Trustee’s Rule Of Conduct
In determining whether a trustee is prudent or not, the law will examine your conduct, and not necessarily your investment returns. The prudent investor rule is a rule of conduct: how you as a trustee are acting or not acting—how you acted, or failed to act. Investment returns, or lack of investment returns, may be a gauge of damages, but do not necessarily indicate prudence or imprudence.
For example, assume a trustee invests all trust assets in gold, and the value triples over six months (when the S&P 500 was up 10%). The trustee was not prudent. The fact that the trust assets tripled is only relative to the issue of damag.es. The trustee invested all the assets in one shot, in one asset class, in one investment – undiversified, highly risky, and a concentration. You don’t put all your investment eggs in one basket. You don’t go to Vegas and put all the trust assets on red.
The trustee’s conduct was improper, and would warrant removal – even though there may be no monetary damage. A 200% return is not a defense. Prudence is measured by conduct, not basis points, ROI or percentage gains.
Is Cash Really King?
By the same token, consider a trustee who is “nervous about the market and keeps it all in cash for two year while the equity markets have appreciated 4% annually. Absent some type of doomsday scenario, such as a world war, or a threat of one, or extreme cash needs, it is difficult to justify keeping everything in cash for two years.
How much trouble is the trustee in? One of the measures of damages is what a properly managed, prudent investment port folio would have returned over that same period of time. The equity markets returning 4% a year would suggest one damage model, to which you would add interest, costs and perhaps attorneys fees.
There are scenarios which would justify keeping everything in cash, depending on the trust’s purpose. Going to cash may make sense to lock in gains, and eliminate investment risk, when, for example, the money will be used to pay tuition or make a final distribution.
View The Portfolio As A Whole
Prudent investing views the trust portfolio as a whole, without necessarily determining whether a particular investment is prudent or imprudent, “good” or “bad”.
If individual investments are part of a reasonable, overall investment plan or strategy, and they lose money, that loss will not necessarily have been imprudent.
Remember, the prudent investor rule is a test of conduct, not necessarily return. The law will examine not an isolated investment by the trustee, but rather the totality of the trustee’s conduct – what his or her investment plan or strategy was, how that plan or strategy was implemented, and whether that was prudent or not.