PNC Bank has been hit with $15 million of punitive damages because Allegiant Bank did not know its client.

Before opening a fiduciary account, banks are required to perform due diligence on the trust’s grantor and on the trust’s purposes.   Such due diligence is referred to as ‘know your client’ or “KYC”.  KYC requirements had been in the works prior to 9/11, but the terrorist attacks provided the political momentum needed to pass the Patriot Act.  For preneed trusts, the Office of the Comptroller of the Currency had issued due diligence guidelines in April 2000.  The OCC memorandum warned that preneed trusts posed unique risks to banks, and that a preneed trust should be accepted only after due diligence reviews of the funeral company and the applicable state preneed laws.

In a March 2015 post (NPS Trustees: Pre-acceptance Due Diligence), we discussed the legal arguments made that Allegiant Bank had breach its fiduciary duty by accepting the NPS trusts without adequate due diligence of NPS and Chapter 436.  Although we did not know the facts and circumstances of Allegiant Bank coming to be the NPS trustee, one SDR argument carried the most weight: Allegiant Bank failed to properly comprehend Chapter 436.  Four years late, the Trial Court cites that argument as its basis for awarding punitive damages.

We learn through the Judgment’s Finding of Facts that Allegiant Bank courted NPS with a list of hand written questions prepared by Herbert Morisse, the bank’s only trust officer.  While Mr. Morisse had 17 years’ experience as an estate planning attorney, he only had 2 and half years’ experience in administering trusts.  The NPS trusts would represent the first preneed trusts under his supervision.  (See Pages 17 through 22 of the Judgment.)  Despite his lack of experience with Missouri’s preneed law, Mr. Morisse did not seek assistance from Allegiant Bank’s outside legal counsel.  Instead, Mr. Morisse sought to ‘familiarized himself’ with the Missouri law and define the due diligence to be conducted.

The Court found Mr. Morisse made several critical erroneous interpretations of Chapter 436, the Missouri preneed law.  Mr. Morisse failed to recognize that NPS associate funeral homes and individual preneed contract purchasers were beneficiaries to the NPS trusts.  Mr. Morisse also erroneously applied the Missouri law to allow the income distributions from the NPS trusts.  But worse of all, Mr. Morisse interpreted Section 436.031 to hold the preneed trustee harmless from any investment made by an outside investment advisor.

In a discussion starting on Page 284, the Court states that the decision is not about the vilification of Mr. Morisse, but rather an indictment of the institutional failure of Allegiant Bank to understand the requirements of a Missouri preneed trust.

As discussed in our 2015 post, the OCC’s preneed trust guidelines have been modified since April 2000, and are now part of the Personal Fiduciary Activities Handbook (Page 67).  The guidelines recognize that the preneed trustee is dependent upon the funeral company for individual consumer account information that will be used for performance and cancellation distributions.  Consequently, the OCC also refers banks to OCC Bulletin 2013-29 (additional requirements for assessing and managing risks inherent to third party funeral home relationships).  Thanks in part to NPS, banks have a KYC obligation to periodically assess the risk posed by the preneed trust:

  • Are the parties’ respective responsibilities and duties clearly outlined in the governing documents?
  • Does the funeral home provide periodic reports sufficient to reconcile deposit and distribution requests to consumer account balances?
  • Does the bank document periodic efforts taken towards oversight, accountability, monitoring and risk management?

National Prearranged Services is back in the news after a trial court issued a new $102 million judgment against PNC Bank (the corporate successor of Allegiant Bank).  Allegiant Bank served as NPS’ Missouri preneed trustee for six years beginning in 1998.  When PNC Bank agreed to purchase Allegiant in 2004, PNC performed due diligence that found several serious problems with Allegiant’s administration of the NPS trusts.  PNC required Allegiant to resign from the NPS trusts.  Four years later, NPS collapsed and several civil lawsuits were stayed while criminal proceedings were brought against Doug and Brent Cassity, several NPS officers and David Wolf, the investment advisor used by NPS.  In 2015, the Special Deputy Receiver won a $395 million civil judgment against PNC Bank.  That judgment was successfully appealed by PCN Bank, and the matter was sent back to the trial court with instructions to re-try the issues under breaches of trust law rather than tort law.  The appeals court also instructed that lawsuit be tried as a bench trial rather than to a jury.  After a four week trial, the court issued a 305 page ruling that found Allegiant Bank breached several fiduciary duties owed to funeral homes and preneed consumers.  (To access the ruling click this hyperlink.)

