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May 30, 2013 Articles

Trustee Bank's Breach of Investment Management Fiduciary Duties

Advice for avoiding pitfalls while adhering to a higher standard of care

by O.A. Ishmael

Prudent investment of trust assets can minimize trustee-fiduciary litigation risk, in addition to maximizing trust beneficiaries' economic interest potential. When investing trust assets, a trustee bank is held to a higher standard of care than the average individual trustee, e.g., the sole lawyer acting as a trustee. This higher standard of care comes from the trustee bank's "professional" fiduciary status. Thus, it is easier for a trustee bank, compared to the "non-professional" individual trustee, to breach investment management fiduciary duties. However, the trustee bank's investment management fiduciary duties originate from the same source as an average individual trustee.

The average individual trustee can greatly minimize her fiduciary litigation risk if she is aware of, and subsequently avoids, the trustee bank fiduciary pitfalls while being held to the lower standard. Similar to the average individual trustee, the trustee bank's powers arise from the trust purposes, trust terms, and state laws. Similarly, the trustee bank's powers are mandatorily exercised. These powers are exercised through an unforgiving standard of care and their accompanying fiduciary duties. The standard of care and fiduciary duties are further defined and refined by the Prudent Investor Rule and uniform acts based on a restatement. As a rule of thumb, the trustee bank will breach the higher standard of care and fail to meet fiduciary duties if the trustee bank jeopardizes the beneficiaries' economic interest potential. Alternatively, for both the average individual trustee and the "professional" trustee bank, the prudent investment of trust assets will maximize the beneficiaries' economic interest potential and minimize fiduciary litigation risk.

Fiduciary Duty Stems from Fiduciary Powers
When a litigation attorney represents the trust, the beneficiaries, or the trustee, the rules of engagement depend on the fiduciary duties. Fiduciary duties stem from the responsibility of having fiduciary powers, e.g., the investment management fiduciary power. The investment management fiduciary power, in conjunction with the duty of undivided loyalty, creates the standard of care and scope of the investment management fiduciary duties. Subsequently, the investment management fiduciary duties that are capable of breach increase the trustee bank's fiduciary litigation risk.

Similar to other fiduciary powers, the trustee bank's investment management fiduciary powers arise from the trust's purposes, trust's terms, and state laws. The trust's purpose and the trust's terms can be inconsistent (purpose trumps terms), but, inasmuch as they are consistent, they determine the powers available to the trustee bank.

Clearly, state law controls where the trust is silent. It is also possible for state trust law to take precedence over inconsistent trust provisions. Since much of the fiduciary powers, and resultant fiduciary duties, are defined by state law, the risk of fiduciary litigation varies from state to state.

Duty of Undivided Loyalty
Litigating a trust case requires a showing that the trustee did (or did not) perform the required duties according to the required standard of care. The trustee bank's standard of care and investment management fiduciary duties arise from the fiduciary powers and the duty of undivided loyalty. Trust investments require a duty of prudence that flows out of the duty of loyalty. However, courts have held that a trust can be written to limit the prudence standard of care. Nelson v. First Nat. Bank & Trust Co. of Williston, 543 F.3d 432, 435 (8th Cir. 2008); W.A.K. ex rel. Karo v. Wachovia Bank, N.A., 712 F. Supp. 2d 476, 482 (E.D. Va. 2010).

Fiduciary duties, like the duty of undivided loyalty, arise from the powers conferred by the trust (as drafted by the settlor), through the trust terms. Generally, trust terms comprise the scope of duties that can be performed on behalf of the beneficiary. U.S. ex rel. Atkinson v. Pennsylvania Shipbuilding Co., 255 F. Supp. 2d 351, 404 (E.D. Pa. 2002) aff'd on other grounds sub nom. U.S. ex rel. Atkinson v. PA. Shipbuilding Co., 473 F.3d 506 (3d Cir. 2007).

