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

Here is proof that readership of newspapers is going down.

The Milwaukee Journal Sentinel called a few weeks back about a Wisconsin legislative bill that sought investment freedom for cemetery trust funds.  With the legislative battle that was waged a year ago in Wisconsin, we had expected the bill might represent a renewed effort to allow common ownership of funeral homes and cemeteries.  But instead, five Wisconsin legislators are sponsoring a proposal that would allow Wisconsin cemeteries to bypass fiduciary institutions and allow their trust funds to be administered by broker-dealers. The lead sponsor commented to the newspaper reporter that “It’s really not a big deal. Cemeteries are already investing with these folks.”  The sponsor indicated that he introduced the bill at the request of a stockbroker who had been investing a cemetery’s funds for years without knowing he had been doing so illegally.      

Death care operators should take note that the duties of the “fund manager” differ as between a broker-dealer and a registered investment advisor (RIA).  As explained in the SEC’s 2011 “Study on Investment Advisers and Broker-Dealers”, while the RIA has a fiduciary duty to know his client, the broker-dealer does not have such a relationship unless the circumstances dictate otherwise.  The broker-dealer is only required to make recommendations consistent with the customer’s interests.  Ask any RIA if the difference is important.  But, the Wisconsin cemetery bill underscores the duty that is missing from both RIAs and broker-dealers: the duty to comply with the laws applicable to the client’s trust fund. 

The OCC made this duty known to federally chartered preneed trustees more than 10 years ago.  But, a broker-dealer has no duty to stay up on Wisconsin’s Chapter 157.  It makes you wonder whether the sponsors of Assembly Bill 79 were staying up with the troubles of the Wisconsin Master Trust. 

But then again, that trust did have a fiduciary.    

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If you haven’t noticed, there has been some turnover among the associations’ preneed fund managers. With the threat of additional litigation in Wisconsin, this trend could continue. But not all of the turnover has been as publicized as what we have seen in Illinois and Wisconsin. After 20 years at the helm, Merrill Lynch recently gave notice to the Michigan Funeral Directors Association of its resignation. There are no search protocols for preneed fund managers, and so Michigan borrowed from the retirement fund community by publishing a request for proposal (RFP). While the MFDA should be commended in their effort to bring transparency to their program’s asset management, they missed (or ignored) an opportunity to shift more investment responsibilities to the financial industry. Instead of using FINRA Rule 2111 (“know your client”) to their advantage, the MFDA structured the RFP to perpetuate (and extend) the funeral director’s controlling role in investment decisions.

Hidden investment charges have been ‘part of business’ in the death care industry for decades, and this author has contemplated whether ERISA’s fee disclosure requirements could ever be incorporated into preneed trusts by the Federal Trade Commission. The Michigan RFP focused on the same ERISA fee disclosure requirements, which could lead one to assume that association’s leaders did not want to make the same mistake again. The Michigan RFP also raised another ERISA concept worthy of the preneed industry’s consideration: the 401K approach to investment by individual contract. We too have wondered why larger programs have not looked at data from individual contracts and the sponsoring funeral homes to build an investment options matrix.

But, the Michigan RFP can be faulted for cutting off the diligence requirements of FINRA Rule 2111. To insulate the Association from solicitations, the RFP provided summary information about the program and required all inquiries to go through an ERISA consultant. Prospective fund managers were required to submit investment strategies on limited facts and without direct communications to the Association. It is understandable that the Association would want to narrow the field before initiating an exchange of confidential information with prospective managers, but the screening of candidates should have preceded the request for investment strategies. Subsequent to the screening, the MFDA should then have provided detailed information pursuant to a confidentiality agreement. Under FINRA 2111, this sequence would have expanded the fund manager’s diligence responsibilities regarding investment strategy recommendations. The nature of the questions posed by the candidates would also have helped the MFDA in its assessment of the candidates. Instead, the RFP narrowed the fund manager’s diligence to an old investment strategy with a history of mixed results and challenges.

Within the context of ERISA retirement funds, RFPs may take a formula approach to finding a replacement fund manager. But the preneed industry is fragmented by 50 different state laws, and by program issues such as whether non-guaranteed contracts are sold, the association’s role as a seller versus an agent, investment restrictions, and trusting percentages. Injecting preneed asset management with a dose of ERISA could help to discourage hidden fees and improve the quality of fund managers, but the industry also needs an alternative to the strategy of offering funeral directors three investment options to choose from.
 

