Best practices to minimize liability
Acting as a trustee, in an individual capacity, carries with it risks and responsibilities that need to be understood by anyone stepping into that role. Trustees can be held personally liable for failure to adequately serve the needs of the trust and its beneficiaries. Pursuing a fiduciary role through a Private Trust Company (PTC) insulates individuals from their personal risk to some extent but transfers that risk to the PTC.
Managing the liability isn't always easy, but it's achievable if the trustee follows certain policies and procedures, approaching the management of all trusts and execution of it activities in a professional and responsible manner. There are several areas in which the trustee can take action to minimize its liability.
While this is easier for corporate (PTC) trustees, all trustees should endeavor to obtain insurance for their errors and omissions. If there's a corporate entity, directors and officer's insurance should be obtained as well.
Understand All Trust Documents
Understanding the trust documents and ensuring that the trustee has the ability to administer the assets, directly or through the use of outside vendors, is an important part of risk mitigation.
Hold Quarterly Communications with Beneficiaries
As a best practice, we recommend that trustees have regular and frequent communication with the trust beneficiaries: quarterly and annually. A typical review will consist of a review of the following areas or topics:
Overview of summary or trust operations.
These include income earned, distributions and investment performance. Depending on the trustee's choice of custodial platforms, the generation of these reports should be mostly routine with some manual work needed to polish and collate information.
In addition to the performance reporting of trust assets, the trustee (or PTC) will need to provide a broad market overview, as well as a discussion of the tactical and strategic asset allocation of the trust, review of the investment policy guidelines and distribution provisions, with a summary of what this means to the beneficiary and the trust longer term. Outside managers may join for all or part of this review, depending on logistics (in the case of multiple managers, we would have one member of the administrative team handle this, perhaps in conjunction with the investment committee). The investment review should also be consistent with the investment committee and PTC's approach to investing and philosophy around trust management.
Principal and income review.
Conduct a review at each quarterly meeting, with an in-depth review annually, of the principal and income accounts of the trust, as well as what this means for the beneficiary cash flows and taxes.
Next steps and outlook.
Each review will conclude with a summary of changes to objectives and outlook for future of trust investments or distributions.Manage taxation of trusts. The trustee needs to review, at least annually, the state and federal tax returns of the trust in conjunction with the distributions and investment objectives of the trust.
Develop an investment approach appropriate to trust management.
The trustee (or PTC) needs to identify its approach to investment management and recognize where personal biases might be at odds with the investment needs of a trust. For example, the Uniform Prudent Investor Act (UPIA) is predicated on a belief that there's no ability to efficiently capture market alpha, or an outperformance of a benchmark, through active management. As such, the UPIA favors index-based approaches to trust management in which low fees and strong adherence in the portfolios to their applicable benchmarks ensure that the trust will keep pace with its asset allocation.
This belief places the focus on strategic asset allocation with tactical tilts in the portfolio balance to reflect market conditions and is executed through exchange-traded funds, option overlays and capital protected strategies. When there's a belief in market alpha, the trustee (or PTC) would need to articulate why this belief is held and why this manager is able to obtain the excess return expected. Moreover, the trustee (or PTC) is responsible for ongoing review and oversight of the investment manager, would need to articulate a timeframe for such performance and be willing and able to fire that manager over time.
Create formal written investment statements.
Each trust needs to have a formal written investment policy statement (IPS). These IPS statements address a number of topics, depending on the trust, but usually include: the time horizon of the trust and its impact on the way investments are made; the distribution or income required by the trust terms and attendant impact on investments; the risk tolerance of the trust and trust beneficiaries; the manner in which any large concentrated positions are incorporated into asset allocation; and the investment philosophy.
The PIA imposes a duty on the trustee to pursue and overall investment strategy, having risk and return objectives reasonably suited to the entire portfolio, which will enable present and future distributions to/for the beneficiaries as required under the instrument. In constructing a portfolio investment strategy, Trustees must consider risk tolerance of the trust and the relevant circumstances of the beneficiary. Trustees are also required to diversity assets unless it is reasonably determined by the Trustee that it is in the best interest of the beneficiary not to diversity.
Create formal written distribution policies.
Each trust should have formal written distribution policies. These distribution policies will include a recitation of what the trust documents provide with respect to distributions, the trustees interpretation of these documents and any philosophical approach or belief that the trustee will use when reviewing special distribution requests.
Develop strong (detailed, comprehensive but workable) fiduciary policies and procedures.
In the case of a PTC, the PTC Board will approve the policies and procedures to address operational issues in all areas of trust management.
Ensure meticulous record keeping across all areas.
In particular, the trustee (or PTC) will need to have strong records for accounting, tax compliance, custody and reporting, beneficiary meetings and communications.
Trustee Best Practices
Many of the best practices of a trustee are set forth above in the “Risks and Risk Mitigation” section.
A few additional things to note include:
- Do understand the implications of the UPIA and the Principal and Income Act (P & I Act) on trust management.
- Do understand your rights and responsibilities as a trustee.
- Do create a philosophy for the PTC to follow in the creation and operation of the enterprise.
- Don't let family ties, views or prejudices obscure your legal obligations as a trustee.
- Do focus on collaboration and consensus. Ensuring that all parties act in sync, that there is sufficient financial planning and education of beneficiaries to ensure that they understand their trusts, will be important to any long-term success.
- Do have clear, repeatable metrics for making investment decisions, implementing trust structure and distribution decisions.
- Do understand trust documents and distribution provisions.
- Do recognize and use the flexibility offered to trustees under the P & I Act to ensure that the best result for the beneficiary is obtained, while balancing the fiduciary obligations of the trust.
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As a reminder, this Blog Post is for informational purposes only and is not intended as legal or tax advice.