Off Shore Trusts: The SEC is Looking; Not Just the SEC

In the last 40 years, the estate planning world has, in the parlance of some, divided into “domestic” and “off shore” practice areas.  As part of the response to U.S. citizens using off shore trusts, the Treasury Department instituted income tax reporting requirements and the bankruptcy  courts addressed whether language in off shore trusts prevents creditors in the United States from reaching the assets and compelled compliance by holding the trust beneficiaries in contempt.  The Federal Trade Commission has weighed in. Recently in a Securities and Exchange matter, civil disgorgement and prejudgment interest imposed by the Southern District Court of New York against two brothers, Texans (one deceased), will probably result in an ever greater chill factor on taxpayers and their counsel practitioners when considering the use of off shore trust planning.  Securities and Exchange Commission v. Wyly and Miller, Executor, 10-cv-5860-SAS (S.D. N.Y. 2014).

U.S. citizens, resident aliens, and certain nonresident aliens must report worldwide income from all sources, including foreign accounts.  Income from those accounts is taxable in the U.S.  The Internal Revenue Service recognizes that there are many legitimate reasons for holding off shore accounts, including convenience, investing, and facilitation of international transactions.  (Often, off shore trusts are referred to as “offshore asset protection trusts” or “OAPTs”.) To use an off shore trust or entity to avoid the payment of tax is not allowed. In most cases, taxpayers with off shore assets need to fill out and attach Schedule B to their income tax returns; Part III of Schedule B requires information about foreign accounts and usually requires reporting of the country in which each account is located.  Certain taxpayers may also have to fill out and attach IRS Form 8938, Statement of Foreign Financial Assets. Additional filing requirements apply to those with foreign trusts.

Another requirement is that a taxpayer whose foreign accounts are greater than $10,000 at  any time during the year must file by June 30 each year Form 114, Report of Foreign Bank and Financial Accounts (FBAR) electronically through FinCEN’s BSA E-Filing System.  (For more details on reporting for foreign accounts, see, “Reporting Requirements for Foreign Accounts”, 39 Tax Management Estates, Gifts and Trusts J. 140 (Bloomberg USA No. 3, May-June 2014)).

Bankruptcy courts that have considered off shore trusts (created under the laws of the Cook Islands, Jersey Channel Islands, Bermuda, for example) have held that the situs for determining if creditors are able to reach the assets is determined under U.S. situs law, not the situs of the OAPT.  In re Portnoy (Marine Midland Bank v. Portnoy), 201 B.R. 685 (Bankruptcy, S.D. N.Y. 1996 ; In re Butler, 217 B.R. 98  (Bankruptcy, D. Conn. 1998); In re Lawrence (Goldberg v. Lawrence), 227 B.R. 907 (S.D. Fla. 1998); aff’d, 251 B.R. 630 (S.D. Fla. 2000, affirming turnover, contempt, and jail time where a self-settled off shore trust in the Mauritas was in issue), aff’d, 279 F.3d 1294 (11th Cir. 2002).

Cases outside of the bankruptcy court have also held that repatriation of off shore trusts’ assets can be ordered where the settlor may have directed that a “protector” can change the trustee.  See the Federal Trade Commission case known colloquially as the “Anderson case” (discussed more below) where a court held both Mr. and Mrs. Anderson in contempt when they refused to repatriate assets in a trust in the Cook Islands and let them do some jail time.

Federal bankruptcy courts are not the only place where U.S. Federal law and the interests underlying the law are used to prevent assets in an off shore trust from being reached by the U.S. citizen’s creditors.  In 1999, the Federal Trade Commission became interested in the off shore trust world.  Federal Trade Commission v. Affordable Media, LLC, 179 F.3d 1228 (9th Cir. 1999) deals with a couple with a Cook Islands trust that had a provision directing any foreign trustee to refuse repatriation if the couple was under “duress”. Why was the FTC interested?  Did you ever see those late-night television infomercials about investing and selling bar bells that could be filled with water and also investing and selling talking pet tags?  The Andersons made millions in what has been described as a Ponzi scheme where they took fees from investors who were never able to recover their investment, much less make money, and then moved the monies off shore.

