PR 07240.035 New York
A. PR 01-225 Investment of Conserved Funds
DATE: August 15, 2001
In the New York Region, both New Jersey and New York 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.
The UPIA has not been enacted by Puerto Rico or the U.S. Virgin Islands. Puerto Rico's Civil Code does not include an express standard of conduct for fiduciaries. The U.S. Virgin Islands retains the “prudent man” rule, but there are no reported cases interpreting that section of the U.S. Virgin Islands Code. However, both Puerto Rico and the U.S. Virgin Islands will look to Anglo-American common law in situations where there is no case law on a specific statute, or when the statutes are silent on the matter.
The law in both States and jurisdictions is silent on whether parents, as natural guardians, are permitted to invest funds belonging to their minor children differently than other payees.
In both New Jersey and New York, 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.
You asked us to provide an opinion examining the law of each state and district within our region with respect to the following three questions:
Which types of investments are considered appropriate under the "prudent man" rule?
What are the rules governing trustees regarding the investment of funds with which they are entrusted?
Under state law, are parent payees permitted to invest the finds belonging to their minor children differently than other types of payees?
QUESTION #1 PRESENTED
What types of investments are considered appropriate under the “prudent man” rule?
Under the Uniform Prudent Investor Act (“UPIA”), no investment type is appropriate or inappropriate. The UPIA is proposed legislation which once enacted, is a modern codification of the “prudent man rule.” At least forty-five states have enacted this legislation, including New York (effective January 1, 1995) and New Jersey (effective June 5, 1997). It has not been enacted by the U.S. Virgin Islands or Puerto Rico. The Virgin Islands retains the “prudent man” rule, but there are no reported cases interpreting that section of the Virgin Islands code. Puerto Rico's Civil Code does not include an express standard of conduct for fiduciaries. However, both the Virgin Islands and Puerto Rico will look to Anglo-American common law in situations where there is no case law on a specific statute, or when the statutes are silent on the matter.
I. The Uniform Prudent Investor Act, In General
The UPIA is a standard of conduct for trustees to follow when making investment decisions over the property in their control. The Act explicitly states that any type of investment is permitted. “A trustee may invest in any kind of property or type of investment consistent with the standards of this [act].” U.P.I.A. §2(d). Thus, as long as any given investment decision comports with the standard of conduct contained in the act, the trustee will not be found liable merely because of the type of investment.
The standard itself is based on prudence, as was the “prudent man” rule. Under the UPIA however, the trustee must invest as a “prudent investor would by considering the purposes, terms distribution requirements, and other circumstances of the trust.” Id . at §2(a). In doing so, he must exercise “reasonable care, skill and caution.” Id . The UPIA eliminates the traditional requirement that trustees act as intelligent and discrete men would, when managing the disposition of their own funds in regard to the probable income as well as the probable safety of their capital.
Whether an investment decision complies with the UPIA standard will be determined by examining the totality of the circumstances at the time the decision or investment event occurred. Decisions will be judged “not in isolation, but in the context of the trust portfolio as a whole and as a part of an overall investment strategy having risk and return objectives reasonably suited to the trust.” Id. at §2(b). Thus, no investment is inappropriate in its essence, but may be inappropriate in light of the factors existing at the time of the decision.
The drafters of the UPIA based the Act on section 227 of the Restatement of Trusts (Third). See Uniform Laws Annotated, “Uniform Prudent Investor Act” §2, Comment (1994). Both the UPIA and section 227 of the Restatement disavow the categoric restrictions on types of investments that had developed in some jurisdictions under the old “prudent man” rule. Rather than measuring prudence by investment outcome, the new rule encourages management of risk. Id.
Specific investments or techniques are not per se prudent or imprudent. The riskiness of a specific property, and thus the propriety of its inclusion in the trust estate, is not judged in the abstract but in terms of its anticipated effect on the particular trust's portfolio.
Restatement of Trusts (Third) §227, Comment f, at 24 (1992). Investment decisions made by trustees, or payees, in New York and New Jersey, and to a lesser extent Puerto Rico and the Virgin Islands, see infra, will be judged on this standard.
