TY - JOUR
AU - O’Hagan, Patrick
AB - Abstract In this article, the author considers the key issues relating to trustees’ liability for investment losses including breaches of fiduciary duties and breaches of duties of care and skill before considering the risks of obtaining advice or delegating asset management and custodian functions and the risks of in-house advice or asset management. In doing so, he weaves into these the salient enactments of Singapore, Jersey, the BVI, the Cayman Islands, Bermuda and the Isle of Man. Liability risk for trustees in the context of investment losses arises from the decreased value of trust assets or defalcation on the part of a custodian or other party who holds the assets. However, a trustee is not a guarantor of the value of the trust fund1 so that loss of value due to investment performance or fraud on the part of a third party asset manager or custodian will not per se fix a trustee with liability. What is required in addition is a breach of duty.2 For these purposes, there are two types of breach; first, breach of fiduciary duties in relation to which strict compensation rules apply with potentially harsh results for trustees. Secondly and separately, breach of duties of care and skill in respect of which a less strict regime will apply. The substantial differences in the nature of liability and the amount of compensation a court will order depending on the type of breach should be the first consideration for trustees when prioritizing risk management measures. Breach of fiduciary duty— unauthorized investments The principal fiduciary obligation of a trustee is to adhere to the terms of the trust. Thus, if the trustee purchases or retains an unauthorized investment, the beneficiary can elect whether to accept the asset or hold the trustee to account and force him to reconstitute the trust fund.3 If the latter occurs, the trustee retains the unauthorized asset on his own account and puts the trust fund in the position it would have been ‘but for’ the breach. This is a strict obligation to reconstitute the fund under which a trustee cannot, as in other areas of law, dispute liability or reduce the quantum to be paid in compensation by arguing that the extent or nature of the loss was not foreseeable or was caused or aggravated by intervening factors. For example, if the trustee sells shares in an authorized investment and purchased an unauthorized investment with the proceeds, the beneficiaries can force the trustee to reconstitute the fund by replacing the original shares or their value at the time of judgement plus interest.4 The fact that the shares have enjoyed a wholly unforeseeable increase in value is not taken into account. The risk of straying into unauthorized investments is less than formerly was the case as, even in the absence of an express investment provision in broad terms in the trust deed, statute in all major trust centres will authorize the trustee ‘to make any kind of investment that he could make if he were absolutely entitled to the asset of the trust’.5 However, caution is still required; trust deeds may contain express prohibitions on types of investment or set out in terms what form of investment must or must not be held or the proportions in which they must be held. Overlooking or misunderstanding such provisions presents a substantial fiduciary risk. In addition, placing trust assets in the hands of a custodian or nominee who misappropriates these will lead to strict liability on the part of the trustee to reconstitute the fund if the trustee did not have the authority to use that custodian or nominee. The nature and extent of powers on the use of custodians should always be confirmed. Finally, as discussed below, investments may be considered to be unauthorized due to improper or unconsidered advice or a failure to properly appoint a discretionary assets manager. Breach of duty of care A second and different form of breach occurs when the purchase or retention of authorized assets results in loss to the trust fund. This need not constitute a fiduciary breach but may be a breach of the trustee’s duty of care, or what more traditionally was referred to as loss resulting from an absence of prudence or wilful default. While in most, but not all,6 of the major offshore trust centres the investment duties of trustees have been codified in statute, trustees continue to be judged by the standards of the prudent man whose characteristics were developed by the courts. However, although the legislation in many jurisdictions continues to refer to ‘prudence’,7 the term does not appear in the amended or new legislation in other places, most notably in England and Wales (2000), the Isle of Man (2001) and in Singapore (2004) where it has been replaced by a statutory ‘duty of