EPTL 11-2.3: The Prudent Investor Act — Investment Duties of New York Trustees

EPTL 11-2.3, the Prudent Investor Act, sets the standard by which a New York trustee’s investment decisions are judged. It requires a trustee to invest and manage trust property as a prudent investor would, looking at the portfolio as a whole, diversifying, weighing risk against return, and keeping the trust’s purposes and the beneficiaries’ needs in view. It applies to executors and administrators holding estate assets as well as to trustees, and to assets the trust started with as well as to those the trustee bought. The standard is one of conduct, not outcome: a trustee who followed a prudent process is not liable because the market fell, and a trustee who did not is not excused because it rose. Where the Act matters in practice is the accounting, because that is where a beneficiary objects to an investment loss and the court decides whether the trustee is surcharged for it.

The Standard

The Act asks whether the trustee exercised reasonable care, skill and caution in making and carrying out an overall investment strategy suited to the trust. In deciding what was reasonable, the trustee is expected to consider the size of the portfolio, how long the trust is expected to last, the trust’s need for liquidity and its distribution requirements, general economic conditions including inflation, the tax consequences of investment decisions, the role each investment plays in the whole portfolio, the expected total return from income and appreciation together, and the needs of the beneficiaries for present and future distributions. A trustee with special investment skills, or who was appointed because of them, is held to the standard of a prudent investor with those skills; a bank or trust company cannot defend a loss by pointing to what a lay trustee might have done.

The list is the trustee’s working checklist. In an accounting proceeding the most damaging fact for a trustee is usually that there is no record of any of it having been considered.

The Portfolio, Not the Position

Older law judged each investment on its own and kept a list of what a fiduciary could buy. The Act replaced both with a portfolio standard. No single holding is imprudent in isolation; the question is whether it fits a strategy with a reasonable balance of risk and return for this trust. A speculative holding can be prudent as a small part of a diversified portfolio. A portfolio that is entirely bank deposits can be imprudent for a trust that will run thirty years for a young beneficiary, because it ignores inflation and the interest of whoever takes the remainder. There is no list of permitted investments; the trustee may invest in any kind of asset, subject to the standard, and may incur only costs that are appropriate and reasonable in relation to the assets and the purposes of the trust.

Diversification

The trustee must diversify unless the trustee reasonably determines that it is in the beneficiaries’ interest not to, taking into account the purposes and terms of the trust. This is the provision most often litigated. A trust that holds most of its value in one stock, one building or one business is exposed to that asset’s fortunes, and when the asset falls the remainder beneficiaries look for someone to hold responsible. A decision not to diversify can be prudent, for tax reasons, because the instrument directs retention, or because the asset is a family business the trust was created to hold, but it must be a decision, made on stated grounds, and revisited as conditions change.

The Assets the Trust Started With

Within a reasonable time after taking office, the trustee must decide whether to keep or dispose of the assets the trust received. This is the trap in inherited portfolios. A trustee who simply keeps whatever the decedent owned, never analyzing the concentration and never making a decision, has breached the duty even without buying anything. What is reasonable depends on the asset and the market, but the clock runs from the trustee’s appointment, and a concentration that was never examined is very hard to defend years later.

The Will’s Investment Directions

The Act applies except as the governing instrument provides otherwise. A will or trust agreement can broaden or narrow the trustee’s investment duties, and a specific direction to retain a named asset, a family company or a particular building, is generally honored even where a prudent investor would sell. Courts read such clauses narrowly. A general clause authorizing the trustee to retain any property received does not by itself excuse the trustee from monitoring a dangerous concentration; only clear language directed at the asset in question reliably changes the duty. A trustee who holds a concentration in reliance on the instrument should be able to point to the sentence that permits it, and should still document why holding remains in the beneficiaries’ interest.

Delegation

A trustee may delegate investment and management functions to an investment adviser or manager. The trustee remains responsible for selecting the adviser with care, setting the scope and terms of the delegation consistent with the trust’s purposes, and reviewing the adviser’s performance and compliance periodically. Delegation is not abdication: a trustee who hires a manager and then does not read a statement for five years has not complied with the Act and answers for the manager’s losses. Delegation done properly, with a written investment policy, regular reports and periodic review, is the best evidence of a prudent process a trustee can have.

Conduct, Not Outcome

Compliance is judged in light of the facts and circumstances at the time of the decision, not with hindsight. A trustee who followed a prudent process and lost money is protected. A trustee who followed no process and made money has still breached the duty, though with no loss there is nothing to surcharge. What this means in an accounting is that the argument is about the record: what the trustee knew, what the trustee considered, whom the trustee consulted, and when. Underperforming an index is not a breach. Failing to think is.

