the court to testify at the civil trial, and his expert witness report methodically examines the fiduciary duties of the Missouri preneed trustee, and the fiduciary claims made by the NPS receiver.  In subsequent posts, we will examine the duties as outlined by Professor Hanna.

Groundhogs Day 2015: Six Weeks of NPS Civil Trial

Posted in NPS/Lincoln

The National Prearranged Services civil trial is scheduled to begin this week, and trial briefs have been filed with the Court.  The briefs outline the arguments that each party plans to prove during the course of the trial.  It is our understanding that the Special Deputy Receiver has settled with all defendant trustees except Allegiant Bank (and its corporate successors National City Bank and PNC Bank).   Hyperlinks are provided to the SDR brief, the National City Bank brief, the US Bank brief and the Court’s ruling on the parties Motion in Limine.   (While the SDR settled with US Bank subsequent to the filing of US Bank’s brief, we anticipate the remaining trustee bank will continue to pursue those arguments and the issues outlined by US Bank’s expert witness.)  We will address the arguments in future posts.

Qualified Funeral Trusts: Illinois and Schedule M

Posted in Preneed Tax, Taxes

The Illinois Department of Revenue made a revision to Schedule M of the 2014 IL-1041 form that may go unnoticed by many trust tax preparers.  The change is meant to clarify that preneed accounts established pursuant to the Illinois Funeral or Burial Funds Act may take an adjustment that will eliminate the preneed trust’s state tax liability.

Approximately a year ago, this author reviewed the tax returns prepared by one of the country’s largest tax prep firms and noted that income taxes were being paid on all accounts.   I provided that firm a copy of 2000 Practitioners’ Questions and Answers to suggest that the client trusts were overpaying taxes to the State of Illinois.  The tax prep firm did not feel the Q&A was sufficient to change its procedures.  The Q&A indicated that 86 Ill. Adm. Code Section 100.2470 would be amended to include the rule set out by the Q&A, but that action was never taken.  Consequently, the tax prep firm took the position that Illinois income taxes had to be paid on all QFT accounts.

What the tax prep firm failed to understand was that Section 100.2470 had been amended to exempt income earned by preneed trusts established under the Illinois Pre-Need Cemetery Sales Act.   For purposes of the Federal Form 1041qft, all preneed trusts are taxed the same regardless of which state preneed law has jurisdiction.  Accordingly, this author framed the issues in a request to the IDOR.  In a somewhat cryptic response, the IDOR issued a General Information Letter that agrees the two types of accounts are to be taxed in the same manner by the State of Illinois.  The General Information Letter failed to explain how the Il-1041 should be prepared, and in subsequent telephone conversations a procedure was agreed upon until Schedule M could be amended.   That procedure included a disclosure to the IDOR explaining why the Federal Form 1041QFT would differ from that to be attached to the Il-1041.

The end result should be that a Qualified Funeral Trust has no tax liability to the State of Illinois.  Most preneed trust have probably paid income taxes to the state because the IDOR’s General Information Letter points out that trustees can only go back three years to file for refunds when returns are amended.

Questions for the Jury: the mirror trust account

Posted in Administration, Compliance, Investments, NPS/Lincoln

A recent order issued by the Federal Court trying the NPS civil suit referenced a mirror trust employed by the defendant bank (12-31-14 Order – Comerica MSJ ).  To facilitate the trading of investment securities, a brokerage account is established with a firm that can administer the transactions more efficiently than the fiduciary institution.   The fiduciary institution may not actually custody the assets, but rather, records the transactions on its accounting system.  This practice is prevalent when independent fund managers have established relations with brokerage firms.

In the order denying a request for a summary judgment, the NPS Federal Court suggested that such a practice may not satisfy Iowa law that requires a preneed trustee to control and protect trust assets.

Question for The Jury: Exculpatory Clauses and Preneed Investment Supervision

Posted in Associations, Investments, Master Trusts, NPS/Lincoln

It is common for master preneed trusts to have investments directed by an independent fund manager.  The pooling of smaller trusts allows funeral directors to achieve the critical mass needed to engage professional asset management.  When investment functions are delegated, the trustee typically wants to be relieved of the supervision and liabilities that accompany those functions.  In contrast to Missouri’s old preneed law, the Iowa preneed funeral law authorizes the appointment of an independent investment advisor (Iowa Code Section 523A.203(4)) but is silent on whether the trustee could be held harmless.  One of the defendant NPS banks cited this law to the Federal court as authority for delegating its investment functions, and then cited authority under the Uniform Trust Code to vary the terms of trust management from those set out by statute.   The bank required the trust agreement to indemnify it for any investment decisions made by the investment advisor.  State association master trusts have followed the same legal path with regard to getting the trustee to agree to an independent fund manager.

