Wealth Management: Betraying Your Trust
Diamonds are forever, but not so the patriarch of a diamond house. When Harry Winston, founder of the prestigious diamond jewelry business, died in 1978, he unwittingly provoked a bitter legal struggle, first between his two sons and ultimately between one son and the trustee that the father had chosen to administer his estate.
According to Winston’s will, the sons were to divide their father’s trust, including the business, equally. Ron, the elder son and the one widely considered more financially savvy, received his 50 percent share of the company’s stock outright. Bruce, who showed little interest in the operation of the company, would receive his inheritance in installments. According to one of Bruce’s attorneys, Raymond A. Bragar of the New York firm Bragar Wexler Eagel & Morgenstern, Bruce filed "objections to the accounting" (a legal statement questioning bookkeeping practices) after the company’s chief financial officer alleged that inventory was disappearing. Later, an appraiser hired by Bruce’s legal team claimed that the value of the company—namely the diamond inventory—had fallen nearly $100 million since the patriarch’s death. In December 2000, a judge allowed Ron and a group of investors to buy Bruce’s half of the company for $44 million, plus $10 million for an outstanding note and for what was called "a personal matter."
The sale resolved the legal dispute between the brothers, but Bruce also holds the institutional trustee (now Deutsche Bank after it acquired the original trustee, Bankers Trust, in 1999) responsible for his losses, alleging breach of its fiduciary duty. According to another of Bruce’s attorneys, Paul Wexler, Deutsche Bank was involved in a banking relationship with Ron that began prior to its purchase of Bankers Trust, and therefore had a conflict of interest in making company decisions that affected both brothers. In addition to seeking $1.3 bil-lion to cover losses in the company’s value, plus potential interest that was forfeited, Bruce’s lawsuit demands that Deutsche Bank be removed as trustee.
In response to the suit, Deutsche Bank issued a statement that reads, in part: "Far from new, Bruce Winston’s campaign against Deutsche Bank is 11 years old. What is new is that Bruce’s advisors have multiplied the previous amount of his claims to a headline-getting $1.3 billion. Bruce Winston’s continued campaign testifies to the wisdom of Harry Winston in setting up a trust to protect Bruce Winston from himself."
Indeed, Harry Winston may have drafted the trust to protect his son. Settlors (those who create trusts), such as the elder Winston, determine how much decision-making power beneficiaries have concerning the trust’s management, and that usually does not include at-will authority to remove a trustee. "A lot of parents, even with adult children, if they’re concerned about their spending habits, are not going to give that leverage [to remove a trustee]," says Bob Goldman, a trust and estate litigation attorney at Goldman, Felcoski & Stone, in Naples, Fla. "That’s the thing about institutional trustees," says Wexler. "We’re surmising what Harry Winston wanted."
Although the particulars of the Winston case are unique, the situation raises important points about beneficiary rights, including the amount of authority a beneficiary can exercise over a trust’s management. If, for example, you suspect that your trust is being mismanaged, what can you do? The first step, attorneys say, is to examine the trust document thoroughly. If it states that the beneficiary or beneficiaries do not have the at-will power to remove a trustee, you have the option of petitioning the court to have the trustee removed. For the court to act, you must prove that the trustee did not perform its fiduciary duty—a broadly defined responsibility subject to interpretation.
"Over the last two years, the number of breaches of fiduciary duty cases in my station has gone up 80 or 90 percent," says Goldman. "I think that will be temporary. I think it’s the economy—people just lost and lost and lost, and they have to believe it was somebody’s fault." Most of these cases, he adds, simply involve bad luck, not breaches of fiduciary duty.
According to the widely accepted Uniform Prudent Investor Act of 1994, a trustee has a fiduciary duty to protect assets by diversifying an investment portfolio through a reasonable investing strategy. "It’s not a matter of whether money was lost, but whether the trustee had an appropriate plan for investing," explains Goldman. "I’m willing to bet a large majority [of cases] end up being in favor of the trustee. It’s a business judgment—you don’t like it; but the trustees had a plan. People walk in my office and want to sue because they lost 40 percent. And I say, ‘Only 40 percent?’"
Standish Smith, a retired space engineer living near Philadelphia, says the system is flawed and that beneficiaries should be able to choose their trustees. His dissatisfaction grew as the value of his wife’s trust fell from $15 million to $8 million during a three-year period. "They made some incredibly bad business decisions," he says of the trustee, which has been administering the trust since 1976. "They made a speculative gamble that the markets would improve, and that didn’t happen." Because he could not prove that the trustee acted illogically or arbitrarily, Smith had no basis to have it removed. "Settlors don’t understand how banks manage trusts," he says. "They think that banks can invest more wisely [than the beneficiaries], so they leave it to the discretion of the bank. The beneficiary is not a client, he’s a risk factor because he can sue."
Goldman is sympathetic to the plight of beneficiaries such as Smith. "The fact that you have a corporate trustee doesn’t mean you should accept what they say, nor does it mean that they’re going to get it right," he cautions. "If you read these statements and your eyes glaze over, call someone and get explanations." Respectable trustees will want to meet with the beneficiaries, he says, both to understand their needs and to protect themselves from possible accusations of mismanagement.
