July 2012
In this bulletin we look at some of the
issues concerning trustees and
beneficiaries where a complaint is made
about the performance of trust
investments.
In recent years in particular, trustees will
be excused for having had many
sleepless nights, lying awake asking
themselves such questions as:
 Is my fund exposed to any of the
reported $50bn losses in Bernie
Madoff’s Ponzi scheme?
 How much of the decline in global stock
markets – $32trn from their 2007 peaks
to mid 2009 – are in my fund?
 Does my fund have exposure to the
$50trn market in CDOs that has now
blown up with such spectacular effect?
Contemplation of the English authorities
that confirm that the trustee is neither
insurer nor guarantor of the trust fund
could be the only effective sedative.
Victorian beginnings
The legal framework within which
complaints about the exercise of trustee
investment powers must be considered is
very different now to that in place in
Victorian England, the era in which
investment trusts became commonplace
as wealth management vehicles. The role
of the trustee then became as concerned
with managing financial investments for
the new industrial rich as it did the
preservation and management of landed
estates.
The leading Victorian authority on
investment duties, which applied
throughout most of the 20th century, is the
House of Lords case Learoyd v Whiteley
(1886). It contains the classic statement
of the trustee’s prudential duty of care in
exercising his investment function:
“The duty of a trustee is not to take such
care only as prudent man would take if he
had only himself to consider, the duty
rather is to take such care as an ordinary
prudent man would take if he were
minded to make an investment for the
benefit of other people for whom he felt
morally bound to provide.”
From this decision the principle emerged
that certain investment classes, for
example equities, were hazardous per se,
and so should be out of bounds for any
prudent trustee. As a result Parliament
regulated the trustee investment function
through lists of permitted investments,
generally varieties of annuities, fixed
income securities and mortgages. The
lists of permitted investments were
gradually expanded, including by the
Trustee Investment Act 1961, which
allowed for an allocation of ‘narrow
range’ (secure) investments and ‘wide
range’ (riskier) investments, including
some equities.
The advent of inflation as a feature of
modern economic life increasingly
rendered that limited approach to
investment not only undesirable but
positively dangerous. Investors have now
long recognised that in the longer term
fixed interest securities may be as risky
as, or even more risky than, investment in
equities or alternative asset classes. At
the same time global markets have
become ever more accessible, and the
range of financial instruments offering
access to equity and debt markets in
different ways has increased enormously.
The modern legislative framework
The problem was first addressed by the
habitual inclusion in trust deeds of clauses
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private capital
Trust investment disputes
conferring on the trustee much wider investment
powers than were contained in the English statutes.
A great liberalisation of statutory trustee investment
powers then took place in the last years of the 20th
century. The Trustee Amendment Act 1988 in New
Zealand, the Uniform Prudent Investor Act 1995
(UPIA 1995) in the United States, the Trustee Act
2000 (TA 2000) in England and Wales, as well as
similar statutes in Canada, Singapore, the Isle of
Man and elsewhere, replaced the Victorian
“ordinary prudent businessman” test as the
governing principle behind trustee investment
duties, with the less restrictive “prudent investor”
test.
These statutes were introduced as legislatures
worldwide recognised that modern investment
conditions were so complex that, in order to
manage their funds prudently, most trustees would
need to access a wide range of financial markets,
would have to rely on specialist advice and might
even have to delegate the investment of their funds
to professional managers. The statutes establish
the necessary procedures that must be followed as
the trustee seeks to navigate safely the murky
waters of modern investment finance.
A common core of principles emerges from the
modern legislation.
1. The trustee may be permitted to invest in any
kind of asset. UPIA 1995 section 2(e) provides
that “a trustee may invest in any type of
property or type of investment consistent with
the standards of this act.” TA 2000 section 3(1)
provides (subject to certain qualifications
relating to land) that “a trustee may make any
kind of investment that he could make if he
were absolutely entitled to the assets of the
trust.” Thus any restrictions on the assets
available to the modern trustee are swept
away.
2. Each individual investment may be considered
not in isolation but in the context of the overall
portfolio construction. This is a reflection of
Modern Portfolio Theory, which recognises that,
in the context of a broad portfolio, the risk
associated with an asset should not be judged in
isolation, but against the contribution it makes to
the overall risk profile of the portfolio. The goal
is the proper assessment of ‘systemic risk’ as
opposed to ‘individual risk’.
