Death Care Law Blog : Kansas Death Care and Preneed Lawyer & Attorney : Stalter Legal Services Law Firm : Funeral Law, Elder Law : Kansas City

In the days that followed the Wisconsin Funeral Directors Association being placed into receivership, some of the WFDA’s sister associations were quick to point out they had ‘checks and balances’ that would protect consumers’ funds from the problems that tripped up the Wisconsin Funeral Trust. As we reported in our last post, a crucial ‘check and balance’ missing from the WFT was investment oversight. The fact that a trust has a corporate trustee does not necessarily mean that fiduciary has responsibility for monitoring the prudence of the investments. Corporate fiduciaries often look to uniform trust codes for the authority to delegate investment responsibilities. If a grantor wishes to use an outside asset manager, general trust laws will accommodate those wishes. The problem with preneed trusts (and cemetery endowment funds) is that there is more than one “grantor” to the preneed trust.

We have previously stated our support for allowing a relationship between preneed seller and a qualified fund manager. However, the fiduciary must provide a ‘check and balance’ to that relationship by maintaining responsibility for the investments. The ‘scandals’ from Missouri, Illinois, California and Wisconsin stem from a lack of investment oversight. Missouri’s regulators responded to NPS with a law that precluded any relationship between the advisor and the seller. Appropriately, the Missouri association obtained revisions to allow an agency relationship between its fund manager and the trustee. However, the Missouri law does not go far enough to require the disclosures we recommended in 2011. Funeral directors and consumers need to know that Missouri preneed fiduciaries ‘have their back’ when it comes to investment oversight.

Investment oversight is also a concern for cemetery regulators. Kansas’ cemetery regulators were dismayed to find that a corporate trustee had turned over the investment reigns to a Hutchinson cemetery operator. The operator hoped to cover declining revenues (and the failure to make trust deposits) with higher investment returns. For months, the operator attempted to hide the ball from the auditor, but eventually it was discovered that those investments had lost hundreds of thousands of dollars.

The investment supervision issue is also a concern for Nebraska regulators. As they prep the death care industry for legislation in 2013, they raise this issue:

Seller’s Power to Direct Investments

A question has arisen regarding the seller’s ability to direct the trustee’s investment decisions. Specifically, should the seller be able to instruct the trustee to deposit or invest funds in securities that do not meet the trustee’s own investment guidelines?

If it is determined that the trustee should be free from the seller’s investment influence, section 12-1107 should be amended to reflect this fact.
 

In what may be a perfectly legal arrangement, Illinois funeral directors have handed off investment oversight to their new fund managers. The master trust instrument carefully outlines the code provisions which authorize the delegation of investment authorities. But the document goes that extra step of exculpating the trustee from responsibilities for investment oversight. Where is the check and balance in that structure? Are the industry’s expectations so high that a trustee will not accept the fund without a hold harmless? If the industry does not establish its own ‘checks and balances’ with regard to investment supervision, the authority to participate in the investment decisions could be taken away.
 

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For the past few years, some Kansas cemeteries have been getting nasty grams from their regulator about their care fund trustee’s treatment capital gains taxes. Kansas, like most states, requires a portion of each grave space sale (interment right) to be contributed to a fund or trust for the future care of the cemetery. Kansas law calls that fund a permanent maintenance fund. Missouri law calls it an endowed care trust. In some states it is defined as a perpetual care trust.

Despite what the fund is called, these state laws universally seek to provide the cemetery a source of income to pay for the upkeep of graves (while keeping the contributions in tact). That latter objective, protecting the contributions, brings cemeteries and regulators into conflict when the fund realizes capital gains and losses. The Kansas cemetery regulator has been taking the conflict a step further by interpreting the law to preclude the trustee from paying taxes or fees out of capital gains.

The Kansas regulators (like many of their peers) perceive a ‘looming’ problem with cemeteries: abandonment and the eventual transfer to the municipality or county. Cemeteries are dependent upon the cash flow that comes from space sales (and the accompanying interment fees and marker sales). When a cemetery runs out of spaces, grave maintenance will be completely dependent upon income from the care fund. To minimize the financial burden placed on the county, the Kansas regulator has adopted a very strict interpretation of the law for the purpose of preserving the care fund for the day the cemetery transfers to the government. This interpretation not only precludes the fund from distribution capital gains earnings, but also the trustee’s payment of taxes and fees from the earnings. The regulator reasons that capital gains must be allocated to principal, and the law forbids all distribution of principal.

