In Focus: Fiduciaries

April 1, 2001 Advisory
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Those whom the law entrusts with the management of other peoples'
assets, whether they are executors of decedents' estates or trustees of
revocable or testamentary trusts, are fiduciaries, and, as such, are
charged with certain legal duties and responsibilities. The details vary
somewhat from state to state, but virtually all fiduciaries are held to
certain fundamental standards.
The duty of loyalty. Perhaps first and foremost is a fiduciary's duty of
loyalty, which dictates that a fiduciary must always act in the interest
of the beneficiaries, not in the fiduciary's own interest. Self-dealing
between a fiduciary and a trust or estate is prohibited, as are
transactions in which a fiduciary may have an indirect interest (such as
transactions with the fiduciary's family members). Importantly, a
fiduciary may breach the duty of loyalty even though a transaction was
at fair market value and even if the fiduciary does not profit from the
transaction. However, some acts that would otherwise violate the duty of
loyalty may be permitted under the terms of a trust agreement. For
example, institutional trustees, such as banks, are often expressly
permitted to invest trust assets in their own proprietary mutual funds
and deposit accounts.
The duty of impartiality. Fiduciaries must treat all beneficiaries
fairly and impartially. This can cause tensions, particularly if there
is a current beneficiary (e.g., a surviving spouse) who has interests
and needs that are different from those of the contingent beneficiaries
(e.g., children of a prior marriage). The current beneficiary may want
assets to be invested to generate high income at the expense of
long-term growth. The contingent beneficiaries may resent the erosion of
long-term growth potential. The management of unique assets, such as
vacation homes or closely-held company stock, can also cause friction
among multiple beneficiaries if they have different ideas about how such
assets should be managed.
The duty of prudence; the prudent investor standard. The duty of
prudence has evolved in recent years from a standard that looked at each
investment made by a fiduciary and separately analyzed whether it was
prudent, to a more flexible, portfolio view of the appropriateness of
investment decisions, taking into account the purposes of the trust or
estate, its assets and the circumstances of the beneficiaries. This
allows the fiduciary to develop an overall investment strategy that
incorporates risk and return objectives suitable to the tasks at hand.
Thus, for example, it is often prudent to liquidate certain assets to
ensure that there will be cash available to pay death taxes, even if
cash is not then the best investment available. Similarly, sometimes the
circumstances of a surviving spouse dictate that the family home be held
in trust, even though it may not be a profitable investment.
Other duties. Fiduciaries must act in accordance with their governing
documents. For an executor, this would be the decedent's Will; for a
trustee, it would be either the Will (for a testamentary trust) or the
separate trust agreement. Fiduciaries are often permitted to delegate
certain duties. For example, a family member who has been asked to act
as an executor or trustee may be expressly authorized to hire an
independent investment advisor to assist with financial matters. In such
cases, the fiduciary will be held to a fiduciary standard of care and
prudence in the selection of the advisor, but may be relieved of
responsibility for the actual results achieved by following the advice
of the advisor.