In anticipation of a February trial date, a group from the fiduciary bank defendants has filed a motion for summary judgment in the Federal court that will try the NPS civil lawsuit. The intent of the summary judgment request is to narrow the scope of claims made by the Special Deputy Receiver. The pleadings filed with the court are lengthy, and for purposes of this post, we provide a hyperlink to the Table of Contents, Introduction, and Conclusions of the Memorandum in support of the banks’ request. The SDR’s legal team will next respond with countering arguments and facts. The moving bank defendants will then have another opportunity to reply. The banks have requested oral arguments, and the issues could go before the trial court by Thanksgiving.
There are three scenarios for administration of preneed installment payments: the funeral operator collects payments, the trustee collects payments or a third party administrator collects payments. The entity collecting installment payments must be able to apply each payment to the correct preneed account, and provide the other party (or parties) current payment balances. If the payment administration is performed by the fiduciary or a TPA, the funeral operator must be informed of any outstanding payment balances. If a death occurs before the contract is paid in full, the operator must be able to include the amount owed in the final statement of goods and services. Families also call on the funeral home for payment balances when they desire to pay off a contract. The trustee must also know how much can be distributed on performance of the contract.
The legal authority for a funeral home to administer consumer payments is based on the preneed contract constituting a sale of goods and services. The trusting requirement is a safeguard for future performance of the contract. For decades, it has been appropriate for the funeral home to handle the payments, and to book those payments to its accounting records. However, smaller operators often lack the accounting resources required to administer significant numbers of consumer payments. Seeing the need for administration, state associations obtained SEC No Action letters premised on the guaranteed preneed contract. The SEC No Action letters enabled the master trust programs to limit their liability exposures when providing administrative services to member funeral homes. While one such SEC No Action letter included a description of non-guaranteed contracts, the submission was made by Fleet Bank, not a state association or funeral operator.
From the perspective of a consumer or a regulator, the safest method would be to require all payments be deposited directly to the trust. However, few trustees have procedures or accounting platforms designed for frequent deposit and distribution activity. Allegations made against the National Prearranged Services trustees include improper custodial arrangements intended to simplify the banks’ role in administrative functions. The pending Federal civil trial will explore whether administrative procedures outlined by some of the banks amounted to an aiding and abetting of fraud by NPS.
The NPS civil trial may also implicate the administration of consumer payments by the independent TPA. Doug Cassity asserts that no fiduciary duties were owed with regard to consumer payments until the contract’s purchase price was paid in full. In one court pleading, Mr. Cassity argued Chapter 436 was silent on the issue and that Chapter 214, Missouri’s cemetery law, authorized NPS’ administration of consumer payments. While it may be an absurd argument, the assertion will bring into question whether the TPA owes fiduciary duties to the consumer, funeral home and trustee. For rollover preneed trusts, NPS was not the preneed seller, but rather served as an administrative agent appointed by the funeral home. Few TPAs may perceive their role as one owing duties to either the consumer or the trustee.
The industry will need to move cautiously in offering the consumer options regarding installment payments and non-guaranteed contracts.
The conventional guaranteed preneed transaction is premised upon investment returns offsetting performance cost increases to the funeral home. Many funeral homes restrict consumers to single payment preneed contracts to limit their exposure to funding short falls. If the funeral home allows the consumer to pay the preneed purchase price over 60 months, the preneed trust is put at an investment disadvantage until the contract is paid in full at the end of the five year payment period. The lure of non-guaranteed preneed is that consumers can pay on the arrangement at their own convenience until the trust is large enough to have investment returns that offset cost increases. But while the arrangement is in the non-guaranteed phase, the consumer bears the investment risk and the trustee must therefore make reasonable market value allocations to the consumer’s account. As we alluded to in prior posts, the master trust programs in Illinois and Wisconsin skirted this issue with fixed rate returns. It was not that long ago when some industry experts recommended that preneed trusts use ‘book value’ or tax cost basis as the basis for allocations to individual accounts. The simplicity of this approach would be that the trust could use its tax accounting platform for ‘market value’ allocations. That approach was defendable with preneed trusts invested exclusively in fixed income securities held to maturity. The last decade has been particularly brutal to preneed trusts that stayed their course with an investment policy that relied exclusively on interest income. As trusts have revised their investment policies to incorporate diversification into equity holdings, the trustee must have administration that makes periodic allocations of actual market value.
A few weeks ago, we discussed the need to offer to consumers new preneed funding options, and outlined the various administrative hurdles faced by funeral homes that rely upon trust funding. (Preneed Trust Options: Administrative Limitations) With this post, we will examine how the non-guaranteed option impacts tax allocations and makes spreadsheet administration impractical.
