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

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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As reported by the Memorial Business Journal*, the Illinois Funeral Directors Association has taken back the helm. For the past three years, the IFDA has been a floundering ship in risk of sinking. The master trust that paved the Association’s growth, has been threatening to bring it down. The IFDA took a crucial step to righting the ship when it relieved the ‘Calvert Group’ as plaintiff in the master trust lawsuits. IFDA leadership still faces several challenges to the Association’s survival, but taking charge of the master trust litigation was crucial. Now they must chart a course for resolution of the litigation. IFDA members will be asked to temper their expectations, and that may require an understanding of the master trust and how it crashed.

The Association built a massive master trust through the participation of hundreds of funeral homes from Chicago to Cairo. The program advisors sought to provide what members wanted: simple contract forms, contract data inputting, no risk investments, a consistent return, immediate payouts, and no tax statements. Those advisors also sought to provide the Association a growing source of revenue to support lobbying efforts, educational programs, conventions and even a museum. While all may have seemed good for twenty years, IFDA Services, as the trustee, was playing by its own set of rules. The architect who designed the master trust exploited a provision in the Illinois law that was intended to allow the small operator to avoid the costs of a corporate fiduciary.

In the absence of institutional oversight, the program was more akin to a defined benefits plan or a fraternal insurance company than a trust. The program architect ignored the fundamental fiduciary duties of the preneed trustee, and treated consumers’ payments as though they belonged to the Association. Having crossed that threshold, the program began purchasing an insurance product that would never have been a suitable investment for a preneed trust. The program has been flawed for many years, with many individuals contributing to its problems.

Many IFDA members are measuring their damages by the “values” reported by IFDA Service before the crash, and will not want to settle for less. But, the reason the Comptroller pulled the plug on the program was because, among other things, the master trust promised more than it could deliver.

 *Reprinted with permission from the July 21, 2011 issue of the Memorial Business Journal. To subscribe please call 609-815-8145.
 

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Preneed scandals in Illinois, Missouri, Texas, and California have state regulators moving to implement new audit procedures. But with new laws passed in the wake of NPS and state master trust problems, the frequency and scope of the future audit could change dramatically.  It is no secret that the scope of the preneed audit in Missouri is work in progress. When asked how the audit was being revised for its licensees, Illinois regulators politely declined to provide their written guidelines. Regulators in Kansas and Nebraska are also evaluating their audit procedures. But, the legal battle being waged in California provides a glimpse of one regulator’s intent to change the scope of the preneed audit.

The Ninth and Tenth Causes of Actions from the California Attorney General’s lawsuit against the California Master Trust allege that defendants either failed to maintain, or to produce, the preneed records required by law and regulation. California Code of Regulations, title 16, Section 1267 sets out those records that must be maintained by the funeral home. The regulation dates back 30 years, and reflects a view of the preneed transaction that is no longer consistent with the view taken by the Attorney General, and with the direction of the audit and lawsuit.

In a nutshell, the regulation asks for records which are intended to confirm whether the preneed payments were deposited to trust. The underlying principal is that the preneed contract represents a sale that the funeral home will book to its GAAP financial records. The regulation defines the funeral home’s cash receipts journal and general ledger as preneed records. The requirements contemplate that the funeral home will book these sales and payments for compliance with income tax reporting. By requiring the financial books and records, the preneed auditor can then track a consumer payment from funeral home receipt to the preneed trust. While the funeral director might not fear the preneed regulator, he is not likely to hide the income from Uncle Sam.

However, the California litigation is not about money that didn’t make it to trust, it is about the administration of the trust assets. In attempting to investigate the administration of the trust, the preneed auditor went beyond what the regulation calls for. The best evidence of the expanding scope of the audit is the defendants' response letter to the Cemetery and Funeral Bureau audit findings. The response letter indicates that one funeral home was cited for failing to have the following records:

• All correspondence with the trust administrator
• Copies of contracts that provide services to the trust
• Records of administrative costs
• Records of administrative costs allocated among the trustee and its vendors
• The portfolio of trust investments

When questioned about its authority for the requests, the Bureau reply stated that the trustee failed to make available “complete financial records for all preneed contracts and arrangements”. This answer fails to clarify what trust and financial records the funeral home must maintain on its premises.

