PR 07240.025 Michigan
A. PR 04-239 Investment of Conserved Funds by Representative Payee in the IDS High Yield Tax-Exempt Fund, Inc. for Elijah G. S~, SSN: ~ Cl
DATE: August 24, 1994
Under Michigan State law, the investment of the beneficiary's conserved funds in this type of mutual fund appears proper. However, the fund is improperly registered and the representative payee should be informed to change the title on the account to indicate that the beneficiary is the owner.
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 funds.
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." Id.
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 or state.
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
B. PR 01-225 Investment of Conserved Funds
DATE: August 2, 2001
Five of the six States in the Chicago Region, with Wisconsin as the exception, have adopted The Uniform Prudent Investor Act (UPIA) within their laws.
The UPIA was approved and recommended for enactment in all States by the National Conference of Commissioners on Uniform State Laws in 1994. The UPIA provides investment rules for trustees and like fiduciaries, including representative payees, that result in greater protection of assets while providing a prospect of better income. Although Wisconsin has not adopted the UPIA, much of its law parallels the Act.
In each State, trustees must use reasonable care, skill, and caution with the interest of the beneficiary as the key element. There is an assumption that the trustee will be impartial with no conflict of interest. Trustees may invest in every kind of property and type of investment subject to the prudent investor rule. No specific types of investments are required or restricted. No specific investment or course of action is, taken alone, prudent or imprudent. Trustees should diversify investments unless it is in the best interest of the beneficiary not to diversify.
State law in Illinois is silent and the other five States in the region do not directly address the issue of whether parent payees are permitted to invest funds belonging to their minor children differently than other types of payees. However, the standards stated above appear to be the same for parents and for other types of trustees.
You asked us to research the laws of the six states in Region V as those laws impact a representative payee's responsibilities for the conservation and investment of benefit payments. The regulations provide that, after a representative has used benefit payments for the current maintenance of the beneficiary, any remaining amounts are to be conserved or invested on the beneficiary's behalf. See 20 C.F.R. § 404.2045. Any such "[c]onserved funds should be invested in accordance with the rules followed by trustees." Id. We look to state law to determine how trustees should invest funds. See POMS GN 00603.040A. Generally, states tend to follow a "prudent investor" rule.
You have asked that we examine the laws of the states in our region to determine:
(1) What investments are considered appropriate under the "prudent investor rule?"
(2) Does state law permit parent payees to invest funds belonging to their minor children differently than other types of payees? and
(3) What rules do trustees follow when investing funds?
The laws of the states within our region require trustees to use reasonable care, skill and caution with the interest of the beneficiary as the key element. Our specific state answers are set out below.
What investments are considered appropriate under the “prudent investor” rule?
The prudent investor rule is found at Michigan Compiled Laws Annotated (M.C.L.A.) 700.1501. No specific types of investments are required or restricted. No specific investment or course of action is, taken alone, prudent or imprudent. The trustee may invest in every kind of property and type of investment, subject to the prudent investor rule. M.C.L.A. 700.1503(4).
Although the prior Michigan statute, M.C.L.A. 555.201, has been repealed, the types of investments noted in that section can provide some guidance to the types of investments that Michigan has considered acceptable. This list would include:
Mortgages and mortgage notes
Annuity or insurance contracts
Under State law, are parent payees permitted to invest the funds belonging to their minor children differently than other types of payees?
Michigan law does not directly address this issue. Michigan law requires that a fiduciary with special skills or expertise has a duty to use that special skill or expertise, suggesting that certain types of investors, such as investment bankers, have a heightened duty. M.C.L.A. 700.1503(5); M.C.L.A. 700.7302. Parents who do not have such special skill or expertise would not be held to this higher standard. However, there is an assumption that the prudent investor be impartial and with no conflict of interest. If the parent's investment suggests a conflict of interest, based on the family relationship, the investment should be investigated.
What are the rules followed by trustees regarding the investment of funds with which they are entrusted?
A trustee has a duty to invest and manage assets as a prudent investor would, taking into account the purposes, terms, distribution requirements and other circumstances of the fiduciary estate. M.C.L.A. 700.1502 (1). A trustee has a duty to provide reasonable care, skill and caution. M.C.L.A. 700.1502. A trustee should diversify investments, unless it is in the best interest of the beneficiary not to diversify. M.C.L.A. 700.1504. A trustee should review the funds reasonably soon after taking over the fund. M.C.L.A. 700.1505. A trustee should have an overall strategy and consider the fund as a whole. M.C.L.A. 700.1503 (1). A trustee may delegate investment decisions, provided that the fiduciary exercises reasonable care, skill, and caution in selecting an agent. M.C.L.A. 700.1510. Thus, investment in a managed fund, such as a mutual fund, would be appropriate, if otherwise reasonable. Compliance with the prudent investor rule is determined in light of the facts and circumstances that exist at the time of a fiduciary's decision or action, and not by hindsight. The prudent investor rule requires a standard of conduct, not outcome or performance. M.C.L.A. 700.1509.
Five of our six states, with Wisconsin as an exception, have incorporated the Prudent Investor Act within their laws. Wisconsin has incorporated most of the theory behind the Prudent Investor Act. Ohio is the only state that sets out guidelines by individual types of investments that are considered prudent as a matter of law. In other states, there is some guidance in the case law, other parts of the state statutes, (in Michigan) in repealed statutes.
In each state, a representative payee must use reasonable care, skill and caution with the interest of the beneficiary as the key element.