The interest of the Securities and Exchange Commission has grown over the last 14 years when citizens’ actions really cross the line, resulting in convictions for securities fraud and conspiracy to defraud the United States.  In Securities and Exchange Commission v. Bilzerian, 112 F. Supp. 2d 12 (2000), the taxpayer, after the SEC started proceedings against him, transferred assets to a “complex ownership structure of off-shore trusts and family-owned companies and partnerships.”

More recently, in May 2014,  the Southern District Court of New York held Samuel Wyly and his deceased brother, Charles Wyly, liable for civil fraud in failing to report stock sales by 4 off shore trusts and subsidiary entities (in the Isle of Man) and profits of $553 million:  $123.8 million again Samuel, $63.9 million against Charles and his estate, with prejudgment interest that could result in $300 to $400 million in penalties.  The Wylys sat on the boards of the publicly-traded companies in which the off shore trusts and entities traded, including holding warrants and options.  The judge’s decision included a finding that the Wylys did not continue to file required reports with the SEC after transfers to the off shore trusts because they did not want there to be “inconsistent positions in their SEC and IRS filings when millions of dollars were at stake.”  (The SEC also sued the family’s lawyer – a former Jackson Walker partner and Jones Day consultant, who entered into a settlement agreement before the Wylys’ trial admitting wrongdoing and agreeing to pay $795,000; he also testified at trial.  The Texas State Bar Association website indicates that this attorney is now “retired”.  (The attorney whose seminars led to his consultation on off shore trusts for the Wylys later went to Federal prison for felony money laundering and gambling.)

Of note is that lawyers’ memoranda and meeting summaries were admitted into evidence.  Clearly, there were repeated discussions about the grantor trust status of the off shore trusts for income tax purposes and whether purchase of options and warrants resulted in the off shore entities having taxable, reportable income and also whether renouncing citizenship could help avoid income taxes in the United States.  Also, the court learned of a non-name meeting between three of the brothers’ attorneys and IRS officials in 2003 (before the IRS had initiated an investigation) to discuss voluntary disclosure; the attorneys learned that the IRS was very interested in whether or not SEC requirements had been ignored.  (There is no discussion of the attorney-client privilege and one cannot but wonder if attorney advice will be used routinely in future cases by federal entities to help convict clients of federal crimes and hold them liable for civil penalties.  If so, will the attorney advice also be used to prevent the attorney from practicing before the Federal entity or affect the attorney’s license in the state(s) of practice?).

The judge (Judge Shira A. Scheindlin) recognized that the penalties being imposed were large, quite large: “By any reasonable measure, the disgorgement and prejudgment interest awarded in this proceeding will be staggering and among the largest awards ever imposed against individual defendants.”

The SEC and defendants had six attorneys on each side.  The defendants’ attorneys were all with the same law firm in three different offices, Dallas, Houston, and New York.

Conclusion:  The Federal government wants more and more information about off shore trusts, investments, and companies in which U.S. citizens have interests.  Clients with off shore interests should expect inquiries in one or more of the following areas: (1)  Bankruptcy – especially choice of law being that of the settlor/beneficiary and not (necessarily) that of the state or off shore jurisdiction where the trust was purportedly established; also Congress has changed the Bankruptcy Code to say that any transfer to a self-settled trust within 10 years of bankruptcy can result in trust being included in the bankruptcy estate (11 U.S.C. § 548(e(1)); (2) Federal Trade Commission – if the activities that generated the monies (that are then invested off shore) violated FTC rules (which has clearly happened, but is not necessarily going to be a frequent occurrence), the weight of the Federal government is likely to be exercised through the Federal Trade Commission; (3) Securities and Exchange Commission – the SEC is pursuing citizens and their off shore trusts and entities when one does not comply with SEC reporting rules; and (4) IRS – the Wyly opinion indicates that the IRS has an investigation open into the income taxes that would have been paid had there been no off shore trusts and subsidiary entities (companies).  Between 1992 and 2002, income related to exercise of options and warrants transferred (some by sale) to the offshore trusts and then sold was not reported by 4 public U.S. companies on whose boards the Wylys sat as the Wylys’ position was that the offshore trusts were not taxable in the U.S.  The Federal Judge disagreed, holding that the offshore trusts were grantor trusts as described in Section 674 of the Internal Revenue Code and must disgorge an amount equal to the taxes avoided on profits relating to the exercise of options and sale of stock in the 4 companies where the Wylys were influential insiders (about $112 million for Sam Wyly and $59 million for Charles Wyly).  Section 674 of the Internal Revenue Code treats a grantor as an owner of a trust when the beneficiary enjoyment of that trust “is subject to a power of disposition, exercisable by the grantor or a nonadverse party, or both, without the approval or consent of any adverse party” and that the trustee physically located in the Isle of Man was not an independent trustee and followed dictates delivered by the Wylys.

