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

Criminal Intent: Use of the Wrong Deposit Book

Posted in Exams/audits, Preneed, Trust Funded

An Oklahoma funeral director faces serious prison time over the deposit of preneed funds to his business operating account.  The Oklahoma Department of Insurance decided to go to a local prosecutor when a Department audit found the funeral director had routinely failed to deposit consumer funds to the preneed trust required by state law.  The funeral director’s attorney has suggested to news sources that although the funeral director admitted the funds were deposited to the operating account, no funds were missing.  Consumers were getting their funerals, and his client was only guilty of being ‘sloppy’.  But, the Department would have no part of the ‘no harm, no foul’ defense.   The Oklahoma authorities have taken the position that criminal intent is determined by the decision on whether to comply with the deposit requirement, not whether the funeral director has intent to honor the contract.

Missouri and Illinois funeral directors have similar deposit requirements with regard to consumer preneed funds.  So do Missouri cemeteries that sell merchandise and services on a preneed basis.  Prior to the overhaul of Chapter 436 in 2009, the Missouri preneed law was ambiguous regarding the deposit requirements for consumer funds.  Today, Section 436.440 requires consumer funds to be deposited directly to trust within 60 days of receipt by the seller.  The ‘deposit directly to trust’ brought objections from large operators that include finance charges and other fees in the preneed sale, and an accommodation was made by the State Board to allow deposits to a clearing account.  However, Missouri funeral homes that use a clearing account bear the burden of proof that the account is merely an extension of the trust.

Until December 2016, the Missouri funeral director who fails to deposit consumer funds to trust within 60 days of receipt has exposure to class c felony charges.  Subsequent to January 2017, these violations of Chapter 436 will carry a class d felony penalty.  With the 2009 law change, the preneed auditors of the Missouri State Board of Embalmers and Funeral Directors are now on the front line for determining compliance with the trust deposit requirement. While Chapter 436 provides concurrent jurisdiction to the Missouri Attorney General and local prosecutors, the law contemplates the State Board first referring possible prosecution matters to the AG.  As an industry board, the State Board will lean towards giving funeral directors every opportunity to ‘get right with the Lord’, but we are five years into the ‘new’ law and that should be enough time to figure out which deposit book to use.  Restoring consumer confidence requires proactive use of the authorities granted by the Legislature in 2009, including the Oklahoma option.

NPS’ Legacy of Damages: No One Knows How Deep the Waters Were

Posted in Associations, Exams/audits, Master Trusts, Missouri - SB1, NPS/Lincoln, Recordkeeping

When NPS first collapsed, the estimate of the company’s liabilities to funeral homes was reported to have been as much as a billion dollars.  When the SDR finally brought the case to trial, the damages awarded by the jury were less than half of the original estimate.   While this author believes the actual damages are closer to the original estimate, the truth may be that no one, including those who ran NPS, knew all what had been promised funeral homes.    Chapter 436’s lax standards for regulatory oversight and fiduciary duties meant that no one was asking NPS for records that would have shown whether the trusts were appropriately funded.   Consequently, it is ironic that members of the Missouri funeral industry are now suggesting that the State Board of Embalmers and Funeral Directors has exceeded its audit authorities, and that the Board’s members could have personal exposure for doing so.

At a recent State Board meeting, it was suggested that a Supreme Court decision now puts Board members at risk for personal liability.  In North Carolina State Board of Dental Examiners vs Federal Trade Commission, the Supreme Court held that the members of an industry board could not claim state action immunity because the state had not provided adequate supervision of an entity that was acting more for the benefit of the industry than for the good of the public.   The North Carolina dental board passed regulations controlling who could provide teeth whitening services, and the FTC found the regulations to be in violation of antitrust laws.

The Missouri State Board has a history with the FTC and the antitrust laws.   About eight years ago, the Board passed a regulation controlling who could sell caskets.   As a part of the settlement with the FTC, the Board had to include disclosures on its website.   The North Carolina case also reminds us of the time when California regulated the funeral industry with an industry board.  That state board retained its own legal counsel and pursued issues which seemed closely aligned with the state association.  Eventually, the California Funeral Board was eliminated by a sunset law, and regulation of the industry was transferred to the Cemetery and Funeral Bureau.

We have heard the industry’s frustrations with the Missouri audit process.  Auditors have written up issues that could have been explained through an exit interview.   Audit exceptions based on insurance policy assignments made decades ago for an accommodation to families.  The auditor’s failure to incorporate explanations into reports forwarded to the State Board.   Exceptions left open without a formal response by the State Board.  But, it is disingenuous to raise the North Carolina decision in context with the preneed audit process.    However flawed the process may be, audits are not intended to further industry interests over those of the public.  That may be best typified by the obvious friction between the State Board and the state association over the audit of their master trust.  Second, the State of Missouri provides oversight of the State Board through a staff and attorney who are Division of Professional Registration employees.

