Can You Trust the Trustee?

November 16, 2016

Trustees and executors have a fiduciary duty to the beneficiaries of a trust or estate.  According to the Law Information Institute of Cornell University, “A fiduciary duty is the highest standard of care [and] by imposing [fiduciary] duties, the law reduces the risk of a beneficiary by the fiduciary.”   Fiduciary duties include:

  • Duty of Loyalty – to invest and manage trust or estate assets solely in the interest of the beneficiaries.
  • Duty of Care – to exercise reasonable care and skill in their management of assets.  If not addressed specifically in the governing document, the Uniform Prudent Investors Act requires a trustee to manage assets as a prudent investor would do.
  • Duty of Impartiality – to not favor any beneficiary over another.
  • Duty of Disclosure – to provide complete and accurate information as to the property and transactions in the trust or estate.

Given the nature of the situation, certain frauds can start before estate administration even begins.  Someone can present a false will or codicil, or one that has been superseded or revoked.  Someone could have taken assets while the decedent was ill or just after his death while others were grieving.  Other frauds can occur during the administration of an estate or trust and by the very person the document maker (the decedent or grantor) trusted.

The extent of asset misappropriation and self-dealings by trustees and executors is not well reported.  In 1973, Donald Cressey developed a theory as to why individuals commit fraud, which evolved into the fraud triangle propounded by the Association of Certified Fraud Examiners.  The three components which lead to fraudulent behavior are 1) pressure/motivation, 2) opportunity and 3) rationalization.  Pressure/motivation can simply be greed.  Opportunity was handed to the fiduciary, who has control over the assets.   Rationalization as to why the fiduciary believes the asset misappropriation or self-dealings is okay can differ:

  • proper commission is not enough money to deal with administration of the trust or estate;
  • with regard to relationships with the document maker, the (other) beneficiaries are less deserving;
  • the (other) beneficiaries don’t need the money; etc. 

The use of the term “other” is because sometimes the trustee or executor is also a beneficiary. The means by which trustees and executors can commit asset misappropriation or self-dealings can differ.  It can start with not reporting the initial assets properly or completely.  Naturally, this likely occurs more often in the administration of an estate because, generally, all the assets held by the decedent were not known by all the beneficiaries.  Transactions may not be properly recorded covering up theft or self-dealings.  A straight-forward example would be that an asset was sold and only a portion of the proceeds were reported, with the trustee or executor taking the difference.  Also, the fiduciary can commit self-dealings by not timely distributing to the beneficiaries, thereby extending the period for which they receive fees.

Asset misappropriation and self-dealings can be more difficult to detect when the administration involves closely held businesses.  The commingling of roles that a trustee or executor may have if they are involved in that closely held business gives the fiduciary more opportunity to disguise the nature of transactions, as well as the value of the business itself.  

The law provides a deterrent to fraud and self-dealings, but that deterrent only goes so far.  To further prevent and detect such problems begins with the drafting of the governing document.  Assets, especially significant assets, should be described accurately and completely.  With respect to assets under a will, this asset list should be updated from time to time.  The document should require that a fiduciary disclose transactions and the status of assets on an annual basis.  Estates and trusts, especially, can last for years, even decades.  Supporting documents can be lost, and later irreplaceable, with little to no consequence to the fiduciary.  Most importantly, the language of the document needs to be clear.  A poorly written document can give a fiduciary an opening to conduct themselves and manage assets in a manner in which the document maker had not intended.  Consulting an attorney specializing in estate and trust planning, as well as one dealing with related litigation, may be advisable depending on the magnitude or complexity of the assets.

Take the following case.  A trust had two trustees: a family member, Mr. X, and an unrelated family friend, Mr. Y.  The trust had been in existence for approximately 15 years when some of the beneficiaries asked to review records and to receive belated distributions due to them upon attaining a certain age.  The trustees eventually prepared an accounting which raised questions.  The totality of the investigation unearthed a multiple of issues, including the following:

  • Mr. Y was seemingly a rubber stamp trustee, not truly involved in the management of trust assets.  Yet Mr. Y did seek a commission payment from the trust for his services from inception to the present.
  • Mr. X used some trust assets to fund a struggling family business.  Without the funding from the trust, the company would have been bankrupt long ago. 
  • Part of the company funding went to pay the salary of Mr. X.  In addition to this salary, Mr. X was also asking for commissions from the trust for his services from inception to the present.
  • Mr. X placed trust investments in a limited liability company he created, making himself the managing owner, to avoid distributing marketable securities to a beneficiary.
  • After a heated disagreement with a beneficiary, Mr. X liquidated an entire brokerage account, realizing capital gains and incurring significant income taxes for the trust.  This affected the possible future growth and income of the trust.

Ultimately, the beneficiaries settled with the trustees, which included the complete distribution of the remaining assets in the trust to the beneficiaries.  In the end, the inappropriate actions of Mr. X and the litigation-related fees still cost the beneficiaries in excess of a million dollars.  If there had been a requirement to provide an accounting, whether formal or informal, on an annual basis, it may have deterred Mr. X from misappropriating trust assets or, at a minimum, shortened the period of bad acts thereby reducing the financial impact.  

The preceding should not be taken as legal advice.  This content does not address all the legal aspects of statutes or relevant case law governing trusts and estates.  If you are not an attorney, you should consult an attorney regarding legal matters.


About Hubert Klein

Hubert Klein is a Partner and Practice Leader in the Financial Advisory Services Group with technical resources in various litigation actions. He has consulted in complex damages, business valuations and due diligence analysis.

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