care’. It is not yet clear whether the prudent man has disappeared from these shores or survives to play an altered or, effectively, the same role in statutory garb.8 Until the contrary becomes apparent, or unless a lower standard expressly applies as in the British Virgin Islands,9 trustees should assume that the new statutory regimes permit neither more nor less risk taking nor afford more or less leeway to trustees in the event of loss than that traditionally allowed the prudent man. The new trustee legislation in the various centres also codifies judicial statements10 that professional and paid trustees and those who advertise their competence will be judged by a harsher standard than unpaid or non-professional trustees.11 The statutory regimes have the advantage that the legislation sets out the steps required to discharge the duty of care. Trustees subject to the English or Manx statute, or that of Singapore, must in the first instance have regard to ‘standard investment criteria’12 including the need for diversification13 and advice.14 This, however, is the default regime and the requirement to have regard to these matters is subject to the terms of the trust.15 Suitability While the English (Manx and Singapore) Trustee Act expressly requires consideration of the suitability to the trust of any particular investment, no further guidance is given on how this is to be established. We know from the common law that determining suitability includes consideration of the size of the fund,16 whether there is a life tenant whose interests need to be balanced against the rights of remaindermen,17 and the differing requirements of the beneficiaries.18 We also know that in the absence of express provisions, investment suitability is judged exclusively in terms of financial returns without heed to moral or ethical matters.19 The Trustee Act of Bermuda (as amended) indicates that the requirement to act as a prudent investor will be met: by considering the purposes, terms distributions requirements and other circumstances of the trust and by exercising reasonable care, skill and caution.20 The Bahamas Trustee Act sets out an extensive list of matters to be considered21 by the trustee in choosing investments and provides that trustees shall: have regard to the suitability of individual investments, not in isolation, but in the context of the trust property as a whole, with a view to obtaining an overall balance of risk and return reasonably suited to the trust …22 The express recognition of modern portfolio theory 23 in the Bahamas and also in the Bermuda24 legislation follows the common approach in the United States.25 This is implicit in the English 2000 Act26 and had, in any event, been accepted by the judges when the prudent man was at large.27 From a liability perspective, modern portfolio theory is about taking risks which do not in themselves constitute breaches of the trustee’s duty of care. Excessive timidity and trustees’ duty of care While losses due to speculation are usually clear to see, it is more difficult to impugn a trustee’s actions for not being sufficiently active or daring. Portfolio theory notwithstanding, a trustee might be tempted to take as few risks as possible and stick with a defensive approach premised, to the extent possible, upon protecting the nominal capital value of the trust fund. This is a difficult stance for a beneficiary to successfully attack.28 Although the English Court of Appeal29 has accepted that loss can be incurred by a trust when it makes a gain less than would be made by a prudent businessman, a problem for a claimant in arguing lost opportunity is to prove that loss has in fact been caused by a breach of duty. A second higher hurdle is that the claimant must show that the course adopted was one ‘which no prudent trustee would have followed’.30 Compensation for breach of duty of care A loss to the trust fund due to negligence or want of care in relation to the exercise of investment powers is not in itself a breach of a fiduciary duty by the trustee (even though it may be termed as a breach of trust).31 Liability, if found, is not a strict liability to reconstitute the fund so that foreseeability and causation are available as defences or to reduce the extent of compensation payable. The trustee can exempt himself from liability in the trust instrument, thereby effectively causing the standard of care to which it is subject to vary between ‘wilful default’, which in this context means a want of prudence, through different degrees of negligence to ‘actual fraud or dishonesty’.32 Risks in obtaining advice Both at common law33 and by statute,34 unless not required on a reasonable basis, trustees must obtain proper advice in exercising their power to make and retain investments. It may be