NOTE: This article was published in September 2012 and reflects the law as it stands on the date of publication and not at any later date.

Duties of trustees with regard to investments

Trustee Act 2000

Trustees owe specific duties, with regard to investments, under the Trustee Act 2000.

A general power of investment is conferred by the Trustee Act 2000 on trustees (s. 3). Subject to complying with “standard investment criteria” and obtaining and considering proper advice, a trustee may make any kind of investment that he could make if he were absolutely entitled to the assets of the trust (s. 3(1)). The general, statutory power of investment can, however, be excluded or restricted.

Trustees must:

(a)  in exercising any power of investment (whether express or statutory) have regard to the “standard investment criteria” (s. 4(1));

 

(b)  from time to time review the investments of the trust and consider whether, having regard to the standard investment criteria, they should be varied (s. 4(2));

 

(c)  obtain and consider proper advice, having regard to the standard investment criteria, before exercising any power of investment, and in reviewing investments, unless it is reasonably considered unnecessary or inappropriate (s. 5).

Standard investment criteria

 

The standard investment criteria, in relation to a trust, are:

(a)  the suitability to the trust of investments of the same kind as any particular investment proposed to be made or retained and of that particular investment as an investment of that kind, and

 

(b) the need for diversification of investments of the trust, in so far as it is  appropriate to the circumstances of the trust (s. 4(2)).

 

Summary of duties

 

Trustees should:

(a)  understand the extent of their investment powers, taking legal advice if necessary;

 

(b)  have particular regard to the need to obtain a good spread of investments so as to reduce risk;

 

(c)  review the investment portfolio at regular intervals (at least yearly, or even on a constant monitoring basis): it is not sufficient to leave the whole of the trust fund invested in equities, without consideration of alternative types of investment (e.g. land), simply because those equities have performed satisfactorily;

 

(d)  consider what class or types of investments they consider suitable, and then whether a specific investment of that type is suitable;;

 

(e)  take care to ensure that the trust fund is not retained as cash, but is invested (subject to holding part of the trust fund in the form of cash deposits as part of a reasonable and prudent investment strategy);

 

(f)    obtain advice from a person who is reasonably believed by the trustee to be qualified to give it by his ability in, and practical experience of, financial and other matters relating to the proposed investment (s. 5(4));

 

(g)  only reject investment advice if there are reasonable grounds for doing so;

 

(h)  put on one side their own social or political views, eschewing moral considerations, and having regard only to financial considerations, unless investments are of equal financial merit, or all the beneficiaries are adult and capable, and agree that the trust fund should be invested in accordance with their moral, ethical or political preferences (Cowan v Scargill [1980] Ch 270).

 

(i)    confine themselves to the class of investments permitted by the trust, and avoid all investments which are attended with hazard, taking a predominantly risk-averse strategy.

 

Diversification

In some cases, it may be justifiable not to diversify having regard to the circumstances of the trust, e.g. a trust of the matrimonial home. In Gregson v HAE Trustees [2008] EWHC 1006 (Ch) there was a settlement of shares in a company by the founders of the company. It was the intention of the settlors that the shares should be retained, so that the settlors’ family should retain control of the company. Substantially all the assets of the trust consisted of the shares in the company. The company became insolvent, and the shares worthless.

A beneficiary sued the trustees alleging a failure to diversify the investments. It was held that the trustees did not, on the facts, have any duty to diversify since the clear intention of the settlors was that the trustees should continue to hold the shares in the company. Trustees can properly take into account matters such as the nature and purposes of the settlement, the terms of the trust instrument, any letter of wishes, and the shareholdings of other family members.

