A trust department's reputation is linked to its skill in managing conflicts. Becky Kelly and Roger Pond are partners in the Fiduciary Education Center and instructors at AccuTech University, a Muncie, Ind.-based education resource for fiduciary professionals.

One of the many challenging aspects of being a trustee is the fiduciary duty of loyalty to the trust document and the beneficiaries protected under that document -- the "Golden Rule" of trust, as it were.

Correlation

This came to us forcefully when, early in our careers, we witnessed at close hand an example of a trust department working against the interests of its parent company to safeguard the interests of a trust's beneficiaries. In this case the owner of a run-down commercial building(in which the trust held a first mortgage) failed to keep up with payments on two mortgages, one held by the trust and one held by the bank. To make sure the beneficiaries were not harmed, the trust area foreclosed. As a result, the trust client remained whole, but the bank lost thirty cents on the dollar.

How many occupations can cause the mother company to lose money even as a department of that bank earns plaudits doing a good job? In the fiduciary business, achieving profitability while maintaining the trust department's reputation is directly correlated to its skill in managing conflicts of interest. As a result, trust-department staffers have to be committed to understanding how conflicts of interest occur and how they can be avoided or resolved.

The foreclosure we described certainly wasn't a joyful experience for the bank. But from the trust department's point of view, it was necessarily and inevitable. Now, with changing lifestyles and merger activity sweeping our industry, other issues, equally touchy, are coming to the fore. In many cases, however, the appropriate response is not as clear cut.

Capacity

Because it's common these days for adult "children" and their parents to live far from one another, the living trust -- with associated investment management and bill pay -- is an attractive security alternative in the case of incapacity for the grantor as well as a safety net for their children.

These arrangements work in case of incapacity, but note: the grantor's incapacity in fact makes the relationship irrevocable. This has several implications. Most portfolios are fairly well diversified. But sometimes a grantor directs that there is no liability for holding a concentrated position. Provided the grantor is fully functioning, his request to hold an undiversified portfolio can be justified. But, once the grantor has become incapacitated, courts tend to find that a direction to retain a concentrated portfolio is no longer valid. Knowing this, the trustee should have at hand an action plan to diversify the portfolio taking into account the grantor's health -- and of course being mindful of the fact that assets receive a step-up in basis at the grantor's death).

The tricky part is determining "capacity." Family doctors are generally unwilling to assume the responsibility of determining this because of patient-physician confidentiality. So it's important for the grantor, the grantor's physician and the beneficiaries -- who are presumably the children -- to have a conversation about the grantor's wishes before incapacity sets in.

Mergers and Turnover

If you haven't lived through a merger, you've probably seen a fair share of staff turnover in your trust department. In either case, it's imperative to review trust documents -- not just the synoptic data and the account abstract: the entire document. Though the assets in a trust are required by law to be reviewed annually, there is no such requirement with regard to the language of the document itself. In practice, unfortunately, the document might not have been reviewed since inception. As a result, trust administration errors can and do occur.

Though the trust function is generally a small piece of the pie in a merger of banks, there are a number of things that can be examined to see how well the trust department has run in the past. Internal audit and examiner audit reports will show outstanding complaints or litigation and management's response. The more recent reports will show the company's perspective on risk, hopefully in matrix format.

Conflicts of interest will be included in the report as well as general findings over a period of time. An examination can help determine if the findings are repetitive and management's response to them is logical, both from a timeline perspective and process. Additionally, the minutes of the appropriate trust committees should be reviewed for irregularities, or sometimes even worse -- because it might indicate that the trust committees are not providing the required oversight -- no irregularities. Employee information should also be reviewed: has there been a lot of turnover? Are employees experienced? Have they demonstrated a commitment to keeping up with the changing fiduciary environment?

By these means, problems can be brought to light. And once they're identified, swift and decisive action is required. The consequences of not doing so can be costly, as a recent court decision revealed.

In this case, a trust held a piece of real estate that the trustee sold, taking back a mortgage collateralized by the property formerly in the trust. After the sale, the trust no longer owned the property, but held the mortgage as a trust asset. The trust department had no procedures in place to monitor collateral, which was not technically a trust asset.

Those were the building blocks of a "perfect storm." The purchaser of the property allowed the property to deteriorate, dropped insurance coverage and stopped paying property taxes as well as the mortgage. The uninsured property burned down and the mortgage in the trust became worthless. In its review of the facts, the court found the trustee negligent for failing to monitor the condition of the collateral for the mortgage. A prudent approach requires that the trustee receive evidence of insurability, payment of property taxes and other things -- even if the property is not technically a trust asset. The judgment against the bank approached seven figures.

And the bank that faced this judgment had acquired this "situation" through a merger.

Second Marriages

Another group that will gravitate toward trusts is those in second marriages who have already have children. Typically trust professionals advise couples jointly on financial and estate planning, but in these cases it can be -- to say the least -- difficult to advise a couple that comes into the marriage with children of their own. Frequently their beneficiaries are not the same, and their future planning may not meet the expectations of the other spouse. Add to that the possibility of unequal wealth for a couple with a desire to take advantage of the tax savings of a marital deduction, and a trust professional could end up with a real mess. Still, many couples find it easier to take "medicine" prescribed by a corporate fiduciary than by a family member.

If the couple is not in agreement about distribution, the husband and wife should have separate counsel. The balance between the surviving spouse as the income beneficiary and the children by a previous marriage as remaindermen requires an investment allocation that may not make either generation particularly happy. Their trustee will need income producing assets for the spouse and growth equities for the children. In a dysfunctional family, neither group will be happy.

The other critical decision to make as executor is the election for a Qualified Terminal Interest Trust or "QTip." This trust structure allows for a marital deduction, but makes sure the principal goes to the children of the decedent at the death of the surviving spouse. This is the decision of the trustee alone to elect as executor and will obviously have great effect on the family as a whole.

Children

As fiduciaries we often see parents bending over backwards trying to treat children equally. But the truth is that different children have different needs and, in particular -- where money is to be held in trust -- such differences need to be taken into account. Frequently clients will address their offspring's shortcomings verbally, but not in their documents. But these are matters that must be documented. Drug problems, spendthrift issues, illnesses are things that should be taken into account and, when done so, helps trust professionals fulfill their proper function of standing in for, and following the wishes of, the individual who created the trust.

As you can see from the examples we've provided, no troubleshooting on behalf of a trust and its beneficiaries is particularly easy. Mind you, if it were there would be little need for trust professionals.

In the last analysis, the least risky route is to do the right thing. But, in order to achieve that, the trust professional has to understand the trust document through an understanding of the document's creator and its intent. Such an approach, however arduous, is the best thing for the trust department and -- far more important -- it's the best thing for the trust's beneficiaries. -FWR

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