You asked whether the investment of RSI benefits by the representative payee in certain
mutual funds is proper under the prudent investor rule in Indiana. Indiana state law,
which is applied in these circumstances, indicates that a representative payee must
use reasonable care, skill and caution with the interest of the beneficiary as the
key element. We conclude that the investment vehicles proposed do not appear to meet
that standard.
FACTS
It appears that D.J. H~ is the representative payee for the conserved funds of Eric
W. H~. (Stephen H~ is listed both as a contact person and “payee” in one agency note.) In about August - September 2001, the payee had invested $22,744.00
in four Putnam Mutual funds: (1) Voyager; (2) Capital Appreciation; (3) New Opportunities;
and New Century Growth. The notes in the file show that the Agency contacted Mr. Jack
D~, an investments adviser at a bank in Columbus, Indiana in August 2001, and that
Mr. D~ described the investments as “an aggressive portfolio with a well known fund with a good track record.” Report of Contact, August 16, 2001. Mr. D~ would not comment as to whether or not
this investment met the prudent investor standard. Id.
In particular, Mr. D~ stated that the Capital Appreciation and New Opportunities funds
were “highly volatile,” and the New Century fund was “more volatile.” Id. He indicated that the Capital Appreciation fund had a two-star rating (on a five-star
scale); the New Opportunities fund had a three-star rating; and the two other funds
were too new to be rated. Id. Mr. D~ also stated that historically Putnam funds have been good funds, that the
market was down, and that lots of good funds were down. He added that these funds
were “more volatile” because they were new funds and also because they were “aggressive.” Id.
ANALYSIS
Federal regulations provide that, after a representative payee has used Social Security
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(a). 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 Program Operations Manual System (POMS) GN 00603.040(A). Generally, states tend to follow a “prudent investor” rule, and that rule is applied in Indiana. See Indiana Code (IC) 30-4-3.5; Six State Survey, Investment of Conserved Funds, 2001-08 SSA 01-P-06 (Gumm, Region V).
The regulations state that the preferred investments for excess funds are United States
Savings Bonds and deposits in an interest or dividend paying account in a bank, trust
company, credit union, or savings and loan association which is insured under either
Federal or State law. 20 C.F.R. § 404.2045(b). Similarly, operating procedures require
that excess benefits be conserved or invested with minimum risk, with preferred investments
being United States Savings Bonds. Benefits may also be invested in accordance with
state law governing the investment of trust estates by trustees. POMS GN 00603.001.
The prudent investor rule is found at Indiana Code (IC) 30-4-3.5. 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. IC 30-4.3-5-2(e). Indiana
case law does not provide much guidance in this area. However, we located one case
that discussed transactions in stocks generally. In Malachowski v. Bank One, Indianapolis, 590 N.E. 2d 599 (Ind. 1992), the court discussed whether the sale
of Eli Lilly stock breached the trustee's fiduciary duty, and found that it did not.
In addition, a trustee in Indiana is required to consider the purposes, terms, distribution
requirements, and other circumstances of the trust. A trustee exercises reasonable
care, skill, and caution. IC 30-4-3.5-2(a). The decisions must be evaluated, 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. IC 30-4-3.5-2(b). Funds should be diversified, unless it is in the best
interest of the beneficiary not to diversify. IC 30-4-3.5-3; see also Malachowski, 590 N.E. 2d at 564. A trustee should review the funds reasonably soon after taking
over the funds. IC 30-4-3.5-4. A trustee must use reasonableness, prudence, and diligence
and must be impartial with no conflict of interest. IC 30-4-3.5-6. A trustee may delegate
investment decisions, provided that the trustee exercises reasonable care, skill,
and caution in selecting an agent. IC 30-4-3.5-9. Thus, investment in a managed fund,
such as a mutual fund, would be appropriate, if otherwise reasonable. Further, compliance
with the prudent investor rule is determined in light of the facts and circumstances
existing at the time of a trustee's decision or action and not by hindsight. IC 30-4-3.5-8.
Likewise, the Restatement (Third) of Trusts, § 227, sets forth similar standards.