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Both the Memorial Business Journal and the Funeral Service Insider commented last week on the Milwaukee Journal Sentinel’s February 7th article regarding the former executive director of the Wisconsin Funeral Directors Association. Several issues were raised that should be included in future industry debate, and in particular, I would agree with Mr. Isard’s questions whether association executives are qualified to manage a master trust. But the following comments beg an immediate response:

“The whole situation with [the] Wisconsin Preneed Trust went off the rails when the goal shifted from trusting funds to investing funds.”

“The assumption that these trust funds are in the investment business is a mistake. We’re not. We’re in the trust business. From my view, that is a presumption of a preservation of principle. With a trust, you have an obligation to be prudent.”

Those comments suggest that trusting funds and investing funds are somehow mutually exclusive. While the comments may reflect the views of much of the death care industry, they also reflect a failure to understand the fiduciary’s duties. When entrusted with the money of another, the fiduciary has a duty to invest those funds consistent with the purposes of the trust and the interests of the trust beneficiaries. The fiduciary’s investment duties are governed by other laws, and a majority of our states have adopted the Prudent Investor Act. Wikipedia provides the following explanation of that Act:

In enacting the Uniform Prudent Investor Act, states should have repealed legal list statutes, which specified permissible investments types. (However, guardianship and conservatorship accounts generally remain limited by specific state law.) In those states which adopted part or all of the Uniform Prudent Investor Act, investments must be chosen based on their suitability for each account's beneficiaries or, as appropriate, the customer. Although specific criteria for determining "suitability" does not exist, it is generally acknowledged, that the following items should be considered as they pertain to account beneficiaries:

• financial situation;
• current investment portfolio;
• need for income;
• tax status and bracket;
• investment objective; and
• risk tolerance.

The majority of preneed trusts involve a single seller/provider and guaranteed preneed contracts. Under such circumstances, the funeral home operator has assumed the investment risk when the preneed contract is performed as written. Fiduciaries (and fund managers) have viewed the operator as the account beneficiary for purposes of the Prudent Investor Act. But depending upon state law, and whether the contract is ‘re-written’ at the time of death, the preneed purchaser may bear the investment risk. Accordingly, the fiduciary and fund manager should not completely ignore the preneed purchaser as the account beneficiary for purposes of the Prudent Investor Act.

Neither fiduciaries nor fund managers want to bring the preneed purchaser into the Prudent Investor equation for obvious reasons. But are suitability of investments for two that dissimilar? We would suggest not if the objective is to have investment performance track the prearrangement’s purchase price increases. As we noted in a March 2010 post about the IFDA master trust, the purchaser of a non-guaranteed contract was unhappy because the return on her non-guaranteed contract (1.7%) did not keep pace with the price increases of her planned funeral (4.2%).

Determining who to include as an account beneficiary in the Prudent Investor equation only gets more complicated when the preneed trust is an association master trust with dozens, or hundreds, of funeral home operators. If the master trust includes a healthy percentage of non-guaranteed contracts, the number of account beneficiaries could swell to the thousands. If the association is not the preneed seller (as is the case in Missouri, but not Illinois), what interest does the association have in the trust so as to justify being considered an account beneficiary? There are arguments in support of the association being such a beneficiary, but can those interests ever outweigh the funeral operator and the non-guaranteed contract purchaser?

One could argue that the Wisconsin Master Trust was never fully on the rails. The Association determined early on that a depository account could not keep up with rising funeral costs. Rather than seek legislation that would clarify the trust’s investment authority, the Association leadership sought regulatory permission to allow the master trust to embark on the path of investment diversification. The program derailed only after the executive director enmeshed his personal objectives with those of the association and then conspired with the fund managers to treat the association as the master trust’s primary account beneficiary.
 

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Fiduciary Partners, the corporate fiduciary for the Wisconsin and Illinois master trusts, broke its silence this week with a statement to the Funeral Service Insider. The statement was made in response to criticisms previously reported by FSI, and reflects the receiver and fiduciary working together to get their “message” out and avoid the kind of litigation that has hamstrung the IFDA, its membership and the Illinois funeral industry.

