Using Index Funds to Save Costs: Some Suggestions for Oregon Conservators

If you are an Oregon court appointed fiduciary the writing is on the wall. The days of hiring stock brokers to manage money for the disabled are coming to an end. The Department of Labor has proposed a fiduciary standard for investment advisors dealing with retirement funds. Elizabeth Warren is tweeting, and a new law in Oregon requires court appointed conservators to disclose every year the full fees paid for asset managment. Paying full-service commissioned financial advisors from the funds of the helpless may not yet be unethical, but the day is not far off when it will be.

Index funds--funds invested across a market and managed by a computer--have the potential to do to retail stock brokers what the internet did to travel agencies. The only question for an Oregon fiduciary is whether she will dive into index funds or be dragged in. This post if for those who would rather make the move voluntarily.

(For my post on index funds and conservatorships generally, go here.)

An Oregon trustee or conservator is bound by the Prudent Investor Rule. The rule is common sense. It requires the fiduciary to match the risk in the investment to the risk tolerance of the beneficiary and potential heirs. At its very basic this means diversification. Mutual funds by their nature are diversified and an investment account containing different kinds of mutual funds is doubly so. Index funds are a type of mutual fund in which the money is invested across a market and managed by a computer instead of individuals. The management fees for index funds are smaller than those charged by actively managed funds. The biggest vendor of index funds is Vanguard. I will use the company in this post, but index funds from other vendors work equally well.

Let's say a conservator has an eighty-six year old disabled male with care costs of $2,000 a month more than his monthly income. He has $150,000 to manage, and a life expectancy of 5.7 years. If he dies on schedule he will need nearly every penny he has to pay care costs and related expenses. He has little if any tolerance for risk.

So Google a conservative index investment at Vanguard. Let's say you like the Wellesley Income Fund. It is safe and diversified (mostly bonds, some stocks). It tends to produce 2.62%, and the charge for management is 0.23% of the principal.  On $150,000 that is $3,930 a year of income for $345 in fees. Even more conservative is the Vanguard Intermediate-Term Government Bond Index which collects government bonds. It has an estimated return of 1.33% and an expense of .1%. The income it $1,843 on expenses of $151. (You can check these at the FINRA Fund Analyzer).

Of course a fiduciary could park the money in a Wells Fargo Money Market account at .03% and make a whopping $45.  Or the fiduciary could send the money to Fidelity Advisor Asset Manager® 20% Fund Class A (FTAWX), a randomly chosen managed fund with a ten year history of return at 3.8% and a front end load. The fiduciary would have fees and sales charges of $6,484 for a first year loss of $1,006. You can go to the FINRA site and do the math.

Even with no-load funds, the costs of management don't pan out. A Thrivent Conservative Asset Allocation Fund (TCAIX) with no load and a return of 3% has charges of $1062 (.7%) while the Vanguard Wellesley fund has Charges of $395 (.23%). Over the short life of our example, that is a $5,000 difference, just from management costs. Thrivent advertises on television that its funds are not managed by robots. I wonder if they also manually add up large numbers because they just can't trust those new fangled calculators.

The investment choices, even in mutual funds, are daunting, and can scare a fiduciary into simply paying the freight and having a commissioned money manager make the choices for him. The person who suffers from this timidity, however, it the disabled beneficiary. The professional management comes at such a hefty cost that it wipes out the benefit of the expertise.  Additionally, there are online tools at Vanguard and other places that make the process fairly easy. Simply plug in the factors that contribute to risk tolerance and let the computers do the work. If you want online help with selecting index funds you can look at Betterment or Wealthfront, although neither are really necessary.

Another hurdle to using index funds is having to actually open an account without a hand-holding and socially skilled financial adviser to do it for you. For a Vanguard account, the process starts with this form. The form is largely self explanatory, but I can offer these tips.

• On page one, check the box indicating that the application is by a guardian.
• On page 4 enter the information for the protected person using the address of the conservator.
• On page 5 enter the information for the conservator. You do have to enter the conservator's tax ID number. This is for identification only and transactions will not affect the personal finances of the conservator.
• When sending the paperwork include a certified copy of the letters of conservatorship that are less than 90 days old and a  letter explaining that Oregon courts (like California and other states) do not use a raised seal.

The form has areas to fill in the index funds you want to buy and instructions for funding the account from an existing bank account. This will probably be the conservatorship account.

If the protected person's money is already at with a commissioned adviser and invested heavily in managed funds, you may be able to get the broker to sell and reinvest in index funds. If the broker balks at this, as she probably will, you can move the securities from the existing broker to a Vanguard brokerage using this form. Once the form is filled out, your signature must be guaranteed with a Medallion Stamp. I have written about Medallion Stamps here. Once moved, it is a simple matter to sell the managed funds and replace them with appropriate index funds using the Vanguard web page.

Index funds chosen after consideration of the risk tolerance of the protected person (almost always very low) provide as close to a safe haven for a conservator as one could find. The investments are diversified because they are mutual funds. Unless the conservator made a huge mistake in evaluating risk tolerance, the investments will easily meet the requirements of the prudent investor rule. The protected person is protected and the professional conservator who has to report all management fees will not have to wince when he or she reports to the court how much of the protected person's money went to the brokerage house.

