Duties of FiduciariesFinancial Planners, Trustees, and Executors

Chris Tyler, Dylan Franklin, J.J. LeVan

Nature of Fiduciary Relationship

Fiduciary relationships arise when a client entrusts their money to a professional to make or influence important client decisions

Fiduciary duty: level of care bestowed upon a professional entrusted with other people’s money

Fiduciary duties are commonly imposed by law

Fiduciary’s Professional Responsibility

To act solely in another parties best interest

Elements of a Fiduciary Relationship

Heightened client vulnerability

Dominant position of financial control or knowledge by the fiduciary

Usually…

Accountant is not considered a fiduciary

AICPA Professional Code of Conduct creates something similar:

Objectivity

Integrity

Free from conflicts of interests

Honesty

*Auditing and tax engagements don’t generally create a fiduciary relationship

Fiduciary Relationships in Accounting

Created when clients entrust money to their accountants

Examples:

Accountant oversees client investments

Accountant serves as trustee of a trust fund

Accountant serves as retirement plan asset manager

Accountant serves as executor of deceased client’s estate

In the News

May 2015: U.S. Supreme Court ruled against Edison in the case of Tibble et al. vs. Edison International et al.

Edison, a 401(k) plan was found to have breached their fiduciary duties

Edison chose retail-priced investments over less expensive institutionally priced versions of the same investments

Supreme Court stated that benefit plans have a ““continuing duty to monitor trust investments and remove imprudent ones”

Personal Financial planners and asset managers

Applicable professional standards

CPA’s that provide personal financial planning service must follow

Statement on Standards in Personal Financial Planning Services

Governs conduct of CPA’s who design or implement strategies in

Estate planning

Risk management

Retirement planning

Applies when CPA’s sell

Insurance

Securities

Other financial products

Specific duties associated with custody of assets

According to IFAC Code has 5 core duties

1. They must not commingle client assets with their own assets

2. They must use assets only for their intended purpose

3. They must maintain up-to-date accounting for these assets and the related income generated

4. They must comply with all relevant laws and regulations

5. If client funds appear to have been derived from illegal activities, they must follow all applicable laws and avoid associating with others who might discredit them or the accounting profession.

How to avoid creating a fiduciary relationship

Ensure that clients have the ability to understand and evaluate the advice given to them

Ensure that clients understand that they have the ultimately responsibility for a decision

Keep clients fully informed about relevant facts, so they are able to make their own decisions

Encourage clients to consult with others, such as attorneys and insurance professionals, about the advice given to them

Expressly enter into agreements with clients that specify that a fiduciary relationship in not created

What is a Trust?

A relationship where one party holds property for another

Party who holds property is the Trustee

Trustee: An accountant, Lawyer, or close relative

Set up to ensure that wealth is managed and disbursed wisely after a grantor’s death

Minimizes estate taxes

Shields assets from creditors and litigation claims

Generally established in a written will

Structure of a Trust

Trust(Manage

d by Trustee)

Grantor Beneficiaries

Cash or Other Assets

John D. Rockefeller

- Founder of the Standards Oil Company

- Considered one of the wealthiest historical figures in American history

- First person to ever reach a net worth $1 billion

- Estimated adjusted wealth at time of death was $374 billion

- Considered one of the greatest philanthropists of all time

The Kennedy Family

- Father Joseph Kennedy accumulated wealth as a bootlegger

- Family fortune today roughly $1 billion

- Majority of family wealth today held in trusts ranging from tens of thousands to as much as $25 million

- Result:

Some assets are untaxable

Beneficiaries cannot tap into more than 10% of the principal

Types of Trusts

Intervivos Trusts: Take effect when grantor is alive

Testamentary Trusts: Take place when a grantor dies

Irrevocable Trust: When the grantor permanently relinquishes control over assets

Spendthrift Trust: Prevents beneficiaries who are minor children from accessing trust wealth

Living Trusts: A trust that a grantor creates for their own benefit

Blind Trust: Beneficiaries are prevented from knowing about the trust’s assets or earnings performance

Why Establish a Living Trust?

1. Protecting Property for Certain Beneficiaries

2. Reduce or Eliminate Estate Taxes

3. Managing Property upon Incapacity

4. Avoiding Probate

5. Avoiding a Will Contest

6. Privacy

The Political Implications of Blind Trustshttps://www.youtube.com/watch?v=JgT1DJSPAOM

Split-Interest Trusts

Trust(Managed

by Trustee)

GrantorIncome

Beneficiaries

Remainderman

Income

Principal

Duties of Trustees

1. Duty of Loyalty: A trustee manages a trust for the beneficiary, but they are expected to be loyal to the grantor

2. Duty of Care: Without clear guidance, the trustee should invest in low-risk investments

3. Duty of Impartiality: A trustee must select investments that further the interest of all trust beneficiaries

Example-Duty of Care

A trustee primarily invested trust funds in government bonds. However, she also invested a small portion of the trust’s assets in a gold mine. The gold mine was quite risky, standing alone. However, the trustee determined that, in times of high inflation, the value of gold mines tends to go up as the value of government bonds goes down. Trust documents do not provide any guidance about the grantor’s investment goals. Did the trustee violate her duty of care?

Solution

No. Under modern portfolio theory, the gold mine actually reduced the overall riskiness of the trust’s investments by moving in value in the opposite direction of the trust’s existing bond holdings. In statistical terms, the gold mine acted as a risk-minimizing hedge because its returns were inversely correlated with returns on other trust investments.