In response to the need for funding options, an increasing number of funeral homes are exploring a combination of non-guaranteed contracts and guaranteed contracts that include a surcharge for price protections. The non-guaranteed contract is necessary for the consumer that could not afford a preneed contract even before the surcharge was added. The non-guaranteed option gives the consumer with limited finances the ability to establish a fund that may someday be converted to a guaranteed arrangement. However, until that day, the fund will more closely resemble a savings plan (search this blog for “MyPA”). Once the MyPA is included in the preneed program, both the funeral home and the trustee must give consideration to how income and expenses are allocated to individual trust accounts.
In our post, Qualified Funeral Trusts – once a simple concept, we discuss how investment diversifications have made tax allocations and the preparation of the Form 1041QFT more difficult. To simplify the allocations of income and expenses, tax administrators often base allocations on the year end balances of individual accounts. That allocation approach does not comply with Notice 98-66, where the IRS provided the industry a quarterly allocation method that avoided the burdens of monthly allocations. While the IRS has had little reason to challenge the trust’s tax return when it was invested in fixed income securities, that approach becomes suspect when non-guaranteed contracts are added to the preneed trust. With the non-guaranteed contract, the consumer bears both investment risk and the trust’s tax consequences.
When yearend account balances are used for tax allocations, a consumer purchasing a non-guaranteed contract on December 30th would be allocated income and expense as though he/she had been in the trust since January 1st, the same as the consumer that actually purchased a non-guaranteed contract on January 1st. State regulators will ask how two contracts purchased almost a year apart have the same income. Most trusts will be dominated by guaranteed contracts, which mean that the majority of serviced accounts will also be guaranteed. If those contracts are omitted by the tax administrator, the active non-guaranteed accounts will bear a portion of the tax liability of the serviced accounts.
If a funeral home is considering whether to offer both term guaranteed contracts and non-guaranteed contracts, periodic allocations of income and expenses could eventually become a requirement. Tax preparers and funeral homes will have to go beyond the current practice of making allocations based on year end account balances.
The remaining members of the Cassity clan have filed motions in opposition to the dismissal of Doug Cassity from the NPS civil lawsuit. Rhonda Cassity and Tyler Cassity argue that they too are the victims of Doug’s scheming and fraudulent conduct, and that good ole’ Dad should be compelled to testify, and held accountable.
The plan to shelter assets under other family members has shown its ugly side.
The Massachusetts Division of Professional Licensure and the state Board of Registration of Funeral Directors and Embalmers are taking flak over the one and half million dollars of preneed funds that may been diverted by the owner of the defunct Ryder Funeral Home in South Hadley. The Daily Hampshire Gazette reported that 200 Massachusetts funeral homes are late in filing their annual preneed reports and the newspaper is pressuring state regulators to explain how some funeral homes, such as the Ryder Funeral Home, were allowed to go years without filing a report.
Massachusetts death care regulators are not alone in the quest to obtain prompt preneed reports from funeral homes and cemeteries. This issue was highlighted by Nebraska’s Department of Insurance when preneed legislation was discussed with the industry last year. The Illinois Comptroller implemented a new fine system with the annual report form released last month. A few years ago, Missouri’s State Board of Funeral Directors and Embalmers began suspending sellers’ licenses when their paperwork was not timely submitted. But with limited staff and resources, how is a regulator to distinguish the tardy licensee from the funeral home or cemetery that is diverting preneed funds to their operating account? As a representative of the Massachusetts State Board points out, there is no way to distinguish tardy guys from bad guys if so many operators are late to file. So, the first course of action for that State Board was to request administrative complaints filed against all tardy filers. But, will this provide regulators the information they need to red flag operators that may be diverting preneed funds?
Another member of the Massachusetts State Board described the preneed reports as useless, and recommended that preneed funds be kept out of the funeral director’s hands by requiring preneed payments be made with checks made payable to insurance companies or guaranteed trusts.
Missouri sought to implement a similar approach with regard to trust funded contracts, but the requirement met strong opposition from operators that provide primary accounting of contract payments. Most corporate trustees do not have the administration required for installment payments or consumer payments that must be split among contracts and charges. Nor did funeral operators want to bear the cost for banks to develop such administration. Use of a clearing account dedicated to the operator’s preneed sales could remedy this problem. Dictating the format of deposit transmittals to the clearing account, reports of the division of the payments, and resulting transmittal of trust deposits would provide inspectors an audit trail from the consumer’s hand to the preneed trust. But, such reports may be difficult to understand if they are not produced monthly or quarterly. While the Board’s staff may not have the time to review each quarterly clearing account report, the timely production of the reports would signal the operator is at least making timely deposits to the trust.