A Guide to Medallion Guarantees for Transfers of Stock by Oregon Conservators and Executors

Oregon fiduciaries--conservators and executors, and even agents under a power of attorney--often have stocks that must be sold to pay the needs of a protected person or to close an estate. When trying to sell or transfer stock the fiduciary will be faced with having to get a Medallion stamp on the form that requests the stock transfer. This post is my attempt to explain what is going on with stock transfers and Medallion Guarantees.

Let's assume that the protected person or decedent owned stock in Big Farma, Inc. Big Farma is too busy with its big farms to keep track of the millions of people who hold its stock so it has hired a transfer agent to keep track of them. The transfer agent issues and cancels stock certificates to reflect changes in ownership. The transfer agent may also pay out dividends, handle lost certificates, and do other things related to helping stockholders maintain their accounts. Most transfer agents are also banks, brokerages, or trust companies.

Transfer agents are are allowed to (and generally do) demand a guarantee that a person requesting a change of ownership has the authority to do so. Signature guarantees are covered by the Uniform Commercial Code. (UCC 8-306 if you want to read it) When a bank for other financial institution guarantees a signature on an instruction to transfer stock the bank making the guarantee is guaranteeing that (1) the signature is genuine; (2) the person making the signature has the authority to issue the instruction; and (3) the person has capacity to sign. If the bank making the guarantee is wrong about one of these things, and the transfer agent suffers a loss because of it, the bank that made the guarantee is liable for the loss.

(A notary, on the other hand, certifies only that the signer signed the document voluntarily, signed the document in the presence of the notary and provided proof of identity.  There is no agreement to pay damages to anyone who relies on the notary stamp.)

Banks guarantee signatures to the satisfaction of transfer agents by associating with the Securities Transfer Agents Medallion Program, Inc., (STAMP, Inc) a not-for-profit corporation. STAMP, Inc. uses a company called Kenmark Financial Services to administer the Medallion Guarantee program. The bank or brokerage house that wants to issue Medallion Guarantees must meet certain financial standards and purchase a bond to cover liability for any mistakes. The amount of the bond determines the liability limit of the bank, and banks will not guarantee a signature if the transaction has a value that exceeds the amount of its bond.

Once the bank has qualified to make Medallion Guarantees it can offer the guarantees as a service to its customers. It is not required to provide the service and you cannot force a bank to do so. Therefore, the first step for an Oregon conservator or personal representative in search of a Medallion Guarantee is to find a friendly banker. Most banks limit the service to their customers.

Of the three things that a Medallion Guarantee guarantees, the first two are easy. The bank must guarantee that the signature is not a forgery. Personally appearing with good identification usually covers this hurdle. The second it that the signer has the capacity to sign. This means that the signer is over eighteen years of age and is not obviously crazy or demented. This, again, is seldom difficult.

The third element of the guarantee is that the signer is the appropriate person to sign the transfer instruction. When the signer is a fiduciary--a conservator, personal representative, or an agent pursuant to a power of attorney--the signer must prove his or her authority to engage in the proposed transaction.

For a personal representative or conservator, proof of authority is normally in the form of certified copies of the letters testamentary or letters of conservatorship. Many banks will require that the letters be less than sixty days old. If the conservator has old letters, she might consider getting a new set prior to approaching the bank. If the person seeking the Medallion Guarantee is the personal representative of an estate the bank will also want to see a certified copy of the death certificate. Every bank has its own internal procedures and requirements. You can read sample procedures promulgated by the American Banking Association here.

The tricky case is where the fiduciary seeking a Medallion Guarantee is an agent under a power of attorney. The banker is required to read and interpret the power of attorney to determine if the power of attorney permits the transaction that the agent wants to complete. Thus, if the agent wanted to transfer the stock to himself, the banker might search the power of attorney for the power to make gifts. In this situation, obtaining of a Medallion Guarantee depends on the ability of a retail banker to interpret a power of attorney. This sort of interpretation is difficult enough for experienced elder law lawyers. Your results in a bank are guaranteed to vary.

Transfer agents are form-driven bureaucracies and the forms are not always the easiest to understand.. When you, as a fiduciary, need to make stock transfers, get the forms from the transfer agent. Make sure that the forms show the value of the transaction (so the Medallion stamp holder knows whether it is within his or her authorization). Then cross your fingers and go to the bank for the for a Medallion Guarantee

Computershare is one of the big transfer agents in the U.S. It's forms are as confusing as any and it is not unusual to get odd decisions out of them. Recently I submitted a transfer request--with a Medallion stamp--and Computershare responded with a statement that the company believed my client to be dead. Proving through documentary evidence that someone is alive is fairly difficult. I invented a "life certificate" to do this, but I suspect Computershare came around when I pointed out that the Medallion stamp guarantees capacity. One of the elements of capacity is life. Computershare bought the argument and allowed the transfer. In most cases, getting the Medallion Stamp is only an annoying hassle. In that case, the Medallion Guarantee actually helped the fiduciary.