Trusting the Trustees and Additional Trust-Related Issues

Shahnaz Mahmud
Published Date:
Aug 1, 2014

This article is the second in a two-part series about trusteeship that summarizes the discussions held during the NYSSCPA Family Office Committee’s fourth annual conference in February 2014. Part one of this series, “Navigating the Perilous Waters of Trusteeship: The Issue of Control,” published in the Tax Stringer’s July 2014 issue, addressed the issue of control; this article focuses on trusting the trustees and handling conflicts of interest.

The first article in this series discussed trusting the beneficiaries, but what about trusting the trustees? At the NYSSCPA Family Office Committee conference, Randy Werner, a loss prevention executive at CAMICO, urged participants to truly think about what is involved. She encouraged them to ask themselves why a trust is being created and why they are being asked to be that trust’s trustee. In addition, trustees should consider whether they have the competency to perform in that role.

Planning for the Unexpected

Sometimes, unexpected situations can get a trustee into trouble. One such situation is when a death occurs. In 2013, Werner’s firm was working with a fairly young man who was very productive, with his own thriving manufacturing business. His death was sudden and, because his particular business was very specialized, not just anybody was suitable to fill his role.

“The problem for the CPA [who was serving as trustee] was that he then had to step into this role himself,” Werner said. “He had been his trusted financial advisor who knew more about the business than anybody else and was in the process of trying to search for a replacement because the death happened so fast. There was no way to plan for the succession. It created an enormous amount of problems for him and an enormous amount of problems for the business.”

Werner again addressed the question of competency. “We call it the ‘back to the future’ rule,” she quipped. That is, it helps to imagine what the consequences of a troublesome event might be; then, professionals, such as herself, can step in and help plan for the possibility before it happens.

Other Trust-Related Issues

Laura Twomey, partner at Simpson Thacher and Bartlett LLP in New York, spoke at length about a special-purpose trust, with particular emphasis on holding shares in a family business that has, perhaps, gone public since the trust was created. She stressed that, while the trust agreement expressly states the desire of the grantor to go public, it doesn’t mean it will be shielded from liability forever. Twomey called for careful consideration and mindfulness of the rules in one's particular state.

“What we found to be important is for trustees to take the time to document their decision-making,” she said. “In other words, don’t just hold the stock in the publicly-traded business forever because the trust document says so. Sit down annually and consider why it makes sense to do so. The grantor’s intent and the family control of the company are both good reasons. But the idea is to monitor a situation actively, to make a record of your decision-making, to consider the alternatives and to have all of that in writing.”

Susan Schoenfeld, founder and CEO of Wealth Legacy Advisors LLC and immediate past chairwoman of the NYSSCPA Family Office Committee, weighed in on the undiversified position. This can include the family-owned company or the publicly traded company where the parents have worked their whole lives and accumulated tons of stock. As trustee, it’s of great benefit to review and document. “Even though the beneficiaries can’t tell the trustee what to do, it certainly makes sense to get their buy-in on a regular basis because you don’t want them suing you later,” said Schoenfeld.

And what about the issue of “trust fund-dependent” or “trust fund babies”? The best piece of advice, according to Barbara Hauser, founder of Barbara R. Hauser LLC in Minneapolis, is to keep educating the beneficiaries. She noted that it’s also smart marketing for any professional advisor to build those bridges via education with the next generation and to keep them involved. Hauser pointed to the example of one very prominent US family that has traditionally written trusts but, as a practical matter, decided to create committees instead. These are not mentioned in a trust agreement. One of the committees concerned trust distributions, which have no legal authority. “[Nonetheless,] it’s become an entrenched family discipline that, every quarter, the adult beneficiary looks at their needs for income for the next quarter,” Hauser said.

Another part of this topic is the issue of non–pro-rata distribution. This applies to “pot trusts,” or one big trust created for all family members with the idea that it provides tremendous flexibility. For example, there is one child who becomes a teacher and another an investment banker. They may reach a point where the trustee is asked to give larger distributions to one or the other, perhaps because the teacher wants to start a business and needs a distribution from the trust, whereas the banker is getting along just fine with the current income distributions. These situations are generally discretionary, notes Twomey. Having a disciplined process around documenting, as well as clear communication with the beneficiaries, is key. “Beneficiaries not getting a distribution can be made to understand what the request is, why the trustee deems it appropriate. And the trustee can seek information from the beneficiary requesting outside distribution, asking why he needs it and how he plans to use it, and then document that it made sense at the time,” Twomey said.

For the trustee, Werner offered suggestions to minimize risks. There are two likely scenarios: either the trust has already been drafted or you are working with a settlor and can make suggestions, she said. The more suggestions, the better, as the settlor is going to have their own family members and their own best interest at heart. “You want to make sure you get the no contest clause; you want to make sure there is indemnification,” Werner said. “You have to defend yourself.”

Walking a Fine Line

Another issue is conflict of interest. How can trustees avoid this? Werner recalled a situation in which the parents had both passed away and the successors, two sons, were essentially trust fund babies. The trustee, she described, had a very strong personality and was charging quite a bit for his services, which he felt were valued appropriately. One son became unhappy and called Werner and the tax partner who managed the engagement. The son had a longstanding relationship with the tax partner. But as it turned out, the trustee was originally the tax partner’s mentor and, at one point, his business partner.

Meanwhile, the son took the tax partner out for dinner and proceeded to detail his unhappiness with the trustee and his desire to get him fired. Werner noted the thin line that had to be walked. “What was important was he was the keeper of all the historical knowledge of this family group; that was one of the problems,” she said. A few days later, Werner got a call saying the son also wanted to fire the CEO because he didn’t like him, even though he had run the business very successfully. This posed an even bigger problem. At that point, disclosure could be made to the trustee. “You have to … decide, ‘How am I going to protect myself? How am I going to protect the interest of the beneficiaries of the trust?’ It’s a very difficult line to walk,” said Werner.

Private Trust Companies

The discussion moved to private trust companies, a trend that has been discussed more widely in recent times. “I would say it’s a good thing to consider for families of a certain wealth,” Twomey said. “However, I will say that most of those families opt not to pursue them because of the amount of administration necessary, the added expense, all of those things that play into it.” Twomey added that she has seen clients use them in a number of different ways. One use is to get around very restrictive trust terms, perhaps a trust that only allows for one or three trustees.

But there are many family members who would like to participate in the administration of the trust, she said. “We put a family trust company in place so that it could have a board that encompassed more members of the family. Those family members feel included, eliminating some of the potential disenfranchisement of having to pick one senior family member and then pass it to another senior family member,” she continued.

In another instance, Twomey’s firm utilized a family trust company when it had a trustee who moved to a state that would impose new taxes on that trust. The purpose is for the firm to continue to have an active role. Lastly, Twomey said the firm had some families in which all generations share a fierce desire for family privacy, and they have explored family trust companies as well. “It’s a shared value and it’s something that keeps them together,” she said. “But I would say in most instances those three factors are not present and we end up looking at it and deciding it was nice to have thought about that option but we are not going down that road at this point.”

Hauser added that if a family does want to have a private trust company, then the “friendly amendment” she would offer is to have that family run a private trust company that acts more like a front office and then make an arrangement with a real trust company to do the administrative, regulatory and back office work. “All the big banks I know of are happy to do that,” she said. “So you have the best of both.”

Perhaps the greatest takeaway from the day’s discussion was the critical importance of starting conversations as early as possible. This will lead all parties to the much-sought-after ideal of trust.

This article originally appeared in the February 2014 issue of Family Office Review. Copyright Family Office Review, 2014. Reprinted with permission.

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