A “fiduciary” is from the Latin fiducia meaning “trust”, a person (or a business like a bank, trust company or a stock brokerage) who has the power and obligation to act for another ( often called a beneficiary) under circumstances which require total trust, good faith and honesty. Typically, a fiduciary has greater knowledge and expertise about the matter being handeled. A fiduciary is held to a standard of conduct and trust above that of a stranger or casual business person. He/she/it must avoid “self-dealing” or “conflicts of interest” in which the potential benefit to the fiduciary is in conflict with what is best for the person who trusts him/her/it. Basically, one person has an obligation to act for another’s benefit.
Courts have neither defined the particular circumstances of fiduciary relationships nor set any limitations on circumstances from which such an alliance may arise. In order to prove a breach of fiduciary duty claim the plaintiff is required to show 1) a fiduciary relationship doe, in fact, exist , 2) the relationship was breached, 3) damages were proximately caused by the breach. Typically, breach of fiduciary claims focus on either how the trust assets were managed, and/or how the trust was administered.
A fiduciary relationship exists whenever the relationship with the client involves a special trust, confidence and reliance on the fiduciary to exercise his/her/its discretion or expertise in acting for the client. A relationship of trust and confidence exists in all cases where there has been a special confidence reposed in one who in equity and good conscience is bound to act in good faith and with due regard to the interests of the one reposing the confidence.
Fiduciary requirements of a trustee and executor that could provide grounds for a breach of fiduciary claim include:
Misappropriation or theft of trust assets
Conflicts of interest or self-dealing acts
Disloyalty to beneficiaries
Colluding with certain beneficiaries to the detriment of others
Failure to account to the beneficiaries or to keep them informed
Allowing a co-trustee to commit a breach
Comingling outside funds with trust assets
Hopefully, this brief review of what creates a fiduciary relationship and various fiduciary duties and responsibilities will be of assistance in your practice in analyzing and establishing if a fiduciary relationship has been established in your clients’ situation and whether a breach occurred resulting in actionable damages.
I have enjoyed working with you and your firm providing expert witness services concerning fiduciary liability litigation on trusts, estates and investment management matters in the past and look forward to doing so in the future. Over the past 10 years I have worked with nearly 100 law firms in 22 states providing fiduciary litigation consulting and expert witness services for both plaintiff beneficiaries and defendant trustees and have testified in both state and federal courts. If I can be of any assistance please call me at: 704-366-8875, or email me at: [email protected] Thanks!
The trustee of my late father’s testamentary trust continues to use dad’s old commission based broker at a wire house firm to buy and sell securities for the trust. Several of the investments have not done well and don’t seem to be appropriate for either my mother as the current income beneficiary or for me as the remainderman. Can I get any redress against the broker and/or the trustee in light of the Department of Labor’s (“DOL”) recently promulgated Final Fiduciary Rules, possibly a breach of fiduciary duties and responsibilities?
Admittedly, the new Department of Labor Final Fiduciary Rules are designed to primarily apply to retirement accounts and IRAs, not personal trust accounts. However, views expressed by the SEC and FINRA at hearings concerning the 2015 preliminary regulations and the April 6, 2016 final regulations suggest that fiduciary responsibility has been redefined and is taken quite seriously by regulatory agencies concerned with “trust accounts”. Accordingly, a brief overview of the DOL Final Fiduciary Rules is in order to get ahead of industry trends that may impact fiduciary litigation and potential personal trust trustee and investment management responsibility and liability in the future.
DOL FINAL FIDUCIARY RULES
The new DOL regulations expand the definition of who is a fiduciary when providing investment advice on retirement accounts aiming to eliminate conflicts of interest (along the lines of 12 CFR Part 9 “Fiduciary Activities Of National Banks”, and Regulation Section 9.12, “self-dealing and conflicts of interest”), and to give investors transparent information about the total costs of investments, including fees and commissions. As the Final Fiduciary Rules explain, ERISA safeguards participants in a qualified plan by imposing trust law standards of care and undivided loyalty on plan participants and by holding fiduciaries accountable when they breach those obligations. In addition, fiduciaries to plans and IRAs are not permitted to engage in “prohibited transactions” which pose special dangers to the security of retirement, health, and other plan benefits because of fiduciaries’ conflicts of interest with respect to the transactions.
The new rule covers anyone paid directly or indirectly for providing retirement account investment advice. This is a major shift for brokers and broker-dealer firms who will no longer be judged by a suitability standard but instead owe a higher fiduciary duty to put their clients’ best interest first. The new rules prohibit commission based fee arrangements and other forms of conflicted compensation in the brokerage industry.