For a discussion of the possible rather serious fallout in the income tax arena of the Wyly court’s discussion of the offshore trusts as grantor trusts for income tax purposes based on the manner in which the offtrusts operated on a day-to-day basis (and not on the actual provisions in the documentation), see Akers, Resurrection of “De Facto Trustee” Concept – Securities Exchange Commission v. Wyly, 2014 WL 4792229 (S.D.N.Y. Sept. 25, 2014), at www.bessemertrust.com/portal/site/Advisor.

Thus, offshore trusts face not only creditors bringing actions in state court, but various Federal agencies attacking positions taken by the settlors and beneficiaries of such trusts.

Kathleen Ford Bay

Cemetery Plot – Do You Own Any?

If you own one or more cemetery plots in Texas, who gets those plots upon your death?

You might think that the plots will pass pursuant to the Texas Estates Code and to the persons who receive your “residuary estate” (all the rest, residue, and remainder of your estate after specifically described gifts in your Will).  Take a look at the Texas Health & Safety Code, though, and also any contract you have signed with the cemetery association that oversees the particular cemetery where you own plots.

            What is a plot?  “ ‘Plot’ means space in a cemetery owned by an individual or organization that is used or intended to be used for interment, including a grave or adjoining graves, a crypt or adjoining crypts, a lawn crypt or adjoining lawn crypts, or a niche or adjoining niches.” Texas Health & Safety Code § 711.038(25).

            Who gets the plots when you die (to the extent not used for your internment)?  If you have a Will, you must specifically describe the plots and then give them to one or more persons.  Or, during your life, you may do a written declaration, filed and recorded in the cemetery organization’s office, stating who is to receive the plots upon your death.  (Check with the cemetery organization as it may have a form it wants you to use.)

            If you do neither, then the right to use (be interred) in your cemetery plots passes as follows: (1) to your surviving spouse, (2) to your children in order of need “without the consent of a person claiming an interest in the plot”, and (3) to your heirs at law.  Health & Safety Code § 711.039 is where these rules are set forth; it is quite repetitive and not all that clear,  What is clear, however, is that even though a cemetery plot is real property, unlike a deed to a residence, commercial buildings, and raw land, its ownership is not conveyed by filing a deed in the official public records.  Its ownership is recorded with and controlled by the records of cemetery organization which controls the cemetery where the plot is located.  Plots are different from other real property; see Oak Park Cemetery v. Donaldson, 148 S.W.2d 994 (Tex. Civ. App.-Galveston 1940, writ dismissed) discussing that plots are a right of burial, akin to an easement, license, or privilege.

            Are you able to sell your cemetery plot to a friend who needs one for a deceased relative of theirs?  Maybe and maybe not.  You also have to check the contract with and governing documents of the cemetery organization.  You may be surprised to learn that if you want to sell the cemetery plot, you may be required to sell it back to the cemetery organization, perhaps for the same amount paid for it.

            If you have cemetery plots that are important to your family, please be sure to deal with them by specifically describing them in your Will or completing paperwork with the cemetery organization that directs who receives the plots upon your death.  What happens if the plots are located in a cemetery that no longer has an active cemetery organization?  Consult an attorney.  It could well be that the right to the plots will just keep descending to the heirs of the original owners.  All the living heirs might be required to sign off on any interment, such as the placing of ashes into a grave which already has a relative’s body buried there.  This could become rather unwieldy.  The living heirs might be able to designate one of them as an “agent” to give directions regarding the plots.  

– Kathleen Ford Bay.