Both New York and New Jersey have enacted the UPIA. Consistent with the act, each state's statute includes the caveat that any type of investment is permitted under the standards of the Act. In New York, under the “Prudent Investor Act,” a “trustee” _1/ may
invest in any type of investment consistent with the requirements of this paragraph, since no particular investment is inherently prudent or imprudent for purposes of the prudent investment standard;
McKinney's EPTL §11-2.3(b)(4)(A). The act in New Jersey _2/ states:
Subject to the standards established in this act, a fiduciary may invest in any kind of property or type of investment. No specific investment or course of action is inherently imprudent.
Case law in New York and New Jersey does little to clarify what types of investments are permitted by the courts under the prudent investment acts in these states. No state or federal courts have reported adjudicating New Jersey's prudent investor law enacted in mid-1997. _3/ However, a few courts in New York have ruled on its 1995 prudent investor act.
In the context of common trust funds, two cases decided by New York courts indicate that the prudent investor act permits greater flexibility for trustees when considering investment of trust assets. In Matter of Bankers Trust Company, 636 N.Y.S.2d 741 (N.Y. App. Div. 1995) the Appellate Division, First Department responded to income beneficiaries' objections to the trustee's accounting and reviewed investments of funds from a common trust fund. Bankers Trust Co., at 742-43. In doing so, the court stated that the prudent investor act did not apply to the case at hand, but made a point of also stating that “the prudent investor [act] provides for greater flexibility in individual investments because of the recognition that consideration should be given to the portfolio as a whole.” Id . at 744.
A second common trust fund case supports the view that the prudent investor act offers greater flexibility to trustees. In Matter of Onbank & Trust Co., 649 N.Y.S.2d 592 (N.Y. App. Div. 1996), the court was asked to review the propriety of mutual funds investments made from funds in a common trust fund. Onbank & Trust, at 594. The court found that investments therein were not subject to the act because they had been made prior to January 1, 1995. Id. at 595, n. 1. In so doing, the court stated that investments in mutual funds would not be prohibited by the new prudent investor act. Id. at 595, n. 2.
In Matter of Siegel, 665 N.Y.S.2d 813 (N.Y. Sup. Ct. 1997), the court was asked to split a trust in two and relax the investment restrictions in the trust agreement. Siegel, at 814. In determining whether to loosen the restrictions, the court reviewed investment theory, and in so doing, stated
The prudent man standard (EPTL §11-2.2), in effect at the inception of the trust, categorized particular investments, such as certificates of deposit, as prudent. In contrast, the prudent investor standard (EPTL §11-2.3) now in effect judges prudence by reference to risk management and the underlying determination of the appropriate level of risk for a particular portfolio.
Id. at 815. The court ordered the trust split in two and permitted relaxed investment practices in accordance with New York's prudent investor act. Id.
Investments which would previously have been considered high-risk under the old standard, such as mutual funds, would now potentially be considered prudent in New York. In deciding whether, and how to invest social security benefits, the Administration and representative payees in should weigh the appropriate level of risk for those funds. According to the prudent investor act, factors to consider are the purposes and terms of the benefits received, current economic conditions, other resources of the beneficiary and the beneficiary's needs for liquidity and preservation of capital.
QUESTION #2 PRESENTED
Under State law, are parent payees permitted to invest the funds belonging to their minor children differently than other types of payees?
The law in all states and jurisdictions is silent on whether parents, as natural guardians, are permitted to invest funds belonging to their minor children differently than other payees.
In general, parents manage the property of their minor children. However, parents are frequently appointed legal guardian over their own children when large sums are involved. Where investing of funds is permitted, a parent-guardian's investment decisions will be subject to the same standards as other fiduciaries. It should be noted that New Jersey and Puerto Rico have statutory maximums for funds which parents may manage without a guardian being appointed. Case law in New York suggests that when large amounts are involved, a guardian will be appointed.
New York State law
When a parent is a court-appointed guardian of a child, unless the court has ordered otherwise, his or her investment decisions are subject to New York's prudent investor act. Otherwise, when a parent is simply managing a child's property without court-appointment, New York law is silent as to whether a parent may invest a minor child's funds differently than other fiduciaries, or payees.