A broker who wants to continue to receive otherwise prohibited compensation may utilize the new rules “best intent contract” ( Best Interest Contract Exemption – “BICE”) approach acknowledging their fiduciary duty owed to clients to provide advice in the clients’ best interest including disclosure up front of the total cost of each new investment, fees, conflicts of interest, etc. They must also adopt policies and procedures designed to mitigate conflicts of interest. The BICE now covers all asset types. These requirements are to be included in a written agreement for IRA’s or clients that are not otherwise subject to ERISA (possibly personal trusts?). Proprietary investment products may be offered under certain circumstances. Retirement Advisers are not required to recommend the lowest fee option if another product is better for the client.
Admittedly, the currently issued DOL Final Fiduciary Rules are designed primarily to apply to retirement accounts, including IRAs, however, it is probably not unrealistic to assume that a court might give some type of expanded judicial cognizance to these new fiduciary rules and requirements when reviewing future personal trust and investment management litigation, including robo-advisors, possibly including a breach of fiduciary duties and responsibilities.
Federal Rules of Civil Procedure Rule 26 was revised in 2010 resulting in a favorable environment for attorneys in that now they do not have to worry about discoverable documents such as Expert Witness Report drafts. The attorney no longer has to disclose draft expert witness reports and all communications between the attorney and the expert witness. Many state courts are also adopting a similar arrangement.
Under the new FRCP Rule 26 most communications between the attorney and the expert witness are now protected from discovery under the attorney work product doctrine. In order to be compliant with the new FRCP Rule 26, and to be admitted as evidence, an Expert Witness Report must:
Contain a statement of all opinions to be expressed and the basis and reasons for them
Contain the facts and data considered by the expert witness in forming the opinion.
Any exhibits to be used.
The witness qualifications including a list of all publications authored in the previous 10 years.
A list of all other cases during the past 4 years where the expert witness testified as an expert at the trial or by deposition.
A statement of compensation to be paid to the expert witness.
Contact John Rodgers & Associates ( www.fiduciaryconsultants.com, [email protected], 704-366-8875 ) for fiduciary litigation consulting and expert witness services concerning litigation matters for trusts, estates and investment management .We are fully compliant with the new above stated requirements of FRCP Rule 26. Take advantage of the recent FRCP Rule 26 changes to assist your clients trust, estate and investment management litigation efforts.
JULY, 2013 WAS A BIG MONTH FOR JOHN RODGERS & ASSOCIATES!
During July, 2013 John Rodgers & Associates provided fiduciary litigation consulting, expert witness services, reports, depositions and trial testimony in three successful litigation’s:
Retained by counsel as an Expert Witness representing a family of trust beneficiaries versus a large professional trustee. Qualified as an expert in trust administration in Federal Court in a case that was tried to a verdict and settled on appeal resulting in a judgment for the plaintiffs in excess of $1Million.
A successful verdict representing a corporate fiduciary in a jury trial in Wisconsin state court
A successful verdict representing a corporate fiduciary in Ohio state court.
We look forward to working with you and your clients.
If the transferor, or grantor or settlor intends to create a trust the transferor will impose certain duties on the transferee with respect to the transferred property. Typically, the establishment of a trust relationship brings with it five fundamental duties:
The duty to be generally prudent (to include the duty to segregate the property);
The duty to act and to carry out the terms of the trust;
The duty to be loyal to the trust (to include acting honestly and in good faith;
The duty to give personal attention to the affairs of the trust: and
The duty to account to the beneficiary.
If any one of these duties is totally lacking, there is a good chance that the transferee’s legal status with respect to the property is something other than that of a trustee.
Duty to Be Generally Prudent
The Uniform Trust Code, in Section 804, states that, “A trustee shall administer the trust as a prudent person would, by considering the purpose, terms, distributional requirements and other circumstances of the trust. In satisfying this standard the trustee shall exercise reasonable care, skill and caution. ” In addition, Restatement (Third) of Trusts, Section 77(2) states that, “The duty of prudence requires that the trustee exercise reasonable care, skill and caution in the administration of the trust.” In fact, Scott & Ascher in Section 17.6 indicates, ” It is not sufficient that a trustee uses such diligence as the trustee ordinarily employes in the trustee’s own affairs. The standard is an objective one, that of the prudent person.”
