CREATIVE WEALTH PLANNING

Professor Randall RothUniversity of Hawaiirroth@hawaii.edu

Copyright © 2009, Randall W. RothAll rights reserved in all media

IMPORTANT NOTICECircular 230 and General Disclaimer

These slides and the companion presentation do not constitute tax or legal advice, and cannot be relied upon for purposes of avoiding penalties under the Internal Revenue Code. They are intended to stimulate thought and to provide general guidance to experienced estate planning professionals. Each reader and seminar participant should review original sources to determine the law and its applicability to each situation. In no event should a reader or participant rely on these materials or companion presentation in planning any specific transaction or litigation. These slides and the companion presentation may omit discussion of exceptions, qualification, definitions, effective dates, and other relevant authorities and considerations. Neither the sponsoring organization nor Professor Randall W. Roth will be responsible for any error, omission, or inaccuracy under any circumstances.

CREATIVE WEALTH PLANNING

Peace of mindA plan that fits the clientA plan the client choosesA plan the client understandsA plan that evolves with the clientA trusted adviser

WHY WEALTH PLANNING?

WHY WEALTH PLANNING?

THE REASONS JUST KEEP COMING

Non-lawyer’s Role• Estate planning is often a team effort,

but it always involves the practice of law.• Be careful not to engage in the

unauthorized practice of law.• Do not rely on lawyers who are not

competent in estate planning.• Define and document your role.

POSSIBLE ROLES FOR NON-LAWYERS

• Estate planning expert• Captain of estate planning team• Co-Captain of estate planning team• Position player (e.g., financial adviser, return

preparer, appraiser, trustee, protector)• Cheerleader• Trusted Adviser

FIRST TOPICSAVING ESTATE TAXES

(on the transmission of wealth to future generations)

WAYS TO REDUCE ESTATE TAXES

Spend wildly Invest poorly Make gifts to charity Make gifts to other donees (e.g., the

kids, grandkids, etc.)

NATURAL VS. UNATURAL GIFTS

Natural GiftsDonees need financial helpDonees deserve financial helpDonors can “afford” it

Unnatural GiftsExploit “loopholes”

MY EXPECTATIONSThe 2009 exemptions and tax rates.Sooner or later, Congress will look to the

wealth-transfer tax system as a logical source of significantly more revenue.

If a significant tax is incurred when your wealthy clients die, their children will ask, “Why didn’t mom and dad do more to avoid estate taxes?”

Hindsight bias is a powerful force.

ESTATE TAXES ASSUMPTIONS

Unified Credit = $3.5 million exemption

$1 million available to offset gift taxes

$13,000 annual exclusion

45% federal rate

Combined 50% rate (thinking ahead)

WHY GIFTS SAVE ESTATE TAXES

The Kids, Grandkids, Etc.

TAXABLE TRANSFERS

Uncle Sam lets the exemption go by, then grabs at the rate of 45

cents per dollar of value.

TAX-FREE TRANSFERS  1. $13,000 annual gifts 2. Payment of tuition 3. Post-gift appreciation 4. Post-gift income 5. Taxes on IDIT income 6. Interest paid to IDIT 7. Discounts 8. Gift taxes three years prior to death 9. Etc.

GIFTS ARE GOOD(for people who want to save taxes)

(tax-free transfers)

WHY GIFTS SAVE ESTATE TAXES

1. The $13,000 annual exclusion

Example: Mr. and Mr. Client each make annual gifts of $13,000 to each of their two children, two children-in-law, and four grandchildren.

16 annual gifts Total annual gifts = $208,000 After 10 year: $2,080,000 Projected tax savings@50% = $1,040,000 Present value (4% inflation) = $678,704

TEN YEARS IS NOT A LONG TIME If Mr. and Mrs. Client are each 60 years old,

they have life expectancies of about 20 and 23 years, respectively.

If they are 70 years old, they still can reasonably expect to live another 13 to 16 years.

A person’s life expectancy does not shrink to less than ten years until reaching 75 to 78 years of age.

WHY GIFTS SAVE ESTATE TAXES

2. Annual payment of tuition and medical expenses

Example: Mr. and Mrs. Client pay the private school tuition of their four grandchildren, the total of which averages $40,000 annually (2009 dollars).

