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 about the financial affairs of the trust. Often the lack of transparency about the financial affairs of the trust is core to any dispute among stakeholders, resulting in the trustee’s actions being placed under an even higher degree of scrutiny.

So what challenges do trustees face when trying to maintain accurate and meaningful financial records? And what are the best practices for trustees aiming to mitigate the risk of trust accounts becoming the subject of a future dispute?

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 events that can lead to dispute among 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 is perceived to have had, more transparency into the operation of the trust. The trustee, caught between emotional attachment and commercial thought, has to deal with immediate and burdensome requests for up-to-date financial information 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 less 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 themselves in a contentious situation. If the trust accounts have not been maintained on an accurate, consistent and current basis, the trustee opens themselves up to potential backlash from the trust’s stakeholders or, worse, a breach of trust claim for failing to maintain accurate records.

‘Regulatory changes may affect reporting and record-keeping measures’

One example of such a case 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 because of inadequate record keeping and financial reporting over the trust’s life. 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 among the trust’s stakeholders, meaning increased frustration for all parties and potentially significant legal costs. If a trustee finds themselves 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 for the trustee or the trust, but these are likely to be insignificant in comparison with the costs associated with a prolonged legal dispute.

When a significant change in the trust’s circumstances has occurred, a proactive approach by the trustee to ensure transparency of the trust is a key consideration. If, for example, a family patriarch has died, as in the scenario described earlier, the trustee will probably be required to report to new parties, who may not be intimately familiar with the trust structure and its assets. Trust beneficiaries are likely to have questions about the trust’s financial affairs and be predisposed to thinking that the trustee is purposely failing to disclose complete information or is otherwise disadvantaging them in some way. For example, on seeing a trust’s balance sheet for the first time, a beneficiary may have an inherent bias toward thinking the asset values are understated, for no reason other than believing that they must 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.

Trustees can take measures to limit the possibility of a dispute from occurring in the first place, or at least be prepared to handle a potential dispute. These 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 only, to support tax filings in single or multiple jurisdictions, or perhaps to explain 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 to consider 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. Although 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 that are inherently difficult to value, including derivative financial instruments, real estate and common or preference shares in underlying holding or operating companies. Consideration should be given 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, it is recommended that the trustee, with assistance from their accountants, is engaged in the process of drafting the financial reporting language in the trust deed.

The scope and complexity of financial reporting issues a trustee faces will ultimately depend on the particular nature of the trust structure and its assets, but 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 an understanding of business operations and the key members of management. They may experience difficulty extracting meaningful information from 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, observing its operations first-hand.

Recent regulatory changes may also affect reporting and record-keeping measures. The new Foreign Account Tax Compliance Act, increased enforcement of the Foreign Corrupt Practices Act in the US and the introduction of the UK’s Bribery Act may give rise to actual and contingent liabilities within a trust. This 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.

So, while the pressures from regulatory bodies and stakeholders in trust activities have never been greater, the trustee can take 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 reduce the chance of the trust accounts becoming the subject of future dispute, saving the trustee and stakeholders valuable time and resources.