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August 24th, 2015

Have you been presented with this question: “The bank has handled the investments for dad’s trust under his will for the past 10 years since he died. I don’t think that they have done a very good job, have they?”

Quite often we are contacted by litigation attorneys involved with a dispute resolution question similar to the one above concerning the duties, responsibilities and possible liabilities of a bank acting in some capacity for their client’s estate and/ or financial planning/wealth management needs. To a great extent, the duties, responsibilities and potential liability of the bank will depend on the actual capacity under which the bank is acting. This can often be ascertained by referencing the language in the underlying document, i.e. trust agreement, will (typically prepared by an attorney), investment management agreement, agency agreement, custody agreement, brokerage agreement, etc. (typically on bank prototype forms).

The bank may be acting in one of several capacities:

  1. Trustee or Cotrustee: Depending on the specific language in the underlying trust instrument (will or agreement), the bank will assume fiduciary duties and responsibilities.
  2. Investment Agent/Managing Agent: Under this account relationship, typically administered in the bank’s Trust Department, the bank would also assume fiduciary duties and responsibilities.
  3. Custodian: Again, this account relationship would typically be administered in the bank’s Trust Department. Tthe bank would generally not assume fiduciary duties and responsibilities being primarily responsible only for the safekeeping of the assets in the account and following the account principal’s directions as spelled out in the Custody Agreement form.
  4. Investment Agent/Managing Agent – administered by a Registered Investment Advisor (“RIA”) subsidiary of the bank or the bank holding company: The bank would assume fiduciary duties and responsibilities with it’s affiliate RIA being regulated by the Securities Exchange Commission (“SEC”) under the Investment Advisors Act of 1940.(“Act”)
  5. Broker: Under an account maintained at the bank’s, or the bank holding company’s, registered broker/dealer (“BD”) firm regulated by the Financial Industry Regulatory Authority (“ FINRA”) ,formerly the National Association of Securities Dealers (“NASD”), the bank currently has no fiduciary duty or responsibilities being held only to “suitability” rules governing the brokerage industry.Accordingly, the duties, responsibilities and potential liability of the bank are determined, to a great extent, by the exact capacity under which they are acting.

Advice versus Transactions: Fiduciary Duties versus Suitability Requirements

Blacks Law Dictionary describes a fiduciary relationship as founded on trust or confidence reposed by one person in the integrity and fidelity of another. Law.com defines a fiduciary as, “ A person who has the power and obligation to act for another under circumstances which require total trust, good faith and honesty”. A fiduciary has both ethical and legal responsibility to act for another’s best interest at all times.

A RIA under the Act is required to act as a fiduciary , putting the clients interest above the RIA and to declare any conflicts of interest that may arise. A Broker, or a Registered Representative of a broker-dealer firm, regulated by the Securities Exchange Act of 1934, is required only to recommend investments that are “suitable” for the client. Thus, a broker can legally put his/her own interest above the client’s when recommending investments as suitable for the situation.

Brokers/Registered Representatives are typically paid by commission on products sold through transactions. In addition, many broker/dealer firms manufacture investment products and utilize their brokers as a prime distribution channel to sell their proprietary in house investment products. RIAs typically do not take marketing incentives or commissions from investment product providers. RIAs receive advisory fees generally based on the size of the account.

Registered Representatives of broker-dealer firms must provide the client with suitable investment products. However, the “suitability standard” is very broad and often difficult to impose. A suitable investment recommendation may mean that the investment has to fit the client’s needs and tolerance for risk. However, the suitability standard permits the Registered Representative to recommend an inferior investment fund because it gives them a higher commission, as long as it is still a suitable investment.