• $40,000 for ten years = $400,000 (2009 dollars)• Projected savings @ 50% = $200,000 (2009 dollars)• Total projected tax savings = $878,704 (2009

dollars)

WHY GIFTS SAVE ESTATE TAXES3. Post-gift income and appreciation

Example: In addition to their annual gifts, Mr. and Mr. Client each make a one-time gift of $1 million to their children.

If 7% total return, after ten years $2 million is worth about $4 million.

Projected tax savings@50% = $1 million Present value (4% inflation) = $676,000 Total proj’d savings (2009 dollars) = $1,554,704

WHY GIFTS SAVE ESTATE TAXES4. Donors pay income taxes on donees’ income

Example: Mr. and Mrs. Client make all their gifts using an Intentionally Defective Irrevocable Trust (IDIT).

If 3% yield, then income from the one-time gifts of $2,000,000 is $60,000 per year (2009 dollars)

Add $6,240 (3% of $208,000) per year for each set of annual-exclusion gifts (55 sets by the end of ten years), totaling $343,200 (2009 dollars)

Income taxes@35% on total annual income of 403,200 (60,000+343,200) equals $161,280 (2009 dollars)

Projected estate tax savings in 10 years@50% = $80,640 (2009 dollars)

Total projected savings = $1,635,344 (2009 dollars)

WHY GIFTS SAVE ESTATE TAXES5. DiscountsExample: Mr. and Mrs. Client make the above-described gifts in

the form of non-controlling interests in a family entity.

• Because of minority, non-marketability, and possibly other discounts, the projected tax savings are magnified

• The size of the combined discount will depend on many factors

• Done properly, 25% is conservative estimate• Projected total savings = $2,180,459 (2009 dollars)

Petter, TC Memo 2009-280• $22 UPS stock in LLC• Gifts (10%) and sales (90%) to two GST-exempt

IDITs w/ value-adjustment provisions for donor-advised funds

• 5% CRUT for cash flow; ILIT for estate taxes; special-needs trust for 3rd child)

• Claimed 53.2% discount (Moss Adams, CPAs)• IRS agreed to 35%• Issue: deduct excess to donor-advised funds?

THE NUMBERS GROW OVER TIME

• If Mr. and Mrs. Client continue the above-described gifting program for 20 years, the projected savings are well in excess of $5 million (2009 dollars).

• If Mr. and Mrs. Client are each 60 years old when they start making these gifts, each had a life expectancy of at least 20 years.

RETURN ON INVESTMENT

• Such planning costs money, but the issue should be framed as one of expected return on investment, rather than cost.

• We have projected tax savings of more than $2 million in 2009 dollars.

• Let’s assume fees of $200,000. • 10 to 1 is attractive despite the lack of a

guarantee.

WHY GIFTS SAVE ESTATE TAXESReview:1. The $13,000 annual exclusion2. Tuition and medical expenses3. Post-gift income and appreciation4. Donors pay income taxes on donees’ income5. Discounts6. Tax-exclusive calculation7. Other reasons not addressed today

A KEY QUESTION• If projected savings from non-

charitable gifts can be this large, why are so many wealthy people still “sitting on the sidelines?”

• Why don’t more wealthy people make tax-motivated gifts?

TOP 10 REASONS WHY PEOPLE DON’T

MAKE GIFTS TO SAVE ESTATE TAXES1. Financial insecurity (how much is “enough?”)2. Lost cash flow (how much is “enough?”)3. Lost control over assets and activities4. Lost control over donees5. Stunted character development6. Possibility of a donee’s divorce or of other creditors7. Complexity8. Inflexibility9. Concern that IRS will question something10. Loss of stepped-up basis

BUILDING BLOCKS FOR CREATIVE WEALTH PLANNING

1. Trusts2. Crummey powers3. Non-general powers of appointment4. Independent but friendly trustees (and protectors)5. Power to hire and fire independent trustees6. Opportunity to borrow, lease, or buy trust assets7. Intentionally Defective Irrevocable Trusts (IDIT)8. Closely held entities9. Zeroed-out short-term GRATs10. Alaska/Delaware/Nevada/etc Trusts

Not ready to give anything away to the kids, kids-in-law, or grandkids?

