“The provisions of the Trustee Act 2000 do not provide trustees with unlimited powers of investment and delegation. In truth, the Act contained substantial safeguards against unlimited trustee powers in investment and delegation.”
Critically discuss this statement.
The enactment of the Trustee Act 2000, the duties of trustees has been the subject of considerable change. The Act is the culmination of a long history of proposals for reform, the most recent of which is “Trustees Powers and Duties (1999)” Law Com No 260. The primary rationale for reform has been the area of trustee investment. It has long been recognised that the Trustee Investment Act 1961 with its restrictions on investment in equities and land had failed to keep pace with social and economic developments and that change was needed. The Act implements a change in this area as it repeals most of the Trustee Investment Act 1961.
The Statutory Duty of Care
The Trustee Act 2000 established a new precisely defined duty of care applicable to trustees when carry out their functions under the Act. The new duty is intended to bring certainty and consistency to the standard of competence and behaviour expected of trustees. It is additional to the existing basic duties of trustees to act in the best interests of the beneficiaries and to comply with the terms of the trust.
Although the new duty of care does not apply to the exercise of a discretion, if trustees do exercise that discretion, then the new duty of care will be applied to the manner in which they exercised it. By virtue of s.1(1) Trustee Act 2000 whenever the statutory duty of care applies a trustee “must exercise such care and skill as is reasonable in the circumstance, having regard in particular:
a) to any special knowledge or experience that he has or holds himself out as having and
b) if he acts as trustee in the course of a business or profession, to any special knowledge or experience that it is reasonable to expect of a person acting in the course of that kind of business or profession.”
Thus when, for example investing in shares, a higher standard of care is expected from a trustee who is an investment manager than one who is a brain surgeon, particularly if the investment manager is acting as a trustee in the course of his business. The idea of a higher standard for someone with special knowledge or experience was previously recognised in the case of Bartlett v Barclays Bank (no 2). Here the bank was trustee of a settlement, which consisted of all the debenture stock and shares in a private company. Without the bank’s knowledge, the board embarked on hazardous property speculation, and lost a great deal of money. The bank did not attend board- meetings, and the only information it had was gleaned at annual general meetings. The bank was held to the standard of that of a competent bank, and as an expert on trustee investment, here they were found to be in breach of trust, and liable for the loss occasioned.
There are traditionally two approaches of regulating the way trustees carryout their investments, these are the:
- The Legal List Approach and
- The Prudent Persons Approach
These are general techniques found in any legal system, the interesting issue is how changes in the investing climate in the last 100-150 years has altered the way in which the law uses these techniques of regulation.
The Legal List Approach
Under a legal list approach you specify particular types of investment, which that are permitted. For example under a legal list approach trustees are permitted to invest trust funds in the following investments or categories of investment: A, B, C, D or F.
Prudent Person Test
The other approach is not to specify any particular type of investment, but just to say that trustees must act prudently in relation to investment. This does not restrict investment by specifying particular categories; trustees just need to invest prudently. The same distinction is used in other areas, in regulating driving for example, to say drivers must drive reasonably can alternatively be stated, as drivers must not drive above 40mph where specified on the road, one is very specific and the other is general and requires judgement.
Advantages and Disadvantages of Each
Broadly speaking the advantages and disadvantages can be seen of the two approaches. The legal list method is precise to state and easy to enforce, it is easy for a trustee to know what is permitted and what is not and it is easy to known when he has breached that duty. Stating which categories must be invested in could be an unnecessary restriction in some circumstances, denying the trustee of any discretion. It promotes the message that inactivity is safe to the trustee, this suggestion is incorrect in some cases for example where inactivity would ignore small growth or small returns which do not take into account the growth of inflation which will erode the value of the trust fund. The prudent person approach will be more difficult to enforce and it provides less guidance to the trustee, but there are reasons for it practicality, it is more flexible given that you would like trustees to invest the trust fund so far as possible. This in turn gives the trustee the freedom to invest and flexibility to diversify the investment within that discretion and judgement.
In s 3(1) of the Trustee Act 2000 it states:
3. – (1) … a trustee may make any kind of investment that he could make if he were absolutely entitled to the assets of the trust.