FSI commentators used Fiduciary Partners’ link to the two states to drive home with funeral directors various preneed problems* including the management and investment of preneed funds, and the state of the guaranteed preneed contract and its impact on funeral pricing practices. While the issues need to be incorporated into a national dialog, Fiduciary Partners interpreted the FSI report as encouraging Illinois and Wisconsin funeral directors to assign blame to Fiduciary Partners. Consequently, Fiduciary Partners and the receiver felt compelled to respond.

As reported in a prior post, the WFDA leadership had muzzled Fiduciary Partners with a very strict confidentiality provision through an amendment to the master trust. Accordingly, the statement given to FSI has been made with the receiver’s approval, and could be taken as having the WFDA’s endorsement.

To neutralize litigation over the trustee’s role in administering investments, Fiduciary Partners and the receiver sought to clarify that the company had a very limited role that never included the management of investments. The message goes on to reinforce the need for Fiduciary Partners to continue to provide administrative functions related to individual contract accounting and performance payments. The statement also conveys a tacit acknowledgement of the WFDA’s secrecy, with Fiduciary Partner’s commitment to a new transparency.

It is inevitable that comparisons will be made between Wisconsin and Illinois, and to conclude that litigation may also be inevitable. However, one stark difference exists between the two situations: Illinois funeral directors faced a recalcitrant board that refused to acknowledge and correct its mistakes. That leaves the question whether Wisconsin funeral directors will bring litigation to recover damages. As one FSI commentator points out, damages will be difficult to measure when the association reported inflated numbers (through the guaranteed rate of return). And as the other commentator points out, member funeral directors need to take responsibility for hiring executives and fund managers that are competent and professional. It was their hire of an inexperienced executive that ultimately directed the use of trust funds to establish an insurance company.

The multi-million dollar question to be asked is what if Fiduciary Partners had responsibility for investment oversight? Would the trustee have been able to check Mr. Peterson’s actions? In our next post, we will look at the hold harmless provisions so popular in the preneed trust agreement.

*Reprinted from the Funeral Service Insider – October 29, 2012
**Reprinted from the Funeral Service Insider – November 5, 2012

To obtain a full copy of the Funeral Service Insider, contact  www.funeralserviceinsider.com to subscribe.
 

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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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Recent document disclosures are reflecting that several factors contributed to the WFDA’s master trust deficiency (and the appointment of a receiver). Certain of those factors relate to the fees paid to fund managers and the association’s sponsorship charges. Those factors are relevant to other association master trusts, and we will explore them in subsequent posts. However, the ‘straw’ that broke this camel’s back came straight from the National Prearranged Services’ playbook.

The Wisconsin State Journal reported that it was the formation of a life insurance company by the WFDA’s Wisconsin Funeral Trust that prompted a regulatory audit by the Office of the Commissioner of Insurance. In 2009, the WFDA used the master trust to set up an insurance company to provide its members a preneed funding alternative to the trust. Wisconsin law requires 100% of the consumer payments to be deposited to trust. In contrast, insurance funding provides funeral homes commissions to offset the costs of a preneed program. This same reality led National Prearranged Services to form a life insurance company. NPS needed an insurance program in order to expand into 100% trusting states. To jumpstart that insurance program, NPS tapped its Missouri and Texas preneed trusts.

NPS exploited a provision of the Missouri law that exculpated the trustee from investment oversight when an independent investment advisor was appointed by the seller. Held harmless by state law, NPS trustees may not have looked further than the statements the seller provided. NPS then appointed an investment advisor that directed the trusts into policies issued by the sister insurance company. In a similar fashion, the WFDA amended its master trust agreement in 2009 to remove the trustee’s investment responsibilities and authorities, and to vest investment control in the fund manager of the WFDA’s choice. And to top that move off, the amendment made information about the trust and parties confidential. If the trustee was unhappy with the situation, it could resign, but it could not make “any public communication that may be reasonably considered derogatory or disparaging to the Association, the Trust, the successor Trustee or any party relating to the Trust.”

There are indications the WFDA funeral trust had been struggling for years to keep up with promised return. But, over the course of three years, the WFDA made radical changes that culminated in the formation of the insurance company. Who was the driving force behind those changes? When advice was sought in 2007 to allow the trust to diversify its assets, the legal opinion was directed to the WFDA executive director Scott Peterson, not the corporate fiduciary.
 

