DELEGATION OF TRUSTEE POWERS
When a client has a large asset base and a trust that will continue for a long period of time or in perpetuity, trustee selection often becomes an important issue to address. There may not be another person the client trusts to make decisions or who has the sophistication to invest, distribute or administer the trust assets. The client likes the idea of having distribution and administration decisions made by a third party such as a corporate trustee but wants to retain their investment adviser to make investment decisions. This could be because of the long-standing relationship with the adviser, trust and confidence in their service and continuity of the investment philosophy. Unfortunately, most large banks and corporate trustees require the assets to be converted to their investment platform, thus creating the conundrum.
Directed or Delegated Model?
There are two models to solve this issue, the directed model where the investment adviser directs the trustee to make investment decisions and the delegated model, where the trustee delegates the investment decisions to the investment adviser, subject to the trustee’s review. The directed model receives a lot of attention, but has significant shortcomings because of the division of responsibility, lack of oversight and potential for finger pointing if issues arise. The delegated model addresses these concerns and is more closely aligned with the objectives of the settlor and interests of the beneficiaries. The delegated model grants the appointed trustee some authority over the investment agent and imposes responsibility on the trustee if the trustee fails to take appropriate action, giving beneficiaries a clear line of authority if an issue arises in the future.
Under the delegated model, the trustee delegates the investment responsibility, or a portion thereof, to an investment adviser. The investment adviser makes the investment decisions and is primarily responsible for such activities. The trustee receives statutory relief under Arizona law from liability if certain oversight duties are met – the trustee must provide reasonable care in selecting the agent, establishing the scope and reviewing the agent’s actions. As important, the trustee also retains a direct claim against the investment agent if the agent fails to perform.
What Powers should a Trustee Delegate?
A trustee serves many functions, but they can be loosely summarized into three roles – (i) administration (tax, record keeping and reporting), (ii) investment selection and management and (iii) determining discretionary distributions to beneficiaries. Of these roles the investment function is the most often power that is delegated to a third party, but other functions are routinely delegated as well such as accounting and legal. The investment power delegated can be broad – over the entire portfolio, or narrow – a unique segment of it, such as commercial real estate, a closely held business, a bond fund, etc. A trustee should not delegate roles or functions that it has a particular skill to perform. For example, an investment adviser appointed and serving as trustee will not be relieved of liability for investment decisions delegated to another investment firm.
Best Practices for Using the Delegated Model.
Trustees, whether individuals or corporate, relying on the delegation of powers should consider the following actions to insure they receive the liability protection afforded by Arizona law:
A. Agent Selection.
1. Confirm the agent has sufficient experience with the area or industry delegated.
2. Confirm status of federal and state licensing authorities, complaints and investigations. For investment advisers, confirm active status of FINRA license.
3. Review customer reviews.
4. Review any outstanding lawsuits.
5. Confirm the agent has sufficient capital and resources or insurance, relative to assets delegated, to cover any claims for malfeasance if the agent falls below the standard of care.
6. Review proposed plan or objectives for compliance with applicable laws and appropriateness for the trust and its beneficiaries. For investment advisers, is the plan compliant with the Prudent Investor Act and consistent with trust and primary beneficiary’s goals and characteristics (such as age, risk tolerance and needs)?
B. Scope Letter.
1. Specifically define authority delegated to the agent. For investment advisers, is it all marketable securities or just a specific portion e.g. the bond portfolio?
2. Set forth whether the agent is acting as a fiduciary.
3. Include specific goals and objectives, and where appropriate, attach a copy of the proposed plan. For investment advisers determine whether investment plan is compliant with the Prudent Investor Act or other applicable law.
4. Address who is primarily responsible for client communication.
5. Include beneficiary’s characteristics, goals and objectives, age, risk tolerance, etc.
6. Require written reports, define reporting periods and information to be included.
1. Review reports. Is the performance meeting the plan and if not, why? For investment advisers, has the investment philosophy changed?
2. Third party review of complaints, investigations or limitations on license. For investment advisers, review FINRA license status.
3. Review any outstanding lawsuits.
4. Consider engaging a third-party auditor to audit performance, accounts and transactions.
When circumstances dictate separating a trustee’s distribution and administration functions from the investment function, the delegation model should be considered over the directed model. The delegation model has practical advantages and is more closely aligned with the objectives of the settlor and the interests of the beneficiaries. In using this model, the trustee must make sure the function is delegable and use reasonable care in the selection of the agent, terms of engagement and monitoring. For more information on this topic and to determine if this model is appropriate for your circumstances, please contact us to set up an appointment.