• Intervivos credit-shelter trust(s)– Spouse can be trustee and current beneficiary– Income and corpus as needed (ascertainable

standards)– Kids, etc are “takers in default”– Non-general powers of appointment– 5 and 5 general power of appointment– Grantor trust (which is good)– “Spouse” as defined in the trust agreement

What about annual exclusion gifts?

– Cristofani version of Crummey powers– New list of power holders each year– Holders have way more to lose than to gain by

exercising a withdrawal power– Court in Crummey didn’t require notice

(interesting but unnecessary variation)

THE CRUMMEY COURT "It is likely that some, if not all, of the

beneficiaries did not even know that they had any right to demand funds from the trust. They probably did not know when contributions were made to the trust or in what amounts."

Want to keep “power of the purse-strings,” or avoid “spoiling the kids?”

–Can prohibit distributions (except for Crummey powers)

–Better to keep flexibility–Friendly but independent trustees –Power to hire and fire trustees –Trust protectors

HOW FRIENDLY CAN A TRUSTEE BE?

“[T]he testimony elicited . . . in this case is insufficient to establish that [the trustee] was a mere conduit for petitioner and that it would automatically comply with any request of petitioner. . . . Certainly [the trustee] was not going to turn a deaf ear to suggestions from petitioner . . ., and indeed we think [the petitioner's lawyer] would not have recommended [the trustee] if he thought otherwise. . . . [A] mere willingness to listen to and consider ideas and proposals is not commensurate with an abdication by [the trustee] of its duty to exercise its independent judgment. . . . Despite [the trustee's] favorable disposition toward requests from petitioner, it had the power to reject any and all requests as it saw fit . . . .” Hart, TC Memo 1983-364.

WHAT INDEPENDENCE MEANSGift/Leaseback of dentist’s office buildingIRS argued Step Transaction DoctrineIRS contended that the trustees were not

independent"Although the trustees were [the taxpayer’s]

wife and lawyer, such fact does not cause them to lack independence. The trustees were aware of their fiduciary duties.“ Wolfe, TC Memo 1984-446.

HIGH-WATER MARK?Taxpayer transferred his office building to himself as

guardian for his children. (Brooke, 468 F.2d 1155)“Many decisions pivot on the issue of the

independence of the trustee.”“The necessary independence of the trustee is

achieved in a guardianship.”“The taxpayer . . . retained few, if any, controls over

the . . . property.” “If the taxpayer should at some future date breach his

fiduciary duty toward his children, the government might well renew its challenge.”

STATEMENT OF TRUSTEE “I have read and understand completely each

provision of the attached trust agreement, and I understand my fiduciary duties, which include loyalty, impartiality, prudence, communication, and obedience to the terms of the trust. I have not agreed, expressly or by implication, to be subject to the control of anyone. I understand that to do so would be a breach of my fiduciary duty and thereby subject me to personal liability.”

Want access to cash in the trust?

– Borrow it (high yet reasonable interest is ideal)

– No income tax consequences if using IDIT– Sell something to the trust (e.g., interests in

family entity)– Again, no income tax consequences if using

IDIT– Rid yourself of the 2036 “string”

Worried about inflexibility?

– Non-general power of appointment allows complete change regarding who gets what, when, and on what conditions

– Anticipate and facilitate change of trust situs

– Protector can modify trust as circumstances warrant

Worried about a valuation dispute with the IRS?

– GRAT formula– Automatic value-adjustment clause (marital

deduction formula)– Relatively little incentive to question value of

gifted or sold interests in closely held entity– If a gift tax is incurred, it probably will be just

another excellent investment

Loss of stepped-up basis?

Buy appreciated assets from IDIT

WORRIED ABOUT FINANCIAL SECURITY AND/OR FUTURE CREDITORS?

Consider an Alaska (or Delaware, etc.) Self-settled Spendthrift and/or Discretionary Trust

Local law mattersStarted with OAPTs and a fishing tripRace to the bottom?

WORRIED ABOUT THE IRS? Intolerance for uncertainty can be a major

hurdle Tried and proven strategies Aggressive variation may save more Cannot just play the “audit lottery” What is the downside? Gift taxes paid more than 3 years prior to

death can be a great investment

GIFTS TAXES SAVE ESTATE TAXES

6. Tax-exclusive calculation

Example: If they wanted to do so, Mr. and Mrs. Client could intentionally incur a gift tax on an “extra” gift of $1 million.

