PR 07240.053 Washington

A. PR 01-225 Investment of Conserved Funds

DATE: August 1, 2001

1. SYLLABUS

In the Seattle Region, the States of Alaska, Idaho, and Oregon have each adopted The Uniform Prudent Investor Act (UPIA) within their laws. While the State of Washington has not adopted the UPIA, it has adopted a Trust Act which is substantially similar.

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

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 laws in all four States are silent on the issue of whether parent payees are permitted to invest funds belonging to their minor children differently than other types of payees. It appears, however, that parents must follow the same standards as all other types of trustees.

2. OPINION

Introduction

You have asked us to research the laws of the four states in Region X as those laws concern a representative payee's responsibilities for the conservation and investment of benefit payments. The specific questions asked are:

  • What types of investments are considered appropriate under the “Prudent Man” rule (if applicable);

  • Are parent-payees are permitted to invest differently than other types of payees; and,

What rules must be followed by trustees in their investment decisions.

As discussed on our teleconference meeting, our answers are set out below, by state. The following general observations can be made about this area of law in our region. All four states have adopted the Uniform Prudent Investor Act, or, in the case of Washington, a Trust Act which is substantially similar (though Washington's Trust Act does have some variations, noted below). There is relatively little case law considering, in great detail, which investments are proper and which are improper. This is particularly true in Idaho and Alaska, where our research has led to the conclusion that case law in these areas is almost nonexistent. The courts in this region in general seem inclined to adopt common law or hornbook understandings of the duties of a trustee to a beneficiary.

Because of this lack of particularity, it is useful to cite as a starting point the “prudent man rule” set out in 1830 in the Harvard College case, which has served as a model for the Uniform Prudent Investor Act: “All that can be required of a trustee to invest, is, that he shall conduct himself faithfully and exercise a sound discretion. He is to observe how men of prudence, discretion, and intelligence manage their own affairs, not in regard to speculation, but in regard to the permanent disposition of their funds, considering the probable income, as well as the probable safety of the capital to be invested.” Harvard College v. Amory , 26 Mass. (9 Pick.) 446, 460-61 (1830). As one Court of Appeals in Washington has observed, in Harvard College, the court recognized that trust assets could never be fully protected from the uncertainties of the market place; thus, the prudent investor standard was necessarily flexible. See Estate of Cooper , 81 Wash.App. 79, 88-89, 913 P.2d 393, 398 (Wash.App. 1996).

Washington

Which types of investments are considered appropriate under the “prudent man” rule?

The prudent investor rule is found at R.C.W.A. § 11.100.020.

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.

Under State law, are parent payees permitted to invest the funds belonging to their minor children differently than other types of payees?

Washington law is silent on this issue. However, there is an assumption that the prudent investor be impartial and with no conflict of interest. To the extent that a family relationship may be a barrier to such impartiality and may create a conflict of interest, one may need to scrutinize these funds more carefully. The standard, however, appears to be identical.

What are the rules followed by trustees regarding the investment of funds with which they are entrusted?

Washington's Trust Act provides as follows:

(1) A fiduciary is authorized to acquire and retain every kind of property. In acquiring, investing, reinvesting, exchanging, selling and managing property for the benefit of another, a fiduciary, in determining the prudence of a particular investment, shall give due consideration to the role that the proposed investment or investment course of action plays within the overall portfolio of assets. In applying such total asset management approach, a fiduciary shall exercise the judgment and care under the circumstances then prevailing, which persons of prudence, discretion and intelligence exercise in the management of their own affairs, not in regard to speculation but in regard to the permanent disposition of their funds, and if the fiduciary has special skills or is named trustee on the basis of representations of special skills or expertise, the fiduciary is under a duty to use those skills.

(2) Except as may be provided to the contrary in the instrument, the following are among the factors that should be considered by a fiduciary in applying this total asset management approach:

(a) The probable income as well as the probable safety of their capital;

(b) Marketability of investments;

(c) General economic conditions;

(d) Length of the term of the investments;

(e) Duration of the trust;

(f) Liquidity needs;

(g) Requirements of the beneficiary or beneficiaries;

(h) Other assets of the beneficiary or beneficiaries, including earning capacity; and

(i) Effect of investments in increasing or diminishing liability for taxes.

(3) Within the limitations of the foregoing standard, and subject to any express provisions or limitations contained in any particular trust instrument, a fiduciary is authorized to acquire and retain every kind of property, real, personal, or mixed, and every kind of investment specifically including but not by way of limitation, debentures and other corporate obligations, and stocks, preferred or common, which persons of prudence, discretion, and intelligence acquire for their own account. R.C.W.A. § 11.100.020.