But, only the consumer may know whether all deposits have been made to his or her trust. Consequently, the Massachusetts State Board may want to expand its preneed requirements to include an annual consumer statement similar to that required by Illinois. Each year, Illinois preneed trustees must produce a consumer statement that advises the contract purchaser the deposits and withdrawals that have been made to their preneed account. The statement must also disclose the fees and taxes paid from the account, and its market value. In theory, the consumer statement will trigger inquiries if the trustee fails to report a contract sold, or reports lower trust deposits than what the purchaser could expect. The concept has merit for state death care regulators that lack the resources to turn every page of a funeral home’s preneed records. Until a contract goes paid in full or lapses for failure of payments, the trustee could produce an annual consumer statement that would be mailed to the consumer, and made available at the funeral home where the contract was purchased. The regulator’s website could advise consumers to expect a statement from the trustee, and to visit their funeral homes if the statement causes any questions. If funeral director’s explanation does not add up, then an inquiry should be made to the state board. That inquiry would create the red flag that would prompt the examiner to review the periodic reports filed on behalf of the funeral home.
Better to remain silent and be thought a fool than to speak out and remove all doubt.
Pleading by pleading, the Cassitys are speaking out against injustice. Brent Cassity followed his father’s lead, and filed a motion to dismiss from the civil lawsuit against NPS’ former management and trustees. The younger Cassity made a hodge podge of legal arguments better suited to a death row inmate. As if the Cassitys’ actions haven’t already cost the public enough, Brent has requested the court appoint a qualified attorney to represent his interests. Otherwise, “basic fairness and due process” should dictate that Brent be dismissed from the SDR’s lawsuit.
The lawyers at Reilly Ponzer have to be chuckling.
The Memorial Business Journal’s July 10th story on the NFDA 2014 consumer survey included a commentator’s suggestion that preneed funding has declined because so few options are offered the consumer. The story’s commentators interpreted the decline in preneed funding as reflecting fewer consumers being motivated by price guarantees, and those that might be, need installment options. The commentator was alluding to a generation of funeral home operators having built their preneed programs around guaranteed contracts that required consumers to make single payment purchases. Unable to pay for the entire cost of a preneed contract, fewer consumers are funding their prearrangements.
For funeral homes that rely upon trust funded preneed, installment options and/or non-guaranteed options require administration that becomes too complex for the spreadsheet software that opened the door to self-administration. If your father’s preneed program required single pay contracts, investments in bonds (that were held to maturity) and grantor tax treatment to the funeral home, the program could easily be administered by the operator with spreadsheet software. Lotus 1-2-3, the early frontrunner in spreadsheet software, was introduced in 1983, about the same time many preneed laws were being written. While the earliest spreadsheets had their limitations, the software could easily handle the allocations required of a preneed program that sold guaranteed single pay contracts. With income reported to the funeral home, the frequency of income allocations to contracts was often at the operator’s discretion. For some states, the administrative standards were even lower.
When written in 1982, the Missouri law contemplated that all contracts would be guaranteed. That law allowed sellers to withdraw income to the extent the trust market value did not fall below trust deposits. Absent the income accrual requirement, Missouri sellers had no individual allocation requirements for income or values until 1988. With Rev. Rul. 87-127, Missouri preneed contracts faced new income and expenses reporting requirements. However, many trusts erroneously changed to tax exempt investments to avoid income reporting to consumers. Until Missouri law changed in 2009, preneed sellers had the means to avoid all forms of individual account allocations.
Nebraska is another state that has a trusting requirement that lends itself to spreadsheet allocations. That state allows a partial distribution of trust income (to the extent the trust income exceeds the consumer price index). The law was written in 1987, and contemplates the CPI increase being computed on the trust as a whole. The law does not have a market value requirement, and nor does it contemplate non-guaranteed contracts. As a consequence, the account increases could be allocated in conjunction with tax allocations. There was no need for periodic allocations, which makes for easy administration by an Excel spreadsheet.
Spreadsheet based administration becomes cumbersome when the preneed trust provides for periodic allocations of payments, income, expenses and values. Add non-guaranteed preneed to the mix, and the trustee must then consider whether the allocations are fair to the consumer. As witnessed in Illinois and Wisconsin, the preneed program cut corners on trust administration by resorting to fixed investment returns. Fixed returns avoided the complications of periodic allocations of income, expenses and value changes, and allowed the continued use of spreadsheet administration. Funeral homes in those two states will be paying for the administrative corner-cutting for years to come.
In future posts, we will take a closer look at the administrative burdens of installment payments, non-guaranteed, tax allocations and market value fluctuations.