Every trustee is duty bound to be loyal to every beneficiary, as identified by the trust terms. French v. Wachovia Bank, Nat. Ass'n, 800 F. Supp. 2d 975, 985 (E.D. Wis. 2011). As an illustration, a trustee bank will be bound to be loyal to both the current beneficiary and the remaindermen of the trust corpus. The trustee bank must balance both interests in an impartial manner, in accordance with the trust terms. Marold v. United States, 322 F. Supp. 664, 669 (D.N.J. 1970).

Fiduciary liability becomes a possibility when the trustee does not adequately perform fiduciary duties. As an illustration, the trustee bank can open itself up to liability if it represents the current beneficiary's economic interests to the detriment of the remaindermen, or vice versa. This liability exposure can be mitigated by adherence to the applicable standard of care and prudent performance of the investment management fiduciary duties.

The concept of undivided loyalty means that the loyalty is not shared between beneficiaries and non-beneficiaries. This duty of undivided loyalty is waivable by the settlor. Hence, as an illustration, the settlor's drafting of the trust terms may allow the trustee bank to represent the remaindermen's interests in detriment to the current beneficiary, under a state's codification of the Uniform Principal and Income Act. Among other powers, if enacted, the Uniform Principal and Income Act gives power to the trustee to reallocate trust funds between principal and income, in an impartial, yet unfair manner.

The trustee bank's fiduciary duties include the exercise of the powers conferred by the trust. Although the trust terms are static, the trustee bank's duties can change based on changes in facts and circumstances. The trustee bank's duty can be limited and expanded by the possibilities available through acting in conformance with the trust terms and the state's laws. Restatement (Third) of Trusts § 91 (2007). The trustee bank's standard of care and investment management fiduciary duties do not only arise from the fiduciary powers and the duty of undivided loyalty. The standard and duties are refined by the Prudent Investor Rule and the Uniform Prudent Investor Act.

Prudent Investor Rule and Uniform Prudent Investor Act
The trustee's standard of care and investment management fiduciary duties are refined by the Prudent Investor Rule and uniform acts (As previously discussed, the Uniform Principal and Income Act may allow unfair, but necessary, fiduciary action). The Prudent Investor Rule is a persuasive secondary authority from Section 90 of the Restatement (Third) of Trusts. It sets the ordinary prudence standard of "reasonable care, skill, and caution." The non-absolute Prudent Investor Rule requires trustees to invest in "trust-quality" assets. Donato v. BankBoston, N.A., 110 F. Supp. 2d 42, 48 (D.R.I. 2000). As a result, there exists greater latitude for trustees in states that have not codified the rule or amassed sufficient case law following the rule. The Uniform Prudent Investor Act also describes an objective standard of care as prudent investment and management of trust assets. Uniform Prudent Investor Act §§ 1 comment, 2(a).

However, the trustee bank, as a professional trustee, is held to a higher standard of care as a result of its professional status or holding itself out as having special investment management skills. In re Killey's Estate, 326 A.2d 372, 375 (1974); Uniform Trust Code § 806, Uniform Prudent Investor Act §2(f) ("A trustee who has special skills or expertise, or is named trustee in reliance upon the trustee's representation that the trustee has special skills or expertise, has a duty to use those special skills or expertise."). The trustee bank's standard of care and investment management fiduciary duties will be breached when the beneficiaries' economic interests are jeopardized by the trustee bank's actions.

Jeopardizing Beneficiaries' Economic Interests Constitutes Breach
Winning a trust case depends on the status of the beneficiaries' economic interests. Jeopardizing the beneficiaries' economic interests constitutes a breach of the trustee's standard of care and investment management fiduciary duties. A trustee's fiduciary liability arises from the mismanagement of the trust, i.e., jeopardizing the beneficiaries' economic interests. A trustee must continue to monitor the trust assets even after the initial investment outlay.  Pub. Serv. Co. of Colorado v. Chase Manhattan Bank, N.A., 577 F. Supp. 92, 104 (S.D.N.Y. 1983). Despite the continued monitoring, the propriety of the initial investment will not be judged by the existing outcome but by the circumstances at the time of investment. Pitts v. First Union Nat'l Bank, 262 F. Supp. 2d 593, 596 (D. Md. 2003); In re Hanes, 214 B.R. 786, 817 (Bankr. E.D. Va. 1997). The proper management of a trust implies a duty to diversify investments. Robertson v. Cent. Jersey Bank & Trust Co., 47 F.3d 1268, 1273 (3d Cir. 1995).