Other provisions of Washington law clarify the duties imposed on fiduciaries under this rule. Interestingly, Washington specifically provides for certain types of investments by fiduciaries. In Washington, for example, a fiduciary is authorized to invest in new, unproven, untried, or other enterprises with a potential for significant growth whether producing a current return, either by investing directly therein or by investing as a limited partner or otherwise in one or more commingled funds which in turn invest primarily in such enterprises. The aggregate amount of investments held by a fiduciary under the authority of this section valued at cost shall not exceed ten percent of the net fair market value of the trust corpus. See R.C.W.A. § 11.100.023. Also, any fiduciary may hold and retain any real or personal property received into or acquired by the trust from any source, and is not liable for any loss incurred with respect to any such investment, “if that investment was permitted when received or when the investment was made by the fiduciary, and if the fiduciary exercises due care and prudence in the disposition or retention of any such investment” R.C.W.A. § 11.100.060.

A duty against self-dealing is codified in Washington. See R.C.W.A. § 11.100.090. A Washington fiduciary is specifically authorized by law to use trust funds to acquire life insurance upon the life of any beneficiary or upon the life of another in whose life such beneficiary has an insurable interest. See R.C.W.A. § 11.100.120.

Washington also provides for the duty to the beneficiaries, the duty of impartiality and the duty to diversify in terms substantially identical to those of the Uniform Prudent Investor Act. See R.C.W.A. §§ 11.100.045, 11.100.047.

Finally, and most importantly for our purposes, fiduciaries in Washington are prohibited from entering into certain “significant nonroutine transactions” without providing written notice to the trustor. “Significant nonroutine transactions” include:

(a) Any sale, option, lease, or other agreement, binding for a period of ten years or more, dealing with any interest in real estate other than real estate purchased by the trustee or a vendor's interest in a real estate contract, the value of which constitutes twenty-five percent or more of the net fair market value of trust principal at the time of the transaction; or

(b) The sale of any item or items of tangible personal property, including a sale of precious metals or investment gems other than precious metals or investment gems purchased by the trustee, the value of which constitutes twenty-five percent or more of the net fair market value of trust principal at the time of the transaction; or

(c) The sale of shares of stock in a corporation whose stock is not traded on the open market, if the stock in question constitutes more than twenty-five percent of the corporation's outstanding shares; or

(d) The sale of shares of stock in any corporation where the stock to be sold constitutes a controlling interest, or would cause the trust to no longer own a controlling interest, in the corporation. R.C.W.A. § 11.100.140.

The best discussion of the Prudent Investor Rule in Washington jurisprudence has been in the case of Estate of Cooper. According to that court, overall trust performance is a factor in evaluating the performance of the trustee, but it is not by itself controlling. The court's focus in applying the Prudent Investor standard is conduct, not the end result. The prudent investor standard is necessarily flexible. Two principles, the court noted, can be observed: First, whether an investment is prudent or not is a question of fact. Second, the prudent investor standard requires that the fiduciary maintain a balance between the rights of income beneficiaries with those of the remainderman. Washington's version of the rule also requires that the trustee consider income as well as the safety of the capital and the requirements of the beneficiaries. The focus is on the trustee's performance, not simply on the net gain or loss to the trust corpus. See Estate of Cooper, 81 Wash. App. 79, 913 P.2d 393 (Wash. App. 1996), citing Harvard College v. Amory , 26 Mass. (9 Pick.) 446, 460-61 (1830); In re Lincoln First Bank, N.A. , 165 Misc.2d 743, 630 N.Y.S.2d 472 (Sup.Ct.1995).

In Allard v. Pacific National Bank, 99 Wash.2d 394, 663 P.2d 104 (Wash. 1983), the Washington Supreme Court discussed a trustee's duty to inform a beneficiary of all material facts in connection with a nonroutine transaction. According to the Allard court, the trustee's fiduciary duty includes the responsibility to inform the beneficiaries fully of all facts which would aid them in protecting their interests. That the settlor has created a trust, and thus required the beneficiaries to enjoy their property interests indirectly, does not imply the beneficiaries are to be kept in ignorance of the trust, the nature of the trust property, and the details of its administration. If the beneficiaries are able to hold the trustee to proper standards of care and honesty and procure the benefits to which they are entitled, they must know of what the trust property consists and how it is being managed. Thus, the trustee must inform beneficiaries of all material facts in connection with a nonroutine transaction which significantly affects the trust estate and the interests of the beneficiaries prior to the transaction taking place. See Allard v. Pacific National Bank, 99 Wash.2d 394, 404-405, 663 P.2d 104, 110 (Wash. 1983). A trustee must determine the best possible price for trust property either by obtaining an independent appraisal of the property or by "testing the market" to determine what a willing buyer would pay. Id. at 406.

With regard to the duty to diversify investments, the Washington rule is that a trustee has a general obligation to diversify, unless there is either (1) an express provision by the settler relieving the trustee of the duty to diversify, or (2) the circumstances dictate that it is not prudent to diversify. See