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Trusts • Trustee Powers & Duties
TRUSTS#037
Legal Definition
The Uniform Prudent Investor Act (UPIA) is a standard that sets out guidelines for trustees to follow when investing trust assets on behalf of a trustor. It adopts a modern portfolio theory and total return approach to the exercise of fiduciary investment and discretion.
Plain English Explanation
The UPIA helps to standardize and modernize the guidelines followed by trustees. Traditionally, trustees followed the "prudent man rule," which came about in 1830 and basically told trustees to treat investments as they would their own while being mindful of the needs of the beneficiaries, health of the trust, and overall need for income to keep the trust alive long enough to serve its purpose. In 1992, the UPIA made four primary changes:
(1) Under common law, each individual investment is scrutinized. Under the UPIA, the portfolio as a whole is scrutinized. In other words, a trustee need not worry about individual stocks not performing so long as all of the investments—as a whole—are performing well.
(2) UPIA requires diversification of investments (meaning don't put all the money into a single company or type of investment).
(3) Category restrictions were removed, allowing a trustee more freedom in deciding which types of investments to put in the portfolio.
(4) Finally, the UPIA allows the trustee to delegate investment management and other functions to qualified third parties.
(1) Under common law, each individual investment is scrutinized. Under the UPIA, the portfolio as a whole is scrutinized. In other words, a trustee need not worry about individual stocks not performing so long as all of the investments—as a whole—are performing well.
(2) UPIA requires diversification of investments (meaning don't put all the money into a single company or type of investment).
(3) Category restrictions were removed, allowing a trustee more freedom in deciding which types of investments to put in the portfolio.
(4) Finally, the UPIA allows the trustee to delegate investment management and other functions to qualified third parties.
Hypothetical
Hypo 1: Bob dies and leaves $1 million to a trust for his son Timmy, naming Timmy's friend Amy as trustee. Amy invests all the money in a start-up company that goes bankrupt. Timmy sues Amy, saying she violated her duties by not diversifying the investments. Result: Under the old prudent man rule, Amy may have breached her duty by putting all the trust's money into a single risky investment. Also, under the UPIA, trustees must diversify to manage risk. By failing to diversify, Amy violated modern prudent investor standards, despite possibly having good intentions.
Hypo 2: Bob dies and leaves $1 million to a trust for his son Timmy, naming his friend Sam as trustee. Sam delegates investing decisions to a qualified financial advisor. The advisor makes reasonable choices, but due to a recession, the trust assets decline 25% in value. Timmy sues Sam for improperly delegating his management duties. Result: Under the UPIA, trustees can delegate tasks like investing to experts. Sam acted properly in relying on a qualified financial advisor. The losses, while unfortunate, do not mean Sam breached his duties - markets involve risk even with prudent choices.
Hypo 3: Bob dies and leaves $500,000 to a trust for his son Timmy, naming his friend Amy as trustee. Amy diversifies the investments, but a few tech stocks greatly outperform, so 60% of assets end up concentrated in them. Timmy sues Amy, saying the lack of diversification violates prudent investor rules. Result: Under UPIA, trustees must review the entire portfolio when assessing prudent investing. Here, even though some holdings grew large, Amy made reasonable choices to diversify, and Timmy can’t expect perfect 20/20 hindsight investing. No breach occurred.
Hypo 2: Bob dies and leaves $1 million to a trust for his son Timmy, naming his friend Sam as trustee. Sam delegates investing decisions to a qualified financial advisor. The advisor makes reasonable choices, but due to a recession, the trust assets decline 25% in value. Timmy sues Sam for improperly delegating his management duties. Result: Under the UPIA, trustees can delegate tasks like investing to experts. Sam acted properly in relying on a qualified financial advisor. The losses, while unfortunate, do not mean Sam breached his duties - markets involve risk even with prudent choices.
Hypo 3: Bob dies and leaves $500,000 to a trust for his son Timmy, naming his friend Amy as trustee. Amy diversifies the investments, but a few tech stocks greatly outperform, so 60% of assets end up concentrated in them. Timmy sues Amy, saying the lack of diversification violates prudent investor rules. Result: Under UPIA, trustees must review the entire portfolio when assessing prudent investing. Here, even though some holdings grew large, Amy made reasonable choices to diversify, and Timmy can’t expect perfect 20/20 hindsight investing. No breach occurred.
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