How Investment Objections Are Framed and Measured

Investment claims are raised as objections to the trustee’s account. The losses appear on Schedule B (realized decreases) and, for holdings still on hand, in the difference between the Schedule A value and the current value on Schedule G; the trustee’s purchases and sales appear on Schedule F. A beneficiary who suspects imprudence asks for the account, examines the trustee under SCPA 2211 about the investment record, and files objections under SCPA 2209 identifying the holding, the period and the ground: that a concentration was retained without analysis, that cash was left uninvested, that the portfolio was invested entirely for income or entirely for growth, that the manager was never supervised. See objecting to an accounting and, for trustees, defending one.

If the objection is sustained, the court surcharges the trustee with the loss. The measure most often applied to a retained concentration is the value of the position on the date a prudent trustee would have sold it, less what the trust actually realized when it was finally sold (or its value at the accounting), with interest from the date of the loss. Objectants sometimes press for a larger measure: what a prudently diversified portfolio would have earned over the same period. The comparison to a prudent portfolio is in any case how the objection is argued, usually through expert testimony on each side about what a prudent trustee would have held and when. Commissions may be reduced or denied for the period of the breach. See surcharge.

Example. A trust is funded with $2,000,000, of which $1,400,000 is a single stock at $100 a share. The trustee never analyzes the concentration, consults no one and keeps no notes. Three years later the trustee sells the shares at $40, realizing $560,000. On objections, the court finds that a prudent trustee would have diversified within six months, when the stock was at $95. The surcharge is the value then, $1,330,000, less the $560,000 realized: $770,000, plus interest, and the trustee’s commissions for the period are at risk. Change one fact: the trustee obtained a written analysis in the first months recommending an orderly sale over eighteen months for tax reasons, and followed it. With the same market loss, the trustee likely prevails, because the Act judges the process at the time, not the result.

Holding Cash Too Long

The opposite failure is as common as the concentration. An executor leaves the proceeds of a house sale in a checking account for three years while the estate waits for a tax closing letter; a trustee keeps a trust in money-market funds for a decade because nothing can go wrong. Something did: the beneficiaries lost the return a prudent portfolio would have earned. Estates in administration are given more latitude than trusts, since the money will be distributed soon and liquidity matters, but an estate that stays open for years without a reason is expected to invest, and a trust that will run for years has no excuse. The objection is measured by what a prudent portfolio, or at least a prudent fixed-income allocation, would have earned over the period, and interest may be charged on the idle funds.

Concentrated Positions the Decedent Left

“My father loved that stock” is not a defense. Neither is the beneficiaries’ sentimental attachment, unless they consented in writing with full knowledge. A trustee who receives a concentration should, within a reasonable time, obtain an analysis of the position, consider tax cost, the instrument’s directions, the beneficiaries’ needs and the risk, decide what to do, record the decision, and revisit it. A trustee who wants to keep the position, for a good reason, can protect themselves by disclosing the decision to the beneficiaries and obtaining their written consent, or by seeking the court’s advice and direction. Where the beneficiaries insist on retention, their consent should be in writing and informed, because a beneficiary who consented cannot later object.

Pitfalls

For a trustee, the recurring failures are of record and of attention. Trustees who considered the statutory factors but never wrote anything down fight the case at a severe disadvantage; contemporaneous notes, advisers’ reports and an investment policy statement are the trustee’s best evidence. Keeping the decedent’s portfolio unchanged for years, without a decision, is the most common breach. Boilerplate authority to retain property is read as permission, not as a direction to hold a concentration. A manager is hired and never reviewed, and the manager’s losses become the trustee’s. And a portfolio is run entirely for the life beneficiary’s income, or entirely for the remainder’s growth, which breaches the duty of impartiality that runs through the portfolio factors.

For a beneficiary, the failure is waiting. Losses compound, records disappear and releases get signed. A beneficiary who suspects imprudent investing should ask for the account and the brokerage statements promptly, and if refused, compel an accounting under SCPA 2205; see beneficiaries’ rights to trust information. And no beneficiary should sign a release without the statements for the whole period, because the release bars later objections to whatever was disclosed.

Where the Act Fits

Investment prudence is one of a trustee’s duties, alongside loyalty, impartiality and disclosure, and the duty to account when asked. A trust accounting covers the whole term of the trust, however long, and investment decisions made years ago can be examined when the account is finally settled. That is a reason for trustees to account periodically, and for beneficiaries to ask for the statements rather than wait. See when a trust accounting is required and whether a trustee must account.

If you are a beneficiary facing unexplained investment losses or a concentration the trustee never addressed, or a trustee whose investment decisions are being questioned, call 212-233-1233 or email [email protected]. In either case the outcome usually turns on the investment record, and the sooner it is secured and analyzed the stronger the position.