The ruling spares no criticism of Herbert Morisse and the upstart trust department of Allegiant Bank.  Allegiant Bank established a trust department late in 1997, and Mr. Morisse was the department’s first and only trust administrator.  Mr. Morisse had practiced law as an estate and probate attorney for 17 years before joining the trust department of UMB Bank in 1995.  Three years later, he left UMB Bank with a marketing officer to join Allegiant Bank.  The ruling’s findings of facts provide detailed background on Mr. Morisse’s experiences, which did not include supervision of trust investments.

Allegiant Bank’s trust department had 2 employees other than Mr. Morisse: an administrative assistant and the marketing officer.  The court found the trust department woefully understaffed and inexperienced.  The ruling repeatedly describes fund transfers made from the NPS trusts that Mr. Morisse either failed or neglected to reconcile.  Mr. Morisse would authorize transfers without knowing whether they were for contract performances, investments or intercompany transfers.  When intercompany transfers were made, Mr. Morisse assumed something of value would be transferred back to the trust.  But, in actuality, many transfers simply went to a Cassity controlled entity without the return of any asset.  Mr. Morisse also failed to question NPS about insurance reports that reflected outstanding policy loans.

The ruling’s finding of facts suggests that NPS was not necessarily hiding from Mr. Morisse all that it was doing.  Rather, Mr. Morisse erroneously assumed that Section 436.031 held him and Allegiant Bank harmless from any investments made by David Wolfe, and that the trust officer need not review the transactions between the trusts and Lincoln Memorial.

In the next few weeks, we will use the blog to delve deeper into the ruling’s conclusions of law that could impact Missouri preneed trustees.

The Missouri Court of Appeals recently issued an opinion involving facts that are all too familiar with funeral directors: family members disputing who controls a funeral and the right to cremains.

A mother contacted a St. Louis funeral home about arrangements for an adult son who was gravely ill.  The funeral home sold the mother a preneed life insurance policy in an amount to cover a visitation and cremation.  The mother also signed an authorization form indicating she was her son’s “next of kin”.  When the son died a month later, the mother went to the funeral home to make the final arrangements for the cremation.  While the funeral home was meeting with the mother, the deceased’s adult son arrived at the funeral home and demanded that his father be given a full funeral and burial.  The funeral home advised the mother that her grandson had the legal right under Missouri’s right of sepulcher law (Section 194.119) to determine the disposition of his father’s remains.  At that point, Grandma informed Grandson that he would have to pay for the funeral and burial on his own because she would only allow the preneed insurance policy to be used for a cremation.  Unable to come up for the cost of a funeral and burial, Grandson agreed to the cremation and signed the funeral home’s statement of funeral goods and services.   After the cremation was performed, Grandson collected his father’s cremains from the funeral home.  Shortly thereafter, Grandma went to the funeral home to get the cremains but was advised her grandson had already collected the cremains.  Grandma felt that since she had paid for the cremation she was entitled to her son’s cremains and sued for a refund.

The appeals court ruled against Grandma, finding that she was not a party to the contract for her son’s cremation.  Even though she had paid for the insurance policy used to fund the cremation, the cremation contract was between the funeral home and Grandson.  Relying upon Section 119.350, the court reasoned that since the cremation contract was silent on who was to receive the cremains, the statute authorized the funeral home to release those cremains to the son.  One lesson other funeral homes could take from this case would be to discuss release of the cremains with the family members and include an instruction in the statement of goods and services about the cremains’ release.

In our last post we discussed the need for the Missouri State Board to provide guidance to their financial examiners regarding Section 436.425 and insurance funded contract forms.  In this post we will discuss Section 436.425 and trust or joint account funded contracts.

Subparagraph 9 has created confusion for examiners and sellers.  That section states that a preneed contract shall “set forth the terms for cancellation by the purchaser or the seller”.   The Missouri law is clear that consumers must have the right to cancel a preneed contract and receive a refund.  But what about the seller?   Funeral homes frequently will leave a contract in place when the consumer has defaulted on installment payments.  The question is whether a funeral home must include some form of cancellation rights.  Other than default on installment payments, are there circumstances when a funeral home should be authorized to cancel the preneed contract?  Would that be true even for non-guaranteed contracts?