• Tax-exclusive vs. tax-inclusive calculation• $1.5 million at 50% equals an estate tax of $750,000, but a gift tax of

only $500,000• Effective gift-tax rate of 33% vs. estate-tax rate 50%• Donor must survive three years• Relatively few clients intentionally utilize this “opportunity”

2008 CHRISTIANSEN COURT “We do recognize that the incentive to the IRS to audit returns

affected by such disclaimer language will marginally decrease…. Lurking behind the Commissioner’s argument is the intimation that this will increase the probability that people … will lowball the value of an estate…. There’s no doubt that this is possible. But … fiduciaries … owe a duty to settle and distribute an estate according to the terms of the will … [and] the state attorney general has authority to enforce these fiduciary duties…. We therefore hold that allowing an increase in the charitable deduction to reflect the increase in the value of the estate’s property going to the Foundation violates no public policy and should be allowed.”

THE BISHOP ESTATEThe Christiansen court:“The famed case of Hawaii's Bishop

Estate shows how effectively the IRS can use the threat of the loss of exempt status to curb breaches of fiduciary duty.”

CHISTIANSEN’s IMPACT

“This case is not likely to stop the government’s challenge …, although it likely will empower planners who have been on the sidelines regarding this form of planning prophylaxis.” Jeffrey N. Pennell, Recent Wealth Transfer Developments, 2009 Hawaii Tax Institute, p. 6

VALUE-ADJUSTMENT FORMULA

"I give to X a fractional share of the property described in Schedule A. The numerator of the fraction is $1,000,000 and the denominator is the value of such property as is finally determined for federal transfer tax purposes. All the rest goes to the XYZ charity."

SECURITY BLANKETS

Control over investmentsControl over entitiesControl over remaining estateControl over identity of trusteeProtectorsUnderstanding and accepting that control is

relative and fleeting

Complexity?

– Must be willing and able to pay the cost of doing it right (which includes making it user-friendly)

– The key ingredient is a trusted adviser– Challenge is to translate complex strategies

into words, concepts, and images to which the client can relate

– A picture can be worth 1,000 words

WHY GIFTS SAVE ESTATE TAXES

The Kids, Grandkids, Etc.

TAXABLE TRANSFERS

Uncle Sam lets the exemption go by, then grabs at the rate of 45

cents per dollar of value.

TAX-FREE TRANSFERS  1. $13,000 annual gifts 2. Payment of tuition 3. Post-gift appreciation 4. Post-gift income 5. Income taxes on IDIT

income 6. Interest or rent paid

to IDIT 7. Discounts 8. Gift taxes paid three

years prior to death 9. Etc.

GIFTS ARE GOOD(for people who want to save taxes)

(tax-free transfers)

ADDITIONAL TOPICS

GST (exempt) Trusts Discount Planning Asset Protection Planning Fiduciary Duties and Exposure

INTERESTS IN FAMILY ENTITIES The sum of the parts does not have to equal

the whole An asset's value is no higher than what a

hypothetical buyer would pay for it The hypothetical buyer is an outsider who

doesn't already own an interest in the entity The hypothetical buyer has no reason to

expect to be treated like family

HIGH WATER MARK?Keller v. U.S. (Aug. 20, 2009) $350 million, mostly liquid assets Worried about divorces; investment .1% corporate general partner (100% owned, but

planned to sell; 49.95% limited partners as trustee of trusts for two children)

Started paperwork (e.g., unsigned check for initial capital contribution to corporate general partner) but died before signing

Successor trustee paid $147,800,245 in estate taxes Attended CPE seminar one year later

HIGH WATER MARK? Court: “significant and legitimate nontax business purpose

… to consolidate and protect family assets for management purposes and to make it easier for these assets to pass from generation to generation.”

“[T]he primary purpose … was not federal estate tax avoidance and the actions taken to form these partnerships were not done so to create a disguise gift or sham transaction as those terms are used in estate taxation.”

“[T]ransfer of the [securities] to the Partnership was a bona fide sale [under IRC Section 2036].”

