Minimizing Risk Exposures in a Trusteeship

By Ron Klein

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A trusteeship often appears relatively risk-free, especially for those with considerable experience and expertise in finance and business matters. It seems like a simple responsibility with just two basic duties: follow the instructions in the trust document and keep the beneficiaries satisfied. Because a CPA may be the one financial advisor a client trusts above all others, accepting a trusteeship from a long-standing good client without sufficient consideration of the risks could easily happen.

Trusteeships are rarely as simple in practice as they are in theory. For example, the trust document instructions may prevent the trustee from keeping all of the beneficiaries satisfied. The instructions may even create disappointments and conflicts between beneficiaries. Competing interests, sibling rivalries, family dysfunction, disruptive lawsuits, and financial losses can all play havoc with a relatively simple family trust. The results can be excessive stress and loss of time for the trustee, who might suffer damage to her reputation and, even worse, be sued.

The trustee also has a fiduciary duty to the trust and its beneficiaries, requiring the trustee to follow the trust instructions and to act solely in the interest of the trust. Any actions by the trustee that serves a self-interest, or serves any purpose unconnected with the trust, create legal liabilities. Such actions also create the perception of self-dealing and are not consistent with the trustee’s fiduciary obligations. For example, the trustee should not borrow from or lend to the trust, or engage in outside business with the trust, even if it is a “good deal” for the trust. The trustee can be personally liable for any breach of fiduciary duty to beneficiaries and nonbeneficiaries, such as contract creditors, tort creditors, and federal, state, and local governments.

Trustee claims against CPAs have risen steadily in frequency and severity over the past several years, and the trend will likely continue. The Social Welfare Research Institute of Boston College studied the intergenerational transfer of wealth projected between 1998 and 2052; it estimated such wealth to be at least $41 trillion (assuming a 2% growth scenario). Much of that wealth is being placed in trusts designed to provide for surviving spouses, children, grandchildren, and other beneficiaries. Increasingly, families creating such trusts are approaching their CPAs to serve as trustees. Trusteeship is not a role to be taken lightly, considering its potential for difficulty, stress, and loss. There is often little guidance for trust work unless the trustee petitions for judicial instructions, a relatively simple legal process that should be initiated on the advice of a trust attorney. Without such guidance, trusts are sometimes so poorly managed that they end up in court anyway, so it is important for trustees to consider whether they will need a trust attorney.

Before Accepting a Trusteeship

The following are some of the most common sources of risk in trusteeships:

  • A lack of understanding or appreciation for the duties and responsibilities of a trustee;
  • A lack of clear and consistent communication between the trustee and the beneficiaries or other interested parties;
  • A conflict of interest (or perception of a conflict) on the part of the trustee;
  • A lack of appropriate engagement checks and balances on the activities of the trustee;
  • Fee and billing issues;
  • Imprudent or controversial investment strategies; and
  • Dysfunctional relationships among the beneficiaries, settlors (those who create a trust), and prior trustees.

Dysfunctional relationships are often major sources of risk in trusteeships. Prospective trustees should look carefully at the relationships among the interested parties, especially between family members, and decide whether the risks posed by them can be managed and minimized.

When a CPA considers a trusteeship engagement, professional standards require that she have the requisite skills and knowledge to render the services competently. If a business is being managed by the trust, the trustee should understand the business and possess the expertise to manage the business. If a CPA does not have the necessary skills and knowledge, standards require that she acquire them or decline the engagement.

All but the simplest of trusts will require at least an annual review by a trust attorney. Prospective trustees should assess whether and what an attorney should review in the trust document before accepting a trusteeship. It may not be possible to change the document, but a trust specialist should examine it thoroughly.

Finally, prospective trustees should know the answers to the following questions: Why was the trust created, and why was I asked to serve as trustee?

Applying Engagement Control Techniques

Even though an individual in a CPA firm, rather than the firm itself, is usually asked to be a trustee, the firm should treat the trustee work as it would any other engagement. The success or failure of a firm member acting as a trustee often has a significant impact on the firm as a whole, and the firm’s reputation, insurance coverage, and legal liability can be significantly and negatively impacted.

A clear distinction between the trust services provided by the firm member and the nontrust services provided by the firm (e.g., accounting, tax) is crucial. While the trustee is responsible for supervising work done for the trust, the firm is responsible for supervising its firm member. A nontrustee partner of the firm should review and sign off on the firm’s accounting work done for its trust, thereby enabling the firm to control oversight for the trust engagement.

