The law of investment management for fiduciaries in bank trust departments is in the midst of major revision. In many states, the old "prudent-man rule" is being replaced by a new statutory standard, the "prudent-investor rule."
The new rule is intended to free fiduciaries from rigid and outdated investment practices, allowing them to use a full array of tools available in the modern investment world for the selection and management of a portfolio.
While the new rule shouldn't dramatically alter the decision-making process at most bank departments, some features of the new standard must be taken into account by executives and trust officers alike.
The prudent-investor rule, because of its emphasis on the portfolio as a whole and on the interplay between risk and reward, is a more dynamic standard and requires consideration of more factors in making investment choices.
The fiduciary must determine an investment strategy for the entire trust portfolio, and be able to justify and document both the reasonableness of that strategy and the prudence of each investment in light of that strategy.
The strategy, furthermore, must protect the real value, as opposed to the historic value, of the trust principal while providing for a suitable return for the income beneficiary.
As a result, the strategy will necessarily change over time, depending on changes in the economy, individual investments, and the needs and resources of the trust's beneficiaries.
The prudence of the strategy and its investments depends on the facts and circumstances prevailing at the time of the decision or action of the trustee.
Most of the prudent-investor-rule statutes spell out, in varying detail, the factors a trustee must consider to meet the prudent-investor standard.
The New York statute, which to date is the most detailed, requires consideration of the following factors: the terms of the governing instrument, the size of the portfolio, the duration of the trust, the nature of the fiduciary relationship, general economic conditions, possible effects of inflation or deflation, expected tax consequences of investments and distributions, the role of each investment in the portfolio, the expected total return of the portfolio, and the needs of the beneficiaries.
It further encourages the fiduciary to consider other related trusts, beneficiaries' other income and resources, and whether any asset in the portfolio has a special relationship or value to a beneficiary.
Although not all statutes specify the considerations in such detail, a review of those factors would seem to be basic in any analysis of relevant "facts and circumstances."
To ensure that the necessary work has been done to review all the relevant considerations, trust departments will need to establish consistent procedures to gather and record basic factual information about the family needs and finances - not only at the trust's inception, but on an ongoing basis.
The same applies to general analysis of the economy and performance of the investments.
Records should be maintained of the considerations and decisions resulting in a particular strategy or investment.
The burdens on a trust department resulting from increased inquiry and record keeping may well be offset by the opportunities for increased contact with family members and their input into the decision-making process.
There are a great many unknown areas in the application of the prudent- investor rule. It cannot be predicted how easily the courts will move away from the more clear-cut standards of the prudent-man rule when faced with actual lawsuits, or how they will reevaluate the fiduciary's decisions years after they were made.
In addition, it is not clear how the prudent-investor rule interacts with other existing laws that have not been (and may not be) modified to fit its concerns.
Fiduciaries will be acting in a realm of uncertainty for some time to come.