How Not to Bungle a Trust: A Checklist for Investment Trustees

Earlier this month I attended the Heckerling Institute on Estate Planning, what Deborah L. Jacobs of Forbes calls “the annual Super Bowl on the subject sponsored by University of Miami School of Law.” As expected, there was a lot of discussion about the recent passage of the American Taxpayer Relief Tax Act of 2012, or ATRA, and its implications on financial and estate planning. But what piqued my interest was a discussion on the prudent investor rule after the financial crisis — and the perils of concentrated positions. (Trustees, read: litigation risk.)

Trust investments are governed by the Uniform Prudent Investor Act, and trustees — those responsible for managing the trust assets for the sole benefit of the beneficiaries — owe a duty to the beneficiaries to comply with the prudent investor rule.

In many jurisdictions, fiduciary duties can be shared among, assigned to, or divvied up between several trustees, including family members, a non-family adviser (such as a trusted financial adviser, accountant, or lawyer), or an external trust company (often referred to as a corporate trustee or institutional trustee). Either way, selecting the right individual or corporate trustee or group of co-trustees is vital to maintaining a well-functioning trust.

While a trustee may be tempted to sit on a big chunk of a stock that has served the trust well over the years, he or she has a legal duty to thoroughly diversify investments, unless “the trustee reasonably determines that it is in the interests of the beneficiaries not to diversify, taking into account the purposes and terms and provisions of the governing instrument.”

This fact was brought home by Steven B. Malech, a litigation partner in the New York City office of Wiggin and Dana LLP. Malech represents beneficiaries, fiduciaries, and creditors in a broad range of threatened or actual disputes involving alleged violations of the Prudent Investor Act and its predecessors, alleged breaches of fiduciary duty, disputed accountings, and/or will contests.

Based on this experience, Malech has put together a list of 10 tips for trustees to bear in mind to avoid litigation — or defend against it. While the themes apply more broadly to institutional trustees, many are just as relevant for individual trustees. And though they may seem like common sense, they bear repeating. (It will come as no surprise that trust litigation is a thriving area of the law. Back in 2001, the authors of a paper titled “Suing and Defending Fiduciaries,” noted that there had been “a dramatic increase in the number of lawsuits involving estates and trusts.”)

If you are an investment trustee overseeing a trust, you should:

1. Choose the right team. Ask yourself: What’s the experience of the people on the team? For example, if you have a concentrated position in equities, does the person responsible — the portfolio manager — have experience dealing with a concentrated position? Has he ever managed a fiduciary account before? What are the assets? If the position is concentrated in real estate, do you have anyone who knows anything about real estate? Are there complex or other tax issues? Can the team respond to the issues? Does the team know the law. “It is amazing how many fiduciaries don’t know the law for the jurisdiction under which the trust is covered,” Malech said. It’s important to know what is expected of you as the trustee: What are the standards set out in the Uniform Prudent Investor Act? What are the local laws and procedures? What are the document retention rules?

2. Designate a team leader. The buck has to stop somewhere. And the leader cannot be a figurehead. Malech said that it’s important for someone to have ultimate responsibility for ensuring the trust is administered properly. (If the trustee is an individual, he/she is the de facto “team leader,” but will probably need to delegate some responsibilities.)

3. Train the team. Attending industry conferences can be very beneficial. “You don’t want to go to a doctor who last went to a medical training session 15 years ago,” Malech said.

4. Develop a written plan for what that team is going to do with the assets for which it is responsible. This involves: (a) establishing the investment objectives (needs versus risks); (b) selecting investments to meet the objectives; (c) executing the objectives; and (d) remaining flexible so that you can address uncertainties and risks as they arise. “It follows from this that you have to have meaningful reviews of the plan,” Malech explained, because you many need to change to the plan.

(Consider drafting an  investment policy statement (IPS), which formalizes the investment policy in a written document, summarizes a fund’s key policy decisions, and explains the rationale for those decisions. As explained in A Primer for Investment Trustees, published by the Research Foundation of CFA Institute, the IPS has three main functions: to facilitate communication of the investment policy; to ensure continuity of policy during periods of trustee and staff turnover; and to provide a baseline against which to evaluate proposed policy changes.)

5. Stick to the plan. In other words, keep in mind (d) in step four. It’s important to be flexible as the plan may need to change, but it’s important not to ignore the process and procedures you have set out.

6. Communicate with the beneficiaries. This doesn’t mean an occasional form letter — it must be meaningful communication. You should review the timing of key events with beneficiaries and include them when you formulate and review the investment plan or IPS. This will help identify potential concerns and enable you to get “buy-in.” Don’t underestimate the value of in-person meetings and staying in touch.

7. Communicate with the rest of the team. As the saying goes, two heads are better than one. As such, there are times when it is helpful to get input or counsel from one’s peers. “If you are worried about what’s going on in the market and communicate with the team, you can benefit from the internal experience and have a better chance of getting it right,” Malech said.

8. Take the high road. In other words, don’t refuse to communicate, don’t punish “problem” beneficiaries, and don’t unnecessarily increase expenses.

9. Paper the file. Good records provide a contemporaneous record, a foundation for future decisions, a primer for new team members, a basis for legal/management review, and a good defense.

10. Think long term, but act promptly. Don’t be a tardy trustee, especially when it comes to communicating with beneficiaries (who can easily end up being plaintiffs if you breach your fiduciary duties).

For more on this topic, see our previously published blog post “Advising Trustees: The Five Biggest Pitfalls.” And for a much more detailed discussion, take a look at A Primer for Investment Trustees, published by Research Foundation of CFA Institute. It’s a go-to resource for information on governance structure, investment policy, the fund’s mission, investment objectives, risk tolerance, investment assets, performance evaluation, and ethics in investing. And if you would like to learn more, our e-learning session for investment trustees is a free online resource.

Please note that the content of this site should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute.

Photo credit: ©iStockphoto.com/MHJ