What seems to come through from the California litigation is that original approach to the audit, ensuring the funds made it to trust, and leaving trust oversight to the independent CPA and an opinion, failed the California consumer. But, could the Bureau have better protected the consumer if the financial records have been kept at the individual funeral homes? (No, not without additional guidelines on the management of master trusts and pooled accounts.) And even if such regulations existed, it would be expecting too much from the auditor whose duties entail visits to hundreds of the funeral homes.

While the field auditor is an important element of the preneed compliance program, the program has to include the administration of preneed trust. Does this mean the funeral director must maintain correspondence and records related to the trust’s administration? The best course of action would be to establish a file for all trust related documents and correspondence. With the increase of preneed portability and the sale of non-guaranteed contracts, the funeral director's reliance on the ‘guaranteed contract defense’ becomes more tenuous. In a limited sense, the funeral director is becoming a fund manager on behalf of the consumer.
 

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Microsoft’s early efforts to force regular program updates were a nightmare. Like a gremlin that visited at night, the update often changed default settings that you never completely understood in the first place. Sometimes the update would impact the compatibility of other critical programs. To avoid the hassle of these updates, I toggled off the Microsoft updates for several years. And then when a drive failed, dozens and dozens of MS patches and updates had to be downloaded and installed, costing me time and expense.

The preneed regulatory systems set up by various state legislatures in the 1980’s have begun to crash for the same reason: a failure to update. Preneed has changed since the days when bonds paid double digit returns and preneed programs were the fad. California was no different from most states where preneed opponents outnumbered preneed proponents. Legislative compromises favored the traditional operators who opposed preneed, and the resulting law was disjunctive and confusing.

As time passed, more and more California funeral homes began to offer preneed. In most cases, it started as an accommodation to the consumer who sought to put funds aside. Eventually, competition not only drove all funeral homes to offer some form of preneed, it also drove them to factor preneed into their business plan. The investment markets also became more complex.

But, the California funeral industry left the preneed law update toggled off, and instead, stretched the law’s ambiguities the best it could to “authorize” new business practices. And, the preneed regulators (first the State Board, and now the Bureau) often played the same game. The Bureau and the CFDA are now locked in a lawsuit (over an antiquated law) that will leave both sides bruised and defensive. The posture taken by the AG suggests the fight could be nasty. But the facts suggest, the State should look to make prospective changes.

NPS exploited the weaknesses of Missouri’s 1986 law, and that company’s collapse gave Missouri regulators the ammunition required to force a new preneed operating system on its funeral industry. The 2009 law has its flaws, and needs changes (other than those in SB340), but preneed life continues in Missouri. Missouri regulators would like to go back in time to change some of the prior law’s flaws, but the push to make retroactive changes has been measured.

In Illinois, the IFDA put together a master trust and an insurance program that pushed the envelope beyond the Comptroller’s tolerance. The Comptroller’s responded much in the same vein as the California regulators did. While entrenched in a lawsuit, the Comptroller pushed his legislative agenda through the legislature. But, Illinois got more of a preneed system patch than a new operating system. Eventually, Illinois is due for a significant preneed system upgrade.

Nebraska is another state that may be due for some form of a preneed update. With a reporting system based on tax cost basis, preneed regulators want to introduce market value into the computation for income distributions. The objective has merit, but the 1987 law can only be stretched so far.

Getting a preneed law that works for both operators and regulators will never be a “one and done” project. Occasional updates will be required.
 

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The Springfield Journal-Register reported last week on the latest lawsuit to hit Merrill Lynch, the IFDA and the law firm that represented the Association.