In the absence of a judicial act appointing a guardian, parents are the natural guardian of their children. See e.g. Estate of Crist, 457 N.Y.S.2d 182, 184 (N.Y. Sup. Ct. 1985) (“The profound and familial relationship of a natural father to his child is not the creature of statute or temporal law”). However, for a variety of reasons, New York courts regularly appoint parents as legal guardian of their children. See Matter of the Estate of Mede, 677 N.Y.S.2d 707, 710-11 (N.Y. Sup. Ct 1998) (court required natural father to apply and qualify as guardian of his children); Estate of Muccini, 460 N.Y.S.2d 680, 684 (N.Y. Sup. Ct. 1983) (mother appointed general guardian of minor children and recipient of payments to them of wrongful death settlement); see also SCPA §1701 et seq.
Parents have management powers over the property of their minor children regardless of whether they have been appointed guardian. Matter of Mede, at 710-11 (“Generally, a parent, as father and natural guardian, makes decisions about the management of a child's property.”). However, in cases where a minor is the beneficiary of a large asset or sum as through inheritance or through a lawsuit, a guardian will be appointed by the court. Decker v. Pouvailsmith Corp., 233 N.Y.S. 407, 409 (N.Y. App.Div.); see e.g. Matter of Mede, at 709 (wrongful death settlement).
When a parent is court-appointed guardian, he or she is permitted to invest the child's funds. All guardian's must “protect, preserve and manage the property of the infant” and shall have the power of “investing such property or the proceeds thereof, changing investments and disposing of investments” except when limited by court order. N.Y. S.C.P.A. §1723 (2001).
New York courts maintain the power to direct the investments after the parent is appointed. Courts can order a legal guardian and a designated depository, to jointly collect and deposit funds in the name of the guardian, for the benefit of the child. N.Y. S.C.P.A. §1708 (2001). In such cases, the court can direct that the guardian purchase and invest in “United States savings bonds, treasury bills, treasury notes, treasury bonds, or bonds of the state of New York [or of local governments within the state].” Id. at (b). This suggests that the legislature prefer courts take a conservative approach to investing the funds of a minor.
However, other sections of New York's code direct that guardians making investment decisions are subject to the standards of the prudent investor act. “A guardian holding funds for investment has the powers provided by [prudent investor] law and must not invest the funds in any other security or manner. (footnote omitted).” N.Y. Dom. Rel. Law (DRL) §85 (2001). _4/ In cases where the parent is also the court-appointed guardian, he may invest in any way which does not violate the prudent investor standard.
Generally, funds controlled by a guardian are to be preserved for the infant's benefit when he attains majority. Matter of Curry, 491 N.Y.S.2d 217, 219 (N.Y. Sup. Ct.1985); see e.g. Matter of Muccini, 460 N.Y.S.2d 680, 683 (N.Y. Sup. Ct. 1983).
In particular, funds should not be invested in such a way that they are unavailable upon emancipation. In Matter of the Estate of Mede, 677 N.Y.S.2d 707 (N.Y. Sup. Ct 1998), a father of children who had received a wrongful death settlement had drafted a plan to create trusts for each of his children, remainder of which would be paid to them at age thirty-five. Mede, at 709. The trust assets were to be invested in tax-free investment-grade municipal bonds. Id. The court, noting that New York's SCPA §1707(2) terminates guardianship upon the age of eighteen, denied the father's plan because, regardless of the safety of investments, the funds would not be available to the children until after the age of a majority, an event in clear contradiction to the legislature's intent. Id . at 713.
QUESTION #3 PRESENTED
What are the rules followed by trustees?
In all jurisdictions, trustees must first follow the terms and directions of the trust. Beyond that, trustees in New York and New Jersey will be subject to the standards of conduct found in each state's prudent investor act. Trustees in the Virgin Islands will be subject to the “prudent man” rule and where local law is silent, trustees may look to the Restatement of Trusts for further guidance. Trustees in Puerto Rico will be subject to its statutes creating and regulating trusts, and where Puerto Rican law is insufficient to resolve the matter, Puerto Rican statutes permit trustees to be further guided by concepts and principles of common law. The Restatement of Trusts embodies the common law, and the foundation for the UPIA.
