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Avoiding Trustee Liability for Investment Decisions with Bifurcation

July 20, 2023

Generally, trustees are required to prudently invest the assets of a trust. If they fail to do so, pursuant to the Prudent Investor Act, they can be personally liable to the beneficiaries of the trust. As a result, many trustees prefer to delegate their investment duties to an experienced third party. In certain situations and in accordance with the Prudent Investor Act, the trustee’s legal obligations can be bifurcated with an investment advisor taking over responsibility for investing, while the trustee administers other aspects of the trust. The advantage of bifurcating the trustee’s role is that the trustee can safeguard themself against liability for investment decisions and the trust and its beneficiaries may benefit from the trust having more lucrative investments that may have a higher risk profile because the investments are not diversified, not publicly traded, or otherwise riskier.

What Is the Prudent Investor Act?

The Prudent Investor Act provides guidelines for how trustees should invest and manage trust assets and sets standards for what constitutes prudent investing. The Act was promulgated by the National Conference of Commissioners on Uniform State Laws and has been adopted by most states. Trustees are not required to achieve a particular outcome under the Act, such as increasing assets by a specific percentage, but they must meet certain standards of care when investing trust assets. Importantly, the Act allows trustees to bifurcate their duties and delegate their investment duties to a third-party investment advisor. 

When Can Trustees Bifurcate Their Duties with an Investment Advisor?

Before they can bifurcate their responsibilities, trustees must first ensure that the terms of the trust allow for the appointment of an investment advisor to handle the investment duties and that the advisor can assume personal liability for how trust assets are invested. This is usually done in a “directed trust,” wherein the trust’s creator (or settlor) expressly directs that someone other than the trustee (i.e., an investment advisor) will invest the assets of the trust and that the trustee is relieved of any liability for the investment advisor’s decisions. The investment advisor is given exclusive power to invest. Accordingly, liability for imprudent investments then falls on the investment advisor rather than the trustee.  

If the trust is silent, the trustee can check the statutes of the governing state. For example, Delaware specifically allows bifurcation of the trustee’s role in its directed trustee statute. State law also permits the settlor to specify the scope of the investment advisor’s role in the language of the trust instrument. The trust can state that an investment advisor can only direct, consent, or disapprove an action made by the trustee, or actually direct, consent, or disapprove investment decisions, distribution decisions, or any other decision. The settlor can also direct the investment strategy. This is particularly useful when the settlor has a family business and wants to ensure it stays in the family and that decisions are made by someone other than the trustee. Importantly, under Delaware law, the trustee is not personally liable for the decisions of the investment advisor and vice versa.

In contrast, New York’s Prudent Investor Act specifically allows a trustee to delegate the investment and management of trust assets but they are not required to do so. However, trustees cannot absolve themselves of liability and still retain their fiduciary responsibilities for investment decisions even when such decisions are delegated to an outside advisor. 

How Does Appointment of an Investment Advisor Affect the Trustee’s Duties? 

Where permitted by the trust document and state law, appointment of an investment advisor allows trustees to insulate themselves from liability for investment decisions unless they willfully choose not to follow the instructions of the advisor. The advisor becomes a fiduciary and, therefore, liable to the beneficiaries. 

While this is a beneficial arrangement for trustees, there is an additional cost for the trust when an advisor is involved. A qualified advisor must also be chosen and their fees compared. Different advisors may charge different amounts for their services. As a result, the trustee must consider whether the extra expense is worth the benefit of an advisor’s services and the insulation it provides to a trustee. 

When Should a Trustee Appoint an Investment Advisor? 

Trustees must appoint an advisor when the terms of the trust specifically require it. In addition, while not required, delegating to an advisor may be advisable for any trustees who are concerned about their ability to properly invest the assets of a trust and incurring potential liability under the Prudent Investor Act. 

A trustee of a trust with considerable assets may also want or need the services of a professional investment advisor. Finally, if the trust has particular assets that require the specialty of a licensed professional, an investment advisor should be utilized.

A well-thought-out investment strategy, which may include using an advisor, is the best way for trustees to ensure they are not breaching their fiduciary duty to prudently invest the assets of a trust. It is also advisable to consult an attorney.

If you are a trustee, Smith Legacy Law can help you understand the terms of the trust instrument, explain relevant state law, and coordinate with an investment advisor, if needed. Contact us for a consultation about your trust.

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