Additional steps to consider include the following:

  • Any member of the firm considering a trusteeship should complete a client screening process, with second-partner review if possible.
  • Any trusteeship that has been accepted by a member of the firm should be described and listed so that all owners of the firm are aware of the trustee engagement.
  • If any professional services, other than the trustee services, are to be provided by the firm to the trust, a nontrustee firm owner should review and sign off on the work. Standard firm client screening and engagement letters should be used so that the relationship between the firm and the trustee remains at arm’s length, in perception and in reality.

Applying Client Screening Techniques

As with other types of engagements, the “clients” in a trustee engagement (the settlor, beneficiaries, and prior trustees) may present risk. Appropriate client screening processes will help not only in deciding whether to accept a trusteeship, but also in managing potential risk areas after acceptance.

In trustee work it is easy to become caught in the middle of a family squabble. Many trustee claims result from dysfunctional family relationships. These claims involve disputes among various beneficiaries, constituencies, and interests, often pitting the life estate or income beneficiaries against the remainder beneficiaries. The trustee may be pressured to resign by someone in line to be the successor trustee, or attacked by one constituency which perceives that the trustee has taken sides with another. A trustee should consider the following questions:

  • What is the potential for dispute among beneficiaries and the settlor? Are there differential distributions that may appear inequitable (e.g., disparate treatment of siblings)? Have there been multiple marriages, with children from each? Have there been recent changes to the distribution scheme or the status of beneficiaries?
  • Are there beneficiaries with substance abuse problems, mental illness, or behavioral issues?
  • Has there been prior litigation between or among the beneficiaries? Were there problems with the prior trustee?
  • Are there any transactions (loans, investments) between the trust and the settlor or a beneficiary? Are there any loans to the beneficiaries or other individuals? Are they secured? Are there any loans or transactions between the trust and the firm, or a member of the firm, or another client of the firm?
  • Consider the nature of the trust corpus (principal): Are there specific investments or investment types required by the trust? Are there illiquid assets? Are there assets with negative cash flow? Is there an operating business that will increase the complexity of the trustee’s work? Are there potential environmental concerns with any trust property?

Minimizing Risk Through the Trust Document

If the trust document has not been finalized, or the settlor is still alive, it may be possible to minimize risk through the trust document. Even if the trust document cannot be changed, a prospective trustee should examine it thoroughly and have a trust attorney review it before accepting any trusteeship.

There are some crucial legal points that may significantly affect the risks to the trustee:

  • Any successor trustee has the duty to investigate and report upon the activities of the prior trustee. If this duty is not fulfilled, the successor trustee may become responsible for the acts of the prior trustee. The trust document can state that any successor trustee has no such duty to investigate or report.
  • The trust document can require the trust itself to defend and indemnify the trustee against allegations of negligence. This is a relatively standard clause in trust documents.
  • The trust may also contain a clause limiting liability of the trustee to gross negligence only, protecting him from simple mistakes. Again, this is a relatively standard clause that can provide significant protection to a trustee.
  • Trusts often contain “no contest” clauses that reduce or eliminate a beneficiary’s rights if the beneficiary disputes anything with the trustee. These clauses can reduce risk to the trustee by creating an incentive for beneficiaries to get along.
  • The trust document can grant broad discretion to the trustee. While there are limits on the amount of discretion that can be granted a trustee, discretion clauses can be helpful in specific circumstances. For example, if the trust owns a business that the trustee will likely need to dispose of, the trust document could grant wide discretion to the trustee to determine the best way to dispose of it.

In the area of investments, the trust document can provide “safe harbor” protection to the trustee as long as a “reputable investment advisor” is chosen to manage the investments. Neither the CPA nor her firm, nor an affiliate of the firm, can be considered a “reputable investment advisor” for purposes of the “safe harbor.”

If there are any potential conflicts of interest between the trust and the personal interests of the trustee, the settlor can specifically acknowledge their existence in the trust document. While this does not relieve the trustee of any fiduciary responsibility to the trust or beneficiaries, it can provide some protection. Even with such acknowledgment in the trust document, the trustee must pay special attention to any conflicts, perceived or real. Where they exist, the trustee should be especially diligent about keeping beneficiaries and others informed of actions and decisions, and seek approval from the beneficiaries or the court for actions or decisions that may be affected by any conflict. A conflict of interest might also be reason for a trustee to resign.