Fiduciary Responsibilities and Duties

Under common law Agency rules an investment advisor, as agent, owes fiduciary duties to its client, as principal. See Restatement (Third) of Agency, Section 1.01 (2006). The investment advisor’s fiduciary duty also comes from Section 206 of the Act , 75 U.S.C. Section 80b-1 et seq. and the rules there under, Title 17,Part 275 of the Code of Federal Regulations, also see Section 36(a) of the Act. Section 206 is an anti fraud provision securities section that prohibits an advisor from engaging in fraudulent or deceptive acts or manipulation. In addition, the SEC, and its Division of Investment Management, provide interpretive guidance. Also see SEC v. Capital Gains Research Bureau, 375 US 180 (1963) holding that Section 206 of the Act imposes a fiduciary duty on investment advisors by operation of law. It is implied that every violation of Section 206 would also ground a breach of fiduciary duty claim under common law. Section 202(a)(ii) of the Act sets forth who is required to register.

Fiduciary duties owed to the client by the advisor require care, loyalty, obedience, as well as acting in good faith and disclosure.

Broker-Dealer Registered Representatives may be subject to RIA fiduciary responsibilities

In March 2015 Mary Jo White, Chairman of the SEC, stated that she would propose , pursuant to Section 913(a) of Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”), that a uniform fiduciary duty should be imposed on broker-dealer firms transactions, the same as on RIAs. Also see Section 913(g) of Dodd-Frank. indicating that when providing personalized investment advice about securities to retail customers, the standard of conduct shall be to act in the best interest of the customer without regard to the financial or other interest of the broker-dealer or investment advisor providing the advice. This process would be somewhat similar to the recently announced Department of Labor (“DOL”) rules amending it’s definition of a fiduciary under the Employee Retirement Income Security Act (“ERISA”).

Chairman White’s position was stated shortly after the Obama Administration advanced a plan through the Labor Department to impose the higher standard on brokers who manage retirement accounts. White’s plan would make all financial advisors follow the same rules.

Securities regulators agree that the fiduciary duty should not apply to all brokerage services, but only to those services that fall within a reasonable definition of personalized investment advice to retail customers. The regulators further state that personalized investment advice to retail customers should be governed by a fiduciary duty regardless of whether that advice is provided by an investment advisor or a broker-dealer.

Finally, J.P. Morgan Chase is currently in advanced talks with the SEC to pay more than $150 million to resolve allegations that it inappropriately steered investment clients to its own proprietary in house investment products, typically its mutual funds, without proper disclosure generating excessive fees for the bank.

Conclusion

In analyzing the duties and responsibilities taken on by the trustee or investment advisor of a trust, one must ascertain the exact nature of the appointment or engagement. Potential future regulatory changes could impact the duties and potential liability of the trustee/investment advisor.

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February 7th, 2014

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:

  1. Contain a statement of all opinions to be expressed and the basis and reasons for them
  2. Contain the facts and data considered by the expert witness in forming the opinion.
  3. Any exhibits to be used.
  4. The witness qualifications including a list of all publications authored in the previous 10 years.
  5.  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.
  6. A statement of compensation to be paid to the expert witness.

Contact John Rodgers & Associates ( www.fiduciaryconsultants.com, jarodgers3@aol.com, (704-618-8062) 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.

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February 7th, 2014

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:

  1. 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.
  2. A successful verdict representing a corporate fiduciary in a jury trial in Wisconsin state court
  3. A successful verdict representing a corporate fiduciary in Ohio state court.

We look forward to working with you and your clients.

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April 21st, 2010

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:

  1. The duty to be generally prudent (to include the duty to segregate the property);
  2. The duty to act and to carry out the terms of the trust;
  3. The duty to be loyal to the trust (to include acting honestly and in good faith;
  4. The duty to give personal attention to the affairs of the trust: and
  5. 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.

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July 22nd, 2009

TRUSTEE DUTY TO BE LOYAL TO 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).

BACKGROUND

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. 17.2.14.6 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.

DIRECTED TRUSTS

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.

CONCLUSION

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.

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March 27th, 2009

BACKGROUND

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.

CONCLUSION

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.

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August 8th, 2008

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.

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