Subparagraph 15 addresses the installment payment issue more specifically.  This subsection requires a disclosure of what happens when the contract beneficiary dies before all installments have been paid.  Examiners have attempted to apply this section to contracts regardless of whether the form is guaranteed or non-guaranteed.  We have taken the position the disclosure should only be applied to guaranteed contracts paid with installments.   If the contract is guaranteed, but requires a single payment, the disclosure would not be required.  With a non-guaranteed contract, the consumer simply applies the trust or depository account to the costs of the funeral.  No promises have been made about prices.

At its April meeting, the Missouri State Board of Embalmers and Funeral Directors discussed the formation of a “Phase 3 Committee” that would provide input for the revision of the Board financial examination handbook.  The Board staff is about half way through the second round of preneed examinations (“Phase 2”), and the Board wants to adopt new examination guidelines that can be implemented when Phase 2 Exams are completed.   However, there is an immediate need for a Phase 2.5 Committee.   Exception comments from the Board’s preneed examiners suggest there is still confusion on how the Section 436.425 should be applied to certain types of preneed contracts.

Section 436.425 begins with the statement that “All preneed contracts ……shall clearly and conspicuously” and then sets out 16 subparagraphs that require certain contract disclosures.  Shortly after the passage of Senate Bill No. 1, the Board’s staff recommended a regulation that required a specific disclosure statement be given to each preneed consumer.  That ‘mandatory disclosure’ recited all of the Section 436.425 disclosures.  In preparing the mandatory disclosure regulation, the staff had applied a very literal interpretation of Section 436.425 to conclude that all disclosures must be included in a preneed contract regardless of its funding source.  In doing so, the staff violated one of the basic doctrines of statutory construction:  avoid a literal interpretation of a law when such would produce an absurd result.  The Missouri Legislature did not intend for trust funded contracts to include insurance disclosures, or insurance funded contracts to make trust disclosures.  Such disclosures would only confuse elderly consumers. The State Board eventually came to appreciate this and rescinded the proposed regulation before it was formally promulgated.

While the Board’s examination staff is no longer requiring each preneed contract to include all Section 436.425 disclosures, examiners are still confused about certain disclosures.  For example, the Board needs to take a position on the disclosures required for spend down contracts.  The examiners are under the impression that consumers making insurance assignments for spend downs must receive a contract that contains disclosures about cash surrender values and policy cancellations.  Those types of disclosures are intended when the consumer purchases an insurance policy to fund a preneed contract.   When the consumer seeks to assign an existing life insurance policy, the funeral director will not know the policy’s cash surrender value, or the owner’s rights under the policy.  As reflected in the State Board’s own recommendations to the Legislature, Senate Bill No. 1 was intended to regulate preneed contracts issued in conjunction with the purchase of a life insurance policy.  The Section 436.425 disclosures reflect that intent.  The spend down contract funded by an insurance assignment do not pose the same risks as the contract funded by an insurance purchase.

In the next post, we will look at Section 436.425 and trust funded contracts.

We continue our discussion of the composite Federal Form 1041QFT with a post about the individual account statement.

With the composite return, income and expenses are allocated to the individual preneed account and taxes are computed at that level rather than at the trust level.  To allow the IRS to test the composite tax liabilities, the trustee is required to attach a statement to the Form 1041QFT that reflects each individual account’s share of income and expenses.  The statement is required to set out each type of income, the gross amount of each type, each type of capital gain, each type of deduction or credit, the account’s gross and net income, the account’s tax liability and termination date if contract beneficiary died during the tax year.   With qualified dividends and long term capital gains taxed at lower rates, the individual account statement must set out each type of income so that the IRS agent can confirm each account’s effective tax rate.

The QFT form has a composite box on line 12 that must be checked.  The composite box puts the IRS agent on notice that the tax liability is not to be computed using the income and expenses entered into the 1041QFT form.  (We have had IRS agents miss the box and attempt to increase the trust’s tax liability by using the 1041QFT form numbers.  In each case, the issue was resolved by referencing the composite election and the individual account statement.)

We have reviewed 1041QFT returns where the individual account statement referenced a percentage, a single gross income number and the tax liability.  The tax preparer obviously used a year end allocation of income and tax liabilities.  Although this method does not comply with the 1041QFT instructions, the IRS may not challenge because the method frequently computes the tax liability at the higher trust tax rates.