However, the Federal court trying the NPS lawsuit denied this argument in an order (12-31-14 Order – Comerica MSJ ) rejecting the summary judgment request of the defendant bank.  The Court’s order stated that there is a point at which public policy prohibits a trustee from contracting away liability for breaches, and that the jury would decide its liability for any breach.  It went to advise that a trustee always has an overarching duty to protect all trust assets for the beneficiaries.   As we have suggested in prior posts on the use of hold harmless clauses and independent fund managers, the statutes that contemplate fiduciary indemnities require beneficiary consent.  The master trust programs view the preneed seller as the trust beneficiary.  The order issued by the Court is premised on the preneed contract purchasers as trust beneficiaries.

Missouri’s prior preneed law was unique in its granting of exculpation to the trustee when an independent fund manager was appointed.  Consequently, other state’s master trust programs had to follow the course used by the Iowa NPS trustees: reliance of the Uniform Trust Code for authority to incorporate a hold harmless provision in the master trust agreement.  Judge Richard Webber seems poised to strike down a legal argument that the preneed industry has relied upon for more than 30 years.

Getting Personal: liability and the preneed trust officer

Posted in Administration, Compliance, Investments, Master Trusts, NPS/Lincoln

Earlier this week, the Federal Court that is to try the NPS civil lawsuit next month issued an order (Order denying Morisse JOP Mtn) that will raise red flags for the banks that serve as preneed trustees.  In denying the motion of an officer of Allegiant Bank, Judge Richard Webber held that the Special Deputy Receiver had pled sufficient facts regarding intentional misconduct by the trust officer that the claims for his personal liability would go to the jury.  Assuming the facts pled by the SDR, the order found that the trust officer had personally directed the preparation of documents and administration as though the trusts were NPS custodial accounts rather than trusts for the beneficiaries.   Inherent to the ruling is that the Court has accepted that preneed contract purchasers are beneficiaries to the trust, and has rejected the argument that the intent of Chapter 436 was to define the preneed seller as the sole trust beneficiary.

The order cites factual allegations that the Court found persuasive:

  • Failure to monitor the investment advisor’s actions or performance.
  • Took direction from NPS’ employees regarding investments.
  • Failure to provide notices to beneficiaries when the trustee was cited by examiners of statute violations.
  • Allowing NPS to offset deposits and distributions (a practice called netting).
  • Allowing NPS to maintain ownership and control of assets.
  • Drafting custodial agreements for administration of insurance policies.
  • Failing to invest in reasonably prudent investments
  • Failing to diversify the trust investments
  • Failing to maintain sufficient liquidity
  • Allowing the trust to invest in life insurance from a company that was poorly rated and shared common ownership with NPS.
  • Allowing improper income distributions.
  • Reporting the value of insurance policies at face rather than at cash surrender value.

The trust officer had asked for the claims to be dismissed against him because he acted as an employee of the bank and should not be held personally liable.  To be held personally liable, the SDR would have to prove his knowledge of an actionable wrong and active participation.  The trust officer’s defense was premised on compliance with Chapter 436 as NPS being the trust’s beneficiary.  While the order does not reference Missouri’s preneed law, we anticipate the orders to be issued in response to the defendant banks’ summary judgment motions will do so in depth.

Rising Interest Rates: A Return to the Good Ole Days?

Posted in Investments, Master Trusts, Trust Funded

For Fed watchers, last week’s announcement signaled a subtle warning that interest rates will likely begin rising by the Summer of 2015.  Since September of 2012, Federal Reserve statements have warned that interest rates would remain unchanged for “a considerable time” after the nation’s economic recovery strengthened.  The reference to “a considerable time” was dropped from this past week’s Fed statement and an LA Times article examines the history of Fed statements when rate hikes were last implemented ten years ago.

The Fed used the phrase “considerable period” in August 2003 to signal its intent to maintain the then current rates into the foreseeable future.  By the time the Fed dropped that phrase from its statements in 2004, four years had passed since the last interest rate hike.  The rate hike came five months after the phrase was dropped from the Fed’s policy statements.

The article suggests that if the Fed follows the course taken ten years ago, the first rate hike may occur next June, and incremental increases of 25 basis points will be implemented until the historic rate of 3.75% is reached at the end of 2017.  While a 3.75% rate would be a welcomed sight for preneed trusts, it may not be enough to offset the rate at which the cost to perform contracts has risen.  And in the meantime, the incremental interest rate hikes will erode the value of long term bonds issued since 2008.  New trusts, or trusts which were forced to ‘start over’ subsequent to 2008, will be the most vulnerable to market value erosion.

When Missouri re-wrote its preneed law in 2009, drastic changes to trusting requirements caused many funeral homes to establish new trusts.  For IFDA members who left their master trust, those trusts were liquidated before transfer.   To the extent these trusts sought investment return without assuming any equity risks, long term bonds were their only course of action.

