This is with reference to your May 11, 1994 inquiry concerning whether funds invested
in the IDS High Yield Tax Exempt Fund, Inc. by a representative payee for a minor
Social Security beneficiary is a proper investment under POMS GN00603.040. We conclude
that the investment appears proper, but is improperly registered.
Here, the representative payee has invested the beneficiary's conserved funds in the
IDS High Yield Tax-Exempt Fund, Inc. (the IDS fund), a type of mutual fund that in
turn makes various investments. The account is registered in the name of Patricia
L. Brown as custodian for Elijah G. S~, under the Michigan Uniform Gifts to Minors
Act (UGMA). Since December 1988, the representative payee has invested $42,350.00
in the IDS fund on the beneficiary's behalf, and reinvested $12,383.32 in dividends
from the fund back into the beneficiary's account in the fund. The value of the beneficiary's
interest in the fund as of March 25, 1994 was $53,017.73.
The IDS fund invests primarily in medium and lower quality rated tax-exempt notes
that are issued by or on behalf of state and local governmental units./ Other investments
in the fund include derivative instruments (including futures, options, and forward
contracts), money market instruments, highly rated short-term tax-exempt debt securities,
and bonds subject to alternative minimum tax computation.
We note at the outset that this appears to be a failed attempt to transfer the beneficiary's
funds under the Michigan UGMA. The representative payee has attempted to transfer
the funds from herself (on behalf of the beneficiary) as representative payee to herself
as custodian under the Michigan UGMA. Had the transfer been valid under state law,
it would be analyzed as an expenditure, rather than as the investment of conserved
Michigan is one of the few states that retains a version of the UGMA. The UGMA applies
only to gifts from an adult to the child. See Mich. Comp. Laws Ann. §§ 554.451-554.453 (West 1988). Here, the representative payee
attempted to make a gift to the child of property already belonging to the child.
This is not a valid transfer under the UGMA. See "SSI -Property of Minors," OGC V (P~) to G~, Acting ARC-POS, SSA V (June 22, 1994), at 3, n.2. Because this
was a failed attempt to transfer the funds under the UGMA, we will proceed to analyze
the representative payee's actions as an investment of conserved funds.
After a representative payee has used benefit payments to meet the beneficiary's needs
for food, clothing, and shelter, any remaining funds must be conserved or invested
on behalf of the beneficiary. See 20 C.F.R. § 404.2045(a). The regulations express a preference for investments in U.S.
Savings Bonds or deposits in interest or dividend paying accounts in a bank, trust
company, credit union, or savings and loan association insured under federal or state
law. 20 C.F.R. § 404.2045(b). Other investments will be upheld, however, if made in
accordance with state laws governing investments by trustees. See 20 C.F.R. § 404.2045(a).
Michigan follows the prudent person (or prudent investor) rule when determining the
propriety of a trustee's investments. Michigan law provides a long list of investments
deemed proper for investment, including bonds, notes, and any "properties, real or
personal" that "an ordinarily prudent person of intelligence and integrity, who is
a trustee of the money of others, would purchase, in the exercise of reasonable care,
judgment, and diligence, under the conditions existing at the time of the purchase,
having due regard for the management, reputation, and stability of the issuer and
the character of the particular securities." See Mich. Comp. Laws Ann. § 555.201(1) (West 1988). In Michigan, trustees do not have
unlimited authority to make investments as they would with their own funds, but "must
take such risks only as an ordinarily prudent [person] would take who is a trustee
of the money of others." In re Buhl's Estate, 211 Mich. 124, 173 N.W. 651, 654 (1920); see Mich. Comp. Laws Ann. § 555.201(1). A trustee "always assumes the risk of a searching
scrutiny in a court of equity as to the diligence employed and sound judgment exercised."