Doug Cassity has filed a motion to modify the order dismissing him from the SDR’s civil lawsuit. Mr. Cassity asserts that he and his family should be freed of the reign of terror and wrongdoing of the Texas regulators and their attorneys. Seeking a dismissal with prejudice, Mr. Cassity seeks to have the SDR’s claims dropped permanently against himself and his son. While the motion hints at various motivations that Mr. Cassity may have for testifying, he is not inclined to do so if the SDR can reinstate claims after his testimony is given.
The motion and its attachment were prepared by Mr. Cassity, and offer a glimpse of the man and his thought process. Mr. Cassity offers a unique interpretation of the Missouri preneed law passed in 1982. We will explore some of Mr. Cassity’s issues in subsequent posts, but the initial issue that caught our attention was the characterization of the Missouri law as a burial insurance statute and the reliance upon Missouri’s cemetery law for deferring trust deposits until a contract was paid in full. We anticipate that Mr. Cassity is alluding to how endowed care contributions are administered under Chapter 214 because that law did not have a preneed trusting provision until well after the 1992 lawsuit was filed by the Attorney General. Many Missouri cemeteries assert that an endowed care contribution is not required until the lot sale is completed. Mr. Cassity asserts that NPS’ attorneys advised that the company could rely upon such an interpretation when addressing an ambiguity in Missouri’s Chapter 436. Mr. Wittner may have a different recollection of that advice, which gives rise to one of Mr. Cassity’s motivations to testify. The exhibit indicates Mr. Wittner is now cooperating with the SDR.
The motion reflects a desperate man that still seems prepared to say anything. Dismissed from the civil suit, Mr. Cassity will no longer be provided pleadings filed with the court. You could say that Doug has been put into ‘isolation’. He has been cut off from a legal proceeding that continues to put his son at risk. There may be no saving himself from the ‘reign of terror’, but we will have to wait and see if the SDR is prepared to offer up Brent for the truth.
The NPS civil trial is scheduled for trial in February 2015, and the SDR’s strategy took a twist when her litigation team filed a motion to dismiss Doug Cassity as a defendant in the lawsuit. The dismissal probably signals the SDR’s intent to use Mr. Cassity’s testimony. Now convinced that Mr. Cassity does not have hidden funds that exceed the restitution required by the criminal conviction, the SDR will seek to use his testimony against the various bank defendants. It may not matter whether he is a cooperative witness. Consequently, Mr. Cassity’s testimony could have ramifications for fiduciaries and insurance companies that do business in Missouri, and the regulators who supervise the state’s preneed trusts.
As seller of trust funded preneed contracts, NPS directed the trustees to follow an investment advisor selected by NPS. That investment advisor then directed the trustees to purchase insurance policies issued by a related company (Lincoln Memorial Life). The trustees may have also followed the directions of NPS and Lincoln Memorial Life regarding the reporting of trust income.
How far did Missouri law allow the trustee to follow the seller’s instructions with regard to investments, administration and taxation of a preneed trust? To what extent did the trustees owe fiduciary duties to funeral home providers and preneed contract purchasers? Will the results of the trial have implications to preneed fiduciaries in other states?
Preneed insurance companies understand the need to offer consumer options, and some have begun to offer hybrid trust programs. Consumer payments are deposited to a trust pursuant to a contract that requires the trustee to purchase insurance at some future date. This affords the consumer flexibility in making payments until the insurance is purchased. The trustee will take a Section 685 election to avoid income reporting to the consumer until the insurance is purchased. When the contract beneficiary dies, the trustee will collect insurance proceeds pursuant to IRC Section 101 and pay the seller upon proof of performance. For so long as the trust owns an insurance policy, the seller can anticipate a constant, albeit low, trust return.
For these programs, the NPS civil trial could either clarify or redefine the duties owed by trustees to consumers and third party funeral home providers regarding insurance investments. Did the NPS trustees have a duty to look behind Mr. Cassity’s polished presentation before purchasing insurance? Was this a one and done determination of prudence, or was the determination required with each purchase of an insurance contract? For contracts sold after SB1, there is also the question of whether the investment of trust funds in an insurance product complies with the prudent investor rule, and its diversification requirement. What was the diversification requirement under the old prudent man standard?
Must the bank also determine the correct taxation of the insurance product when held in trust? When trusts rushed to insurance products to avoid Rev.Rul. 87-127, there was no Section 685. Rev.Rul. 87-127 afforded trusts the legal authority to treat the purchaser as grantor, and thus claim taxation pursuant to IRC Section 101. What happened when NPS rolled over a seller trust that had a Section 685 election in force? Were the insurance proceeds then taxable?
Mr. Cassity’s testimony may well influence whether trustees can deflect these liability issues back to the seller and the sponsoring insurance company.