Depending on state law and despite the trust terms, a trustee may disregard the trust terms investment strategy in favor of a more prudent investment strategy in line with the trust purposes and beneficiaries' economic interests. Especially concerning the individual trustee, in the interest of meeting fiduciary duties and avoiding fiduciary litigation, approval or ratification of these investment decisions by the beneficiaries or a court cannot be overstated.

The trustee bank's standard of care and investment management fiduciary duties requires prudent investment of the trust's assets, e.g., competent initial investment and continued monitoring. Pub. Serv. Co. of Colorado, 577 F. Supp. 104. The same standards and duties will apply to the individual trustee. This prudent investment of the trust's assets should maximize the beneficiaries' economic interest potential and minimize the trustee's fiduciary litigation risk.

Maximize Economic Interests, Minimize Litigation Risk
Winning a trust case is not solely dependent on the relative change in value of the trust assets. As a longstanding rule, assuming prudent investment management of trust assets, the poor outcome of an investment decision does not open up liability to the trustee. U.S. Nat. Bank & Trust Co. of Kenosha, Wis., v. Sullivan, 69 F.2d 412, 414 (7th Cir. 1934). Exposure to fiduciary litigation is directly related to the trustee's behavior. An investment that merely retains value is unlikely to represent prudent trustee behavior, either due to inflation effects or conduct constituting lack of research into other alternative, reasonable, and attainable investment choices that significantly exceed the trustee's choice of investment. Prudent trustee behavior demands constant and diligent attention to the condition of the trust assets.

Trustee banks utilize exceptional investment management resources in the administration of trust assets. These resources are not available to the individual trustee. To compound the problem, no trustee may delegate investment management duties. Stern v. Lucy Webb Hayes Nat. Training Sch. for Deaconesses & Missionaries, 381 F. Supp. 1003, 1013 (D.D.C. 1974). The trustee individual, however, will need to utilize an investment expert when the situation demands an increased investment expertise. Fortunately, the trustee will not necessarily be deemed to have delegated the investment management duty. Ewing v. Ruml, 892 F.2d 168, 172 (2d Cir. 1989). Nevertheless, decisional, monitoring, and active management responsibilities remain with the trustee, despite the complexity of any investment. In re Unisys Sav. Plan Litig., 74 F.3d 420, 434 (3d Cir. 1996); Uniform Trust Code § 807 (stating that, assuming adequate supervision, a trustee may delegate some investment decisions to a skilled professional).

For the individual trustee, the consultations with a competent investment professional will add value to the economic decisions. Also, the consultations act as extra documentation of diligence and attention in case of future litigation. Unlike a trustee bank, a trustee individual cannot perform exhaustive reviews of investment options. However, a documented, reasonable, yet non-exhaustive, review by the trustee individual minimizes fiduciary litigation exposure.

Prudent investment includes the duty to inform beneficiaries of investment statuses, and rightly so. Increased involvement of beneficiaries will avoid surprises about investment decisions and add value to investment choices. Prudent investment of the trust's assets maximizes the beneficiaries' economic interest potential and minimizes the trustee's fiduciary litigation risk. Nevertheless, without the benefit of foresight, there is no guaranteed blueprint for a court-sanctioned prudent investment.

Keywords: litigation, commercial, business, beneficiaries, trustee bank, standard of care, fiduciary, litigation risk, Prudent Investor Rule, duty of undivided loyalty, fiduciary powers, economic interests, investments, assets

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