There are two methods for preparing a Federal Form 1041QFT.  One method has the trustee applying the QFT tax rate schedule to the preneed trust’s net income.  For larger preneed trusts, this method will likely trigger the highest tax rate (37%).  The other method is called the composite return, where trust income and expenses are allocated to the individual purchaser accounts.  The trust’s tax liability is then computed at the individual purchaser levels (with their respective capital gains and qualified dividend tax rates) and aggregated for purposes of the return.  The individual purchaser accounts would have to realize $2,600 of capital gains and qualified dividends before a capital gains tax liability is triggered.  For diversified trusts, capital gains and qualified dividends can comprise a substantial percentage of the trust’s gross income.  One of the trusts mentioned in our last post reported gross income of about $41,000.  93% of that trust’s income came from long term capital gains and qualified dividends.  When using the composite return method, the trust does not have a tax liability.  Using the other method, the trust had a tax liability of about $6,600.

We have reviewed returns where the tax administrator grasped the benefits of the composite return but the trustee lacked the administration to make periodic allocations to the individual purchaser accounts.  Frequently, the tax administrator will use a spreadsheet to make a year end allocation of income and expenses to the purchaser accounts.  While the QFT instructions state that a trust may use any reasonable method for determining the individual purchasers’ interest in trust income and expenses, periodic allocations are generally required.  The IRS has taken the position that income and expenses cannot be allocated more than 60 days after a purchaser’s death.  This would rule out a year end allocation when contracts have been serviced and paid out of the trust prior to November.  At a minimum, composite return allocations should be made at least quarterly.

Tax Code Section 685 has now been law for 21 years, and this marks our 20th year of preparing the Qualified Funeral Trust return.  (And more specifically, the composite QFT return)  The QFT return was meant to simplify income reporting for a trust that has hundreds, or even thousands, of contract beneficiaries.  Yet, we continue to be surprised to find so many fiduciaries who do not understand the income reporting requirements for these accounts.   During the past year we were engaged by two trustees to review their preneed trust returns.  With each, we found that the administrator had prepared complex 1041 returns that resulted in Federal and state tax liabilities in excess of ten thousand dollars.   A quick Google research should have alerted the administrators that a complex 1041 return cannot be used for a preneed trust.  Preneed trustees have two income reporting options: reporting income to the contract beneficiaries or filing a Fed. Form 1041QFT.  There are two ways to prepare a 1041QFT, and even a standard 1041QFT would have saved the trust thousands of dollars.  If the fiduciary has the requisite individual account administration, a composite 1041QFT can further reduce the trusts’ tax liabilities substantially.  Because these two trusts had diversified investments with substantial qualified dividends and long term capital gains, their tax liabilities were less than $1,000 each.

During the past year, we have also reviewed 1041qft returns that reflect confusion about the requirements of composite return.  We will address some of those issues in our next post.

The Missouri State Board of Embalmer and Funeral Directors met this past December to discuss changes to the Preneed Examination Handbook, and former Board Chairman Don Lakin made a proposal that has merit.

The State Board has licensed approximately 315 preneed sellers.  The current preneed examination procedures contemplate an onsite visit to each seller.  Many of those sellers are small funeral homes that sell less than a handful of preneed contracts in a month.  Mr. Lakin has suggested to the State Board that the examination process could be made more efficient if travel to smaller funeral homes could be eliminated.  This could be done by the State Board giving a reporting option to funeral homes that sell 35 or less preneed contracts during the annual reporting period.  Such funeral homes would be defined as a “small seller”, and in lieu of an on-site examination, a small seller would fax copies of preneed contracts as they are sold and  periodic funding agent reports to the Board.  The examiner could review the small seller documents once each year from their desk to ensure contracts are in compliance and consumer funds are timely deposited with the funding agent.  Using a desk top review of smaller sellers would probably save the Board time and expense spent traveling to dozens of funeral homes.

Our next criticism of Missouri’s pending Exam Handbook is its violation of the Four Corners Rule, which requires a document to stand on its own when being interpreted and applied.  Common law precludes parties from going to outside sources when applying the document to different situations.  While the Handbook gives lip service to the Four Corners Rule in Paragraph 13, other sections of the Handbook send examiners to various sections of law, to rules that have never been promulgated, and to other “Board directives” for directions when reviewing seller contracts or records.

The Handbook needs to be the examiner’s procedure bible that stands alone, and without incorporating statutes, rules or Board directives that exist only in a minute from a prior meeting.