3. Investments are subject to consideration of
suitability and diversification. These, of course,
were not new ideas. Modern Portfolio Theory,
2 Fladgate trusts & private capital newsletter July 2012
while seeking to empower the trustee to utilise
the full range of modern investment tools, also
recognises two fundamental preconditions
necessary for successful portfolio construction:
(i) the need to select investments suitable for
the needs of the trust; and (ii) the need to
reduce systemic risk through diversification.
Suitability and diversification are standard
investment criteria in TA 2000.
4. Imposition of a duty of care on the trustee in
exercising investment powers. TA 2000 section
1 provides that trustees must exercise “such
skill and care as is reasonable in the
circumstances” in exercising their investment
functions. UPIA 1995 requires the exercise of
“reasonable care, skill and caution”.
5. Power to delegate the investment function. The
statutes typically address the circumstances in
which the trustee should take advice before
making investments, and also confer powers on
the trustee to delegate investment powers to
third parties.
A number of jurisdictions, including the United
States, New Zealand and the Bahamas, have
codified the issues a trustee should take into
account in exercising its investment function. The
following list, taken from section 2(c) UPIA 1995, is
a good starting point – note that in the United
States these are matters that the trustee must
consider in making or retaining investments.
 General economic conditions
 The possible effect of inflation or deflation
 The expected tax consequences of investment
decisions
 The role that each investment plays within the
trust portfolio
 The expected total return from income and the
appreciation of capital
 Other resources of the beneficiary
 Needs for liquidity, regularity of income and
preservation or appreciation of capital
 An asset’s special relationship or special value to
the purposes of the trust or to some beneficiaries
This is effectively a more detailed breakdown of the
proper considerations necessary to enable a
trustee properly to conclude that an investment is
suitable for the trust – see principle (3) above. A
properly conducted investment selection and
management process, allowing for the
circumstances referred to above and, as a result,
tailoring trust investments to the specific situation
faced by the trustee, is a key component of the
general duty “to exercise such care and skill as is
reasonable under the circumstances” (TA 2000
section 1).
Last on the list of legislative principles came the
obligation to take advice and the power to delegate
the investment function. Professional trustees are
under increasing pressure with regard to
investment performance. The reality, of course, is
that with access now to global markets in financial
products of ever greater breadth and complexity,
many trustees will rely on expert advice and seek to
delegate some or all of their investment functions.
Indeed, TA 2000 section 5 obliges trustees to take
advice when making and reviewing investments,
unless they reasonably conclude that such advice
is not necessary in the circumstances. Such advice
may not be necessary if:
 the fund is sufficiently small that the costs cannot
be justified
 the trustee has the necessary investment
expertise
 the nature of the trust assets, for example
property or shares in a family company, may
render it unnecessary.
If an English trustee wishes to delegate his
investment function to an external investment
manager, he must:
 make an agreement in writing with the manager
 prepare a written statement that gives guidance
as to how the investment function should be
exercised (Policy Statement)
 formulate the Policy Statement to provide
guidance to the investment manager with a view
to ensuring that the investment functions will be
exercised in the best interest of the trust.
Whilst not a legal requirement in all jurisdictions,
the preparation of a Policy Statement is widely
considered to be industry best practice. It is again
all part of the process of taking reasonable steps to
ensure that the trust investments are suitable. The
trustee will need to have formed a view, if
necessary after consultation with the settlor,
protector and key beneficiaries, as to the
investment objectives for the trust, and set out
3 Fladgate trusts & private capital newsletter July 2012
those objectives in the Policy Statement. The
investment manager should be asked to explain its
proposals for achieving that objective. The actions
of the investment manager should then be regularly
monitored to ensure it is doing what it promised to
do, and those promises are delivering the expected
outcomes. The Policy Statement will be an
essential tool in enabling the trustee to establish
criteria against which to judge the suitability of
investments and the performance of the portfolio as
a whole.
Getting it wrong
It is encouraging for trustees, and disheartening for
beneficiaries, that modern authorities holding the
trustee liable for investment loss are thin on the
ground; none has yet emerged from the financial
crisis. The leading English authority of (relatively)
recent times, Nestle v National Westminster Bank
Plc [1994] 1 All ER 118, was decided by the Court
of Appeal in favour of the trustee bank. It was held
that the bank had misunderstood the scope of its
investment powers, and had therefore breached its
duty both to undertake regular reviews of the
investments and to diversify out of the limited range
of equities that constituted the relevant estate.