New York Trustees
In New York, trustees are authorized to invest and reinvest property of the estate or trust under the provisions of the will, deed or other instrument, or as the law otherwise allows. N.Y. E.P.T.L. §11-1.1 (2001). Trusts in New York are “express trusts.” _5/ However, the statutes present a complex set of regulations that trustees must follow in cases where the provisions are silent or incomplete. Trustees have specific duties regarding where to allocate receipts and expenditures in relation to income and principal. Id. at § 11-2.1(a). The statutes carefully define various categories of income and principal, id . at § (b), and when the right to income arises as well as its apportionment, id. at §(c). Except where provisions are illegal, in all cases the terms of the will, deed or other instrument creating the trust controls. See e.g. id. at § (c)(1); (d)(1).
Thus, under New York state law, in the event that social security benefits were paid into a trust created by will, deed or other instrument, the terms of that document would control. Under the statutes such benefits would be categorized as principal. _6/ The trustee of such a trust must comply with the provisions of the trust. In cases where the provisions are absent or incomplete as to investing, the trustee would have to comply with state law regarding the allocation of expenditures and receipts as related to income and principal.
Trustees, as fiduciaries, are also subject to the prudent investor act of New York for investments made after January 1, 1995. _7/ The act will not control in cases where “otherwise provided by the express terms and provisions of the governing instrument.” N.Y. E.P.T.L. §11-2.3(a) (2001). _8/ As discussed above, no type of investment is explicitly permitted or prohibited because under this new standard of conduct, no investment is inherently prudent or imprudent. Id. at § (b)(4)(A). Thus, in New York, after the provisions of the trust itself and where necessary, the rules relating to expenditures and receipts have been complied with, a trustee of an express trust containing social security benefits may decide to invest in any type of investment so long as it complies with the standards of the prudent investor act.
_1/ In New York, the term trustee includes “personal representative, trustee, guardian, donee of a power during minority, guardian under article eighty-one of the mental hygiene law, committee of the property of an incompetent person, and conservator of the property of a conservatee.” EPTL §11-2.3(e)(1).
_2/ New Jersey's “Prudent Investor Act” is a standard of conduct for “fiduciaries,” defined as “an individual or corporation authorized to act as a trustee, personal representative, guardian, and every other person or corporation charged with the duty of administering a trust estate.” N.J.S.A. §3B:20-1b.
_3/ In Will of Maxwell, 704 A.2d 49 (N.J. Super. Ct.1997), the Superior Court of New Jersey held that trust fiduciaries are governed by standards set forth in New Jersey's prudent investment law, at §3B:20-13 of the New Jersey code. Maxwell, at 60. The significance of this case is unclear however, as it was decided on December 24, 1997, nearly six months after the legislature's enactment of the “Prudent Investor Act” at §3B:20-11.3.
_4/ The excerpted section states that the standard of conduct for guardians making investment decisions is found in N.Y. E.P.T.L. §11-2.2. That section is based on the “prudent man” rule and was replaced by the prudent investor act at N.Y. E.P.T.L. §11-2.3.
_5/ Such trusts are defined as “any express trust of property, created by a will, deed or other instrument, whereby there is imposed upon a trustee the duty to administer the property for the benefit of a named or otherwise described income or principal beneficiary, or both.” N.Y. E.P.T.L. §11-1.1(a)(1) (2001). This definition indicates that documentation is necessary to create a trust in New York.
_6/ “Principal is property, disposed of in trust, in income from which is payable or to be accumulated for an income beneficiary and the title to which is ultimately to vest in the person entitled to the future estate.” N.Y. E.P.T.L. § 11-2.1(b)(2) (2001).
_7/ Investments made prior to January 1, 1995, are subject to New York's version of the “prudent man” rule, found at N.Y. E.P.T.L. §11-2.2 (2001).
_8/ This is in contrast to the New Jersey UPIA which was enacted as a “default rule” which can be rejected or changed by the governing instrument. N.J.Stat.Ann. §3B:11.2b (1983)