CPAs serving as trustees will often provide tax and accounting services to the trust, either individually or through their firm. It is best to have the settlor acknowledge this and stipulate that payment for such services is in addition to the payment of trustee fees.

Beneficiaries and others normally have a statutory period (often three years) within which to object to any “accounting,” which can include notification of specific actions or decisions of the trustee (e.g., decisions to sell trust assets; major investment decisions). Most states allow the trust document to shorten this period to as little as 120 days. A trust attorney should be consulted to determine how this could be done.

Minimizing Risk While Acting as Trustee

Conduct as a trustee is just as critical as the pre-engagement activity. Making good decisions for the trust and the beneficiaries is critical, but it is not enough. Consider the following additional ideas:

  • If either the CPA or the firm provides other services to the trust, issue a separate engagement letter for those services. It may be best to have the engagement letter approved by, or at least seen by, the beneficiaries.
  • Detail the provisions of the trust in a synopsis, along with calendar distribution dates and other events.
  • Most trusts and trustees should, at a minimum, have an annual review of activity performed by a trust attorney. More complex trusts may require further services. Any major decision or transaction may require review by a trust attorney, who can provide invaluable advice regarding any periodic or special reporting as well.
  • The trust attorney should advise the trustee on when and how to seek judicial instruction (e.g., in the event of a major pending decision or a conflict between beneficiaries). Usually the trust will be obligated to pay for the costs of seeking such instruction. In addition, once the court provides instruction, the trustee may gain significant protection from “hindsight” complaints, which otherwise might materialize years later.
  • The trust attorney should protect the trust and the trustee, though the trustee is responsible for monitoring the work of the trust attorney. In some situations, such as a disagreement over the trust attorney’s actions, the trustee may need his or her own attorney.

Investments

The types of investments required by the trust document may affect the selection of an investment advisor. For example, if investment income is required by the trust, but not income at the expense of principal, an investment advisor must be able to fulfill that requirement.

Due diligence should be performed when selecting an investment advisor for the trust. Background, references, and credit histories should be checked. How competent is the advisor? How independent is he? How is the advisor compensated? The trustee is responsible for monitoring the advisor and the fees the advisor charges the trust.

The types of investments required by the trust document may put beneficiaries in conflict. For example, a surviving spouse who receives rental income from a property may be in conflict with beneficiaries who are to receive the property itself, especially if the property declines in value.

If the trust document directs the trustee to make allocations between income and principal, or among different types of investments, the trustee should always keep foremost in mind the purpose of the trust in making such allocations. The trustee may also seek guidance from the trust attorney, who may in turn recommend petitioning for judicial instruction. Regardless of the actions taken, it is critical that the trustee consistently report to settlors and beneficiaries. Even if not required by the court, periodic reporting is necessary to ensure that all affected parties are kept informed in order to start the clock on the time within which anyone can object to an action or decision of the trustee. Periodic reporting should include any financial information as well as any other information necessary for the beneficiaries and others to be fully informed.

Additional special reporting can be used to garner approval from the beneficiaries for a specific act or transaction. A trustee must provide the beneficiaries with full information, including recommendations, in order for the beneficiaries to be bound by their approval. In addition to the formal methods of reporting, the lines of communication to all beneficiaries should be kept open. Any beneficiary who feels left out of the loop is much more likely to feel that the trustee is not acting appropriately.

Keeping Beneficiaries Satisfied

Success in a trusteeship depends to a great extent on keeping clients and beneficiaries satisfied. Success can also depend on having in-house office administrative staff that understand trusts, are alert to the problems related to trusts, and are sensitive to the human side of beneficiaries.

The potential for dissatisfaction by any one beneficiary increases with their number. The trustee, as a matter of risk management, certainly desires to operate on the basis of consensus among interested parties, but the trustee ultimately must follow the trust’s instructions and dictates, even if this runs counter to the consensus. In the desire to seek consensus, the trustee should not do things contrary to her charge as trustee.

If a prospective trustee concludes that she can create the conditions necessary to remain impartial, to administer the trust in accordance with its instructions, and to protect herself, trusteeship can be rewarding. On the other hand, if these conditions are unattainable, it may be wise to simply decline the engagement.


Ron Klein, JD, CFE, is vice president of claims with Camico Mutual Insurance Company. He is a member of the California Society of CPAs’ committee on professional liability and is coauthor of the CPA’s Guide to Loss Prevention Practices and the CPA’s Guide to Effective Engagement Letters (CPA Journal Book Review, November 2002).

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



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