With no legal recourse to remove the trustees managing his wife’s trust, Smith attempted to change the status quo. In 1991, he established Heirs Inc. (www.heirs.net), a reform-minded nonprofit organization for disgruntled beneficiaries, most of whom, he acknowledges, also have little legal recourse. Members, in addition to legal referrals and moral support, receive a 350-page book explaining the legal specifics of trust management. "Corporate trustees advertise their expertise," he says, "but who is going to protect the women in their 60s and 70s who never had to manage a dime in their whole lives?" rel="nofollow"
Smith promotes legislation that would allow the removal of a trustee that, while not necessarily breaching its fiduciary duties, is deemed to be performing unsatisfactorily. First, he says, beneficiaries should be able to change trustees easily and without incurring termination fees. Also, a trustee should not be able to access trust assets to pay legal or accounting costs without the benefi-ciary’s permission—a common practice, he claims. Finally, Smith says, a trustee should not be able to raise the rates of its administrative fees. "[These changes] will motivate [trustees] to make principals rise," he says, adding that he expects trustees to increase the value of the assets yearly. While acknowledging that the cost of managing a trust may increase as the general cost of business rises, Smith steadfastly maintains that "the trustee would still make money with a fixed rate."
If the loss of a trust’s value is not proof that a trustee is ineffective and should be removed, what is? "Essentially, the trustee has a broad discretion, and the courts generally are not going to interfere unless they find that the trustee has acted in an arbitrary manner, or outside of the sea of reasonable decisions," explains Goldman. According to Wexler, Deutsche Bank should not have allowed itself to act as trustee when it acquired Bankers Trust (because of its prior relationship with Ron). Additionally, Bragar says, Bankers Trust should have had an independent expert verify the value of the inventory at the time of Harry Winston’s death.
Cases in which trustees have breached their fiduciary duty—outside of flagrant fraud or theft—are usually, Goldman says, the result of one of two things: a lack of training or a conflict of interest. Dan FitzPatrick, president of Goldman Sachs Trust Co., agrees that financial institutions have not always made good business managers. "A lot of people had bad experiences with some of the earliest entrants of the brokerage firms into this business," he acknowledges.
Brokerages, adds Goldman, are unlike banks in that they have no history, and therefore no expertise, in operating trust departments. "Their business model is to make money so they can invest money," he says. "They are not going to hold Grandma’s hand and help her make important life decisions. The goal now is making money, not managing it." Bankers, Goldman explains, historically kept fiduciary, trust, and commercial concerns separate. "They never saw each other," he says. "They worked on different floors, had different parking lots. Now, they purposely cross-pollinate, and sometimes they are one and the same person. Trustees can’t be all about the bottom line."
One way in which a conflict of interest can lead to breach of fiduciary duty involves what is known as self-dealing, when a trustee uses its position for personal advantage. Currently, Florida’s appellate courts are hearing cases in which they must decide whether trustees who loaned themselves money on favorable terms without proper security breached their fiduciary duties. "Things don’t go as planned, and, to be fair, the trustee will have the best intentions of paying the money back, but they can’t," Goldman says. "He borrows $1 million from a trust because he knows Seabiscuit is going to win this race, and it doesn’t happen."
Banks that serve as trustees and lenders can self-deal as well. For example, a lending officer and trust officer from the same organization could work together to give the lender first position on a property to which the trust held the note, or IOU. Another example is offered by the circumstances surrounding the Gilman estate near Jacksonville, Fla. One of the assets of the Howard Gilman Foundation was a $47 million note from the parent company of a business that planned to buy Gilman’s paper mill. Now, the business that planned to buy the mill is in bankruptcy, and the parent company is suing the foundation (which is itself nearly broke) for fraud.
Deutsche Bank is embroiled with a self-dealing case that dates to 1985 and the former Bankers Trust. As trustee, Bankers Trust hired "inside counsel," a law firm it retained for its own use, to oversee the interest of one of its trusts in probate. Edmund McCormick’s will was represented by White & Case, which was also on retainer at Bankers Trust. Suzanne McCormick, a concert pianist and Edmund’s wife, was unaware of the ties between the companies until 10 years later, when the value of the estate withered from $37 million to $17 million. Her lawsuit alleges that the trust’s loss of value was a result of the trustee’s mismanagement, says Pat Hanley, the widow’s spokesman. The suit alleges several instances in which the trustee did not perform its duties, including allowing coexecutors to embezzle and retaining money-losing properties. McCormick’s trust, meanwhile, has paid $250,000 to White & Case for services rendered. Still, the case drags on.
As for Bruce Winston, the original summer trial date has been moved to early 2004, when, his attorneys say, the testimony from four experts—an accountant, a jewelry evaluator, a fiduciary authority, and a banking industry professional—will show, in part, that Deutsche Bank’s accounting reports were misleading and that the trustee did not adequately oversee the business. "This case shows why [settlors] should be wary of placing their family business in a trust in reliance on an institutional trustee," says Bragar, "[and it] should force institutional trustees to wake up to the fact that the law applies to them just as much as to individual trustees."