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.
Trustee Performance
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.
Investment Performance
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.
Excessive Fees
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.
Document Review
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.
Court Intervention
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.