NPS Trustees: Standard of Care for Investments

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

Now that a judgment has been rendered against Allegiant Bank, the NPS litigation will move on to the appeal stage where the focus will be on R.S.Mo. Section 436.031.  The NPS trustees universally argued that this provision of the Missouri preneed statute relieved them of all responsibility and liability for investment supervision.  As set out in expert report of Professor Hanna, the trustees argued that the law prohibited them from participating in the investment advisor’s strategy and management of trust assets, and required them to follow investment instructions even though preneed funds were being sent to insurance companies with ties to NPS.  In support, the expert report references the 1994 Consent Judgment between NPS and the State of Missouri, and suggests that a reasonably prudent trustee would have determined that the court had approved the purchase of insurance policies from a related company.   While paragraph 6 of the Consent Judgment did obligate NPS to continue premium payments to Lincoln Memorial Life Insurance Company, Statesman National Life Insurance Company, and Memorial Service Life Insurance Company, other comments included in the Hanna expert report suggest that one or more of the NPS trustees were not even aware of the Consent Judgment.

There can be no argument that the trusts’ purchase of insurance from a commonly controlled company enabled the Cassitys to shift funds, first among policies, and then out of the insurance companies.   The SDR argued that the trustees opened the door to this fraud by allowing the trusts to purchase insurance from a related company, and then failing to monitor the cash surrender values of the policies.  The latter part of the SDR argument begs the question of who was in a better position to challenge the irregularities of Lincoln Memorial Life.   If intercompany fraud was a possibility that trustees should have foreseen, why did the Missouri Attorney General allow the continued purchase of Lincoln policies?

In resolving a long running dispute with NPS, the Missouri Attorney General’s office focused on getting NPS to timely fund the trusts.   Exploiting one of Chapter 436’s many ambiguities, NPS claimed it was not required to deposit consumer funds to trust until the contract was paid in full (a theory borrowed from Missouri’s endowed care law).    There is little discussion of Statesman National Life Insurance Company other than there was a reinsurance arrangement between it and Lincoln Memorial Life.   We are left to speculate whether Statesman’s role as original issuer of the policies issued to the NPS trusts was viewed as an element of independence that broke the line between NPS and Lincoln.  But, the Texas Department of Insurance’s records indicate that Statesman was put into liquidation in 1999, which was at a time when the Missouri Attorney General still had oversight of the NPS operations.  Was Lincoln then allowed to assume the Statesman policies issued to the NPS trusts?  It would seem to us that the State of Missouri put too much reliance on the Texas Department of Insurance to keep NPS and Lincoln on the straight and narrow.

For purposes of the civil trial, the Court cutoff any arguments that regulators should share in the fault for the NPS collapse.  So consequently, the defendants will ask the Federal Court of Appeals whether the trial court erred in its interpretation of R.S.Mo. Section 436.031.  Can the preneed trustee be relieved of all investment supervision?  If so, who then assumes the fiduciary duties for investment oversight?  Does the independent investment advisor become a fiduciary to preneed consumers?  Does the preneed seller also assume a fiduciary duty for the fund manager appointment?

NPS Trustees: Standard of Care for Preneed Administration

Posted in Administration, Compliance, Missouri - SB1, NPS/Lincoln, Recordkeeping

Final arguments were heard in the NPS civil trial this past Friday.  With the SDR having presented evidence through the prior Friday, the defendant trustees presented their case in less than a week.  This may reflect that the NPS trustees had viewed their duties as having been defined by Chapter 436 as relatively low.  As the defendants’ expert on fiduciary duties, expert report of Professor Hanna outlined the following areas:  A) Income Distributions;  B) Use of Lincoln;  C)Alleged Knowledge of Inappropriate Banking Activities;  D) Consent Judgment;  E) Policy Loans;  F) Debentures;  G) Adequate Recordkeeping;  H) Investment Advisor; and I) Trust Distributions.

The expert report was prepared as a litigation document to defend against claims being made by the SDR.  As a consequence, the report does not discuss how the preneed trustee’s duties are interrelated.  Nor does it address duties which were omitted by the SDR.   One such crucial duty was the trustee’s responsibility to report trust income pursuant to either Rev. Rul. 87-127 or IRC Section 685.  Either method required the trustee (or its agent) to have individual contract data for periodic income and expense allocations.

The preneed trustee’s duties regarding trust distributions, income distributions, tax administration and adequate recordkeeping are interrelated, and cannot be viewed as separate and distinct duties.    But, subsequent to NPS’ removal of UMB Bank as trustee, the successor fiduciaries did not seek individual contract data.  The defendant banks viewed their recordkeeping as limited to the accounting provided for an account’s asset management.  Professor Hanna argues that a prudent trustee would not read Chapter 436 to impose a requirement to keep individual contract accounting.  The defendant banks’ defense is based on complete reliance upon the preneed seller for instructions for distributions and tax allocations.

The intent behind SB644 was to enable the state association to establish a master trust program that allowed the fiduciary to look to the seller for all instructions regarding individual account transactions.   But, in 1982, most preneed trusts were also reporting income as a funeral home grantor.   The IRS was already challenging that reporting method, and eventually closed that door in January 1988.  Rev. Rul. 87-127 was the first red flag to the NPS trustees that consumers were a trust beneficiary, and that some form of individual account data would have to be obtained from the preneed seller.

For large preneed programs, individual contract accounting may have to be performed by the preneed seller.  But for such programs, the preneed trustee should have policies and procedures for retention of individual account records that permits internal auditing of distribution instructions and tax allocations.  The expert report would lead us to believe that the NPS trustees did not have such policies or procedures.

In our next post, we will look at the NPS trustees’ standard of care regarding the use of Lincoln and the investment advisor.

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.