Read our article in the Cayman Financial Review Magazine, eversion 

Introduction 

The focus and pressure on trustees from regulatory bodies and stakeholders (beneficiaries, settlors, protectors and other interested parties) has never been greater. Legal, commercial, financial and professional risks to trustees who are responsible for complex portfolios of businesses continue to increase. More sophisticated beneficiaries and settlors are demanding a higher degree of transparency from trustees into the financial affairs of the trust. Often it is the lack of transparency into the financial affairs of the trust that is core to any dispute amongst stakeholders, resulting in the trustee’s actions being placed under an even higher degree of scrutiny. 

In this article we examine a number of challenges we have seen trustees face to maintain accurate and meaningful financial records and highlight selected best practices for trustees to consider, which can mitigate the risk of trust accounts becoming the subject of a future dispute. 

Change in circumstance 

Throughout the life of a trust fundamental changes often occur, some planned and others unexpected. The injection of new funds, sale of assets, restructuring, divorce, addition or removal of beneficiaries and death of settlor are all examples of instances which can lead to dispute amongst different stakeholders in the trust. These disputes are generally between family members, as beneficiaries of the trust, and a polarisation of interest quickly occurs when one group may have had, or perceived to have had, more transparency into the operation of the trust. Because emotional attachment trumps a commercial mindset to resolve the matter quickly, the trustee is caught in the middle and has to deal with immediate and burdensome requests for up to date financial information in order to close the transparency gap.  

If the trustee has maintained accurate records during the life of the trust and has fulfilled the financial reporting requirements as mandated by the trust deed, there is lower risk that the trustee will not be able to meet these information requests on a timely basis and therefore it is less likely that the trustee will find itself in a contentious situation. If the trust accounts have not been maintained on an accurate, consistent and current basis, then the trustee opens itself up to potential backlash from the trust’s stakeholders, or worse, a breach of trust claim for failing to maintain accurate records.  

One example of a case, in which the authors were involved, concerned a dispute between beneficiaries, which had arisen in the wake of a significant change of circumstance in the trust. Assistance was provided to the trustee and their legal team by recreating several years of financial reports for the trust, which were required due to inadequate record keeping and financial reporting over the life of the trust. While the dispute may still have arisen had reliable, timely and accurate financial reports been available, the dispute would have been based solely on principle rather than concern over lack of information, accountability and transparency. 

The lack of reliable financial information and transparency only serves to intensify any dispute amongst the trust’s stakeholders, meaning increased frustration for all parties and potentially significant legal costs. If a trustee finds itself in this situation, immediate steps should be taken to assess risk exposure and then to correct or prepare proper accounts. This will result in unforeseen costs to the trustee or the trust, which is likely to be insignificant in comparison to costs associated with a prolonged legal dispute.  

When a significant change in circumstance involving the trust has occurred, a proactive approach by the trustee to ensure transparency into the trust is a key consideration. If for example a family patriarch has passed on as in the scenario described above, the trustee will likely be required to report to new parties who may not be intimately familiar with the trust structure and its assets. Trust beneficiaries will likely have questions regarding the trust’s financial affairs and may be predisposed to thinking that the trustee is purposely failing to disclose complete information or is otherwise disadvantaging them in some way. For example, upon seeing a trust’s balance sheet for the first time, a beneficiary may have an inherent bias in thinking that the asset values are understated, without any reasoning other than believing that they must somehow be entitled to more wealth than actually exists. Similarly, beneficiaries may be surprised and angered when realising for the first time that other beneficiaries may be entitled to a greater portion of the family’s wealth.  

Limiting the possibility of dispute – selected best practices 

In the following section we examine measures which trustees can take to limit the possibility of a dispute from occurring in the first place or at least be prepared to handle a potential dispute. These measures include ensuring that appropriate financial reporting language is included in the trust deed and having systems and resources in place to ensure accurate and timely financial reporting.  

The trust deed is the starting point for determining the format and frequency of the trust accounts and other financial reporting measures. For the purposes of drafting financial reporting language in the trust deed, it is important to understand who the primary users of the trust accounts and other financial reports will be and what use they have for the accounts and reports. In some cases the financial reporting will be for information purposes only, to support tax filings in single or multiple jurisdictions, or perhaps the impact of financial results on distribution entitlements to beneficiaries. 

Depending on structure, the trust deed should include language robust enough to deal with the reporting on a potentially diverse and complex portfolio of assets, which may include real estate, private equity investments, publicly traded securities, art and other collectibles, yachts or aircraft. 

Other points which should be considered when drafting financial reporting language in the trust deed include: 

If the trust accounts are subject to audit or review by an independent party, an increased administrative burden should be considered by the trustee. This should also include an assessment of the necessary records to be retained and the duration to keep such records. 

Depending on the domicile of the trust or underlying trust assets, knowledge of statutory reporting requirements and information to be retained by the trustee should be considered. 

There are several choices when it comes to determining the accounting principles to be used for preparation of trust accounts such as International Financial Reporting Standards or country specific generally accepted accounting principles. While this may be partially dictated by the statutory requirements, it is important that trustees are aware of differences in accounting principles when it comes to reviewing the financial reports of underlying trust investments. 

Many trust structures contain investments in complex assets which are inherently difficult to value including derivative financial instruments, real estate, or common or preference shares in underlying holding or operating companies. Consideration should be given as to the basis on which the assets will be valued (acquisition cost or fair market value for example) and reported in the trust accounts. Depending on the nature of the asset, the trust deed may call for the trustee to obtain assistance in the form of an independent valuation specialist to perform a valuation of the asset.  

The language in the trust deed should adequately address the financial reporting needs of the users of the trust accounts as well as any statutory reporting requirements. Accordingly we recommended that the trustee with assistance from their accountants, are engaged in the process of drafting the financial reporting language in the trust deed. 

Other considerations and their impact on financial reporting 

While the scope and complexity of financial reporting issues a trustee is faced with will ultimately depend on the particular nature of the trust structure and its assets, trustees should also consider: 

The level of visibility, if any, the trustee has in relation to the operation and financial reporting of private businesses that the trust may have invested in. Trustees should seek to gain an understanding of business operations as well as the key members of management. Trustees may experience difficulty in extracting meaningful information out of company management, if for example the operations are located in a jurisdiction where statutory reporting requirements are less stringent or which is unaccustomed to the concept of transparency and full disclosure. In this case, the trustee may consider visiting the company’s headquarters or primary place of business as often the most efficient method of understanding a business is to be “on the ground” and observing its operations first hand. 

Recent regulatory changes have been adopted which may also impact reporting and record keeping measures on the business. Assessment of exposure to requirements under the new Foreign Account Tax Compliance Act, increased enforcement of the Foreign Corrupt Practices Act in the United States and the introduction of the United Kingdom Bribery Act may give rise to actual and contingent liabilities within a trust which may also need to be disclosed for financial reporting purposes, particularly where the trust or any entities held within the structure are connected with US or UK persons as defined by the relevant legislation. 

Conclusion 

While the pressures from regulatory bodies and stakeholders in trust activities has never been greater, we have shown above that the trustee can take proactive measures to limit or mitigate legal, commercial, financial and professional risks. By adhering to clearly defined financial reporting policies and addressing accounting issues within the trust deed itself, transparent, accurate and timely financial information can alleviate the possibility of the trust accounts becoming the subject of future dispute, saving the trustee and stakeholders valuable time and limited resources.