One aspect of the lawsuit focuses upon the claim that the key man insurance policies sold to the master trust were not suitable investments. Without an insurable interest, the policies could not provide the tax consequences sought for participating funeral homes. Piercing through the “it’s an insurance policy argument”, the allegations are directed at whether Merrill Lynch has violated securities laws. With the implication of securities laws, the Illinois Secretary of State’s jurisdiction has been triggered.

The article also reports on the lawsuit’s allegations against the law firm that represented the IFDA. Concerns over the investments date back to 1987 (which coincides with the issuance of Rev. Rul. 87-127), when the lawyers sought regulatory approval of the plan. While that approval was never provided, the IFDA moved forward, and the law firm is now being blamed for ‘giving the green light’.
 

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The Illinois Funeral Directors Association is living out its own version of A Christmas Carol, with the Ghost of Yet to Come having painted a fate similar to that of Scrooge.

The court decision reported by the Memorial Business Journal* has all but sealed the fate of the Association. While the attorneys can continue to maneuver (and file appeals), the IFDA’s future is dependent upon how its board responds. But, the Ghosts of Christmas Past and Christmas Present offer little hope for the Association’s members. Everything rests on whether the IFDA Board can change course and demonstrate the leadership required to win back the trust of its current (and past) members.

If the situation in Illinois is like that seen in other states (including Missouri), the IFDA board must confront the frustration of larger operators who have felt ignored for years. Unlike Scrooge’s nephew Fred, many of these operators are neither paupers nor inclined to extend hospitality to an ailing, dysfunctional organization. But these are difficult times for the funeral industry, and operators must begin to search for common ground. The demise of an association will result in a vacuum that will be difficult to fill as reform picks up speed.

*Reprinted with permission from the December 16, 2010 issue of the Memorial Business Journal. To subscribe please call 609-815-8145.
 

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According to Wikipedia,

Regulation is "controlling human or societal behavior by rules or restrictions." Regulation can take many forms including legal restrictions promulgated by a government authority…….

So, regulators are charged with the task of interpreting “legal restrictions” and determining what businesses can or cannot do. When the applicable law is well drafted, and further defined by regulations, a business has the means to research compliance and develop appropriate practices and procedures. A business may only need to seek regulatory approval when implementing a novel practice. In the context of Securities regulation or ERISA, procedures exist for businesses to seek written guidance before implementing a new practice. But, as California funeral directors have found out, that is not the case with preneed regulation.

The dispute between the California Funeral Directors Association and the DCA’s Cemetery and Funeral Bureau was widely reported when allegations of mismanagement and lost funds were made. In typical fashion, the Bureau set out its findings regarding the Master Trust. The Association’s administrative subsidiary (the “FDSC”) responded. The Bureau was not satisfied, and a war of written responses ensued. Frustrated with the Bureau, the FDSC has now filed for an injunction. (For a detailed explanation of the situation, click here for a recent Memorial Business Journal article.*)

The FDSC would seem to be asking the Bureau to step out of the traditional regulator’s box, and discuss some practical approaches to the issues. We’ve heard your positions and criticism, but tell us how to reconcile these dated, and somewhat disjunctive, code sections, and apply that to today’s facts and circumstances.

History has a way of repeating itself. In 1988, after years of audits, the IRS decided to force a universal method of income reporting on preneed trusts by issuing Rev. Rul. 87-127. Other than terminating reporting methods that it found objectionable, the Service hadn’t given much thought to whether the industry could comply with the new reporting requirements. Nor did the Service think to provide compliance procedures. For more than eight years, the industry struggled to find a way to comply with the grantor reporting requirements. (Some funeral directors are still struggling today.)

If effective preneed reform is the goal, death care regulators need to do more than inform operators what they cannot do. These laws tend to be ambiguous, and regulators need to participate in the process of finding workable solutions.