This puts the cemetery into a bind. The staple of care fund investments, the fixed income security, has been bearing returns of less than 2% for years. When trust expenses are netted from those returns, there is little left to distribute to the cemetery. Necessity has dictated that these funds begin investing in equities. But, the Kansas philosophy would penalize the cemetery. Not only is the cemetery prohibited from using the equity earnings, the cemetery must also pay the taxes incurred on those earnings (reducing what is received from the care fund). The only ‘winner’ is the county. Or is it? If the eventual abandonment takes years, and the cemetery has been deprived income for upkeep and repairs, isn’t the county getting the property in worse shape?
 

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The ICCFA’s November Magazine included an article by Craig Martin that provides good advice for all death care trusts. Death care trusts are notoriously bad performers, and if operators are to improve investment performance they need to work more closely with their fiduciaries and portfolio managers. Mr. Martin offers 5 tips that are equally applicable to preneed trusts and endowment care trusts:

1. Know your investment guidelines (and statutory limitations)
2. Communicate with the investment manager on a regular basis
3. Use a professional fund manager
4. Include growth in the asset allocation
5. Explore the availability of a master trust

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The Federal Reserve’s December 17th decision to cut its interest rate to less than a quarter of a percent is meant to encourage investors back into the stock market. But for many cemeteries, the prospect of depressed interest rates will have dire consequences to endowed/perpetual care trusts that are subject to state laws which limit or restrict equity investments.

State laws have historically imposed conservative investment standards upon endowed care funds to ensure preservation of the trust corpus. However, the bull markets experienced during the past decade often came at the expense of bond returns and other fixed income investments. With stagnant returns, cemeteries in states such as Michigan and Missouri have been seeking law changes to allow endowed care trusts to diversify for growth and larger distributions.

In 2006, a straightforward approach was introduced in the Michigan legislature. HB 6254 would have allowed an endowed care trust to distribute 50% of its accumulated net capital gains to the cemetery operator. However, that bill got lost in the turmoil of the Clayton Smart fraud. Instead, Michigan is now on the road to a more complex approach to diversification that incorporates the Prudent Investor Rule and oversight governed by rules and regulations to be promulgated by the Cemetery Commissioner.

Some of Missouri’s cemeteries introduced the unitrust concept to legislative negotiations held in 2007, and then again in Chapter 214 hearings held this past summer. That proposal would allow the cemetery operator to make an election to require the trust to make an annual fixed distribution of between 3 to 5% of the trust’s value. Missouri’s cemetery law (Chapter 214) lacks a clear definition of “income”, and regulators have taken contradictory positions over the years about whether capital gains may be treated as income to be distributed to the cemetery operator. In an attempt to clarify this ambiguity, the cemeteries turned to Missouri’s Uniform Trust Code and RSMo Section 469.411 to provide a clear standard for income, to promote diversification and to provide cemetery operators greater distributions. But in doing so, the proponents have ignored certain realities, and the controversies that surround the unitrust concept.

Many endowed care trusts are too small to effectively diversify for a fixed distribution of 5%, and proponents have fought alternatives that would grant the trustee authority to reduce distributions below 3%. The proposal would also restrict a trustee’s authority to make income and principal adjustments, a crucial element of the Missouri law.

In view of the current financial environment, cemeteries need the authority to diversify endowed/perpetual care funds. But, a balance needs to be struck between fostering growth in the trust and meeting the cemetery operator’s income needs for maintenance and care. Finding that balance should not be left to the unitrust concept, and faith in the stock market.

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Even when the need for reform is apparent to all, the legislative process can take years. With the Michigan Senate having approved a House substitute, that state’s cemeteries are a step closer to reform that could have avoided Clayton Smart’s pillaging of $70 million dollars of endowed care funds.

The Michigan Legislature’s website provides the history of SB 0674, from its introduction in August 2007, to the Senate’s December 19th vote to adopt the House substitute. Including the Attorney General’s investigation, the Michigan reform process has taken over two years. As with all reform efforts, some were not happy with the delays encountered in the Legislature’s efforts. Getting it right is not as easy as it would seem.

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