“Lengthy discussions,” “primary purpose … to protect family assets from … ex-spouses,” “significant … assets outside the Partnership,” and “upon liquidation, the partners receive their capital accounts.”

$40 million refund!

IMPLEMENTING FAMILY-ENTITY STRATEGIES

Make sure clients understand how the strategy works.Document the nontax reasons for forming the entity.Keep outside funds to provide for personal needs.Keep personal-use assets out, or pay arms-length rent.Make no gifts or sales until the entity is funded and is operating smoothly for a significant time.Consider counsel for each group of interest holders.Consider tiered entities when appropriate.Make sure the governing instrument (e.g. partnership agreement) reflects the intended arrangement, and that it is followed precisely.

IMPLEMENTING FAMILY-ENTITY STRATEGIESMake sure all state requirements (e.g., certificates of limited partnership; tax licenses; registration statements; employer ID number; books and records) are met in a timely and complete manner.Don’t scrimp on the appraisals.Communicate with your appraiser before the facts have been carved in stone.Review the appraiser’s draft report for factual errors.Take everything in the right order, and document everything carefully.

IMPLEMENTING FAMILY-ENTITY STRATEGIESDetermine that other members of the estate planning team understand the strategy and their respective roles.Make only pro rata distributions.Never use entity funds to pay personal obligations.If possible, have client give or sell all of their interests at least three years prior to death.Consider using a valuation-adjustment mechanism to reduce or eliminate the risk of an unwanted taxable gift.Consider the worst that could happen, including that values could drop precipitously, or that donees could exercise their ownership rights in ways not contemplated.

INTENTIONALLY DEFECTIVE IRREVOCABLE TRUSTS (IDITs)

EXAMPLE: Assume a one-time $1 million gift and all of the following: (1) a grantor and a beneficiary who both are in a 40% state and federal combined income-tax bracket, (2) an income tax-defective trust that is not estate tax-defective (i.e., an IDIT), (3) annual trust income of 6%, all of which is accumulated and reinvested each year, and (4) a state and federal combined estate-tax bracket of 50% on the settlor's estate. Given these parameters, a one-time gift of $1 million will generate "additional" estate tax savings of $12,000 if the grantor dies after one year.

INTENTIONALLY DEFECTIVE IRREVOCABLE TRUSTS (IDITs)

$12,000 is 50% of the amount of income taxes paid by the donor on trust income (40% x 6% x $1 million= $24,000).

Using the same approach, the savings grow to more than $441,427 if the donor lives 20 more years.

That works out to $201,291 in 2009 dollars (assuming 4% annual inflation).

INTENTIONALLY DEFECTIVE IRREVOCABLE TRUSTS (IDITs)

Projected savings in 2009 dollars:10 years = $106,92320 years = $201,29130years = $292,22340 years = $386,28650 years = $491,248

INTENTIONALLY DEFECTIVE IRREVOCABLE TRUSTS (IDITs)

• Grantor or anyone else acting in a non-fiduciary capacity can reacquire trust property by substituting property of equivalent value without the approval or consent of any person acting in a fiduciary capacity. Section 675(4)(C)

• IRS uses a 675(4)(C) power in its sample grantor charitable lead annuity trust

• Trustee has power to distribute trust income to the grantor’s spouse. Section 677(a)(2)

• Non-adverse trustee has power to add beneficiaries. Section 674(c)

INTENTIONALLY DEFECTIVE IRREVOCABLE TRUSTS (IDITs)

• Non-adverse, non-independent party as trustee can make distributions based on standards that are not “reasonably definite.” Section 674(a)

• Grantor can borrow trust assets without adequate security (unless the instrument grants such a lending power in general). Section 675(2)

• Grantor has actually borrowed trust funds and not repaid them prior to the end of the year. Section 675(3)

• Under the reasoning of Mau v. U.S., 355 F. Supp 909 (D. Haw. 1973) and Rev. Rul. 86-82, the trust arguably would be defective for the entire year if the grantor borrowed all the corpus for a single day at any point of the year.

