By William Campbell Ries, Esq.

The four Federal banking agencies  (“Agencies”) (the Office of the Controller of the Currency, the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation and the Office of Thrift Supervision) jointly issued a policy statement on January 5, 2004 alerting banks of the regulators’ concerns over safety and soundness and the legal impediments to a bank providing financial support to investment funds which are advised by the bank or its affiliates.  It also states that the regulators believe investment advisory services can pose material risks to a bank’s liquidity, earnings, capital and reputation, and can harm investors, if the risks associated with such services are not adequately controlled.

The Agencies state: 

“To ensure safe and sound banking practices, today’s policy statement makes clear that a financial institution should not inappropriately place its resources and reputation at risk for the benefit of the fund’s investors and creditors.  In addition, financial institutions should not violate the limits and requirements contained in applicable legal requirements or in any supervisory conditions imposed by the agencies, and should not create an expectation that they will prop up an advise fund.”

Federal laws and regulations such as Section 23A and 23B of the Federal  Reserve Act and Regulation W place significant restrictions on transactions between banks and their advised funds. 

The policy statement requires banks to adopt appropriate policies and procedures governing transactions with bank advised investment funds.  These include assurances that the bank will not:

• Inappropriately place its resources and reputation at risk for the benefit of the funds’ investors and creditors;

• Violate the limits and requirements contained in Section 23A and 23B, Regulation W and other applicable legal requirements; or

• Create an expectation that the bank will prop up the advised fund.  The bank should also maintain appropriate controls over investment advisory activities to ensure that the advised investment funds are properly managed and maintained. 

The policy statement requires banks to review their practices in this regard and adopt appropriate policies and procedures to conform with the regulatory directives. 

William Campbell Ries is chair of the firm’s Investment Management & Fiduciary Services Group. For more information on this topic or for assistance with your review and/or developing your policies and procedures, please contact Bill at 412.594.5646 or via e-mail at wries@tuckerlaw.com.

^ Back to top

Pennsylvania Estate Tax De-Coupling and Re-Coupling

Pennsylvania recently enacted new legislation which will result in the elimination of the Pennsylvania estate tax when the Federal State Death Tax Credit is eliminated in 2005. However, until then the Pennsylvania estate tax will be based on the actual State Death Tax Credit.

Pennsylvania Re-Couples: 

On December 23, 2003 Governor Rendell signed Act 46 into law.  This Act reversed the previous decoupling of Pennsylvania estate tax from the Federal estate tax.  The Pennsylvania estate tax is once again determined by the current federal estate tax State Death Tax Credit and applicable credit amount.  Under current law, therefore, the Pennsylvania estate tax will be reduced and finally eliminated in 2005.

The Fall-Out from EGTRRA: 

The Federal Economic Growth and Tax Relief Reconciliation Act of 2001 (“EGTRRA”) in addition to increasing the applicable credit amount also gradually phased out the State Death Tax Credit between 2002 and 2005 (by 25 percent per year), with the complete elimination of the credit for decedents dying in 2005 and thereafter, until 2011 when EGTRRA expires.  Generally speaking, this State Death Tax Credit reduces the federal estate tax by the amount of death taxes paid to any state, up to a maximum rate of 16 percent  based on a graduated scale.  Most states collect death taxes based at least in part on the amount of the State Death Tax Credit.  As the State Death Tax Credit is gradually reduced and finally eliminated, the same will happen to those states’ revenue from death taxes.  Many states have taken actions to decouple their death taxes from the federal law so that their revenue streams are protected from adverse consequences as the result of changes in the federal law.

Impact on Pennsylvania: 

Pennsylvania has both an inheritance tax and an estate tax.  Inheritance tax is not based on the federal estate tax but instead is a percentage of the value of the estate subject to tax, with the percentage determined by the relationship between the decedent and the person receiving the assets.  Pennsylvania’s estate tax, however, is directly based on the federal estate tax in that the amount of the estate tax is equal to the amount by which the State Death Tax Credit exceeds the inheritance tax actually paid by the estate. 

Pennsylvania’s Initial Response - De-Coupling: 

On June 28, 2002, Pennsylvania enacted Act 89 which applies to decedents dying after June 30, 2002.  The Act provides that the amount of the Pennsylvania estate tax is the amount that would be owed under the federal estate tax  system as it existed on June 1, 2001, and that the state may require another tax form (Federal Form 706) to be filed  reflecting the tax results under the prior system, even if the estate is not required to file an actual Federal Estate Tax Return.