Will gives Real Property to Beneficiary/ies; Do You Need Executor to Record a Deed?

In Texas, the answer is “no”.  (If the decedent died in a county other than the one where the real property is located, a court-authenticated copy of the Will and the order admitting the will to probate needs to be recorded in the other county.)  However, Texas is a “title company state” and the new owner or owners really need a title policy that “insures” ownership to them and insures that if there is ever a challenge to ownership, including liens on the property, the title company will pay the legal fees, not the insured owners.

The beneficiary/new owner really should get a title policy as soon as the Executor indicates that he, she, or it will receive ownership of the property (that is, the estate is not insolvent and the real property will, therefore, not have to be sold to pay creditors or, in any event, the real estate is exempt from non-secured creditors of the decedent).  If the beneficiary delays a year or more after death and probate, the title company may require a deed before it will insure the title.  The title company may ask for a deed even if the beneficiary requests one soon after death and the probate of the Will.  You’ll have to decide if it’s less expensive to have the Executor’s attorney draft a deed or ask a different title company if it is willing to insure the title without requiring a deed. 

Note, that if the Will gives real property to a surviving spouse who is already on the title policy, title insurance may not be necessary.  You should review the title policy and ask the title company, or its successor if it is no longer in existence, to confirm in writing that the surviving spouse’s ownership is completely insured.  (Do not be surprised if the surviving spouse cannot find it and you have to request a copy from the title company.)

You may want to pay a title company to run a search of the real property records (“official public records”) to see if there are any liens either on the property or recorded in the name of someone with a name similar to the decedent.  For example, there may be a mechanic’s lien filed when someone was doing work on your property to insure that you paid your bill.  You may actually have paid your bill and the worker forgot to release the lien.  You will either need to get the worker to sign a release now and, if not available, find out what the title company will need in order to accept proof that the bill was paid.  (In some cases, you may need to get a court order to that effect.)  If there are, you can decide whether to deal with them currently or wait.

– Kathleen Ford Bay

Opening Accounts Banks and Other Financial Institutions; Making Changes to Accounts: The Know Your Customer Rules and How One Bank is (Mis)Interpreting Them

Recently, one of the co-authors, Kathleen (Kathy) Bay encountered the following at J.P. Morgan Chase Bank (“Chase”) where Bay has a safe deposit box to hold original documents of clients and also other old accounts (including ones for children) (dating from 1987).  All Bay wanted to do was add another attorney at the firm as a signatory on the safe deposit box.  After a hearing at probate court one day, Bay and another firm attorney went to Chase.  The customer service gentleman refused to add a new signature unless Bay revealed to him all investment assets she has that were not at Chase.  The reason?  The customer service gentleman said, basically, that “I have to get this information as part of Chase’s Know Your Customer rules.  This is not Chase; the Federal Government requires it.

Bay refused to provide this information, pointing out that she had been a customer for 25 years and if Chase did not know her yet to its satisfaction, it never would.  Bay also offered to sign a statement that she had no off shore assets as she thought perhaps that was one of the concerns Chase might have.

Bay has spoken to an attorney in Chase’s general counsel’s office who stated that Federal law does not specifically require that the question about a customer’s finances needs to be asked.  However, committee members at Chase developed the list of questions so Chase can better serve all its customers by “knowing” them.  Bay noted that she had called a different bank to ask if it was asking this question; the answer was, “no”.  The counsel’s response:  Chase is the first bank to do this.  In 5 years, other banks will be following Chase’s lead.

One can only wonder, why is Chase doing this?  As a result of Chase’s involvement in the Bernie Maddoff fiasco, including consent decrees and agreements with the Feds, Chase may, as of August 1, 2014, have adopted Know Your Customer Rules that are, in Bay’s opinion, truly overreaching.  Is this a case of Chase making lemonade out of the lemons of being under great scrutiny from the Feds?  That is, if you let Chase know what else you own, will this information be used to try to get you to transfer your other assets to Chase and to sell you other products?

Be prepared, though, that if other banks do follow Chase’s lead, you may either be coerced into revealing private information that you consider to be “none of the bank’s business” or being in a position where you are unable to open a bank account or make changes to one you already have.  The silver lining?  You should be able to close an account (or safe deposit box) without revealing private information because you will no longer be a customer if you do so.