*Reprinted with permission from the November 18, 2010 issue of the Memorial Business Journal. To subscribe please call 609-815-8145.
 

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In rejecting the $18 million settlement forced upon IFDA members, an Illinois Circuit Court is telling Merrill Lynch Life Agency to dig deeper into its pocket to compensate funeral homes. As reported by the Springfield Journal-Register, the $18 million represents the revenues the insurance broker received from the sale of key man insurance to the IFDA master trust. Apparently, Merrill Lynch convinced the Illinois Department of Insurance (DOI) that the funeral homes’ damages should be measured in terms of the benefit that Merrill Lynch received. But as the editor of the Memorial Business Journal* suggests, the Circuit Court seems more inclined to consider a ‘deeper’ measure of damages, and that will require the parties to the litigation to assess the master trust’s true loss.

The master trust collapse is framed by a ‘value’ that was set by a fixed return (2%) on consumer deposits. Based on that ‘value’, the loss is reported to be close to $100 million. But, one question funeral directors may be forced to answer will be whether the trust could have attained that value with the investment restrictions imposed by the members and the expenses taken by the IFDA. Another issue that may be raised is whether the IFDA’s past executives and attorneys bear some of the responsibilities for either selecting the investments or approving them. If so, comparative negligence may force the IFDA to shoulder responsibility for a portion of the damages.

The situation begs for a negotiated settlement, and it is unfortunate that time and expense was wasted on an end run with a regulator that had little, if any, authority over the IFDA master trust.
 

*"Reprinted with permission from the March 4, 2010 issue of the Memorial Business Journal. To subscribe please call 609-815-8145."

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The wait for Ms. Garrett’s lawsuit against NPS, the Cassity family (and anyone remotely connected with the Cassity Consortium) ended on August 7th.

If half of the allegations made in the NPS Complaint are true, the misconduct perpetrated on funeral homes and consumers is shocking to say the least. The Complaint provides a bevy of reform issues to explore. However, NOLHIGA and state regulators must be careful in their zeal to recover assets and implement reform.

A search of the Complaint for the term “independent investment advisor” will produce ten hits, with most of the substantive issues addressed on Pages 52 through 57. Chapter 436 of the Missouri statutes authorizes a preneed seller to designate an independent investment advisor to make investment decisions for the trust when it has more than $250,000 of assets. In doing so, the trustee is relieved of all liability regarding the investment decisions by the investment advisor.

As many larger Missouri sellers did, NPS designated an ‘independent’ investment advisor. The Complaint alleges that the investment advisor gave NPS free reign over the various trusts to perpetrate various frauds, including the purchase of the Lincoln Memorial insurance policies.

With regard to the fiduciary duties of the independent investment advisor, Complaint Paragraph 179 hits the nail on the head:

As purportedly “independent” investment advisors, Defendants Wulf and Wulf
Bates owed fiduciary duties to NPS as the entity that settled and funded the NPS pre-need trust accounts, and to the funeral homes and consumers as the beneficiaries of the pre-need trusts. Those fiduciary duties include, without limitation, loyalty, care, good faith, candor, sound business judgment, forthrightness, and fairness, through their direction and control over the trust funds.

In rubberstamping the NPS instructions, this investment advisor neglected his duties to the funeral homes and consumers.

In an effort to hold the NPS trustees accountable under Section 436.031, the Complaint alleges the investment advisor was not ‘independent’. This begs more than one question, but the first one that comes to mind is: independent of whom?
 

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It didn't take long for an Illinois funeral director to confirm that IFDA members have disagreements with their association leadership. 

Several Illinois funeral homes filed a lawsuit in Cook County Circuit Court on January 28th.  The petition, a derivative complaint, seeks remedies and damages on behalf of all Illinois funeral homes that participated in the IFDA master trust.  Various IFDA officers, board members and agents are named the defendants.  The defendants include Merrill Lynch, in its capacities as an advisor to the IFDA. 