Under Act 89, the Pennsylvania estate tax is, therefore, determined based on the amount of the State Death Tax Creditthat would have been allowed to the estate prior to EGTRRA.  Additionally, the State Death Tax Credit is based on the applicable credit amount indicated by the prior Federal Estate Tax Law, which for 2002 was $700,000, not $1,000,000 as provided for by EGTRRA.

Pennsylvania’s De-Coupling Challenged: 

In October 2003 Tucker Arensberg filed an appeal for a client challenging the constitutionality of Act 89 and the Pennsylvania estate tax generally as being in violation of the uniformity clause of the Pennsylvania Constitution.  A full refund of the disputed tax (almost $200,000) was obtained for the client.

Tucker Arensberg Handles Tax Refund Cases: 

If you are administering estates for decedents dying after June 30, 2002 that paid the additional Pennsylvania Estate Tax as the result of Act 89, we would be pleased to assist you in obtaining a refund from the Pennsylvania Department of Revenue. 

^ Back to top

Treasury Department Issues Final Trust Income Regulations

By Charles J. Vater, Esq.

Effective January 2, 2004, final regulations were issued by the U.S. Department of the Treasury concerning the definition of trust income under state law.  These final regulations answer questions raised by the proposed regulations which have been in effect since February 15, 2001.

The final regulations make it clear that the conversion of an “income” trust to a unitrust and the exercise of a power to adjust do not affect the marital deduction, do not constitute a gift, and do not cause a sale or exchange for income tax purposes.  Most significantly, however, the final regulations make it clear that the conversion to a unitrust definition of income or the exercise of the power to adjust in accordance with the UniformPrincipal and Income Act (UPIA) will not be considered a “shift of beneficial interest” from one generation to another, and therefore, an exempt generation skipping transfer (GST) trust will not lose its grandfathered status for GST tax exemption purposes.

By way of background, the proposed regulations attempted to revise the definition of trust income for purposes of Section 643(b) of the Internal Revenue Code.  The proposed regulations took on significant meaning for Pennsylvania trusts when Pennsylvania adopted the UPIA which became effective on July 15, 2002.   

When the proposed regulations (particularly the examples used therein) and the UPIA were read together, there was some question as to whether or not aconversion of an “income” trust to a unitrust or the exercise of the power to adjust under the UPIA might cause certain tax problems, especially relating to the marital deduction and the loss of “grandfather” status for certain exempt GST trusts.

If you would like to discuss the effect of these final regulations on trusts under your administration, please feel free to contact any of the members of the Investment Management and Fiduciary Services Group at Tucker Arensberg.

Charles Vater is a shareholder in the firm’s Investment Management & Fiduciary Services Group and Chair of the firm’s Estates and Trusts Practice Group. For more information on this topic, please contact Chuck at 412.594.5556 or cvater@tuckerlaw.com.

^ Back to top

No Ring. No License. No Problem. Common Law Marriage Survives

By Neil J. Gregorio, Esq.

Historically, some individuals claiming the status of common law marriage have been successful in defrauding employers, insurance companies, and pension and benefit plan administrators for spousal healthcare and related benefits.  Because of the lack of formalities involved in a common law marriage, a third party can never be certain of whether a common law marriage is “real,” or whether the couple is committing fraud. 

In Pennsylvania, two unmarried heterosexual adults can create a common law marriage by exchanging marriage vows without a minister or judge present.  Although their exact words do not have to be: “I take you as my husband/wife,” the words must express a present intention to marry rather than an intention to marry in the future.  As long as the couple had the intention of forming a marriage when they exchanged vows, they are married from the time they stated the words.  Accordingly, each individual is then entitled to all of the benefits of a married spouse.

As recently as 1998, in Staudenmayer v. Staudenmayer, the Pennsylvania Supreme Court stated that it would not abolish the doctrine of common law marriage and that such a decree should come from a legislative act rather than a judicial decree.  Since then, the Supreme Court has not reversed its position, and the legislature has not amended the Divorce Code and/or the Domestic Relations Act to abolish common law marriage. 

Nevertheless, in a decision that appears to contradict the high court’s Staudenmayer decision, the Pennsylvania Commonwealth Court rendered a decision that could, in effect, abolish the doctrine with respect to common law marriages formed after September 17, 2003. 

In PNC Bank Corp. v. Workers Compensation Appeal Board (Stamos), a bank employee, Janet Stamos, died in an airplane crash in 1994 while working for PNC.  The man with whom she had been living since 1989, John Kretz, sought to collect Stamos’ pension and benefits as a surviving spouse.  Kretz successfully argued before a Workers’ Compensation Judge (WCJ) that he was Stamos’ common law spouse and that he was entitled to her pension and benefits from PNC.  On appeal, the Workers’ Compensation Appeal Board affirmed the WCJ’s decision, and PNC appealed to the Commonwealth Court.