reasonable not to seek advice if the trust fund is too small to justify the cost or the trustees are themselves possessed of the necessary expertise. Even in these circumstances, however, the trustees should consider the matter and note their decision.35 Following properly considered advice affords a considerable degree of protection to a trustee. However, trustees must have properly appointed and instructed the adviser on their objectives and must consider whether the recommendations received are in keeping with those objectives.36 The common law position as codified by statute in England, the Isle of Man,37 Singapore38 and the Bahamas39 is that an adviser appointed by a trustee should be a person of ability and practical experience. A trustee would not have received proper advice unless his appointed adviser meets this standard.40 There are several risks in failing to make a proper appointment. Failing to obtain advice or negligently appointing an inappropriate adviser may ground a successful claim of breach of a duty of care in the event of a loss of investment value. However, liability is not strict so that various defences are available including the argument that the trustee could have acted in the same manner even had he received proper advice or no advice. Secondly, and more seriously, an investment without proper basis could be successfully characterized as unauthorized if there is an obligation to receive advice.41 To remove the latter risk, an obligation to receive proper advice must be expressly removed in the trust deed.42 Even if an adviser has been properly appointed and retained, trustees face potential liability if there has been a loss to the trust fund caused by a breach of their duty of care in negligently following advice. Trustees must consider advice and come to their own decisions on investments. The standard of care to which the trustee is subject could, by the terms of the trust deed in all major trust jurisdictions except Jersey, be as low as actual fraud or dishonesty.43 However, fraud includes recklessness and the trustees, having a duty to consider any advice received, would be reckless if they gave scant or no thought to the advice and shut their eyes to the risks. Again, the potentially more serious risk exists that failure to properly consider advice received would render a purchase unauthorized, with that result that the trustee must reconstitute the trust fund for any loss caused by that purchase regardless of whether it was reasonable to purchase the asset in question. Unlike the requirement to receive proper advice, the requirement to consider advice before implementing such advice cannot be ousted. The question here is whether in following unconsidered advice the trustee is acting beyond his powers.44 Risks in delegating asset management and custodian functions The Trustee Act 192545 of England and Wales introduced a statutory power of appointment of agents under which the trustee might not be vicariously liable for the actions of their delegates even if the trustee was himself capable of undertaking the act in question. However, absent an express provision in the trust deed, it was not possible to delegate discretion (as opposed to purely administrative functions) in relation to investments and other matters. Trusts settled by deed in the past half century will usually contain a provision permitting the delegation of investment powers to a professional investment manager to make and execute investment decisions; however, some deeds will not and those which do will not necessarily address all of the various issues faced by trustees in delegating their investment powers. Express provisions must be checked for limitations. For many years, the restrictive approach in the English Trustee Act 1925 was invariably copied verbatim in relation to delegation of duties and most other issues in the offshore trust jurisdictions as elsewhere in the Commonwealth. However, much of the Act was outdated by the 1960s and fresh legislation to meet the changing circumstances of the 21st century was required.46 All major trust jurisdictions by a variety of means now permit delegation of discretion in investment management as the statutory default position.47 Whatever the proper law of the trust and whether the power is statutory or express, in exercising a power to delegate investment management on a discretionary basis, trustees face similar duties and risks. These arise in the appointment and in the ongoing supervision of the delegate in relation to both of which the trustee will be subject to the standards of the prudent man or the statutory duty of care as the case may be. Having confirmed the requisite power48 as in the case of advisers, the trustee has to appoint a proper person to act as a discretionary manager (or custodian) with the same potential for responsibility for losses due to the appointment of someone unsuited to the task.49 In all jurisdictions, in addition to required formalities,50 proper appointment will entail ensuring that the investment manger is appraised of the objectives of the trust and failure to adhere to this obligation may result in unauthorized investments. Under the legislation in England51 and those countries which have followed it,52 the trustee must prepare a ‘policy statement’ providing guidance on how asset management functions must be exercised which the investment manager must expressly agree. A policy statement is not a statutory requirement in other jurisdictions53 but clearly some form of agreement does have to be entered into between the investment adviser and the trustee to set out the terms of appointment and address the potential conflicts discussed below. Policy statements have been adopted as best practice in offshore trust centres even where not required under local law.54 The trustee has a duty to appoint the discretionary investment manager on terms which are not unfavourable to the interests of the beneficiaries of the trust. In particular, the trustee should consider whether terms of the contract of the investment manager which permit him to sub-delegate, self-deal or restrict his liability are permitted by the trust deed or, if not, by statute and, if permitted in principle, whether such latitude is reasonably necessary in the circumstance of the trust.55 Effectively, the trustee must consider and come to a conclusion on whether market conditions and practice is such that it has no choice but to tolerate this. If otherwise avoidable loss accrues to the trust fund due to any of these factors then a trustee must be able to show that he considered the issue properly in respect of the trust in question. A trustee who quiescently accepts a clause excluding liability for negligence without discussion or considering other options is in danger of finding himself liable to account for losses resulting from for the negligence of the investment manager. Similarly, while it will be impossible and unnecessary to impose full fiduciary obligations on a fund manager, the trustee must understand what ‘conflicts of interest’ it is permitting including, for example, whether the manager is permitted to lend securities held by it for customers. Finally, accepting sub-delegation of custody without any or adequate inquiry into the identity of a sub-custodian is unlikely to be considered to be reasonable. In all of these regards, trustees should be aware that vicarious liability remains a risk. Whether exercising prudence or adhering to the statutory standard of care and whether authorized by statute or by express power the delegation to an investment manager must be periodically reviewed. In particular, in those trust jurisdictions which mandate the use of policy statements, a trustee must actively consider whether the existing statement is being complied with by the manager56 and whether there is a need to revise or replace the policy statement.57 If necessary, the trustee should intervene and give further or fresh instructions to the manager or revoke the appointment.58 Risks of in-house advice and asset management It is sometimes said that banks are motivated to provide trustee services in order to obtain business for their core asset management arm. Trustees who are employed or owned by banks must be alive to claims of conflict of interests which, if successfully set up, could result in repayment of losses in poorly performing managed portfolios and disgorgement of fees. Such conflict was before the court in the Hong Kong decision in HSBC (HK) Limited v Secretary for Justice59 in 2001. In agreeing a scheme for a charitable trust permitting delegation of discretionary investment management, Hartman J was requested by the Secretary for Justice to consider whether HSBC Asset Management Bahamas Ltd or other fellow HSBC subsidiary of the trustee should be expressly prohibited from acting due to the apparent conflict of interest. Hartman J indicated that a possibility of conflict was not sufficient for equity to intervene but that what is required is a ‘real possibility’ of conflict. However, before bank trustees and their corporate cousins become too sanguine it is worth noting that the charitable trust in question had enjoyed spectacular growth over the previous 20-year period. Furthermore, the high regard in which the learned judge held HSBC trustees60 and the bank61 was significant. With reference to banks in general,62 it is far from certain whether such matters would tip the balance these days. Trustees affiliated to asset management firms must be particularly careful to ensure that they are seen to discharge their duties in relation to the appointment and retention of both advisers and discretionary asset managers. 