Trustee Risk: Managing Market Volatility

Trusts have become the anchors of modern estate planning, moving beyond the ultra-wealthy, and helping lots of families protect assets, and ultimately direct them to the named beneficiaries. With the growing utilization of trusts, more people than ever are being asked by friends or relatives to serve as trustees—a role that carries significant weight, since trustees are fiduciaries with legal obligations to act in the best interest of the trust and beneficiaries. What, for example, is a trustee to do in the face of market volatility? Read on for guidance. 

The Prudent Investor Rule: A Legal Safeguard

Legally, trustees are held to a high standard–a fiduciary standard–when it comes to their obligations to oversight of the assets and property placed in the trust. 

Depending on the size and nature of the trust, those stepping into the role of trustee can feel overwhelmed by the pressure of managing someone else’s life savings, and market volatility adds to the stress. When the market dips, is the trustee personally liable for asset declines in the trust portfolio? Fortunately no: the law provides a shield known as the Prudent Investor Rule. This rule is a process-based standard, not a performance-based one. Generally, the Prudent Investor Rule requires a trustee to manage trust assets with the same care and caution used for their own finances, focusing on the needs of the beneficiaries, rather than speculative gains. As attorneys at McDermot, Will & Schulte further explain: 

The majority of jurisdictions in the United States have enacted a version of the Prudent Investor Rule as the standard that a fiduciary must comply with respect to the investment and management of trust assets. While the duties imposed by the Prudent Investor Rule may be modified by the trust instrument and may differ slightly between jurisdictions, the Prudent Investor Rule provides, generally, that a fiduciary has a duty to invest trust assets as a prudent investor would considering the purposes, terms, distribution requirements, and other circumstances of the trust. The rule requires the fiduciary to exercise reasonable care, skill, and caution in investing the assets of a trust. 

Although the beneficiaries of a trust may complain about the performance of investments in a trust, the trustee must remember that the care exercised—and documented—while making decisions is ultimately what is most critical in the eyes of the law. McDermot, Will & Schulte underscore that conduct, not market results, is the ultimate test of how well a trustee has performed in their role:

Compliance with the Prudent Investor Rule is a test of the trustee’s conduct, not the resulting performance of the trust. The rule imposes a specific duty upon the fiduciary to review trust assets and make decisions concerning the retention and disposition of those assets. It requires the trustee to adopt an investment strategy that considers both income and principal enhancement consistent with the duty of impartiality. In addition, it creates a duty to diversify the assets of the trust.

In the event that questions arise about trustee performance, a court reviewing the conduct of a trustee against the Prudent Investor Rule will look for documented evidence of diligent process:

• • Did the trustee follow a documented, rational investment strategy?
  • Was the portfolio diversified to mitigate unnecessary risk?
  • Did the trustee balance the needs of both current income earners and future heirs?

To exercise reasonable care in a volatile market–or really at any time, best practices for trustees include:

• • Auditing Investment Policies: Regularly review the strategies used by investment managers to ensure they align with the trust’s long-term goals.
  • Documenting Your Rationale: Maintain a written record of why certain assets were held or sold during market shifts.
  • Maintaining Transparency: Regular communication with beneficiaries can prevent the misunderstandings that often lead to litigation.

Consider Professional Expertise

If you have been designated as the trustee for a trust established by a friend or relation, but have little or no experience with finances and investments, keep in mind that it may be considered “prudent” to hire professional investment or financial experts. Indeed, professional guidance can be a lifesaver, and reasonable fees for these professional services are typically paid directly from the trust assets. Utilizing professional help is a proactive way to demonstrate that you are fulfilling your fiduciary duty with the highest level of care. Be sure to document everything, from how you chose the help, to how you ensured that the fees paid were reasonable.

Attorneys at Frank & Kraft caution that it is important to take trustee appointments seriously, and observe that common mistakes associated with overseeing a trust include:

• • Failure to follow the trust’s terms: If the Trustee does not distribute assets according to the trust’s instructions, beneficiaries may have grounds to hold the Trustee accountable.
  • Overlooking debts or taxes owed by the trust: Failing to pay debts or taxes in a timely manner could lead to fines or penalties that diminish the trust’s value.
  • Lack of communication: Failing to keep beneficiaries informed about significant trust matters may cause issues and result in personal liability for the Trustee.
  • Conflict of interest: If the Trustee’s actions benefit their own interests over the trust’s, this “self-dealing” could result in significant liability.

Good To Know: Trustee Bonds Explained

While the Prudent Investor Rule can protect the trustee from claims regarding investment performance, a Trustee Bond protects the beneficiaries from administrative failure or misconduct on the part of the trustee. Specifically, a trustee bond is a formal agreement involving three parties:

• • 1. The Principal (Trustee): The person responsible for managing the trust.
    2. The Obligee (Beneficiaries): The individuals whose interests are being protected.
    3. The Surety (Bond Company): The entity providing a financial guarantee that the trustee will perform their duties faithfully.

Essentially, if a trustee fails to fulfill their duties, a trustee bond ensures the beneficiaries are financially compensated.

Trustee and Other Fiduciary Bonds Here

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