However, the appellant was unable to establish
causation. It was for her to prove on the balance of
probabilities: (i) that if the bank had regularly
reviewed the investments and had understood its
investment powers, it would, as a prudent trustee,
have diversified the portfolio; and (ii) that the
notional diversified portfolio would have been worth
more than the actual portfolio. This was a matter of
expert evidence. The relevant period under
investigation was 1922 to 1959, and the appellant
was unable to discharge the burden of proof.
We must look further afield for cases where the
trustee has been fixed with liability. In the United
States, the trustee of The Estate of Rodney B
Janes had maintained the trust fund 71% invested
in a single blue chip stock (Eastman Kodak) with a
miserly dividend yield of approximately 1.06%.
Through the 1970s, Kodak stock declined by two
thirds from its value at the testator’s death. The
bank made no effort to diversify, apparently
satisfied by informal representations by the widow
that she and her deceased husband both “loved
Kodak”.
Litigation eventually followed. In 1997 the New
York Court of Appeals, in finding for Mrs Janes (or
by that time, her estate), held that the bank had:
“failed to consider the investment in Kodak stock in
relation to the entire portfolio of the estate…ie
whether the Kodak concentration itself created or
added to investment risk.
Second…in maintaining an investment portfolio in
which Kodak represented 71% of the estate’s
stock holdings, and the balance was largely in
other growth stocks, [the bank] paid insufficient
attention to the needs and interests of the
testator’s 72 year-old widow, the life beneficiary of
three quarters of the estate, for whose comfort,
support and anticipated increased medical
expenses the testamentary trusts were evidently
created.
Lastly, in managing the estate’s investments, [the
bank] failed to exercise due care and the skill it
held itself out as possessing as a corporate
fiduciary… Notably, there was proof that [the
bank]:
 failed initially to undertake a formal analysis of
the estate and establish an investment plan
consistent with the testator’s primary objectives;
 failed to follow [the bank’s] own internal trustee
review protocol during the administration of the
estate, which advised special caution and
attention in cases of portfolio concentration of as
little as 20%; and
 failed to conduct more than routine reviews of
the Kodak holdings in the Estate, without
considering alternative investment choices, over
a seven year period of steady decline in the
value of the stock.”
If the trustee had been obliged to consider the list
of factors now in place with UPIA 1995, it may well
have saved itself several million dollars in
compensation.
The need to balance the competing interests of life
tenants (income) with residuary beneficiaries
(capital) is a key concern for trustees. It was
central in Nestle, and also central in the New
Zealand case of Re Mulligan [1998] 1 NZLR 481.
In that case, a testator died in 1949 leaving his
widow a substantial legacy and a life interest in a
farm, with nephews and nieces as residuary
beneficiaries. The farm was sold in 1965 and the
estate invested $108,000 in fixed interest securities.
It held those securities, allowing the widow to live
happily off the income, until she died in 1990. Both
the trustees and the widow recognised the
damaging effect of inflation on the value of the
capital – in 1965 $108,000 could buy 14 residential
properties in Christchurch; in 1990 it couldn’t buy
one. But the widow seems to have been a forceful
character and the trustees suppressed their instincts
to diversify in order to keep her happy. The
residuary beneficiaries then succeeded in a claim for
breach of duty in failing to treat the income and
capital beneficiaries equally by diversifying into a
mixed portfolio of fixed interest securities and
equities. The court accepted expert evidence in that
case that a prudent trustee would have diversified as
to 40% equities and 60% fixed interest.
Conclusions
As noted above, no authorities on trust investment
loss claims have emerged from the financial crisis.
That may, in part, be because significant falls in the
prices of mainstream investments, such as equities,
have been recovered to a great extent since the
credit crunch. The FTSE 100 declined in value by
over 40% from November 2007 to April 2009.
However, by May 2011 that index was only down
12% from its 2007 peak. A common characteristic
of Rodney B Janes, Nestle and Re Mulligan is that
they all concern misguided investment policies
followed over several decades, leading to plainly
irreversible losses. In those cases, also, the
trustees were accused of not taking simple steps to
align their portfolios with national equity markets.
Prudently constructed equity portfolios may well be
down over recent years, but the trustee, as noted in
my opening paragraph, does not guarantee gains. If
the trustee can demonstrate that proper thought
processes have been applied – with the decision
making process being properly documented – he will
feel confident that no breach of duty has occurred.
All that said, where investment losses arising out of
what may be termed negligence, as opposed to
dishonesty, have been incurred, the limitation period
for bringing such claims may be six years. So
trustees are not out of the post-credit crunch woods
yet! 
Stephen Hayes, Associate (shayes@fladgate.com)
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4 Fladgate trusts & private capital newsletter July 2012