Who is responsible when a trust shows poor performance?
When Chip and Gwen returned from lunch at the club,
they opened their mail and found a letter from their trust officer,
Spencer. The letter explained that Gwen's trust, created by her
grandfather, had experienced a precipitous drop in its value and, as a
result, Gwen's monthly allowance would decrease by 40%. Because Gwen
and Chip spend their allowance not only to finance their lifestyle, but
to also pay their house mortgage, they were alarmed and confused about
what to do.
Chip and Gwen noticed that the trust's value had been dropping a bit, but Spencer had reassured them that the bank knew what it was doing and the trust's value would recover very soon. Now, it was clear that Spencer's assurances had been misguided. Concerned about their financial future, the couple needed to consult an attorney about what had gone wrong and what they could do about it.
Poor performance from trusts, coupled with today's financial and accounting scandals, have fueled investor concerns over potential problems with stewardship by banks and other trustees. While the market is often a factor in poor performance, fiduciary negligence may also come into play and your clients may have reason to consider a trust challenge.
Good financial advisors need to help their clients find their way through a trust dispute. For example, many trust beneficiaries such as Chip and Gwen may only be familiar with attorneys from the same law firm that drafted the original trust and hand-selected the trustee. In such circumstances, a financial advisor should direct clients to an attorney who is not entangled in the trust and who can objectively review the trust's performance, assessing whether the bank has properly fulfilled its fiduciary obligations as a trustee of a family's wealth.
Historically, trustees have been quasi-family members, picked by family patriarchs to faithfully serve the beneficiaries. They have been insiders who enjoyed a life-long relationship with a family. In fact, some families have been so married to a trust department that they never thought of asking questions.
Although many trust laws have remained unchanged, the relationship between trustees and beneficiaries has changed significantly in several ways recently: Trust officers at many large financial institutions get reassigned from year to year, making their services more impersonal. And beneficiaries are much more savvy and informed about financial performance expectations. News of financial scandals and analysis of market trends are a click away on the Internet. Such information used to be accessible to only the most sophisticated financial professional. Now, beneficiaries can more easily question trust performance.
When advising clients, financial advisors should consider the following in determining whether an institution or individual has properly performed the duties of a trustee.
Standard Of Care
Trustees are expected to administer a trust with the same level of care that they would use with their own personal finances. If a fiduciary has obtained its appointment as a trustee by representing that it has special skill to act as a trustee, it may be held to an even higher standard of care.
Duty Of Undivided Loyalty
Banks and other trustees have a duty to make decisions on behalf of the trust that is advantageous to the beneficiaries and no one else. However, in the increasingly complex world of investments, many banks have established their own proprietary mutual funds, which they use extensively, if not exclusively, as investments for their trust funds. When a bank uses its own mutual funds as trust investments to the exclusion of other mutual funds, the duty of loyalty is compromised, particularly when the performance of the bank's mutual funds is less favorable than other available funds.
In the volatile world of investments, the financial advisor must go beyond the simple question of whether the investments are losing money. Instead, the advisor must analyze the investments to determine whether the losses experienced by the trust are greater than the losses demonstrated by the broad-based market indices. Is the account properly diversified, or is it invested heavily in a narrow segment of the investment offerings? Are the investments too aggressive for the circumstances of the trust beneficiaries? The trust portfolio must be carefully analyzed to determine the reason for the trust's poor performance.
Administration of a trust is akin to managing an investment portfolio. If a trustee's fees exceed market standards, beneficiaries may have a case for dispute.
Communication With The Trustee
The trustee has an obligation to keep the beneficiaries informed of the trust's performance and must make certain that the trust's investments are consistent with the needs or constraints of the beneficiary. For example, bonds would be an improper investment when a beneficiary is in a high tax bracket but would be proper for someone in a low tax bracket. The timing of capital gains and losses can have an effect on taxes. There must be effective communication between the beneficiary and the trustee. A breakdown in communication is symptomatic of other problems.
How To Conduct A Trust Challenge
When clients like Chip and Gwen or their financial advisor believe that a challenge to the trustee's performance might be appropriate, the following steps need to be taken.
The first step is initiating a review of all relevant documents. The governing trust documents must be closely reviewed to determine if the creator of the trust imposed any limitations on the trustee. Given the complexity and specificity of these issues, trust disputes are best referred to lawyers who concentrate in estate and trust litigation and will contests.
Request An Accounting Of The Trust
If a beneficiary seems to have a valid trust dispute, then the beneficiary should file a formal request for the trustee to provide a full accounting of all financial transactions associated with the trust. Such a formal accounting is, in most jurisdictions, a requirement before the dispute can be presented to the court. Because such a formal accounting usually covers a long period of administration, this request needs to be made as soon as the beneficiary or advisor begins to contemplate taking formal action against the trustee.
The final arbiter of a dispute over the services of a trustee is the state court system, usually through its probate court division. Once the formal accounting is filed with the court, a beneficiary must specifically set forth his or her complaints. This essentially begins a lawsuit between the trustee, on one hand, defending its actions, and the beneficiaries, on the other hand, advancing their complaints. Like any other lawsuit, discovery ensues with depositions of the trustee and requests for documents in the possession of the trustee and others. Frequently, a financial advisor is retained to serve as an expert to analyze the investment performance. Having legal counsel who concentrate in such work are vital to the effective pursuit of this type of action.