Last week, the Chronicle of Philanthropy published Loss of Trust: Donors, Foundations Say Banks Mishandle Charitable Accounts (Brad Wolverton), describing a shocking number of large financial institutions that have already settled class action lawsuits brought by charitable and other trustees over fees and a number of other administrative issues. The article describes a $21 million settlement with Northern Trust Bank of California, a $111.5 million court-ordered payment by Bank of America, a $23.5 million settlement by First Union, a $9 million settlement with Bank One, and a $42 million settlement by Wells Fargo & Company. It should be noted that in some of these cases, the named organization is a successor to the organization that engaged in the behavior that resulted in the settlement or court decision--providing another lesson for those handling mergers and acquisitions regarding due diligence reviews.
One common complaint has been that trustees have been...
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raising their fees without the consent of the appropriate parties. This is what happened in the case involving Bank of America. See, Nickel v. Bank of America (9th Cir 2002). There is currently litigation pending in Pennsylvania between Wachovia Corporation and W.W. Smith Charitable Trust. In this case, Wachovia sued the trust, seeking to increase future fees and collect additional payments for prior services. A lower court denied the request for additional compensation for past services, but did allow Wachovia to increase its fees for ongoing services. The Pennsylvania Supreme Court has reviewed the lower court ruling and is expected to rule soon.
What is causing this sudden explosion of disputes between corporate trustees and charitable beneficiaries of trusts? The Chronicle and a number of others point to some common themes. The wave of financial institution mergers over the last two decades has often resulted in the corporate trustee and those making decisions on behalf of the trustee being far removed from the community in which the charitable trust does it work. The articles also point to the relatively passive nature of charitable boards and individual trustees (who may simply defer to corporate co-trustees). The Chronicle article quotes attorney Richard D. Greenfield as follows:
Many large banks regard these charitable accounts as the bank’s piggy bank to reach into as needed….Bank officials don’t think anyone is going to raise a big fuss if excessive fees are taken, and they have learned from experience that members of foundations and charity boards tend not to rock the boat.
So what is the answer to the problem? As is all too often the case, the problem is rooted in passive boards. The Chronicle article screams out for boards to start monitoring fees on a regular basis. In fact, the Chronicle points to the Shriners Hospital for Children as a group that has been very aggressive in monitoring trustee fees. Shriners even has one employee who does nothing but monitor charitable trusts under which Shriners is the beneficiary. The efforts have resulted in the Shriners recovering millions of dollars.
The time to address these issues is when someone sets up a charitable trust. The trust should spell out the fee arrangement, procedures for changing the fee arrangement, and procedures (rights) to change the corporate trustee. The documents should make clear that if the trustee doesn’t like the fee arrangement at some point in the future, its recourse is to find a replacement corporate trustee rather than simply increasing its fees.
Trust agreements should stay away from fixed dollar fees because the
amounts will become uneconomic with the passage of time. Instead, fees
should be based on a percentage of assets under management or income
received, or a combination of the two. The trust agreement should
contain a very clear formula for valuing assets or measuring income for
purposes of calculating the fee. It should also provide for periodic
accountings and reports to the charitable beneficiary and co-trustees.
According to the Chronicle article, many corporate
trustees are now adding language to their agreements which limits the
rights of the charitable beneficiary to sue the trustee for what are in
effect breaches of fiduciary duties. It will be interesting to see
whether the courts are willing to uphold provisions that effectively
waive fiduciary duties or whether these provisions will be held to be void as being against public policy.
Fee agreements and waivers should be carefully reviewed before the trust is created. The settlor is in the best position to protect the charitable beneficiary at the time when the settlor is talking with the corporate trustee about setting up a trust with a $100 or $200 million in assets. The “salesperson” will be much more amenable to dropping a trustee-favorable clause before the deal is signed and his institution is appointed the trustee.
Those setting up trusts should also concentrate on more than just the fee arrangement and changes thereto. There is lots of room for abuse when one of the beneficiaries is a charity and another is an individual. Take a not untypical situation, where someone leaves income to a spouse or child for their life, with the remainder being transferred to a charity. Often the settlor’s law firm will act as the trustee. An aggressive law firm may invest the money in growth assets, starving the income beneficiary. Why would a law firm do this? Quite simple: The partner in charge is interested in making a name for himself in the community, viewing the trust as a means to gain prominence through his control of what are valuable charitable assets and his ability to increase those assets at the expense of the widow.
Banks and trust companies are not immune from similar motivations. The settlor should very carefully define the charities that are to be beneficiaries of the trust and the basis for payments to these charities. A corporate trustee with discretion may decide to use the trust assets and income to make gifts that benefits its own marketing efforts rather the charitable mission envisioned by the settlor, but inadequately defined in the trust agreement.
All of these potential abuses may make a charitable foundation, with
its own board of directors, more appealing than a charitable trust with
a corporate trustee. After all, the donor can appoint people that he
or she knows to serve as directors—even going so far as to create
director positions that are to be occupied by persons representing
certain classes of beneficiaries. The foundation can certainly retain
investment managers, but it is much less likely to be locked into one
who is serving as a corporate trustee. But corporate foundations are
by no means panaceas. The donor is still dependent on people after
his or her own demise. There is no question that boards can deviate
from the donor’s original intentions. In short, whether it is a trust
or a foundation, there will be classic principal-agent problems. If
the donor is concerned that his or her assets be used to benefit a
particular community, the donor might want to consider a community
foundation. But once again, people are involved and there have clearly
been disputes between community foundations and the the donor's
survivors over whether the community foundation is truly adhering to
the donor's intentions.
In short, donors need to give very careful consideration whenever
leaving money for charitable purposes. That means reviewing agreements
very carefully, selecting the right people, and thinking about what can
go wrong and planning for it. Charitable beneficiaries under existing charitable trusts should be taking a very proactive review of the fees charged by corporate trustees, as well as distribution and investment policies. If you liked this post, please visit http://www.charitygovernance.com
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