We believe that investment in mutual funds generally would be proper under Michigan
law, which permits trustees to invest in any "properties, real or personal," so long
as the investment comports with the prudent investor rule./ See Mich. Comp. Laws Ann. § 555.201(1). Although we were unable to locate any Michigan
cases discussing investment in mutual funds, The Restatement (Third) of Trusts§ 227 comments h and m (1992), explains that investment in a suitable mutual fund
generally is proper under the prudent investor rule and offers the trustee a means
of obtaining greater diversification at lower cost, so long as the trustee understands
the characteristics of the particular fund and pays attention to fees. Whether investment
in a particular mutual fund comports with the prudent investor rule is a question
of fact to be determined in each case.
Here, one of the more obvious advantages to the IDS fund is that it targets tax-exempt
investments, resulting in a tax saving to the beneficiary. See The Restatement (Third) of Trusts § 227 comment k (tax advantages are an important consideration). Also, because this
is a pooled fund, the beneficiary's investment will be more diversified than would
be possible if the representative payee were to invest the funds independently. Additionally,
this particular fund further ensures diversity with a policy against investing more
than 25% of its total assets in revenue bonds issued for companies in the same industry
We had some concerns, however, because the majority of the investments in the fund
are placed in medium and lower quality notes and bonds. Although government obligations
such as those in which the fund invests are traditionally considered reliable investments,
we were concerned that the particular investments the fund targets are more speculative.
We were also troubled by the fund's investment in derivative instruments, such as
futures, options, and forward contracts. The IDS fund prospectus explains that the
risks involved in such derivative investments include losses of premiums, rapid changes
in prices, defaults by other parties, and the inability to close such instruments.
We did not find any Michigan case law that discussed whether this particular type
of investment strategy was valid under Michigan law. However, The Restatement (Third) of Trusts § 227 (1992), explains that, at least under the current approach, the prudent investor
rule should be "applied to investments not in isolation but in the context of the
trust portfolio and as part of an overall investment strategy." § 227(b). Comments
e and k explain that investments or techniques often characterized as risky or speculative,
such as options or futures transactions, are not prohibited so long as they are employed
prudently to reduce the overall risk of the trust portfolio or to allow the trust,
in appropriate circumstances, to achieve a higher return expectation without a disproportionate
increase in the overall level of risk to the portfolio.
We recommend that when faced with a representative payee's investment in a mutual
fund, you should contact a probate court officer or the trust department of a local
bank, as suggested by POMS GN00603.040, and seek expert advice as to whether the particular
fund involved complies with the prudent investor rule. You should inquire whether
the overall strategy of the portfolio properly balances risk and return, whether the
fund is adequately diversified, whether the fund is reputable, stable, and properly
managed, and whether the fees and costs of participating in the fund are reasonable.
At our request, a field officer contacted a trust officer for the First of America
Bank to inquire about the IDS fund. The trust officer indicated that the IDS fund
is very reputable. The trust officer indicated that he would look with favor on an
investment in mutual funds, like the IDS fund, on behalf of a younger person, since
such investments typically offer a much higher return over a longer period of time
than do bank accounts. He warned, however, that investments in such a mutual fund
would not be advisable for an elderly person since short term performance may result
in actual cash loss. You may probably rely on this advice, under POMS GN00603.040,
to support a finding that this investment conforms with the prudent investor rule.
Even though the investment in the fund comports with the prudent investor rule, however,
the beneficiary's interest in the fund is improperly registered. The account is registered
in the name of Patricia L. B~ as custodian for Elijah G. S~, under the Michigan UGMA.
As explained above, however, this is an invalid attempted transfer of funds. See Mich. Comp. Laws Ann. §§ 554.451-554.453 (West 1988); "SSI -Property of Minors," supra, at 3, n.2. Therefore, the account is improperly registered. See "Representative Payee -Investment of Benefits in Mutual Funds," RA II (B~) to Social
Security Regional Representative (Sept. 16, 1965), at 3 (this type of registration
by a representative payee is improper in Michigan). We suggest that you inform the
representative payee that the title of the account may be changed to: "Elijah G. S~
by Patricia L. B~, representative payee." See 20 C.F.R. § 404.2045(b)(2).
Donna M. W~
Chief Counsel, Region V
Assistant Regional Counsel