Restatement (Third) of Trusts is Section 77 and 77(1) indicates that the standard of prudence is a standard of conduct, not performance. A trustee’s action or inaction will not be judged in hindsight, but will be judged in light of the “purposes, terms and other circumstances of the trust.” It further states, “The duty to act with caution does not, of course, mean the avoidance of all risk, but refers to a degree of caution that is reasonably appropriate or suitable to the particular trust, it’s purposes and circumstances, the beneficiaries’ interest and the trustee’s plan for administering the trust and achieving it’s objectives.”
Restatement (Third) of Trusts Section 77 comment a and Section 801 of the Uniform Trust Code indicate one who holds oneself out as a professional trustee with special skills is under a duty to employ those skills. In fact, 3 Scott & Ascher, Section 17.6 states that the law has been tending in the direction of holding the corporate trustee to a higher standard of care than the standard to which an individual non-professional trustee is generally held.
Duty to Carry Out the Terms of the Trust
Addressing the trustee’s duty to carry out the terms of the trust the Uniform Trust Code, Section 801, states, “Upon acceptance of a trusteeship, the trustee shall administer the trust in good faith in accordance with it’s terms and purposes and the interests of the beneficiaries.” Restatement (Third) of Trusts, Section 76 (1) and comment b, indicate “A person accepting the office of trustee has an affirmative duty to act, that is to say, to administer the trust diligently.”
Restatement (Second) of Trusts, in Section 164, comment a, and 2A Scott 0n Trusts, Section 164 and 154.1 state that the trustee has an overarching duty to carry out the intentions of the settlor as they have been manifested in the terms of the trust.Restatement (Third) of Trusts, Section 76 (2) indicates that in administering the trust, the trustee has a duty to ascertain his duties and obligations, the beneficiaries, and the purposes of the trust. He is then under a duty to “comply with the terms of the trust and applicable law in distributing or applying income and principal to to or for the benefit of the beneficiaries.” According to 3 Scott & Ascher, Section 17.14 and Restatement (Third) of Trusts, Section 76, comment f, the duty to read the governing instrument and get the facts is all part and parcel of the trustees duty to carry out the terms of the trust.
It has been observed that, “…two general principals underline much of the Anglo American law of trusts: the trustee’s duty of loyalty and prudence. As the duty of loyalty is the more ” fundamental” of the two, the trustee is under a duty to act solely in the interest of the beneficiaries as to matters that directly and indirectly involve the trust property”. 3 Scott & Ascher, Sec. 17.2. Also see Uniform Trust Code Sec. 802(a). In fact, a national bank exercising fiduciary powers shall adopt and follow written policies and procedures that address, where appropriate, the bank’s methods for preventing self dealing and conflicts of interest. See Revised Reg. 9 (effective January 29, 1977) in 12 C.F.R. Sec. 9.5(c).
In acting in a fiduciary capacity a trustee assumes various general duties. One of the fundamental duties assumed by a trustee in the establishment of a trust relationship is the duty to be loyal to the trust, which includes acting honestly in good faith, and in accordance with the purposes of the trust. The Uniform Trust Code Sec. 105(b)(2) indicates that this duty may not be waived by the grantor/settlor.
The trustee, according to Uniform Trust Code Sec. 802(a) has a duty to act solely in the interest of the beneficiaries concerning matters that directly and indirectly involve trust assets. The duty of undivided loyalty is called the “bedrock” of the trust relationship in Restatement (3rd) of Trusts Sec. 78, comment c(2). The loyalty rule in equity was established because it is usually humanly impossible for the trustee to act fairly in two capacities and on behalf of two interests in the same transaction.
Again, Uniform Trust Code Sec. 802 indicates that a transaction impacted by a conflict between the trustee’s fiduciary and personal interests is voidable by a beneficiary who is affected by the transaction. These transactions could include a corporate fiduciary purchasing or holding it’s own stock for a trust, or depositing funds in it’s own banking department. Indeed, 3 Scott & Ascher Sec. 188.8.131.52 states that “…as long as banks have both trust departments and commercial banking departments, questions of divided loyalty, sometimes quite difficult, will continue to arise.” However, see Rest. (3rd) of Trusts, Sec. 78, comment c(4) and 3 Scott & Ascher Sec. 17.2.
