The “Prudent Investor” Rule–Opportunities and Challenges

In recent months I have been contacted by a number of potential clients who are the beneficiaries of trusts that have lost a great deal of their value due to the downturn in the stock market.    These potential clients have asked whether they have valid claims against the trustee(s) for mismanagement of the trust assets.

In analyzing whether such a claim is viable,   one need look no further than the "prudent investor" rule.   A trustee has an obligation to prudently invest and manage assets on behalf of a trust beneficiary.  What is "prudent",  of course,  is subject to varying opinions among experts in investment management.  However,  there are some fairly uniform principles that do not provoke exceptional disagreement among those same experts.    For one thing,  experts largely agree that a trustee's investment strategy should be tailored to the age, health, special needs (in the event that the beneficiary is disabled) and income requirements of the beneficiary.    The other principle upon which the experts largely agree is that trustees are not expected to "anticipate" changes in investment returns.     A number of people have asked me why their investment manager trustees did not diversify the trust's investment portfolio prior to the 2007-2008 steep decline in the stock market.     The answer is that investment managers do not have a crystal ball;  if they did,  their competitors would be out of business.

There are trustees, however,  whose strategy out of the blocks can be attacked as imprudent.  For example,   a professional trustee (investment manager) overseeing the trust for a 75-year-old beneficiary should not have a substantial percentage of the trust's assets invested in equities,  even in an "up" market.

Unfortunately for claimants who may have otherwise meritorious claims,  the trust documents may blunt the beneficiary's ability to make a claim against the trustee.   These clauses,  which typically limit the trustee's liability to instances of "gross negligence" or "willful default",  have consistently been held by our courts to be valid and enforceable.

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