The CPA’s Introduction to Serving as a Trustee

By Josh Yager and Ryan Wolfshorndl, Anodos Advisors

So, you're a CPA and a trustee. You said "Yes" when your client asked, "Will you serve as my successor trustee?" We don’t need to belabor why you said yes, or whether you regret saying yes, or if your partners are happy about your decision. What's done is done. You said, "Yes, I will be your successor trustee and care for your widowed wife and orphaned children."

Fast forward — now, the settlor is dead and you are the trustee. And for that you will receive treasures in heaven… and consternation here on earth, because the beneficiaries whom you serve likely don't yet know or trust you.

The disgruntled beneficiaries second-guess your every decision: to sell the apartment building or keep the apartment building, to buy stocks or sell stocks, to increase distributions to Mom or reduce distributions to Mom. It doesn't matter what decision you make. For the most part they believe they should have been made the trustee and not you. So as a result, there is nothing you can do to make them happy.

It is good news that the beneficiary's frustration is not the basis for the trustee's liability. A trustee can only be found liable for breaching a duty of care and cannot be removed from the office, surcharged or be forced to disgorge their compensation unless the beneficiary can prove the trustee has breached a duty of care. So usually: No breach, no liability, no problem.

Good Faith and Best Judgment

CPAs who serve as trustees should adopt a simple governance process that demonstrates that they (1) know their duties of care and (2) have records that they have taken affirmative steps to fulfill these duties. If there ever is a day when a disgruntled beneficiary comes calling with their over-eager legal representative claiming that you have breached your duties as a trustee, you will be prepared.

The courts pay special deference to the trustee’s decisions. The trustee's decisions "shall be conclusive" if the exercise of that discretionary power is made in good faith and according to the trustee's best judgment. (Estate of Bixby, 55 Cal.2d 819.) This is the foundation upon which good fiduciary governance is based. The court holds your decision as "conclusive" so long as you can prove those decisions were made (1) in good faith and (2) according to your best judgment—not the court's best judgment, not the ticked off beneficiary's best judgment, not the deceased settlor's best judgment, but your best judgment.

Further, your decision as trustee will not be judged in hindsight, but in the light of the facts and circumstances that existed at the time you made that decision. Only when the trustee acts intentionally, with gross negligence in bad faith or with reckless indifference to the interests of the beneficiary, will the standardized risk mitigation language included in most trust documents fail. (California Probate Code [CPC] §16461.)

The Compliance Library

The obvious question, then, is how are trustees to provide proof that their decisions, at the time they were made, were made in good faith and in their best judgment? Easy: Write a memo. A prudent trustee will adopt a discipline of defining why they did what they did, when they did it. Ideally this record will include corroborating evidence for the basis of their decision.

A prudent trustee will develop an annual discipline of reviewing each of their duties of care and writing a memo demonstrating how they fulfilled those duties. This will enable the trustee to rebut a beneficiary’s claim that they acted in bad faith or with reckless indifference to the beneficiary’s interests. To be sure, the beneficiary won’t agree with your discretionary decision. That’s okay. There was a reason why Grandpa passed Junior over and asked you to serve as successor trustee.

The Five Duties of Care

Following is a quick outline of the five duties of care that a trustee is obligated to fulfill under the California Prudent Investor Act (CPC §16047-§16052) and suggested topics that should be integrated into each memo that prove the trustee acted prudently and in good faith in the administration of the trust. Note: This article is based on California Probate Code language. If the trust is not in California, the language will be substantially similar to that which is used here, though the statute citations will differ by state.

1) Duty to Prudently Administer
A prudent fiduciary will create and maintain a "Plan" that records their rationale for how the trust capital has been deployed. This memo should begin by reciting verbatim the statute and the trust's purposes, terms, and distribution requirements. This first paragraph of the governance memo demonstrates that the trustee has recognized their duty of care.

2) Duty to Balance Risk and Return
A fiduciary will also create and maintain a document that defines the types and measures of risk that were accepted to produce the return that the trust realized. The Uniform Law Commission identified the balancing of risk and return as the trustee's central consideration. Unfortunately, few trustees have any meaningful ways of measuring the various forms of risk that have been accepted.

Where investment duties have been delegated to an investment manager (in writing), a prudent trustee will require that the manager specifically define the various risks that the trust will be exposed to, how those risks will be measured, and the targeted return that these risk exposures are expected to produce. A trustee is also advised to ask that this analysis include a comparison of the portfolio’s actual return to that of a blended benchmark that has an asset allocation comparable to the portfolio being managed.

