Wealth Recovery

Wealth Preservation and Recovery for Executors,
Trustees, Guardians, Heirs, Attorneys and Advisors

James W. Watkins, III, J.D., CFP®, AWMA®

CEO/Managing Member
InvestSense, LLC

Estates, trusts, and guardianship are often confusing and intimidating to those involved.  Contributing to the confusion is the fact that such legal matters often involve people suffering from the loss of a loved one or dealing with some sort of personal challenge, people with a heightened vulnerability to financial “scams, shams and flim-flams.”

Another factor in the vulnerability of heirs, trust beneficiaries and wards (hereinafter “beneficiaries”) are so-called cognitive biases, personal biases developed over one’s life that impact the way one evaluates information and makes decisions.  In the area of financial decision-making, the “truth,” or “trust,” bias often affects one’s decisions.

The truth, or trust, bias refers to the unquestioned validity people often give to information or advice given to them based purely upon the speaker’s perceived authority or expertise.  In the area of financial decision-making, the public is often hurt by “advisers” that do nothing more than perpetuate long-standing myths that appear to be valid.  The combination of perceived authority (truth bias) and an unquestioned acceptance of a long-standing myth (the so-called “anchoring” bias) often results disastrous financial consequences for the public.

A final factor in the vulnerability of beneficiaries is the fact that investment fraud is often so subtle or so complex that the fraud is difficult for the public to detect.  One of the best illustrations of this fact is the investment industry’s common mantra of “everyone is losing money” when the stock market is going through a rough time.  Everyone is not losing money in down markets, especially not to the extent of the market itself.  For further information on this ruse, see our white paper, “Everyone is Not Losing Money: Investment Myths that Hurt Investors,” at our website.

Executors, trustees and guardians are fiduciaries.  As such, they are legally held to the highest level of loyalty and prudence in the management of their legal duties and responsibilities.  However, there is no requirement that an executor, trustee or guardian be a professional fiduciary.  This can end up being a blessing or a curse, as the use of a professional fiduciary is no guarantee against financial wrongdoing.

I have been receiving an increasing number of requests for forensic audits of estates and trusts, and to a lesser extent, guardianships.  Our forensic analysis process involves reverse engineering, or breaking apart and analyzing, a client’s entire financial/asset allocation plan.   The analysis includes a three level overall suitability analysis of both the original financial advice and the investment portfolio actually implemented, stress testing of the investor’s portfolio, and an overall quality of advice analysis based on a proprietary measure that factors in both the volatility and cost effectiveness of both the original investment recommendations and the investment portfolio actually implemented.   

There seems to be an increase nationwide in requests for forensic audits of financial fiduciaries.  The purpose of this post is to discuss some of the patterns I have seen as a result of my forensic audits of fiduciaries in hopes that it will help other beneficiaries and their advisers avoid such abusive fiduciary practices.

Fiduciary Duties and Breaches

As mentioned earlier, fiduciaries are held to the highest level of loyalty and prudence in the management of their legal duties and responsibilities.  They are required to always put their client’s best interests first.  They are also required to manage their client’s affairs prudently in such a way as to avoid the risk of large losses and to avoid unnecessary costs and expenses.

When a fiduciary lacks the experience and/or skills to manage any aspect of their client’s affairs, it is incumbent on the fiduciary to seek the help of others who do possess the requisite experience and skills to protect the client’s interests. 

Unfortunately, I see a significant number of cases where fiduciaries fail to comply with these standards, resulting in unnecessary financial losses to their clients. The breach of fiduciary cases I often see involving executors involve

  • A failure to identify potential “legal” assets such as claims for investment mismanagement against stockbrokers and investment advisers, and claims against 401k plans and other retirement plans for failure to meet applicable legal standard such as ERISA.  Too many times executors simply accept the assets as they find them at the time of the decedent’s death without properly evaluating the decedent’s estate.  A proper fiduciary audit may reveal a potential claim for substantial amounts of money, especially since the statute of limitations has not yet run on losses suffered during the 2008 bear market.  Whether the heirs decide to pursue such cases is their decision.  However an executor’s failure to evaluate the potential for such claims and disclose same to the heirs is arguably grounds for malpractice where a professional fiduciary is involved.
  • Conflicts of interest where a corporate fiduciary, such as a bank or a trust company, is appointed as both executor of the estate and has provided investment management for the deceased and, in some cases, trusts involving the deceased.  In such cases, it is obvious that the bank, as executor, is not going to disclose any potential mismanagement or other questionable activity by their wealth management division, and vice versa.
  • Actual or potential conflicts of interest arising out a long-standing relationship between an attorney or other professional fiduciary, serving as executor of an estate, and a corporate fiduciary, such as a bank or a trust company.  The concern is that the relationship between the parties may prevent the executor from pursuing valid claims against the bank or trust company, or from properly disclosing the such claims to the estate’s beneficiaries, in order to further the executor’s financial interests.
  • Financial losses due to a fiduciary’s reliance on a non-fiduciary, such as a stockbroker or an insurance agent, and the fiduciary’s failure to recognize the risk exposure created by such relationships.
  • In cases involving non-professional fiduciaries, an inability to properly evaluate potential claims and questionable conduct by others.     