POSSIBLE RESIGNATION AND REMOVAL OF THE TRUSTEE
The fact that a trustee may not allow personal interests to conflict and compete with the interests of beneficiaries could require the trustee to resign from the trust, unless all of the beneficiaries provide their informed consent to the trustee’s retention of the office. See Rest(2nd)Trust Section 170, comment C(1959), 2A Scott on Trusts, Section 170.23 and Rest.(2nd)Trusts, Section 216, Comment g (1959). In fact, the acquisition of a confl;icting interest may be grounds for removal of the trustee. See Rest. (3rd) Trusts, Section 37, Comment e.
EXCEPTION – TRUSTEE FEES AND REASONABLE EXPENSES
A trustee is entitled to take a reasonable fee from the trust for fiduciary services and reasonable expenses, even though this would appear to be a conflict of interest. See Rest. (3rd) Trust, Section 78, Comment c(4), and 3 Scott & Ascher, Section 17.2. It would be unreasonable and unrealistic to expect a trustee to serve without reasonable compensation. See UTC, Section 802 (h)(2), and Rest. (3rd) Trusts, Section 78, Comment c(4). In fact, the trustee has a security interest in the trust assets for reasonable compensation. See Rest. (2nd), Section 242, Comment e(1959).
The reasonableness of the trustee’s compensation can be determined by applying several relevant factors including:
trustee’s skill, experience and facilities
time devoted to trust duties
amount and character of the trust assets
degree of difficulty, responsibility and risk assumed in administering the trust, including making discretionary distributions
Corporate fiduciaries should be mindful of these relevant factors in their internal annual budgeting process for trust department fees. Occasionally, bank trust departments participating in an income/expense ratio analysis universe with other similar institutions experience pressure from senior management to increase trustee fees resulting in a higher ranking in their performance universe.
Trustee powers of fiduciaries were traditionally considered personal and, therefore, non-delegable. Currently the trustee may, however, delegate some investment responsibility to an appropriate investment agent with adequate supervision required, and compensate the agent. See Ret. (3rd) Trusts, Section 80, Comment f, and UTC Section 807. A downward revision of trustee fees is often seen if a trustee has delegated significant duties to outside agents including a Registered Investment Advisor (“RIA”) acting as an investment manager. See UTC Section 708.
Thus, some fiduciary authority may be delegated. The trustee, however, must still personally define the trust’s investment objectives, strategies and programs, and must approve of plans developed by the agent advisor. If the trustee exercised prudence in selection the advisor, participates in setting trust investment objectives, and monitors the advisors performance, the trustee should not be liable for delegation go the advisor. See Uniform Prudent Investors Act, Section 9, versions of which have recently been enacted by several states. See Rest. (3rd) Trusts, Section 80, Comment e, and the Uniform Prudent Management of Institutional Funds Act, Section 5. Delegating some administrative and reporting duties might be prudent under UTC, Section 807 for a family trustee but unnecessary for a corporate trustee according to that Section.
Among the fiduciary duties assumed by a trustee loyalty and prudence are paramount, with loyalty generally considered to be the more fundamental. Accordingly, a trustee must act solely in the interest of the beneficiaries. This fact is especially critical with a split interest trust with various classes of beneficiaries. A violation of this duty could result in the resignation or removal of the trustee, possibly accompanied by a fiduciary surcharge.
In recent years, the adoption by various states of new fiduciary legislation cited above has allowed trustees to depart from many of their common law requirements including fees and the ability to retain and compensate outside investment counsel. Accompanying the new flexibility, however, is the increased potential for liability and fiduciary surcharge actions. The prudent trustee will promulgate and adopt internal policies and procedures to address the question of “reasonableness” in setting trustee fees and the level of compensation for outside investment advisors along with the establishment of internal oversight rules. Thus, increased flexibility presents new challenges to the trustee.
In modern estate planning trusts are often used as a dispositive vehicle to accomplish a variety of purposes. In addition to state and federal tax savings, trusts can create and customize a unique plan to hold and/or distribute assets to different groups of people over a prolonged time period. This situation is typically seen in a trust designed to qualify its assets for the Federal Estate Tax Marital Deduction with the surviving spouse receiving an income interest, with possible invasion of principal, during his/her lifetime. At the death of the surviving spouse another group of individuals, typically the children of the marriage, may then receive an income interest, with possible distributions of trust principal at a date in the future.
This distributive pattern, also seen in a Credit Shelter Trust, provides two distinct groups of individuals, or trust beneficiaries, commonly referred to as current income beneficiaries, and remainder beneficiaries or principal beneficiaries. Thus a trust established in this fashion can have beneficiaries with different and distinct interests, and is referred to as a split interest trust.