For assets that are illiquid or not professionally managed, a trustee will create a short inventory of the particular risks that are being accepted by continuing to hold these illiquid assets. This summary of the risks that are frequently observed with illiquid assets includes the amount of leverage used, the lack of accurate valuation, and the limitation on liquidity.

3) Duty to Diversify
Where the trustee has delegated investment duties to a professional investment manager, the trustee need only ask, "Will you please send me a memo on your firm's letterhead that confirms that, in your professional opinion, the portfolio is reasonably diversified within the standards of Modern Portfolio Theory, with an objective of reducing or removing firm-specific risk from the portfolio?"

For trusts that for one reason or another cannot or should not be diversified, the trustee will identify the rationale for not diversifying. A well-written memo will also argue that although the trust is not diversified, the purposes of the trust can still be accomplished. Suffice it to say, if over 20% of the trust is held in a concentrated or illiquid asset, a prudent trustee will have a series of well-argued reasons for not diversifying the trust.

4) Duty to Pay Fair Fees
In our experience, the two largest "fees" that are charged to a trust are (1) the fees and expenses incurred by hiring a professional investment manager and (2) the fees paid to the trustee for their administration of the trust. A prudent trustee will conduct a simple fee study to determine whether the costs incurred by the trust are consistent with industry standards for an account of similar size and complexity.

This study would include an analysis of not only the fees paid to the investment manager, but also those fees incurred for the underlying products or separate account manager that the investment manager has chosen to use. An additional inquiry would be conducted that compares the compensation paid to the trustee with the fees that would be charged by an institutional trust company or a licensed professional trustee.

5) Duty to Prudently Select, Delegate, and Monitor Agent's Activities
A prudent trustee will conduct a background check of their investment manager to confirm the manager is in good standing with the regulatory agencies that oversee their activities.

This investigation will take into account the manager’s industry experience, any complaints or lawsuits that have been filed against them, or any felony convictions that might put into question the high ethical standard expected of a delegate.

The trustee will also develop a document that serves as a clear delegation of investment duties and records the following: the projected distributions from the trust, the targeted rate of return being pursued, the expected standard deviation (risk) of the strategy, and the agreed upon fee the manager will be paid for their services.

Conclusion

If these five duties are documented—and the documents are reviewed, updated and reaffirmed each year—the trustee will have established the record that they (1) recognize their duties of care and (2) have taken affirmative steps to fulfill each of these duties. With this disciplined governance approach the trustee can expect that the court will hold their decisions as "conclusive" because they will have demonstrated that their actions were made in good faith and according to their best judgment.

To learn more about how trustees can reduce their personal risk by developing and adopting the processes described in the preceding, be sure to attend the complimentary live webinar, below.

Complimentary Live Webinar:

Investment Governance for Trustees: How to Avoid Being a Knucklehead (1 CPE credit)
This one-hour live webinar is intended for current trustees, CPAs considering becoming trustees, and advisors to trustees. Yes, this topic was broadcast in September, but we are repeating it to give more people the opportunity to attend. Watch for future live webinars on related subjects. And, watch for an email during late October with more information on this webinar.

The webinar will cover the governance process, the compliance library that addresses each of the trustee’s duties of care, and the activities that evidence the trustee has acted in good faith and according to the trustee’s best judgment—the foundation upon which good fiduciary governance is based.

Dates:

Thursday, November 8, 8-9 a.m. Pacific / 11 a.m.-12 p.m. Eastern
or
Friday, November 9, 10-11 a.m. Pacific / 1-2 p.m. Eastern


Presenters: Josh Yager, Managing Partner, and Ryan Wolfshorndl, Partner, Anodos Advisors
Anodos Advisors (https://anodosadvisors.com) develops and maintains an investment governance process for trustees to help them fulfill their fiduciary duties, standards of prudence and diligence, and duties of care.

To Register:
Go to https://university2.learnlive.com/camico to register. If you need to create a LearnLive account, please email a request for instructions to lp@camico.com.

Call CAMICO Loss Prevention at 800-652-1772, or email lp@camico.com, with any questions.
For technical questions, please contact LearnLive Support at 800-908-8984 or learnlive.support@thomsonreuters.com.

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