Although the judges of the Commonwealth Court unanimously agreed that Kretz was the common law spouse of Stamos, four of the seven judges felt it appropriate to make an “anticipatory overruling” of Staudenmayer and prospectively abolish common law marriage based on the Supreme Court’s expressed dislike for fraudulent claims that the common law marriage doctrine can foster.  Consequently, if this ruling is given effect, all common law marriages formed after the date of September 17, 2003 are void.

Because the “abolishment” is “prospective,” Kretz will receive the pension and benefits of his deceased spouse.  As  to future claims, however, employers might not be obligated to pay spousal benefits to individuals claiming to be in a common law marriage formed after September 17, 2003.  However, because the Commonwealth Court did not cite to any authority for its “anticipatory overruling” of the Pennsylvania Supreme Court’s statement in the Staudenmayer case, the “prospective abolishment” of common law marriage is questionable at best. Despite the Commonwealth Court’s expressed intent to abolish the doctrine of common law marriage, the PNC Bank decision is inconsistent with the high court’s Staudenmayer decision.

Therefore, employers, insurance companies, and pension and benefit plan administrators should continue to recog-nize the doctrine of common law mar-riage until the legislature or the Pennsylvania Supreme Court speaks otherwise.  In any case, decisions to deny coverage based on the validity of an employee’s common law marriage, or the continuing validity of the doctrine itself, should not be undertaken without consulting legal counsel.

Neil Gregorio is an attorney in the firm’s Labor and Employment Practice Group and represents employers and employee pension and benefit plan administrators in benefit claims litigation arising under the Employee Retirement Income Security Act of 1974 (“ERISA”).  If you would like more information about this topic, please contact Neil at 412.594.3911 or via e-mail at ngregorio@tuckerlaw.com.

^ Back to top

Indenture Trustees No Longer Able To Rely On Representations Of Issuer And Bond Counsel

A late May ruling in the Superior Court for Island County, Washington, has raised many concerns involving duties and responsibilities of indenture trustees with regard to the acceptance of new corporate trust accounts.  The case of Trimble v. Holmes Harbor Sewer District involves the financing of $20 million of revenue bonds to facilitate a six-building office park project in Snohomish County, Washington.  The indenture was issued by Holmes Harbor Sewer District (“Holmes Harbor”), and U.S. Trust Company, N.A. (the “Trust Company”) serving as indenture trustee.  The Bank of New York Western Trust Co. (the “Bank”) became the successor trustee after taking over U.S. Trust Company’s trust business. 

In the State of Washington, a water and sewer district must use the county treasurer or its designee as trustee for all municipal bonds issued except revenue bonds, in which case a private trustee may be appointed.  The bondholder instituted a class action lawsuit, alleging that the bonds were illegally issued and invalid since the bonds were not in fact revenue bonds and therefore Holmes Harbor was required to use the county treasurer or its designee as trustee rather than the Trust Company.  The issuer, Holmes Harbor, and bond counsel, both represented to the trustee Bank that the bonds being issued were revenue bonds. 

Court Ruling

The court in a May 2003 hearing held that the bonds were not revenue bonds, therefore making the indenture between Holmes Harbor and the Bank invalid and unenforceable.  It also held that the indenture trustee should have discovered the illegality of the issuance prior to entering into the indenture. 

The court held that the trustee had a duty prior to becoming trustee to investigate and ensure the legality of the bonds and the creditworthiness of the issuer.  According to the court, relying on the representations of the assurances of bond counsel and the issuer are not sufficient to protect the trustee from liability.  A trustee has a duty to retain independent counsel to determine the legality of the indenture.    

The court issued the following sanctions against the Bank:

• The Bank was removed as indenture trustee.

• The Bank was ordered to account for all funds received from U.S. Trust Company, the original indenture trustee, all funds held for the benefit of the bondholders, and all funds disbursed as interest payments, administrative costs or legal fees, or payment of costs.

• The Bank was required to pay all funds in its possession under the indenture over to the Court Clerk of Island County Superior Court.  The County Clerk will hold these funds pending further order of the Court.