Whether the split interest trust is established at the death of the testator – a testamentary trust – or during the life time of the grantor or settlor – a living trust or trust under agreement – the designated trustee(s) have several specific duties and responsibilities in effectively administering the trust. One is the Duty of Impartiality.
DUTY OF IMPARTIALITY
The Uniform Trust Code Section 803 states that the duty of a trustee to act impartially does not mean that the trustee is required to treat the various beneficiaries equally. Rather, the trustee must treat the beneficiaries equally in light of the purposes and terms of the trust. Similarly, 4 Scott & Ascher, Section 201 states that the trustee is under a duty to act with “due regard” to the beneficiaries respective interests.
Restatement (Third) of Trusts, Section 79(2) indicates that the trustee duty of loyalty is the specific duty to treat all trust beneficiaries impartially, that is, not favor one beneficiary over another unless authorized to do so by the governing instrument. Even when so authorized the trustee’s discretionary acts favoring one beneficiary over another must be in furtherance of the intentions of the settlor/grantor and not in furtherance of the trustee’s own biases and predilections.
Again, 4 Scott & Ascher, Section 20.1 indicates that a trustee runs a major risk of breaching the duty of impartiality in the context of the competing interests of income beneficiaries and remaindermen. This Section further states that the general duty of loyalty also requires that the trustee balance the interests of the income beneficiaries and the remaindermen – the trustee must be impartial when dealing with those with conflicting equitable interests.
IMPARTIALITY INVESTMENT PROBLEMS FOR THE TRUSTEE
Recently several states have adopted revisions of the Uniform Prudent Investors Act, the Uniform Principal and Income Act and the Uniform Trust Code that may impact the traditional and common law responsibilities of handling and managing trust investments under the Duty of Impartiality when administering a split interest trust. Reallocation authority, however, is provided for under Restatement (Third) of Trusts under Section 79 allowing the trustee to make appropriate accounting adjustments to comply with the duty of impartiality even absent permissive legislation.
Consider a trustee of a split interest trust investing a significant percentage of trust assets in “junk bonds” producing an extremely high yield. Over time an erosion of the purchasing power of the trust accounting income may result in an inflationary period. Statutory reallocation authority might allow the trustee to transfer a portion of the income to the principal account without advantaging the current income beneficiaries at the expense of the remaindermen.
Conversely, reallocation authority could also be helpful where a trust investment (a concentration of trust assets in an aggressive “high growth” common stock that does not pay a dividend) advantages a remainderman at the expense of the current income beneficiary.
Unique investment problems occur concerning impartiality with a trust requiring periodic distributions of all net trust accounting income with no provisions for the invasion of principal – an “income only trust”. The potential conflict between current income beneficiaries and remaindermen may result from the traditional distinction between income and principal, a trust accounting concept that takes no account of the investment concept of total return. See Restatement (Third) of Trusts, Section 90 and 4 Scott & Ascher, Section 20.1. Some jurisdictions allow the trustee to petition the appropriate court for a judicial reformation of the trust to a Non Charitable Unitrust to address these problems.
TRUSTEE DISCLOSURE OF INFORMATION
Trustee problems concerning impartiality can arise with a trustee’s duty to disclose versus the trustee’s general duty of loyalty including the specific duty of confidentiality in communications between current income beneficiaries and remaindermen. A possible answer to this dilemma may lie in another specific trustee duty: the duty to balance the interests of the current income beneficiary and the remainderman.
Impartiality applies not only to successive equitable interests, but also to concurrent ones – simultaneous beneficiaries. Current beneficiaries – income or discretionary – may have differing needs and tax positions versus the remaindermen different objectives and risk tolerance.
A trustee of a split interest trust must be mindful of the various fiduciary duties and responsibilities, both statutory and traditional/common law, in administering the trust. A breach of any of these fiduciary duties and responsibilities could cause a significant surcharge against the trustee. This fact is especially true concerning the different interests of current income/discretionary beneficiaries and remaindermen in a split interest trust.
Many banks are now using their proprietary, “in house”, mutual funds as investment vehicles where the bank is acting as trustee of a personal trust account. This practice raises various questions. Unless the fund selection is carefully monitored and reviewed by the Trust Investment Committee (and noted in the Commmittee minutes) a potential breach of fiduciary responsibility may exist. In addittion to being in compliance with state trust laws, and O.C.C. Regulation 9, the bank/trustee must avoid “double dipping” on fees, ie receiving a trust administrative fee along with a fee to mnanage the investments in the proprietary mutual fund. Some banks will rebate the investment management fee to the trust account.