NON PROFESSIONAL TRUSTEE
There are two standards required in the Act, to be applied to two types of trustees respectively. The first applies to non-professional Trustees - that is, people acting as trustees who receive no remuneration for exercising their responsibility, and are not engaged in the business of acting as a trustee.
The duty resting upon this type of trustee is as follows: (Section 13B)
“Subject to Sections 13C and 13D of this Act, a trustee exercising any power of investment shall exercise the care, diligence and skill that a prudent person of business would exercise in managing the affairs of others.”
For a non-professional trustee the obligation is to act as a prudent person.
The second standard, applying to professional trustees, is higher (Section 13C):
“Subject to Section 13D of this Act, where a trustee’s profession, employment or business is or includes acting as a trustee or investing money on behalf of others, the trustee, in exercising any power of investment, shall exercise the care, diligence and skill that a prudent person engaged in that profession, employment or business would exercise in managing the affairs of others.”
THE STANDARD
The standard required is to exercise the care, diligence and skill that a prudent person would exercise in managing the affairs of others or that a prudent person, engaged in that profession (of investing money on behalf of others) would exercise. This may require that trustees meet the standards of a professional investment manager.
INVESTMENT CONSIDERATIONS
Some considerations for trustees to take into account when making investment decisions are: (The list is not exhaustive)
- The desirability of diversifying trust investments;
- The nature of existing trust investments and other trust property;
- The need to maintain the real value of the capital or income of the trust;
- The risk of capital loss or depreciation;
- The potential for capital appreciation;
- The likely income return;
- The length of the term of the proposed investment;
- The probable duration of the trust;
- The marketability of the proposed investment during and on the determination of the term of the proposed investment;
- The aggregate value of the trust estate;
- The effect of the proposed investment in relation to the tax liability of the trust;
- The likelihood of inflation affecting the value of the proposed investment or other trust property.
THE APPLICATION
The Act suggests that trustees are charged with protecting the real value of the trust, after taking into account such factors as inflation, for instance. In other words, a strategy may have maintained the nominal value of the assets, but because the trustees followed a strategy which resulted in real value loss, they could be potentially liable under the Act.
Trustees who prefer fixed interest securities because they protect the nominal capital could also find themselves liable because such a strategy can be demonstrated to be likely to erode the real value of the capital over time.
It is important not to understate the procedural bias in the Act.
The Prudent Person Rule is not concerned so much with the results of investment decisions finally made by the Trustees, but how those decisions were arrived at. Were the decisions made prudently?
If a complainant has suffered loss, to be successful in an action the complainant needs to prove that they have suffered loss because the trustees acted imprudently. As the fact of the loss is not in question, what will be under examination is the care, diligence and skill of the trustees in making investment decisions (i.e. what lay behind the decisions made and on what grounds they were taken).
Any action before the courts may be determined on whether or not the defendant has met a standard commensurate with a professional fund manager.
If that is so, it is likely that the court will apply three general principles:
- Was the investment decision consistent with the prevailing academic consensus at the time on portfolio theory, investment management and the basic rules of prudent investment? Portfolio and investment theory is just as much an academic discipline, now, as any other. It is taught formally in our universities; it has its textbooks, academics, academic journals; it has also been recognised through such institutions as the Nobel Prize committee. Courts will expect that professional fund managers demonstrate that their advice was based upon up-to-date research and awareness of the academic consensus.
- Was the investment decision consistent with the rules, standards and procedures laid down by relevant professional bodies? Reference may be made to any finding or judgement by the Law Society, the International Association of Financial Planners and the Society of Accountants.
- Was the advice based on researched, quality information? Economics and economic conditions are constantly changing and any advice given will need to take into account the latest economic developments both in New Zealand and internationally, if it is to meet professional fund manager standards.
- All investments must also be future-orientated. Investment decisions must be based not only on well-researched, most recent historical information, but also on well-grounded, authoritative forecasts of the future.
- Researched information must also include product research.
- The investor will place funds in one or more securities and probably with a diversity of fund managers and products.
- It is essential that trustees can justify their decisions in selecting particular fund managers or products. Given the large range of investment options, this makes their fiduciary responsibilities even more onerous.
DEFENCES
Diversification
- Diversification is universally regarded as a prudent investment principle. If done properly, it can reduce risk without greatly sacrificing returns.
- However, as all diversification is not “created equal”, it will be incumbent on advisers to demonstrate that the diversification was efficient and consistent with the goals and circumstances of the trust.
Formulated Strategy
- The Act implies that if a strategy were not devised, there is a prima facie case of imprudence.
- If a strategy is devised, the merits of that strategy and the basis for it would become the relevant issues.
- It is important for trustees to obtain and deliver investment decisions in terms of clearly formulated written strategies that are both justified and defensible in terms of the Prudent Person Rule.
- Professional advisors should be sought in making prudent trustee decisions.
IMPORTANT NOTE:
Every effort has been made to ensure the accuracy of the information in this presentation “Prudent Trustee Investment”. Items have been prepared to highlight current issues. Professional advice should be sought in relation to any specific problem. Reproduction of the material is welcomed with the prior written consent of Preston Russell Law.
Warwick Cambridge is a partner at Preston Russell Law. You can contact him by clicking here.