1. Nestle v National Westminster Bank plc [2000] WTLR 795, 797; affd [1993] 1 WLR 1260 (CA). 2. Conversely, a breach of duty without loss will not give rise to liability, see, Nestle v National Westminster Bank plc [1993] 1 WLR 1260, 1283–84 (Leggatt LJ). 3. Known as ‘falsifying the trustee’s account’, see Underhill and Hayton, Law of Trusts and Trustees (17th edn Butterworths, London 2006) para 89.37; Tony Molloy QC, ‘I am a trustee. I can't make head or tail of …’ (2009) 15 T&T 524, 550 and 557.  4. Molloy QC (n 3) at 554.  5. As per s 3(1) Trustee Act 2000 in England and Wales; s 4(1) Trustees Act (Cap 337) in Singapore; s 3(1) Trustee Act 2001 in the Isle of Man. Similar language is found elsewhere: art 20(1) of the Trusts (Jersey) Law 1984; s 4(1) of the Bahamas Trustee Act; s 55A(3) of the Trustee Act 1975 in Bermuda (as amended); s 3 Trustee Act 1961 in BVI (as amended); s 35(a) Trusts Law (2009 Revision) in the Cayman Islands.  6. For example, the Cayman Islands.  7. Arts 20 and 17(1) Trusts (Jersey) Law 1984; s 55A(4) Trustee Act 1975 of Bermuda (as amended by the Trustee Amendment Act 1999); s 5 Trustee Act of the Bahamas.  8. Graham Moffat, Trusts Law (5th edn Cambridge University Press 2009).  9. S 3 Trustee Act 1961 (as amended) provides that subject to the terms of the trust instrument, a trustee must adhere to the ‘diligence and prudence that a reasonable person would be expected to exercise in making an investment as if it were his own money’ (emphasis added). 10. Waterman’s Will Trusts [1952] 2 All ER 1054, 1055 (Hartman J); Bartlett v Barclay Bank Trust Co Ltd [1980] 1 All ER 139, 152 (Brightman J). 11. S A2(1) Trustee Act 2000 in England and Wales; s 3(1) Trustees Act (Cap 337) in Singapore; s 2(1) Trustee Act 2001 in the Isle of Man. However, the irony remains that professional trustees unlike their lay counterparts will frequently use express provisions to limit responsibilities and oust liabilities and, after recent consideration of the matter by the UK Law Commission, their ability to do so will remain available for the foreseeable future in both England and elsewhere (Law Com No 301 Cm 6874). 12. S 4 Trustee Act 2000 in England and Wales; s 5 Trustees Act (Cap 337) in Singapore (as amended in 2004); s 4 Trustee Act 2001 in the Isle of Man. Standard investment criteria are ‘the suitability to the trust of investments of the same kind as any particular investment proposed to be made or retained and of that particular investment as an investment of that kind’. 13. S 4(3)(b) Trustee Act 2000 in England and Wales; s 5(3)(b) Trustees Act (Cap 337) in Singapore; s 4(3) Trustee Act 2001 in the Isle of Man. 14. S 5 Trustee Act 2000 in England and Wales; s 6 Trustees Act (Cap 337) in Singapore; s 5 Trustee Act 2001 in the Isle of Man. 15. S 9 Trustee Act 2000; s 9 Trustee Act 2001 in the Isle of Man; s 2(2) Trustees Act (Cap 337) in Singapore; Hayton and Marshall (n 3)at para 53.21, where the learned authors state that the settlor can exclude the duty to consider diversification or to take proper advice. This conclusion is not readily apparent from the legislation. 16. Trustees of the British Museum v A-G [1984] 1 All ER 337. 17. Re Mulligan [1998] 1 NZLR 481. 18. See n 1, above. 19. Cowan v Scargil [1984] 2 All ER 750. 20. S 55A(4) Trustee Act 1975 (as amended by the Trustee Amendment Act 1999). 21. Trustee Act s 5(2). 22. Ibid s 5(1)(b). 23. Paolo Panico, ‘Trustee Investment Powers in International Trust Law’ (2009) 15 T&T 96, 98. 24. S 55A(5) Trustee Act 1975 (as amended by the Trustee Amendment Act 1999). 25. John H. Langbein & Richard A. Posner, ‘The Revolution in Trust Investment Law’, 62 ABAJ 887 (1976) and also ‘Market Funds and Trust-Investment Law’ 1976 and 1977 Am B Found Res J 1; Jerold L. Horn, ‘Prudent Investor Rule, Modern Portfolio Theory, and Private Trusts: Drafting and Administration including the “Give-Me-Five” Unitrust’, 3 REAL PROP PROB & TR J, 2, 7 (1998); Paul Haskell, ‘The Prudent Person Rule For Trustee Investment and Modern Portfolio Theory’, 69 NCL Rev 87 (1990). 26. Moffat (n 8) at 502. 27. Hoffmann J in Nestle (n 1) and Lord Nichols extra-judicially in (1995) 9 TLI 71, 76. 28. Trustees adopting this approach will often, however, find themselves under pressure to resign or may be removed. 29. Nestle v National Westminster Bank plc (n 2). 30. [1994] 1 All ER 118, 138 (Staughton LJ). Hayton and Marshall (n 3) at 618 states ‘Essentially, to succeed in a claim that negligent or unfair investment of trustees caused loss, a claimant beneficiary has to prove that no trustee, acting with the requisite minimum care and skill and suffering from the bad luck that can effect investors, could possibly have ended up with a trust fund of the complained of value’. In a similar discussion about failure to diversify a remainderman plaintiff in Re Mulligan (Decd) [1989] 1 NZLR 481 was more successful when none of the fund was invested in equities. 