For the past few years, trustees along with other investors, have had it reasonably easy when investing trust funds. But with a number of investments looking worthless, it doesn't take a rocket scientist to figure out that several trustees' investment decisions will come under closer scrutiny. It is more important now than ever that trustees understand the full extent of their duties.
Family trusts are a common vehicle for investments. It has recently been estimated that there are more than 400,000 family trusts in New Zealand. Modern family trusts are commonly controlled to a greater or lesser degree by the person or persons (often a couple) who set them up. They are often not the only the trustees (perhaps along with an independent person such as the family lawyer or accountant), but also the beneficiaries.
What the trustees of family trusts often do not appreciate is that they have far greater responsibilities and restrictions with respect to the investment of trust funds than they would if they were making the investment in their own right. Liability is strict. If any of the duties is breached (even innocently) the beneficiaries can apply to Court for a number of orders including damages against the trustees.
If something goes wrong, many trustees mistakenly assume that no action will be taken because they are among the principal beneficiaries. That might be right to a degree, but most trusts contain other beneficiaries as well, who may not be so forgiving. If the trust has just been set up, those other beneficiaries may be too young now to care about what decisions have been made. But as they grow older, questions may be asked.
So how does a trustee ensure they are complying with their duties?
- Consider the best interests of each beneficiary - not just those who are trustees.
- Trustees must clarify the scope of their investment powers.
The purpose of the trust is paramount here. Many family trusts exist only to hold and protect certain key family assets (such as a home or shares in a business) and provided that purpose is clear and consistent with the best interests of the beneficiaries, the trustees' task is relatively simple.
If there is no clear direction on investment, the Trustee Act 1956 dictates the path which must be taken. It contains general authorisation for trustees to invest any trust funds in any property and to vary such investments from time to time. This is subject to the statutory duty to exercise the care, diligence, and skill that "a prudent person of business would exercise in managing the affairs of others". This means that the Trustee must exercise more caution and act more conservatively than he or she would if they were investing for themselves. This statutory standard of care is higher for trustees whose profession, employment or business is, or includes acting as a trustee or investing money, on behalf of others.
The classic problems that come through the case law on prudent investment include:
- Failure to balance income yield and capital appreciation
- Failure to obtain adequate information and advice
- Failure to diversify
Prudent investment is entirely concerned with the financial outcome. Trustees may still be liable for a breach of trust if they take ethical considerations into account, rather than choosing investments with the best financial performance.
The one saving grace for trustees is that with the duty of prudent investment, Trustees will always be judged on their conduct rather than the results achieved. In judging compliance with the duty, the Court will apply the relevant standards for the period and will not employ the wisdom of hindsight. Therefore it is important to document the reasons for the decisions reached at that time.
Trustees must also not delegate to another person. If they leave the management in the hands of a co-trustee or another person (such as an investment adviser) they will be as liable for the bad decisions of their co-trustees as if they had taken the decisions themselves.
On the other hand, they are also under a duty to take advice if they lack the knowledge or ability to do something that is required. Ignorance is no excuse. This duty is relevant to many trustee investment decisions, as few family trustees could hold themselves out as having expertise across the range of investment options (and not just investment in a single asset class such as property or shares)
On the surface, the duty not to delegate seems to conflict with the duty to take advice. However, in reality the two complement each other, and require a balancing act. Trustees may be obliged to seek advice, but they cannot let the adviser make any decisions. A trustee must make the ultimate decisions about the investment, even if guided by the advice he or she receives.
While taking advice will not excuse the trustees from any liability, it is a prudent step in reducing risk. The onus is on trustees to carefully scrutinise the skills, qualifications and experience of potential advisers. Given some recent experiences, trustees should also assess and request continuous disclosure of the independence of the adviser from the investment products they are recommending.
Gone are the days when a trustee could get away with a "set and forget" approach. Modern circumstances require the modern trustee to come to grips with the complex range of investment options available today, and to regularly monitor, review and reconsider the decisions they have made.
Trustees are also expected to consider diversifying investments to minimise risk and to preserve the capital of the fund.
However, diversification like any investment strategy has its benefits and its costs. Any benefits diminish after a certain number of investments and with smaller amounts of capital. It needs to be weighed against the costs of an extensively diversified portfolio. The purpose and the duration of the trust, and the needs of the beneficiaries will be relevant to the decision whether to diversify.
Any diversification would normally include a range of more common investment types spread over the usual asset classes - given that the duty to invest prudently is generally more conservative than an individual's investment style. Investment of trust funds exclusively in exotic investment assets - that are, perhaps, the "pet" of certain trustees - at the expense of a spread of investments over more usual asset classes is likely to expose trustees in the long run.
Sourced from Duncan Cotterill - Lawyers
Disclaimer: the content of this article is general in nature and not intended as a substitute for specific professional advice on any matter and should not be relied upon for that purpose.