The effect of this provision is to abolish any form of legal list regulation and nowadays the only restriction on investment only a prudent person test. There has been a transformation in the law, where 150 years ago there was a narrow legal list regulation on investment, where the duty of prudence was of no consequence. Now in modern times the legal list system of regulation has been abandoned and the only regulation now is the general prudent person test and this complete transformation is down to the business environment, such as inflation and more stable companies along with the prospects of capital growth.
Ss. 4 and 5 require the trustees to have regard to ‘standard investment criteria’ and in certain circumstances to take advice.
The standard investment criteria
The standard investment criteria are:
(i) the suitability to the trust of the investment of the same kind as any particular investment proposed to be made or retained and of that particular investment as an investment of that kind, and
(ii) the need for diversification of investments of the trust, in so far as it is appropriate to the circumstances of the trust.
Suitability includes consideration of both size and risk of the investment and the need to balance income with capital growth. It is suggested that it will also include any relevant ethical considerations as to the kind of investments that it is appropriate for the trust to make.
Ss. 4 and 5 also apply in the case of express powers of investment in the trust instrument. The new power of investment will apply to existing trusts. However it will not generally apply to trusts which have a power of investment conferred by the Trustee Investment Act 1961. The Act requires trustees to review the investments of the trust from time to time. During such reviews the trustees must consider whether, having regard to the standard investment criteria, the investments should be varied.
Ss. 4 and 5 are not really very helpful in terms of providing guidance the meaning is not clear, but effectively what it is saying is that trustees must first consider the category of investment whether it is debt or investment and ask whether it is suitable. The first part of this question is should the trustee be investing in property or debt investment. Then it has to be asked whether the trustees are making the right choice as to that kind of investment. For example should the money go in a building society or should it go into shares? This is not particularly enlightening because this is part of prudence it does not really add anything except a rather curious form of expression. The second standard investment criteria, refers to diversification, this help reduce risk of investment. Investing a entire trust fund in on company can be very risk and can amount to imprudent investment. Again this is something that anyone would assume is part of prudent investment, however it is formally stated in statute here. Where this
has been more important has been in a issue that arose in the case of Nestlé v National Westminster Bank
Nestlé v National Westminster Bank (Ch D, Unreported, 1988)
NW, a bank, acted as sole trustee of the will of N, who died in 1922. It managed the investments firstly for N’s widow and two sons to provide annuities as expressly required by the will and then for the two sons. From time to time the investment strategy was changed to provide the sons with more income to meet their particular tax requirements. In 1986 G, the granddaughter of N and the sole remaining beneficiary, became absolutely entitled. At that time the fund was worth GBP 269,203. If it had kept pace with the ordinary share index since 1922 it would have been worth GBP 1,800,000. G issued proceedings for negligence against NW. Held, giving judgment for NW, that NW had not been negligent. It had adhered to the standards of prudent investment management and was entitled to be judged by the prevailing investment orthodoxies of the time, Leoroyd v Whiteley 1 applied. The standard to be borne by a trustee was to act with the care of an ordinary, prudent individual acting for someone for whom he felt morally bound to provide. A trustee’s duties towards investments were extremely flexible. If the trustee had acted prudently in the interests of the beneficiaries from time to time it was not negligent if the investments failed to keep pace with market indices.
At first instance Mr J Hoffman said nowadays trustees should be judged by what he called modern portfolio theory. The modern portfolio theory is that you cannot judge any investment in isolation, we can only judge an investment as part of a portfolio investment. In particular he expressed that it might be legitimate to make a terrifically risky investment as part of a overall policy investment, which was otherwise much safer. If this is right then it goes against the traditional rule of that if you are a trustee investing on behalf of a trust then hazardous investments should not be made, as suggested in Leoroyd v Whiteley .2 The portfolio theory says we cannot look at an investment in isolation but whether its is appropriate to the trust as a whole and part of this is because it is no longer accurate to refer to the duty of prudence, which has traditionally been the duty to avoid risk in investments. Nowadays it would be more accurate to describe the duty of care as a duty of optimisation rather than prudence, nowadays it is sensible to take some risk to make a sensible return.
When this case went to the Court of Appeal the court did not refer to the modern portfolio theory and it is not actually clear whether the Court of Appeal would accept if it is ever acceptable to invest in hazardous investments. The general principle must be for the trustee to follow current best practice, this would materialize to be the modern portfolio theory.