An often misunderstood concept under trust and estate administration centers on “letters of retention.” Letters of retention are common where beneficiaries of a trust direct a trustee not to sell something that the trust holds.
An example would be where Dad, during his lifetime, worked for a publicly traded company, and accrued a lot of stock in the company that the family harbors an emotional attachment to. For purposes of illustration, assume that Dad worked at Procter & Gamble. He earned stock options in the company, over time he exercised those options – making Procter & Gamble a major holding of his portfolio. The stock appreciated and paid good dividends, so Dad never sold any of the shares that he built up. Moreover, selling the stock would have resulted in capital gains tax, so there was a strong disincentive to sell during Dad’s lifetime.
Over time, the stock made up a significant portion of Dad’s estate. When Dad died, his successor trustee worries that if the Procter & Gamble Company should tumble in value, then the trustee could be liable to the beneficiaries for failing to diversify the trust portfolio over a number of different companies, rather than putting all of the trust eggs in the “Procter & Gamble” basket.
In fact, under most state laws, including Florida’s, the trustee has a fiduciary obligation to diversify the portfolio. If Procter & Gamble stock were to suddenly lose value (think: Enron), then the beneficiaries would have a rightful claim that the trustee failed to follow the prudent investor rules. If the beneficiaries insist that the trustee not sell the stock, for any reason, then it is incumbent upon the trustee to have the beneficiaries sign a “letter of retention”.
Typically, letters of retention would absolve the trustee from any liability associated with the failure to diversify the portfolio based upon the direction to continue to hold the shares. Letters of retention can be used for a variety of holdings, not just stock. If the family wanted a trustee to continue to hold a piece of real estate, for example, a letter of retention would also be appropriate.
Once a letter of retention has been signed, however, a variety of other factors need to be considered. A trustee, for example, will typically charge a trustee’s fee based upon the value of the portfolio that the trustee is managing. By definition, however, an asset that is being held under a letter of retention is not being actively managed. The trustee’s fee, therefore should not consider the value of any such holdings when calculating its fee.
There was a noteworthy case involving Wells Fargo Bank that was discussed at the Heckerling Estate Planning Conference a few years ago. It was relayed that Wells Fargo had charged a trustee’s fee based upon the value of an entire portfolio – even though a significant portion of that portfolio was being held under a letter of retention and therefore wasn’t actively managed. The beneficiaries brought an action against Wells Fargo for a refund of fees paid corresponding to the assets retained under a letter of retention. The case was quickly settled and Wells Fargo altered its policies.
Dick Riley, a longtime Sanibel resident and Executive Vice President of FineMark National Bank & Trust Company told me that it’s been his institution’s longstanding policy from the bank’s inception not to charge trustee fees on assets being held under letters of retention. “We’re not actively managing those assets – rather they are being held at the direction of the trust beneficiaries. FineMark therefore does not consider the value of those assets when determining a proper fee for the management of the trust. That’s what’s fair and right for all of the parties involved.”
Chris Gair, Senior Trust Officer of Investors’ Security Trust Company offers a thought on what he calls “portfolio insurance” to guard against the potential decline in the retained asset’s value. “While a letter of retention might forgive trustee liability, there are timely safeguards that can be put into place in a volatile market situation. One way to combat the potential decline in value would be to purchase a ‘put’ which is an option that allows you to sell the stock at a stated price for a stated period of time. If the stock falls in value – which is the risk you are trying to offset – the value of the put will correspondingly increase – this is what we call portfolio insurance in these situations.”
These techniques might be used not only after the death of the Settlor of the trust, but during the Settlor’s lifetime. FineMark’s Riley points out that clients who foster a close working relationship with a good financial advisory team are more likely to have a favorable outcome over those that simply name a trust company as a successor trustee in the trust document without ever first establishing a professional relationship. “When we know what the issues are before a crisis may occur, we are that much more likely to offer solutions that serve to avoid the crisis in the first place,” he says.