Using Section 675(4)(C) “A grantor's retained power, exercisable in a non-fiduciary

capacity, to acquire property held in trust by substituting property of equivalent value will not, by itself, cause the value of the trust corpus to be includible in the grantor's gross estate under §2036 or 2038, provided the trustee has a fiduciary obligation (under local law or the trust instrument) to ensure the grantor's compliance with the terms of this power by satisfying itself that the properties acquired and substituted by the grantor are in fact of equivalent value, and further provided that the substitution power cannot be exercised in a manner than can shift benefits among the trust beneficiaries.” Rev. Rul. 2008-22

GST-EXEMPT IDITs Section 678

Ascertainable StandardsCrummey powers

QSSTs“… for purposes of section 678(a), the beneficiary

of [a QSST] shall be treated as the owner of that portion of the trust which consists of stock in an S corporation with respect to which the election … has been made.”

Sec. 1361(d)(3) QSSTs(A) [A trust] the terms of which require that:

(i) During the life of the current income beneficiary, there shall be only 1 income beneficiary of the trust,

(ii) Any corpus distributed during the life of the current income beneficiary may be distributed only to such beneficiary,

(iii) The income interest of the current income beneficiary in the trust shall terminate on the earlier of such beneficiary’s death or the termination of the trust, and

(iv) Upon the termination of the trust during the life of the current income beneficiary, the trust shall distribute all of its assets to such beneficiary, and

(B) All of the income of which is distributed (or required to be distributed) currently to 1 individual who is a citizen or resident of the United States.

A substantially separate and independent share of a trust within the meaning of section 663(c) shall be treated as a separate trust….

SUPER-DUPER GST-EXEMPT TRUST

• Intervivos QTIP from S1 to S2• Unlimited marital deduction• Converts to B trust at death of S2• S1 is grantor of grantor trust• Commentator says stepped-up

basis at death of S2 and S1 too!

GRATs No need to use exemption (zeroed-out GRAT) No risk of inadvertent gift Multiple, short-term GRATs magnify results Volatile assets magnify results even more Grounded in a statute (2702) ETIP rules apply Continue as IDIT

SALES TO IDITs vs. GRATsThe midterm AFTR is lower than the Section

7520 rate (3.2% in December 2009), and the short-term rate (.69% in December 2009 for a 3-year note) is much lower.

More flexibility in structuring a note (e.g., back-end loaded)

Can apply GST exemption earlier.Can work even if seller dies within term of the

note.

GRATs vs. SALES TO IDITs

Statutory authorityConcern about inadvertent giftsAvoid income tax issue completely

QPRTs Undivided-interest discounts Leaseback opportunity On-going IDIT

CRTs Tax-free diversification Income tax deduction Wealth Replacement Plans Merrill Lynch case

A CAUTIONARY TALEMerrill Lynch Trust Company v. Campbell, C.A.

1803-VCN, V.C. Noble (Del. Ch. Sept. 2, 2009; Memo Op.):

10% CRUT with 50-year expected lifeRequest to invest in equities58% decline in value“Disturbing”Fiduciary duties

ASSET PROTECTION PLANNING

Cynical: “How do you keep the creditors away from your hard-earned millions? Consult an asset-protection attorney, that’s how…. Remember, paying up is for suckers.”

Intelligent: “Perhaps, once upon a time a well-designed estate plan did not need to involve deliberate consideration of the asset protection implications to the client. That time has long passed.”

ASSET PROTECTION PLANNING

• Current and Foreseeable Creditors vs. Future Creditors

• Creditors of Current Owner vs. Creditors of Others

ASSET PROTECTION PLANNING

• Risk Management (cost/benefit)• Timing is everything• Part of a well-planned estate• Maybe not every asset and every

creditor and every set of circumstances• Peace of mind

ASSET PROTECTION PLANNINGThe goal should be peace of mind—do APP when you

don’t need it!All else being equal, exempt property is to be treasured.Trusts and powers of appointment generally make it

possible to protect property from the claims of a donee’s creditors, perhaps even if the donee is given the functional equivalent of ownership over that property.

In many offshore jurisdictions and eleven states a settlor’s creditors cannot reach property simply because it might be distributed to the settlor.

ASSET PROTECTION PLANNINGA debtor’s interest in a closely held entity perhaps can be

designed to lose value in the hands of a creditor.APP strategies revolve around changed legal relationships.

