How fiduciaries can avoid liability risks.
Knowledgeable trustees understand their roles, responsibilities and potential for personal liability and realize it can be a thankless job. The trustee who doesn’t understand her roles and responsibilities and doesn’t appreciate the diligence that comes with the job is at risk to make mistakes.
The trustee’s function is to make investment, administration, reporting and distribution decisions in accordance with the grantor’s wishes and trust documents. On the face of it, these responsibilities seem straightforward. But, once the trustee realizes that her decisions can conflict with the grantor’s desires, beneficiary needs and trust document, the job can become overwhelming.
Personal liability arises out of the breach of these fiduciary duties. There are two main fiduciary duties: the duty of care, which relates to the careful and prudent management of assets, and the duty of loyalty, which puts the beneficiaries’ interests before all other interests including those of the trustees and grantor.
Trends
Certain trends in the wealth management industry create further challenges for fiduciaries when executing their duties. The wealth transfer business is expanding and contracting at the same time. The expansion comes from the staggering amount of wealth being transferred intergenerationally. An entire industry has been created over the last 20 to 30 years around wealth management. As wealth management has evolved, it’s become more complex and competitive. This has driven the professionals’ ability to assist families in implementing structures catering to their desire for more privacy, control of their assets and, at the same time, limiting the liability of the trustees. Leading the charge are the directed trusts and the domestic asset protection trust environment in Delaware on the east coast and Alaska, Nevada, South Dakota and Wyoming further west. These jurisdictions have become very competitive, but the laws and regulations are untested.
This trend is exacerbated by the amount of wealth coming into the United States from those seeking privacy and economic stability. This influx of funds into U.S.-based trusts creates additional consequences for trustees to ensure decisions are executed in accordance with U.S. and foreign tax laws. Staying within the bounds of these laws, which are precisely drafted, is important. The execution can be challenging, which in turn can create significant liability for institutional and individual trustees.
The nature of an advisor’s job functions is changing due to the increased exemption from federal estate tax, outsourcing to legal drafting firms and standardized/ template document providers, artificial intelligence and commoditization of the wealth management industry. This has given way to new opportunities. Lawyers, CPAs and life insurance agents wrestle with the future of their profession. Their primary roles have changed from that of a tax advisor to a well-rounded family advisor. They’re increasingly being asked to, and are now accepting, trustee positions, when historically they were uncomfortable doing so. Interestingly, on the flip side, some estate-planning attorneys concerned about serving in the trustee role are becoming fiduciary litigators. This is creating an interesting collision in the profession between lawyers acting as fiduciaries and fiduciary litigators. Additionally, due to the growing need for trustees, there’s been an increase in advisors creating paperclip companies to provide professional trustee services and other fiduciary functions as well as forming their own trust companies.
Multi-Faceted Platform
Because the industry is changing rapidly, more wealth is being passed and structures are complex, there’s more opportunity for mistakes to be made and potential for increased litigation. Consequently, there needs to be a better balance between risk and insurance. What’s needed is a multi-faceted platform.
Risk identification. The first step to rebalance the metrics is risk identification. No trust is the same, no trustees and beneficiaries are the same and the complexity of the trusts increases the need for broad expertise or at least knowing when to hire professionals. The complexity of the trusts requires expertise identifying which potential gaps can create liability. This is true especially in the directed trust environment, where there’s significant bifurcation of duties and responsibilities. Perhaps the most vexing issue involves the unanticipated duties to monitor, report or correct improper actions of other co-trustees. Most estate plans are well drafted and thoughtful. But, problems often arise when executing the plan. I consistently find that trustees aren’t performing all required duties, and co-trustees aren’t coordinating tasks to ensure details don’t get lost. Often, there’s somebody tasked with parts of the duties who has no legal authority. This gap creates liability for all service providers. More importantly, in the directed trust environment, with so many jobs, there’s a possibility for tasks to fall through the cracks, and “it’s not my job” isn’t a good defense. Therefore, trustees should consider implementing a trust charter that identifies, in detail, all roles and responsibilities, who’s responsible for tasks and mechanisms for enforcing accountability.
Risk mitigation. As with any industry in flux, an important step in risk mitigation is education. While there are amazing trustees who understand their roles and responsibilities as well as their personal liability, continuing education is imperative. Additionally, many co-trustees aren’t well informed. Furthermore, beneficiaries are often uninformed not only about the existence and functionality of their trustees, but also about the job of fiduciaries and how to hold them accountable in a positive way. Without disclosing confidential information, better training of trustees and beneficiaries alike can reduce friction between the parties and therefore prevent unnecessary litigation.
Risk transfer and insurance. While, as an industry, we can better prepare fiduciaries and advisors to reduce their risk, we can’t completely eliminate it. Therefore, trustees and other fiduciary service providers should be able to purchase properly structured insurance policies. However, it takes an expert to identify risks unique to each situation and properly design insurance policies.
Trustee liability insurance is a form of errors and omissions coverage similar to directors and officers insurance. These insurance policies are structured by defining what’s insured (the insuring agreement), exclusions, definitions and conditions. Generally, these policies cover defense costs as well as damages when or if there’s a settlement or until a court determination of negligence.
The insuring agreement is designed to define what’s covered, specifically: trustee’s acts, errors and omissions in carrying out his duties or alleged breach of fiduciary duty. Fiduciaries have a duty of loyalty to the trust and its beneficiaries and a duty of impartiality to the beneficiaries. Should a beneficiary allege a trustee or fiduciary service provider (that may be defined as a fiduciary by law) breached these duties, defense costs will be incurred, and potential personal liability can result.
Typically, exclusions are included in the fiduciary policy because other insurance policies that are or should be already in place, such as property and casualty insurance, are designed to cover certain claims. Exclusions for illegal activity, prohibited acts or proven gross negligence are also common. The insurance company won’t cover claims that are excluded from the policy. However, some policies may offer defense coverage until final adjudication of a claim.
It’s extremely important to review the definitions contained in policies because defined terms are used throughout, and these definitions can have a significant impact on the scope of coverage. All definitions must be reviewed and understood, but some key definitions require even more attention. Examples of these are the definitions of claim, claim expense, damages, insured persons and trustee services. If these, and other definitions aren’t structured properly, the insurance may not perform as expected.
While the above is a basic primer, no one policy fits all needs. There’s a litany of available insurance policies and insurance companies with varying degrees of risk appetite. An insurance professional can help you determine which polices and carriers are the best fit for each situation. The needs of individual trustees differ from institutional and professional trustees. Advisors such as lawyers, CPAs and life insurance agents serving as trustees require different policy structures. Finally, institutions such as trust companies have very different insurance requirements dictated by laws, trust instruments and perceived risk.
In general, limits of liability available to trustees range from $1 million to $25 million, but in certain circumstances, higher limits of liability may be available. Premiums range from $1,500 to upwards of $100,000 due to the services provided and analysis of the risk.
Some questions to ask yourself when determining the type of policy to purchase: If I’m an employed professional and/or have errors and omission policies in place, is there adequate coverage? Can the policy be amended to include excluded items or be clarified for gray areas? Am I a co-trustee, and how are the other trustees covered? If the co-trustees don’t have insurance, how will that affect my liability? What are the underlying assets held in trust, and will additional expertise be needed in carrying out my duties? How is the trust structured, and are there any applicable laws to consider?
The goal of risk identification, mitigation and insurance is to reduce personal liability and transfer risk to enable trustees and fiduciaries to serve willingly.
—The author acknowledges Melvin A. Warshaw of Financial Architects Partners in Boston for his contributions to this article.