The Derivative Complaint asserts facts that indicate the IFDA not only concealed critical information, but mislead funeral directors and consumers.  However, the Complaint does not answer the question from my prior post:  Who is the seller of the IFDA preneed contracts?

Page 20 of the Complaint approaches the issue with a discussion of "Participating Member Firm Agreements", but ultimately sidesteps the question and its legal ramifications. 

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Last October, the Illinois Funeral Directors Association posted some “Frequently Asked Questions” on their website. The FAQ page was intended to address questions and concerns raised by funeral directors and consumers about changes being made to the IFDA Master Trust. Page 6 of that FAQ was addressed to the Illinois families that had purchased an IFDA preneed contract, advising that “consumers should feel perfectly confident” in those contracts, and that “guaranteed preneed contracts are guaranteed to provide services in full”. With regard to non-guaranteed contracts, the IFDA represented that the contract’s “principal is protected by the funeral director who sold them”.

If the Class Action Complaint filed last November is an accurate barometer of consumer confidence, the IFDA leadership missed the mark with the public that it’s members serve. Documents also suggest that IFDA leadership has been less than candid with the funeral directors they have pledged to serve.

The current IFDA website offers an explanation that suggests cooperation with regulators, and the presence of financial circumstances that caught everyone off-guard. For consumers, the IFDA offers assurances to the preneed purchaser that the transition will have “very little, if any, impact on them because both ‘non-guaranteed’ and ‘guaranteed’ preneed contracts contain protections for consumers”. The IFDA represents the following:

In the case of “guaranteed” preneed contracts, Illinois law clearly states those contracts are guaranteed and funeral directors are to provide those services in full. 

The message to funeral directors is that they must service these contracts regardless of what is in trust to pay them.

Time to step back and look at theIllinois law and the IFDA preneed contract.

The requirements of guaranteed preneed contracts are set out in 225 ILCS 45/1a-1. Pretty typical of the provisions imposed by other states, but not quite consistent with the IFDA representation. In general, there are two promises made through the guaranteed preneed contract: the purchaser promises to timely pay the sales price according to the contract’s terms, and the contract seller promises not to charge the purchaser any additional amounts for the goods and services described in the contract at the time of the beneficiary’s death.

When the preneed seller and the preneed provider are the same party, the funeral home is on the hook to service the contract regardless of how well the trust performs. But, the funeral home’s legal obligation to perform a preneed contract becomes more complicated when a third party seller is involved. Illinois law authorizes third party preneed sellers so long as disclosures are made in the preneed contract. The $264 million question: the who is the seller of the IFDA preneed contract?

The IFDA has probably used different versions of a guaranteed preneed contract form over the years, but a 2006 form provides clear definitions of “Trustee”, “Provider”, “Purchaser”, “Beneficiary”, and “Depository”, but no definition of “Seller”. There is a single reference to Seller, where the Purchaser is required to acknowledge an explanation of the contract. The context of that provision would suggest the funeral director is the seller. However, Paragraph 15 of the contract muddies the waters.

Per Illinois law, preneed sellers are allowed to retain a portion of the purchaser’s payments. Paragraph 15 is intended to authorize the retention of such amounts, but references the “Trustee, Provider and Depository”. Which one of these entities is the seller? (We can probably rule out U.S. Bank Corp.)

Without the benefit of the agreements and documents that may exist between the IFDA and its member funeral homes, the answer may be reflected by conduct and the application of the Golden Rule. Not that Golden Rule, but rather: he who has the gold, rules.

This would not be the first time an association’s leaders placed control of its master trust above the interests of consumers and its members. The Minnesota Department of Health had such an experience. That association even challenged regulatory orders for the dissemination of information to funeral home members. In the end, the association was forced to enter a Stipulation and Consent Order, and to provide information to its members.  Individual funeral homes also signed consent orders that allowed them protect the consumers by assuming control of the trust funds sold in their name. 