It indicates that the “prudent investor rule,” followed by most states, does not classify specific investments or courses of action
as prudent or imprudent. Although the rule imposes a duty to use caution and a degree
of conservatism in investing, “reasonably sound diversification is fundamental to the management of risk,” and “trustees ordinarily have a duty to diversify investments.” Id. Under the rule, “the permissible investments of trustees are not confined to 'reliable' securities
of governments and 'established' corporations.” Id. “Higher risk domestic and foreign stocks are also permissible investments for trustees
under the prudent investor rule,” and “the stocks of small, expanding companies ('venture capital') are not abstractly characterized
as impermissible trust investments.” Id.
Our research shows that Putnam Investments has various funds listed under the names
of the funds you provided to us, but that the New Century Growth fund has been merged
into the Voyager II fund (a large capital growth fund). See http://www.morningstar.com. As of this date, the Morningstar website indicates that the Putnam Voyager funds
have 3-star ratings (large capital growth funds); the Capital Appreciation fund has
1-star ratings (multi-capital core blended funds); and the New Opportunities funds
have 1 or 2-star ratings (multi-capital growth funds). Morningstar currently recommends
a “wait-and-see” posture towards the Voyager and Capital Appreciation funds and an “avoid” posture with regard to the New Opportunities funds. See http://www.morningstar.com; http://www.putnaminvestments.com. Looking at these investments with a very “broad brush,” we note that, as would be expected, these funds have lost significant value in 2001-02,
and those losses exceed by about 10 percent the losses in a more diversified portfolio,
as exemplified by the Thrift Savings Plan (TSP) C fund for equities. See http://www.putnaminvestments.com; http://www.tsp.gov. We do not know, however, whether the representative payee still has the monies in
these funds.
In any case, it should be noted that the prudent investor standard is not applied
in hindsight. See IC 30-4-3.5-8. In addition, despite the language in the regulations and POMS indicating
a preference that conserved funds be held in instruments of very low risk, see 20 C.F.R. § 404.2045(b), POMS GN 00603.001, it is clear that the law allows the use of mutual funds. See, e.g., IC 30-4-3.5; IC 30-4.3-5-2(e); Restatement (Third) of Trusts, § 22. We have reviewed
the prior opinions from various jurisdictions regarding the application of the prudent
investor rule to conserved funds, and we have located only one such opinion indicating
that an investment plan did not appear to meet the requirements of the rule. This
is the June 10, 2002, opinion from the Office of the General Counsel, Region VII,
Kansas City, found on PolicyNet at POMS PR 07305.030-Nebraska. In that case, a bank trust officer stated that the subject mutual fund
investments in college/education funds standing by themselves did not meet the “prudent person” standard, and that greater diversification in resource allocation was needed, suggesting
that the representative payee should have four to five mutual funds, including growth
and income, large cap, small cap, etc. In that case, the writer relied on the opinion
of the trust officer that the subject investments did not meet the requisite standards.
See POMS GN 00603.040B.
In the instant case, however, the investment banker consulted by the Agency declined
to give an opinion on that matter. The investments at issue here are not, however,
significantly diversified, and it is clear that the law requires diversification in
most circumstances. See, e.g., IC 30-4-3.5-3; Malachowski, 590 N.E. 2d at 564; Restatement (Third) of Trusts, § 227. Mr. D~ described the portfolio
as aggressive and highly volatile although he indicated that Putnam investments, historically,
were reliable. All of the other opinions reviewing particular investments under the
prudent investor standard were significantly more conservative investments. While
the Agency may not want to be in the position of giving investment advice, especially
without an opinion by a financial consultant, we believe that, based upon the facts
presented, the investments do not appear to meet the standard required by the regulations
and Indiana law. We suggest that Mr. H~'s current investment of conserved funds be
reviewed and that, if the portfolio remains “aggressive” and “volatile,” or otherwise lacks diversification, that the Agency suggest that he reallocate some
of the funds to more conservative mutual funds or other investments.
CONCLUSION
Indiana has incorporated the Prudent Investor Act within its laws. Under Indiana law,
the investments Mr. H~ has made appear to be inadequately diversified to meet this
standard, especially in light of the fact that the entire portfolio is considered
aggressive and volatile. We suggest that the portfolio be reviewed, and that, if the
investments remain undiversified and volatile, that it be suggested that Mr. H~ begin
the process of reallocating some of the funds.
Sincerely yours,
DONNA L. C~
ACTING REGIONAL CHIEF COUNSEL
By: ____________________
Carole J. K~
Assistant Regional Counsel