Clients must respect those changes.Advisors must take reasonable steps to detect, and avoid

involvement in, any form of fraud.APP should be carefully and thoroughly documented, and

not hidden.APP sometimes works even better in practice than it does

in theory, but that alone does not justify it. When engaged in APP, there is no sure thing.

Who (may) owe fiduciary duties?TrusteesPersonal RepresentativesAttorneys-in-fact (agents)GuardiansLawyersCPAsFinancial PlannersOthers

WHO IS A FIDUCIARY?Sold stocks without permission: Held to standard of broker with

discretionary accounts (i.e., a fiduciary) “…duty to notify the plaintiffs of all the

circumstances of the unauthorized trades.”$250 million punitive damages ($5.9 million

actual damages)

Fiduciary Duties• Loyalty (e.g., no conflicts of interest; if

cannot avoid conflicts, then deal with them “appropriately”)

• Care (e.g., prudent investing)• Obedience (e.g., follow trust terms)• Communication (e.g., enable self-protection)

LITIGIOUS SOCIETY

“In the view of the beneficiaries, one is presumed guilty until found judgment proof. The search for deep pockets often leads a beneficiary or heir to the doorstep of counsel for the fiduciary or the decedent.” D. Campisi, “The Search for the Deep Pocket—Is It Yours?, Part I,” ACTEC Journal, at 246 (Winter 1999)

HINDSIGHT BIAS“When second-guessed by a

hindsightful observer, misfortune appears to have been incompetence, folly, or worse.”

B. Fischhof, Hindsight does not equal foresight: The effect of outcome knowledge on judgment under uncertainty,” JOURNAL OF EXPERIMENTAL PSYCHOLOGY: HUMAN PERCEPTION AND PERFORMANCE, 1: 298 (1975).

Recent Cases and Current IssuesTwo kinds of fiduciary defendants:Those who have been suedThose who haven’t been sued

“Good judgment comes from experience, and a lot of that comes

from bad judgment.” Will Rogers (circa 1930) and Mulla Nasrudin (circa 1208).

Duty to address problems/opportunities?Discount Planning Galloway Jeanes Gunster others

Peripheral Vision“A lawyer* may . . . face liability when he or she fails to

advise a client about a reasonably apparent matter that could affect the client, the client's rights, or the client's obligations, even if the client never employed the lawyer to advise about or to perform services in relation to the matter. Lawyers must advise clients concerning collateral matters, or alert the client to the need to seek other legal counsel regarding a matter the lawyer declines or lacks the expertise to handle.” Kerry Holleran & John J. Mueller, Advice Attorneys May Not Think to Give: The Peripheral Duty in Kentucky and Beyond, 36 N. Ky. L. Rev. 349, 365 (2009).

*Insert “adviser) where “lawyer” or “legal counsel” appears (i.e., although this article focuses exclusively on lawyers, the issue is not limited to lawyers!).

WHERE DOES IT STOP?

Plain ol’ gift?Disclaimer to save exemption?Generation skipping?Watertight bypass (“B”) trust?Intervivos funding of bypass or GST trust?Asset protection?Special needs trust?

“INFORMED” CONSENTBaker Botts v. Cailloux, 224 S.W.3d 723 (Tex.

App. 2007)Widow disclaimed $65.5 millionConsent document preparedDid the widow understand and agree?$65.5 million “equitable trust”Reversed on appeal, THANK GOODNESS!

Referrals

“Doesn't every referral almost by definition contain at least an implicit recommendation of the attorney's skill and professionalism?”

Barry R. Temkin, Can Negligent Referral to Another Attorney Constitute Legal Malpractice?, 17 Touro L. Rev. 639 (2001).

REFERERALS “[A]t a minimum, conflicts of interest should

have to be disclosed when referrals are given. . . . Indirect financial incentives such as reciprocal cross-referrals between attorneys with different specialties, or non-financial incentives such as loyalty to attorney friends, can . . . conflict with the best interests of the client, and so should . . . be disclosed to the client.” Bruce Ching, Attorney Referral, Negligence, and Vicarious Liability, 33 S. Ill. U. L. J. 217, 237 (2009)

Assuming Greater Responsibility

Merrick v. Mercantile Safe Deposit & Trust, 855 F2d 1095 (4th Cir. 1988) (bank served as “go-between,” and assured client it would review the estate plan; failed exercise of P/A)

Nevin v. Union Trust, 726 A2d 694 (Me. 1999)(bank held itself out as adviser and recommended discount planning; bank liable when lawyer botched the planning)

PRUDENT INVESTINGDuty to invest for optimal total return?Duty to diversify?Duty to perform due diligence?Duty to document decision-making

process?Duty to buy low and sell high?