31. David Halpern QC, ‘Negligent Investment: Claims Against Trustees and Agents’ (2009) 15 T&T 602. 32. At least as a matter of English law (Armitage v Nurse [1998] Ch 241), but not everywhere such as Jersey where trustees are subject to a minimum standard of ‘gross negligence’ [art 30(10) Trusts (Jersey) Law 1984 (revised)]. 33. Cowan v Scargill [1984] 2 All ER 750, 762. 34. Trustee Act 2000, s 5(1) in England and Wales which renders receipt of advice obligatory subject to statutory exception if the trustee reasonably concludes that in all the circumstances it is unnecessary or inappropriate to do so; the identical provision is found at s 6(3) Trustees Act (Cap 337) in Singapore (as amended) and s 5 of the Trustee Act 2001 in the Isle of Man); cf s 6(1) of the Trustee Act of the Bahamas (as amended) which is permissive rather than mandatory in respect of receiving advice. 35. Nicholas Le Poidevin, ‘The Worried Trustee’, (2009) 15 T&T 596, 599. 36. Ibid at 600. 37. S 5(4) Trustee Act 2001. 38. S 6(4) Trustees Act (Cap 337). 39. S 6(3) Trustee Act. 40. Cf. s 6 of the Trustee Act (as amended) of the Bahamas which provides that the trust deed may name or provide for the appointment of a person who is then deemed to provide proper advice. 41. Hayton and Marshall (n 3) 47.11 and 53.22–53.23; See Le Poidevin (n 35)at 600. 42. See n 15, above. 43. See n 32, above. 44. Underhill and Hayton at para 53.22. 45. S 23(1). 46. David Hayton, ‘Developing the Law of Trusts for the 21st Century’ (1990) 106 LQR 87. 47. Pt IV of the Trustee Act 2000 in England and Wales; s 15A and 15B of the Trustee Act 1975 (as amended) in Bermuda; s 24(2) of the Trust Ordinance 1962 (as amended) in BVI; s 30(2) of the Trustee Act in the Bahamas; s 29(2) of the Trusts Law (2009) Revision in the Cayman Islands; Pt 4 of the Trustee Act 2001 in the Isle of Man. 48. The trustee is not subject to duties to act prudently or to a duty of care in deciding ‘whether’ to delegate investment management. This function can be delegated because the trustee does not relish the task and its responsibilities. However, it has been queried whether a professional trustee might be able to justify his full fee in these circumstances, see, Moffat (n 8) at 521 citing The Law Reform Committee Report, ‘The Powers and Duties of Trustees’ (Cmnd 8733, 1982). 49. Fry v Tapson (1884) 28 Ch D 268. 50. Investment managers should be appointed in writing pursuant to s 15(1) of the Trustee Act 2000 in England and Wales [s 41F(1) Trustee Act (Cap 337) in Singapore and s 15(1) Trustee Act in the Isle of Man] which obligation appears to apply whether the investment manager has been appointed by express power or by statute. 51. S 15 Trustee Act 2000. 52. S 15 of the Trustee Act 2001 in the Isle of Man; s 41F(2) of the Trustees Act (Cap 337) in Singapore. 53. Including in Bermuda, Cayman, BVI, Jersey and the Bahamas. 54. For the position in Jersey, see, Carey Olsen, ‘Trustee Investments’, Link Up, 2004. <http://www.careyolsen.com/publications.asp?tid=9> (accessed 16 April 2010). 55. Richard Wilson, ‘The Tension between Trustees and Investment Managers Parts 1 and 2’ [2003] 1 PCB 31 and [2003] 2 PCB 91; see Hayton (n 46), 88. 56. S 22(2)(c) of the Trustee Act 2000 of England and Wales; 41M (2)(c) of the Trustees Act (Cap 337) in Singapore; s 22(2)(c) of the Trustee Act 2001 in the Isle of Man. 57. S 22(2)(b) of the Trustee Act 2000 of England and Wales; 41M (2)(a) of the Trustees Act (Cap 337) of Singapore; s 22(2)(b) of the Trustee Act 2001 in the Isle of Man. 58. S 22(4)(a) and (b) of the Trustee Act 2000 of England and Wales; 41 M(1)(a) and (b) of the Trustees Act (Cap 337) of Singapore; s 22(4)(a) and (b) of the Trustee Act 2001 in the Isle of Man. 59. [2001] 3 ITELR 763. 60. Of whom Hartman J said that ‘all the evidence’ indicated they would make the right choice of investment manager ‘in the full knowledge of their obligations in law (and morality) as trustees’ (Ibid at 774e–f). 61. Which, Hartman J said, would ‘most jealously seek to guard its global reputation’ (Ibid at 774a–b). 62. And most certainly without reference to HSBC in particular. © The Author (2010). Published by Oxford University Press. All rights reserved.
TI - Trust investment losses and risk management: an offshore perspective
JF - Trusts & Trustees
DO - 10.1093/tandt/ttq034
DA - 2010-06-01
UR - https://www.deepdyve.com/lp/oxford-university-press/trust-investment-losses-and-risk-management-an-offshore-perspective-csMImyyubT
SP - 286
EP - 292
VL - 16
IS - 5
DP - DeepDyve
ER -