When you don’t Establish a Trust

https://www.youtube.com/watch?v=WKjWnNsCrHs

- Probate can take anywhere from 6 to 9 months

Result: Potential beneficiaries cannot access assets until probate is complete

Could cost heirs up to 10% of the value of assets

The Vanderbilt Family

Cornelius Vanderbilt accumulated a $100 million fortune during his lifetime.

6 generations later Anderson Cooper, a direct descendent, received no inheritance.

Nature of an Estate

Upon death, a person’s property transfers to an estate

An executor manages the estate, usually designated in the will

If no will, court appoints an administrator to the estate

Usually, a close family member

Executor/Administrator Duties

Executors and Administrators have fiduciary duty in managing the estate

Duties:

Gather deceased’s assets

Investing assets carefully

Winding up deceased’s affairs

Repaying deceased’s outstanding debts

Distributing estate property in accordance w/ deceased’s wishes

Accountants in Estate Practice

Must prepare a final balance sheet

Estate tax return must be filed if deceased has >$5mil net worth

May have to file estate income tax return if estate continues to earn income postmortem

Ex: dividends, interest, rent

Example

When the founder of a real estate business dies, her will appointed her second husband as the executor. The will also stated that estate net assets should be divided equally among the deceased’s three children.

After becoming the executor, the deceased’s widower received invoices to pay the casualty insurance premiums on the estate’s real estate holdings. Due to his grief and unfamiliarity with the estate process, though, he failed to pay these bills. One of the properties now has suffered a large fire loss, and one of his stepchildren has decided to sue him for breach of fiduciary duty, Is this executor personally liable for this loss?

Solution

Yes. An executor has a fiduciary duty to manage estate assets prudently. If an executor is unfamiliar with managing an estate, he has a responsibility to hire an attorney or other advisor to assist in fulfilling his duties. For these reasons, people designated as executors sometimes decline to serve in this capacity

Ethical Considerations by Tax Professionals

Negotiating Tax Refunds

Sometimes checks are sent directly to accountants who handle estate and trust affairs. i.e., Tax refund checks

Purpose: Convenience

Accountants who manage these trusts should maintain a separate bank account.

Potential for embezzlement

Embezzlement Example

- Attorney Robert C. Buschmohle embezzled nearly $400,000 from a living trust fund

- He was supposed to be paid $8,000 for his services

- The Fund was set up Derek Tate for his two sons six weeks before he died of cancer

- Most of the $500,000 living trust is gone

- Buschmohle could be sentenced up to 20 years

Conflicts of Interest

Arise when the accountant performs services for multiple beneficiaries of a trust or estate

Tax Professionals have a professional duty to advocate on behalf of the beneficiaries economic interest

What if a tax election benefits one beneficiary, but negatively impacts another?

Bloodline

Auditor independence requirements for trustees and

executors

The independence rules

CPA will lose independence to the client when1. The CPA is authorized to make investment decisions for the trust

2. The trust is a significant stockholder in the client company

3. The company’s stock is a significant asset of the trust

Example

You are an experienced CPA who has audited Kimberly Company’s financial statements for over a decade.

An elderly client recently formed a trust for the benefit of her grandson, Burton James, and you have agreed to serve as the trustee. The trust gives you the authority to invest trust assets “in any manner you choose, as long as the investment strategy is prudent.” The trust currently holds over 80 different stocks, including a few shares outstanding in Kimberly Company. Do you satisfy the independence standard to audit Kimberly Company?

Solution

No. A CPA-trustee loses the independence to audit a client whose stock is owned by the trust in any of three situations. In this situation, you have investment decision-making authority for the trust. Therefore, the independence rules preclude you from auditing Kimberly Company, whose stock is owned by the trust.

The trust’s ownership interest in Kimberly Company was insignificant, and Kimberly Company’s contribution to the trust’s investment portfolio was insignificant. However, the CPA’s investment decision-making powers made consideration of these additional factors irrelevant.

Am I Ethical?In 1963, a successful entrepreneur created a trust for her 14

grandchildren. Trust documents did not provide instructions on how trust assets should be invested. However, a scrapbook created by this business owner contained several handwritten letters in which she proclaimed her “hatred for the tax devil’s visit every April 15.” The scrapbook also contained a 1963 newspaper article that correctly reported that the United States had a 91% top income tax rate and 77% top estate tax rate.

As the trustee in charge, you now have to decide between two courses of action. Choice #1 is to invest trust assets in a very conservative manner. This is the choice preferred by 11 of the grandchildren. Choice #2 is to invest trust funds in riskier, growth-oriented assets. This choice will greatly minimize the beneficiaries‘ income and estate taxes, but only 3 of the grandchildren favor this choice. Which action should you choose?

Am I Ethical?

A. Select Choice 1 because a majority of the beneficiaries favor this approach

B. Select Choice 1 because a trustee has a duty to conservatively protect trust assets

C. Select Choice 2 because a trustee has a duty to maximize after-tax returns

D. Select Choice 2 because a trustee has a duty to carry out the wishes of the party who creates a trust

Am I Ethical Solution

D. Select Choice 2 because a trustee has a duty to carry out the wishes of the party who creates a trust

You should select this option even though a majority of the beneficiaries prefer the first option. A trustee’s principal duty is to effectuate the wishes of the grantor. Here, the surrounding circumstances clearly indicate that one of the grantor’s main goals was to minimize the family’s tax burden. Also, as an entrepreneur, the grantor apparently was not particularly risk-averse.