Resolving the problems of the IFDA Master Trust will be far more difficult than following the Minnesota example. If the $160 million of life insurance held by the master trust is key man insurance, the IFDA’s valuations need to factor in the proper tax consequence. Hopefully, the IFDA board members purchased some errors and omissions insurance coverage at the same time they purchased those key man policies.

If the IFDA and its membership are in a dispute over the management of the master trust, the Illinois Comptroller holds the key to breaking the logjam.

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Trust a lawyer to add to the tension between clergy and the funeral director.  

A Kentucky priest felt the need to re-establish the ground rules for funerals conducted in his parish, and a local funeral director took offense.   Claiming the rules were "an intentional and wrongful interference" with his business, the funeral director brought suit against the Archdiocese of Louisville.  

The lawsuit has the unfortunate consequence of highlighting what some clergy disdain about today’s funeral: the commercial aspects of the death care profession. However, the lawsuit has also generated dialog about a tension that is also worthy of attention: reconciling the church’s message of hope with the funeral director’s focus on the immediate family.

The GetReligion blog has a thoughtful post regarding the Archdiocese lawsuit.  Denominations can differ substantially in their approach to funeral liturgy, and some provide very little training to its clergy when counseling parishioners facing end of life issues. Every funeral director has a story about a minister who alienated the family with a sermon unrelated to the deceased. But, even trained pastoral ministers are often placed in the awkward position when requested to officiate at a funeral by families they do not know, or for a deceased who did not attend a church.  

Funeral directors that serve denominations that have well established funeral liturgy should adopt cooperative approaches to working with clergy. Suing the priest makes no sense (unless, of course, those parish rules are causing families to cancel their preneed contracts). 

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The class action lawsuit brought against the NPS affiliates on Friday, June 20^th reflects the despair that some funeral directors are experiencing over the situation. Although litigation to recover assets from the Cassity Empire was inevitable, this lawsuit has flaws that need to be corrected through an organized effort brought by the states’ regulators.

Funeral homes have a legal claim for damages against NPS to the extent they have serviced NPS contracts and failed to receive the compensation promised them by NPS. Consequently, I anticipated finding this provider’s associate agreement as an exhibit to the pleading. However, the filing omitted documentation that would evidence the funeral home’s rights and obligations with regard to the performed contracts and the contracts that remain to be performed. As evidenced by the June 9^th Funeral Service Insider, NPS played by fast and loose rules when it came to their relationships with provider funeral homes. So, what are funeral homes entitled to?

The lawsuit also fails to include the consumer as a member of the plaintiff class. With regard to executory preneed contracts, the consumer has superior rights to the funeral home. Ignoring the rollover contracts, the funeral home has an expectation of performing the preneed contract when the death occurs. However, the consumer could always move to another state, or cancel the contract. Until the funeral is provided, it is the consumer who has the greater claim of damages from NPS. His/her NPS contract has no cancellation value or portability. 

The lawsuit is also troubling in the sense it presumes that whole life insurance policies were appropriate trust investments under Missouri’s preneed law. Chapter 436 is a bit ambiguous about insurance funded contracts, but with regard to trust funding, the law permits the preneed seller to retain 20% of the contract’s purchase price, and to trust the remaining 80%. Unless the purchaser makes the contract irrevocable to qualify for public assistance, the contract can be cancelled and the seller must refund the amount that went into trust. So, if the seller trusts only 80%, how can the trustee purchase a whole life policy and have the liquidity required for Chapter 436 compliance?  

This funeral home points an accusing finger at the fiduciaries, but the pleading reflects the funeral home’s acceptance of the trust holding whole life insurance. A question regulators might ask is whether the funeral home received any compensation for the insurance purchased by the trust. 

Regulators have valid excuses for distancing themselves from this lawsuit, but consumers need an independent authority pursuing their (and funeral directors’) claims against NPS.   If regulators do not recover sufficient assets, funeral homes will fail and consumers will lose their funeral promises.  

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