Overview
Discretionary trusts, unlike blind trusts, provide significant disclosure and conflict of interest protection for executive branch appointees. Under a 2008 legal advisory, the Office of Government Ethics (OGE) established a rule that discretionary trusts need not be disclosed on the public financial disclosure report (OGE Form 278), and that assets held in trust could not create potential financial conflicts. This common sense standard prevented nominees from being disqualified by potential conflicts of interest arising from assets as to which they had no enforceable rights. Recent OGE action suggests that this safe harbor may be in jeopardy for future appointees.
In 2008, OGE recognized that discretionary trusts presented a unique circumstance in which an appointee had a potential, but uncertain, financial interest in the trust’s underlying holdings. The 2008 legal advisory defined the scope as follows: “[A] discretionary trust does not give the beneficiary an enforceable right to payment,” citing D.L. v. G.L., 61 Mass. App. Ct. 488, 497, rev. den. 492 Mass. 1108 (2004). Typically, the trust agreement would include language stating that the trustee, “in its sole discretion,” could decide whether to make a distribution. A beneficial interest in a discretionary trust is inherently unvested, because a discretionary beneficiary may end up with nothing. The basis for the ruling was a long-standing OGE regulation excluding a “nonvested beneficial interest in the principal or income of an estate or trust,” and stating that it is the “uncertainty of the right of enjoyment (title and alienation), which differentiates a ‘vested’ and a ‘nonvested’ interest.” 5 C.F.R. § 2634.310(a)(2).
In 2013, OGE reinforced the scope of discretionary trusts by stating that, if the nominee in fact received an actual distribution from a discretionary trust, the distribution would have to be disclosed; however, “[r]eceipt of income alone . . . does not require the filer to report the assets of the discretionary trust itself.” So, for example, if a potential nominee was a discretionary beneficiary, neither the trust nor the underlying assets were included in public disclosure, and the underlying assets were immune from financial conflict of interest problems. If the nominee received a distribution, only the existence of the trust and the amount of any actual cash received would have to be disclosed. In effect, discretionary trusts were a "safe harbor" from government ethics requirements.
This approach to discretionary trusts was both reasonable and proactive. Potential nominees had no legal rights with respect to the investments or management of discretionary trusts, and could not force divestitures of conflicted holdings. Therefore, holding such nominees responsible for disclosure or conflicts was unfair. Had the rule been the reverse, discretionary beneficiaries would be unable to sell their interests in the trusts and would therefore be unable to serve in the government.
OGE has recently expressed concerns about the nature and extent of the discretionary trust rules and by implication the exclusion of such trusts from the conflict of interest regime. In early January 2017, OGE issued a notice and request for public input on the interpretation of “beneficial interests” in discretionary trusts, and in March, OGE extended the time for comments until April 20, 2017. The exact question posed in the notice was whether there were any circumstances under which an eligible income beneficiary of a discretionary trust might, in the absence of a vested remainder interest, be able to compel the trust to make a distribution or payment?
This invitation to comments suggested that there was some question, at least in the minds of certain ethics officials, whether the 2008 standard – that is, that the discretionary beneficiary had no enforceable right to distributions – was in fact correct under the trust law of some or all states. This was notwithstanding the fact that, since 2008, law firms have issued opinions in Massachusetts, New York, and Illinois, among others, stating that the standard in the original ruling had been met.
OGE has received at least two comments suggesting that there are circumstances in which a beneficiary of a discretionary trust may compel a distribution. The American College of Trust and Estate Counsel (ACTEC) notes that the rights of a discretionary beneficiary of a trust are determined under state law and many states have statutory provisions that would permit the relevant state court to compel the trustee to make a distribution under certain limited circumstances. The Project on Government Oversight (POGO) echoes ACTEC’s conclusion and states that “it is in the vein of modern trust law’s intentions that discretionary trust beneficiaries have a property interest in the trust,” although whether a discretionary beneficiary has a “property interest” is not what was asked in OGE’s notice. POGO’s comment recommends that reporting should be required for any discretionary trust that does not expressly disallow the beneficiary from compelling a distribution. Few, if any, current trust agreements include such an express provision, so presumably amended agreements would be necessary.
Both ACTEC’s and POGO’s analysis focus on whether a discretionary beneficiary might be able to sue under some theory to compel a distribution. While these are relevant responses to the question posed by OGE, they miss a number of critical aspects of the real world consequences of applying section 208 to discretionary trusts. Even if a beneficiary could compel a distribution, the same beneficiary almost certainly could not compel the trustee to solve a potential conflict of interest caused by trust assets, principally through divestitures. If the beneficiary cannot compel such actions by the trustee, then the beneficial interest in the trust in and of itself will create potentially insurmountable conflict of interest concerns directly related to the discretionary power of the trustee. Second, even if there is some theoretical right to cause a court to force some distributions under certain circumstances, (one comment notes the ability to force a distribution to pay for medical care) the circumstances in which such a distribution could be compelled are unrelated to the typical conflict of interest situation, which involves day-to-day access to underlying assets. In both cases, a restrictive view of discretionary trusts ultimately will prevent individuals, through no fault of their own, from being able to serve in government. It will be interesting to see if OGE will address this concern.