Right now, what Chase asks of a corporation is much less than what it asks of an individual.  You can create a corporation and bypass the overreaching Know Your Customer rules that way.  Being forced to create a corporation just to avoid such rules is, in the opinion of this author, yet another act of overreaching.

– Kathleen Ford Bay

Durable (Financial) Powers of Attorney, “General”

Background.  You will want to consider a durable (financial) power of attorney when you engage in estate and disability planning.  You will be giving your agent the ability to do much that you, if personally present, could do.  You may appoint your agent under a “general power of attorney” – with lots and lots of authority -- or a “limited” or “special” power of  attorney; for example, a special power of attorney may authorize your agent to sell a car or your home only.  Do not ever appoint as an agent someone you do not trust.  Some people do appoint a relative who is not really trustworthy as agent – this is probably magical thinking: “If I become incapacitated, surely Johnny Boy, my son, will see the light and behave properly.”  Really?  Would you tell your best friend to do this?

Texas has adopted the Uniform Power of Attorney Act (set forth in the Estates Code), including a form (suggested) and the “short form” powers.  For example, the short form power “real property transactions” which is on the actual power of attorney is defined in the Estates Code as granting to the agent a great deal of authority, including the power to: “sell, exchange, convey with or without covenants, quitclaim, release, surrender, mortgage, encumber, partition or consent to partitioning, subdivide, apply for zoning, rezoning, or other governmental permits, plat or consent to platting, develop, grant options concerning, lease or sublet, or otherwise dispose of an estate or interest in real property or a right incident to real property”.

If you choose all of the short forms, you will have granted so much authority to your agent that, colloquially, you will be said to have a “general power of attorney”.  (Starting January 1, 2013, you must initial before each power you want or initial at the end if you want your agent to have all of the listed powers.) 

Unless you choose, using the statutory form or a variation, to make your agent’s authority last beyond your incapacity (effective when you sign it and good even if you are incapacitated – “durable”) or become effective on your incapacity (“springing”), your agent’s authority ends if and when you become incapacitated.  Your Power of Attorney is not effective after your death.

Discussion.  Co-Agents?  Living Revocable Trust?  If you do not have someone who is trustworthy who you can appoint as an agent, consider a revocable trust (also called as a “management trust” and a “living trust.”)  With a revocable trust, you can appoint Co-Trustees and require them to act jointly or allow each to act separately.

If you have someone you trust, you also may appoint one agent or more a Co-Agents and require the Co-Agents to act jointly or allow each to act separately.

BUT,  please note that banks and other financial institutions may not want to be responsible for making sure that Co-Trustees or Co-Agents actually act together.  Recently, two children of a client of our firm were required under the power of attorney he had done years ago to act jointly.  The bank refused to honor the direction that they act jointly (apparently, due to concerns about liability).  Instead, before the bank would allow them to act at all (even jointly), the bank required that each sign an indemnification agreement confirming that the bank was not responsible for making sure that each signed checks or jointly gave transfer and other instructions and also required each to indemnify the bank against any complaints one might have against the other as a Co-Agent.

What do you do to plan for your Co-Agents and/or Co-Trustees refusing to act jointly, especially when the bank is likely not to require joint actions?  Consider asking your attorney to draft in your Power of Attorney or Revocable Trust a plan to be triggered if this happens, like granting to the Agent or Trustee who is following the rule the right to go to  court without notice to the Agent or Trustee who is taking unilateral actions and get a temporary restraining order (“TRO”); authorize the Agent or Trustee who is following the rules to invoke a mandatory mediation or arbitration to be paid for from funds of the principal (who signed the power of attorney) or Trust; include a provision that if a Co-Agent or Co-Trustee who is required to act jointly acts unilaterally, that the Agent or Trustee will be treated as having resigned and an alternate treated as succeeding as Co-Agent or Co-Trustee; and look into whether a bank will allow the Co-Agents or Co-Trustees to pen a so-called safekeeping account (by court order or otherwise) where nothing will be released to pay bills unless both have signed. 

– Cindy W. Veidt, Maura Phelan, and Kathleen Ford Bay