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A short three and a half years ago, the funeral industry reeled from the collapse of National Prearranged Services and the emerging story of the Illinois Master Trust. The NFDA was slow to respond to the crisis, and when it did, this blog joined the criticism. Fast forward to September 2012, and the NFDA responds to the Wisconsin Master Trust controversy with the same guidelines.

Granted: associations are cumbersome organizations that are dependent on volunteer members.

Granted: changing the mindset of a membership that has been historically opposed to preneed will be difficult.

Granted: it is a matter of time before another state association master trust fails.

We need to augment the advice offered the NFDA in 2009: eliminate from your trust evaluation guidelines any suggestions that a guaranteed rate of return is permissible. The days of set rates of return or book/tax cost of account for distributions are over.

The fixed rate of return approach allowed the Wisconsin and Illinois programs to avoid investment transparency and individual account allocations of income and market value. But, providing investment transparency in terms of the investments held by the trust, and the rate of return, can be more complex that the NFDA guidelines suggest. It is not uncommon for three or more investment pools to be offered by a master trust program. Administrators may have different ways to provide transparency at the trust level, in terms of in investments held by the trust and their rates of returns.

Whatever procedure is followed, the end result should be a ‘mark to market’ that will allow an auditor to reconcile each individual preneed contract’s value to the individual funeral home account(s), and in the case of master trusts, each individual funeral home’s account(s) to the aggregate master trust market value.
 

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When news that the Wisconsin Funeral Directors Association and its master trust had been put into receivership, I anticipated that the association may have fallen victim to a perfect storm: when an antiquated preneed law collides with a volatile investment market. But, subsequent news accounts are painting a bleak picture of poor planning and poor oversight.

The Wisconsin preneed funeral law alludes to trusts, but contemplates depository accounts. That is very consistent with the approach taken by most states. Accordingly, many original preneed laws provide very little statutory authority to the preneed fiduciary. Fiduciaries are forced to turn to general trust laws for guidance. If the fiduciary is not knowledgeable about the purpose of preneed contracts, crucial decisions are often deferred to the program sponsor.

Somewhere along the line, the WFDA program added a guaranteed return to its preneed contract. For a state that has a depository based law, that type of promise might seem appropriate enough. But, that promise of a return changed the consumer contract from a purchase of funeral goods and services to an investment contract. The WFDA program crossed a line established by the Securities Exchange Commission in “no action letters” issued to other sponsors of preneed programs (including various state associations).

Besting a certificate of deposit return may not have seemed to be too much of a risk to the fund managers, but they may not have foreseen the 2009 mortgage crisis. “Trapped” by the guaranteed return, the fund managers may have felt that they had little choice but to implement a more aggressive investment portfolio. But, if the program always had an aggressive investment policy, the fiduciary could have exposure for the oversight provided that policy.

If the firm employing the master trust’s fund manager seems familiar (Morgan Stanley Smith Barney), it could be from the litigation swirling around Mark Singer and Clayton Smart.
 

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A Wisconsin bill that would establish a right of sepulcher looks bound for passage (AB 305).   There are several things to like about this bill.  It would establish an individual's right to control the disposition of his or her body, and to designate an agent authorized to carry out that directive.  The bill also provides the hierarchy of kin who may control the disposition in the absence of a directive from the deceased.  In the event of a dispute between kin, the bill requires all concerned to be prepared to assume the financial responsibility for the disposition (avoiding the potential for a disgruntled family member from acting as a 'spoiler'). 

The bill also defines those individuals who may not serve as an designated agent for disposition.  Funeral directors and cemeterians are precluded, as are hospice workers and clergy.   I am puzzled by the exclusion of clergy and hospice workers from those who may be designated (unless related by blood.  I have prepared estate planning documents that included a minister as the individual's fall back choice for implementing his disposition directives.  I could also see where individuals have established relationships with hospice workers and would trust them to carry out plans for disposition.  

Perhaps the Wisconsin legislature was concerned about individuals who might have an undue influence on the terminally ill, but I do not understand the need to restrict an individual's rights with regard to either clergy or hospice workers.  I would welcome comments regarding these limitations. 

But in any event, the bill will benefit Wisconsin citizens by providing the right to control one's own disposition.    If the bill is signed into law, funeral homes and crematories should evaluate their forms with regard to this bill and the Crematory Authority Act passed in 2005.  Preneed contracts that contemplate cremation may want to include an authorization form that addresses both laws.   

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