BUY LOW, SELL HIGH? An heir to the $2 billion Campbell Estate has sued Central

Pacific Bank (CPB) for being “asleep at the switch” while his stocks were falling in value. According to the suit, CPB managed an investment account when AIG, Citibank, and Bank of America began to tumble. For example, CPB paid $69.26 per share for AIG stock in March of 2008 and sold it for $2.17 per share in September of that year. That stock eventually bottomed out at about 35 cents per share in March of 2009. According to the complaint, CPB “neglected to take any action to end the hemorrhaging” (i.e., it didn’t sell sooner). The plaintiff’s lawyer said, “It appeared that [CPB] was buying and selling stocks with no apparent strategy.”

Growney vs. Central Pacific Bank, Circuit Court No. 1CC09-1-001374 (2009).

DIVERSIFICATION IS NOT ALWAYS THE RIGHT THING TO DO

In re Sky Trust, p. 157: The corporate trustee held a large block of its own stock in a revocable trust. Shortly after the settlor’s death, the bank diversified the trust’s holdings, without first inquiring as to the health or financial circumstances of the surviving spouse, who was quite ill and survived less than two years. The trial court found the trustee grossly negligent, and the Superior Court affirmed: “Diversification cannot become a goal in and of itself … [it’s] a tool that can provide the means to effectuate a settlor’s goals … if used properly and prudently with due regard to the specific facts and circumstances that exist in a particular case.”

OTHER EXAMPLES Despite precatory language in the governing instrument that the

decedent was “particularly desirous” that his holdings in TRW be retained (in addition to the surviving spouse’s desire that it be held), the trustee sold about half of that stock within two months of the decedent’s death to diversify the trust estate. It pointed out language in the governing instrument that encouraged retention “unless compelling reasons arise for the disposal thereof.” The need to diversify was compelling, according to the trustee. Unfortunately, the TRW stock went up in value after the trustee sold it, and the widow sued. The Surrogate ordered the trustee to repurchase the stock and to pay the widow’s attorney fees and costs. The Appellate Division affirmed because diversification was not a “compelling” reason to sell, at least not in light of the widow’s objections.

In re Estate of Kettle, 423 N.Y.S.2d 701 (App. Div. 1979), aff’d 434 N.Y.S.2d 833 (App. Div. 1980)

ANOTHER EXAMPLE Several months after a charitable lead trust was funded

entirely with IBM stock, a corporate trustee decided to hold off selling stock until the price recovered from a recent decline. Rather than bounce back, however, the price continued downward and soon lost half its value. The Surrogate Court found that the trustee had been negligent for not diversifying relatively soon after taking the position. The Appellate Division agreed and noted that the trustee had “failed to follow its own internal protocol . . . [and] failed to conduct more than routine reviews of the IBM stock . . . [with] no particular consideration to the unique needs of this particular trust.” In re Rowe, 712 N.Y.S.2d 662 (App. Div. 2000), appeal denied, 749 N.E.2d 206 (N.Y. 2001).

Retention of Inception AssetsDumont, Nelson, Wege, Americans for the

Arts, Webb, Rhodehamel, Scheidmantel, Wood, etc.

Numerous cases with unique factsBishop EstateAuthorization vs. Instruction vs. Exculpation

TRUST ACCOUNTING Evolution of trust accounting rules UPIA Section 104 statutory adjustment

power Unitrusts Constrained investing Impact of the meltdown, etc.

DUTY TO COMMUNICATE

A bank trust company “failed to bring their professional expertise to bear” when assisting lay trustees who had neglected to tell beneficiaries about the exact nature of their interests in the trust. Losses 20% of fee in “public flogging.” McNeil v. Bennett, 792 A.2d 190 (Del. Ch. 2001), aff’d in part and rev’d in part, McNeil v. McNeil, 798 A.2d 503 (Del. 2002)

THE ENDCREATIVE WEALTH PLANNING