Implications

Indenture trustees are now responsible for the development of a due diligence process to analyze new business transactions.  This process should ultimately include the evaluation of business risks, such as, the creditworthiness of the issuer, and the professional experience and reputation of bond counsel and accountants.  Indenture trustees may not simply rely on the representations made to them by these other parties to a transaction, rather than conducting their own independent investigations.  Indenture trustees now must thoroughly evaluate their duties and responsibilities prior to accepting new corporate trust accounts.  This evaluation should include the creditworthiness of the issuer, the expertise of bond counsel and accountants involved in the transaction.  Indenture trustees must take the time and expense to ensure that the transactions they are entering into are legal, because the assurances of issuers and bond counsel are simply not enough.  Trustees must have their business transactions reviewed and if necessary retain outside experts to protect them from liability.  Indenture trustees often do not have the required expertise in house to conduct a thorough due diligence and should therefore consider hiring experts or outside counsel to assist with the risk assessment.    In light of these new requirements, we would be pleased to assist corporate trustees with evaluating new indentures for which they are asked to serve.

^ Back to top

Pennsylvania Uniform Trust Act

By William Campbell Ries, Esq.

The Pennsylvania Joint State Government Commission Advisory Committee on Decedent’s Estates submitted a report to the Pennsylvania legislature recommending the enactment of the Pennsylvania Uniform Trust Act.  If enacted, this legislation will have a significant impact on the administration of trusts in Pennsylvania.  The proposed legislation adopts numerous provisions from the Uniform Trust Act as adopted by the Commissioners on Uniform State Laws; however, certain provisions deviate substantially from the Uniform Act in order to preserve existing Pennsylvania trust law.  If enacted, it will be important that all Pennsylvania fiduciaries become familiar with the provisions of the Act as they will impact trustees’ duties and responsibilities in connection with the administration of Pennsylvania trusts.

Some of the key provisions of the proposed Act are as follows: 

Notices

The Act requires a trustee to communicate with the trust’s beneficiaries and requires the trustee to respond to reasonable requests for information at the request of the beneficiaries.  The trustee is required to notify the beneficiaries of various events occurring after a trust becomes irrevocable.

Revocable Trust as Will Substitutes

The Act expressly accepts revocable trusts as will substitute in Pennsylvania.  It will apply many of the rules applicable to wills to revocable trusts since many settlors employ a revocable trust as a will substitute.  Some of the rules made applicable include standards as to the capacity to execute a revocable trust, the ability to contest irrevocable trusts, notices to the settlor’s family, rules of construction, and provisions dealing with claims of creditors. 

Virtual Representation

Concepts of virtual representation have been expanded under the proposed Act. Under the Act a person may represent minors and unborn descendants unless a conflict of interest arises between them as a result of such representation.  This representation applies to releases, settlements and other transactions both before a court and otherwise.

Choice of Law

A settlor is given the power to choose the applicable law that will govern the meaning in construction of a trust. 

Situs and Venue 

A trustee will be permitted to change the situs of a trust to a state or county by providing notice to the primary beneficiaries and obtaining their consent.  Change of situs is still subject to Court approval. 

Removal of Trustees 

In addition to the removal of the trustee for cause, a new “no-fault” basis to remove a trustee is added so long as a Court concludes that such removal is in the best interests of the beneficiaries and is not inconsistent with the purpose of the trust.

Spendthrift Clause

Certain exceptions are carved from the spendthrift provisions for a beneficiary’s child, spouse or former spouse who has a judgment or court order against the beneficiary for support or maintenance, including a judgment creditor who provided services to protect the beneficiaries’ interests in the trust.  Otherwise, spendthrift provisions are virtually the same as under present law. 

Presumption of Revocability 

Under present Pennsylvania law trusts are presumed to be irrevocable.  Under the Act, trusts will be presumed to be amendable and revocable.

Trustee’s Compensation 

The provisions governing trustees’ compensation codify existing Pennsylvania law and clarify some of the ambiguities regarding a trustee’s compensation. 

Mandatory Rules 

Certain mandatory rules are set forth that cannot be altered in the trust instrument. 

Oral Trusts 

Under the new Act, oral trusts will no longer be recognized.

Applicability 

The Act will apply both to trusts created before and after the enactment of the Act. 

It is not known when the legislature will consider the Act and what changes it will make to the recommendations of the Advisory Committee.  There is no action required at the present time.  We will continue to follow the status of this legislation as will the Advisory Committee and the Pennsylvania Bankers Association.  We will provide you with additional information when the Act is adopted.

William Campbell Ries is a shareholder in the firm’s Investment Management & Fiduciary Services Group. For more information on privacy issues, please contact Bill at 412.594.5646 or via e-mail at wries@tuckerlaw.com.