The breach of fiduciary cases I often see involving trustees involve

  • Basic suitability issues, a failure of the fiduciary to properly evaluate a proposed investment based upon the three prong suitability test-the client’s willingness to accept risk, the client’s ability to bear such risk, and the client’s need to accept the proposed level of risk.
  • Ineffective diversification, portfolios with a lot of different types of investments (visually diversified), but investments that are highly correlated, meaning they act the same way in different types of markets, thereby failing to provide the downside protection investors need (effectively diversified).
  • Portfolios composed primarily of expensive, actively managed mutual funds.  Studies have consistently shown that the overwhelming majority of actively managed mutual funds underperform less expensive, passively managed mutual fund.  As to the impact of fees, a study by the General Accounting Office estimated that each 1 percent of investment fees reduces an investor’s end return by approximately 17 percent over a twenty year period.
  • Portfolios containing a large percentage of proprietary investment products, which are carry higher expense fees and a poor performance record.
  • Portfolios containing a large number of “closet index” mutual funds, expensive funds whose performance is due primarily to the performance of a relevant stock market index, but whose expenses are several times higher than an index fund that tracks the relevant index.
  • Financial losses due to a fiduciary’s reliance on a non-fiduciary, such as a stockbroker or an insurance agent, and the fiduciary’s failure to recognize the risk exposure created by such relationships.

Guardianships are a special type of fiduciary relationship.  I could write an entire book on the abuses within the guardianship practices within the United States.  In far too many cases you have judges appointing lawyers as guardians, attorneys with no background in investing, to manage the financial affairs of truly needy and disadvantaged people. 

Once the attorney/guardian has been appointed, the guardianship usually takes one of three patterns.  In the first pattern, the guardian consults with a non-fiduciary, such as a stockbroker or insurance agent, who provides the guardian with recommendation, typically in the form of a multi-colored pie chart, which will result in an ineffectively diversified portfolio composed of expensive, actively managed investment products (see above). 

In the second pattern, the guardian/attorney determines an asset allocation on their own, such as a 50/50 split between an equity index fund and a bond index fund.  The guardian/attorney then adopts a buy-and-hold management approach, albeit with some occasional rebalancing, despite the fact that history clearly establishes the cyclical nature of the stock market.  Ask advocates of the buy-and-hold approach how they fared in the 2000-2002 and 2008 bear markets.

And then there’s the final approach, combining the ineffectively diversified portfolio with the buy-and-hold management approach.  For further information on the effectiveness of this combo, please read our white papers, “The Devil Is In the Details: Investment Myths and the Unnecessary Losses They Create,” and “Everyone is Not Losing Money: Investment Myths and the Unnecessary Losses They Create.”     

Lessons for the Future

The prevalence of issues with the quality of fiduciary services should come as no surprise to anyone who follows the investment and fiduciary industries.  A 2007 Schwab Institutional study estimated that 75 percent of the investor portfolios studied were unsuitable given the investor’s financial goals and needs. An InvestmentNews story on the Schwab study reported a response of “we’ve known it all along.”

InvestmentNews just ran a story regarding a Cerulli study that found that most financial advisers are overstating their expertise.  A study by CEG Worldwide concluded that only 6 percent of those holding themselves out as wealth managers qualified a process-oriented wealth managers, with the other 94 percent being more product-sales oriented.

Forensic wealth management analysis provides a number of potential benefits to beneficiaries, attorneys and financial advisers.  Forensic wealth management analysis allows all parties to be proactive to ensure the quality of the wealth management and the legal advice being provided.  Forensic wealth management analysis allows all parties to effectively monitor the ongoing management of a client’s financial affairs so as to minimize the chance of unnecessary financial losses. 

Forensic wealth management analysis allows beneficiaries to detect and effectively address potential breaches by a fiduciary of their legal duties and obligations.  Forensic wealth management analysis allows executors and trust and estate attorneys to identify “hidden” or potentially overlooked assets, such as legal claims, to ensure that an estate and its heirs get a full and proper accounting of any and all assets belonging to the estate.

It is important for beneficiaries to understand that a fiduciary’s breach of their fiduciary duty does not mean that the fiduciary is evil or dishonest.  A fiduciary’s breach of their fiduciary duties simple means that they failed to meet the required standards of care and that the beneficiaries suffered a loss as a result of such act or failure to act. The key is to ensure that the beneficiaries receive the level of care required of fiduciaries and the financial benefits properly due them under the law.

In order to recover hidden assets, it is important that heirs and beneficiaries understand the importance of being proactive and obtaining a forensic wealth management analysis prior to signing any releases or similar documents that an executor, trustee or other fiduciary may ask them to sign purporting to close the estate or trust and release any claims that the heirs and beneficiaries may have against them.  While such documents may or may not effectively preclude the heirs and beneficiaries from bringing actions to recover any hidden assets, it is better to avoid any such legal questions altogether by recognizing the potential fiduciary issues and acting proactively prior to executing such documents.  

At the same time, it is important for fiduciaries, both financial advisers and attorneys, to understand the importance of properly considering and evaluating the existence and the management of all of the beneficiaries’ assets, to ensure that beneficiaries receive all of the financial benefits to which they are entitled.  If my experience is any indication of the future, forensic analysis of estates, trusts and guardianships to ensure the proper treatment of beneficiaries under the law is going to continue to grow, both to protect beneficiaries and to protect fiduciaries against liability claims.

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