 

Modern portfolio theory

Trustees will be liable for failure to exercise their statutory duty of care under s. 1 of the Trustee Act 2000 in making and reviewing investments. However, they are entitled to be judged according to the “modern portfolio theory”, which emphasises the risk level of the whole portfolio, rather than the risk attaching to each investment taken in isolation (Nestle v National Westminster Bank [2000] WTLR 795, at 802). A large fund with a widely diversified portfolio of securities might justifiably include modest holdings of high risk securities which would be imprudent or out of place in a smaller fund. In such a case it would be inappropriate to isolate one particular investment out of a vast bulk and to enquire whether that can be justified as a trustee investment.

 

Causation and loss in the context of investments

The case of Nestle v National Westminster Bank plc [1994] 1 All ER 118 demonstrates the need to prove the causal link between the breach and the relevant loss.

In that case, trustees had managed the investment of a family trust between 1922 and 1986. The trust amounted to £269,203 in 1986. It was alleged by the beneficiaries that if properly invested over that same period the trust fund should have amounted to over £1 million, or £400,000 even if it had risen only in line with the cost of living. However, the court held that the beneficiaries had failed to prove that the trustees had been guilty of breaches of trust which had caused loss.

It was accepted that the trustees wrongly considered that the investment clause in the trust deed was more limited than it, in fact was, and that they had failed to conduct periodic reviews of their investments. However, it could not be presumed that, if the trustees had appreciated the extent of their investment powers and conducted periodic reviews, they would have made better investments with the result that there would have been no loss.

The claim was dismissed because the beneficiaries could not prove that these failures had caused the trustees to adopt an investment policy, which no ordinary prudent trustee would have adopted, and that such an investment policy had caused loss. Indeed, the trustees were able to show that their investment policy was in line with other trustees’ investment policies in similar circumstances.

It was, therefore, necessary to prove that prudent trustees would, if they had properly reviewed their investments, have diversified the trust fund, by purchasing more equities; and that, if they had done so, the trust fund would now be worth more than it was. There was no expert evidence to that effect and, therefore, there was no basis upon which the court could reach the conclusion that the trustees had caused a diminution in the value of the trust fund.

By contrast, in Re Mulligan[1998] 1 NZLR 481, the trustees, out of a desire to favour the life tenant-widow of the testator-settlor, failed to diversify at all by investing in equities, but invested the proceeds of the testator’s farm in high-yielding investments allowing depreciation of the value of capital. The New Zealand High Court held that the trustees should in 1972 have diversified to the extent of investing 40% of the capital in equities which would have appreciated at 75% of an appropriate index of equities. The loss was assessed on this basis.

 

Review of performance of investment advisers

Most modern trust instruments permit delegation. There are also numerous statutory exceptions. Under the Trustee Act 2000 trustees are thereafter given wide powers of collective delegation to agents (s. 11). Trustees are also given powers to appoint nominees and custodians (ss. 16-20).

Such powers are particularly useful in the context of investment. In recent years it has become increasingly common for investors to delegate investment discretions to fund managers and/or to appoint nominees so that share transactions can be carried out with minimum delay.

Trustees are under a duty to review the activities of their agents, custodians and nominees, to consider whether they are under a duty to exercise their “powers of intervention”, and to exercise such powers of intervention if they consider that there is a need to do so (s. 22 of the Trustee Act 2000). A power of intervention includes a power to give directions to the agent and a power to revoke the authorisation or appointment. The statutory duty of care will apply to these obligations.

 

Regular reviews

The performance of investment managers, and the terms of any investment policy statement, should be reviewed regularly. It is suggested that reviews should be at least yearly, or more often if matters of concern arise. It may be appropriate to assess performance by reference to benchmarking against a chosen index or performance factor.

Trustees could be sued by beneficiaries if they have failed to comply with their duties of appointment, supervision and intervention. They could be liable for failure to sack an underperforming investment manager, or for failure to sue for loss to the trust fund by reason of underperformance. They should actively consider suing. It may be that trustees will escape liability for negligence by reason of an appropriately worded exclusion clause. However, such a clause would probably not absolve them from liability if they have decided not to sue on the basis that this would be embarrassing or cause reputational difficulties.