Funeral homes with preneed funds parked in long term bonds need to pay heed to the subtle warning given by the Fed.  Your preneed portfolio be vulnerable to market value losses as the Fed implements incremental rate hikes.  So long as the rate hikes are incremental, trusts will have time to adjust their investment policies to minimize or avoid market value erosion.

Preneed Trust: Is it the Consumer’s Funds?

Posted in Fiduciary, Missouri - SB1, NPS/Lincoln, Uncategorized

Attorneys are currently arguing this issue before a Federal court in St. Louis.  While the NPS civil trial does not begin for another six weeks, both the SDR and the defendant trustees want to resolve the question of who is a beneficiary of a preneed trust under Missouri law.  The SDR is arguing that all parties to a preneed contract are beneficiaries to a preneed trust.  The defendant trustees are arguing that the preneed seller is the sole beneficiary of the preneed trust.

The SDR’s brief puts forward several arguments that including the position that the preneed seller is a contingent beneficiary of the trust until performance of the contract.  Until performance of the contract, the contract purchaser has a beneficial interest in the trust.  In support of that position, the brief cites tax rulings and other state laws.  This logic will ring true with many Missouri funeral directors who have expressed a similar view: It’s the family’s money until I perform the contract.

But by the time the Missouri Funeral Directors Association sponsored the bill that rewrote Chapter 436 in 1982, the Securities Exchange Commission had issued No Action Letters to several state funeral director associations defining the preneed contract purchaser as a consumer, not an investor.  The 1982 Missouri law was also unique in that it distinguished preneed sellers and preneed providers, and authorized the preneed seller to become the primary obligor of the preneed contract even though it did not own a funeral home.  As primary obligor, the seller could then control the trust relationship.  That legal structure could better isolate the funeral homes from preneed liabilities.   It also isolated the trustee from the demands of the funeral homes.

The arguments being made in opposition of the SDR position are reminiscent of those made by the industry to the IRS in the 1980’s.  The IRS brushed aside state preneed laws in promulgating Revenue Ruling 87-127, and its conclusion that the preneed contract purchaser is a beneficiary of the trust.  If the Federal court accepts the SDR’s argument, preneed trustees face a dilemma similar to that resulting from Rev. Rule 87-127: how to discharge a duty to individuals with whom you have no direct contact.

Testimony Guidelines for the NPS Experts

Posted in NPS/Lincoln

In August, litigants to the NPS civil trial were required to file expert opinion reports with the court.  Initially, there were essentially 8 defendant banks, and most had retained one or more experts to testify at trial.  As a consequence, a plethora of expert reports were filed with the court.  Many of the experts offered opinions on what Missouri’s preneed law did or did not require. Over the past few months, the NPS Special Deputy Receiver has reached settlement agreements with all but two of the Missouri defendant fiduciary banks, and in an order issued two weeks ago, the court identified those experts who will be allowed to testify.  The order also set the areas of testimony that will, and will not, be allowed.  The following are the areas of testimony that will not be allowed:

1. Whether the actions of the Missouri Trustees, or anyone else, complied with Chapter 436;

2. Interpretations of Chapter 436;

3. Interpretations of the governing trust agreements;

4. Requirements of Chapter 436;

5. Duties imposed by Chapter 436;

6. Actions of a Missouri State Court;

7. Trustees’ liability for the actions of the grantor;

8. Whether trustees lack authority and capability to oversee external business activities of trust grantors or beneficiaries;

9. Trustees’ responsibilities or liability for investment decisions;

10. Duties and Responsibilities of the Independent Investment Advisor;

11. Interpretation of the meaning of “independent” in Chapter 436;

12. Whether applicable statutes require independence from seller or trustee, or both;

13. Prevailing trust customs and practices supersede Missouri law;

14. The appointment of Wulf Bates relieved the trustees completely of all liability for investment decisions;

15. The trustees could not monitor investment decisions of the investment advisor.

Testimony regarding the following will be allowed:

1. Purpose of Chapter 436;

2. Reference the trust agreements and applicable statutes;

3. Purpose of a standard of care;

4. What trustees generally understand their responsibilities to be and their fiduciary duties but not what a specific trustee understood as their duties and responsibilities;

5. What the expert believes the purpose of the trust agreement and the statute were designed to achieve;

6. What the expert currently advises clients to do or not to do;

7. The responsibilities of trustees, in the practice of the expert;

8. Opinions as to independence of David Wulf;

9. Observations of what trustees did or did not do;

10. Whether trustees complied or did not comply with the standard of care;

11. Reference sections in the law and state if evidence was or was not presented to show the acts were done but cannot say the law requires certain actions;

12. How trustees did or did not control trust assets, keep records, or monitor trust distributions but not what the statute requires.

Francis Hanna, a name familiar to Missouri attorneys that practice in trust law, will be one of the experts to testify at the NPS civil trial.  Mr. Hanna’s expert report assumed an approach that seems consistent with the court’s testimony guidelines, and in future posts we will examine the trustee duties as outlined by the report.