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Prudent Investor Rule. Effective April 1, 2000, Michigan adopted the Prudent Investor Rule, which was
incorporated into the new Michigan Estate and Protected Individuals Code (EPIC). The Michigan statute was
modeled after a uniform state law that has been adopted in 38 states or more, at last count. In Michigan
statutes it is MCL 700. 1501-1512. Basically, the Prudent Investor Rule attempts to incorporate modern
portfolio theory into trust management. As readers know, modern portfolio theory takes into account a total
return on a trust’s investment assets, considering the risk tolerance of the beneficiaries. Thus, the Trustee is
charged with managing the whole portfolio with skill and diversification, not necessarily evaluating each and
every separate trust investment as an appropriate one.
Diversification and Asset Allocation. For each trustee, therefore, diversification and asset allocation analysis
are new standards by which trustees will be judged.
Default Rule. In Michigan, the Prudent Investor Rule is a default rule "that may be expanded, restricted,
eliminated or otherwise altered by the provisions of the governing instrument". MCL 700.1502(2). This section
goes on to provide that a Trustee shall not be "liable to a beneficiary to the extent that the fiduciary acted in
reasonable reliance on the provisions of the governing instrument".
Caution. The statute is too new to have been tested in Michigan Courts, but it poses many potential traps for
Trustees, whether the trust is an old one or a new one. Some of these are:
(1) Effective Date. While the statute became effective April 1, 2000, by its terms it applies to trusts created
before that date;
(2) Duty to Diversify. Courts have already held that boilerplate language to the effect that the Trustee may
retain all assets transferred to the trust, is not sufficient to trump the duty to diversify. Trustees who held large
blocks of corporate stock transferred by a corporate insider in many cases, have been held liable for a
substantial decline the stock’s value. Thus, even before EPIC, many corporate trustees insisted upon the
right and obligation to diversify the portfolio, notwithstanding a family’s expressed desires to the contrary. The
author had personal experience with such actions in a trust established by a GE executive and naturally full of
GE stock. With the adoption of the Prudent Investor Rule, the corporate trustee sold a large part of the GE
stock without consulting the family, at a large capital gain, on the basis of their interpretation of the Prudent
Investor Rule.
(2) What Standards for Risk Tolerance and Asset Allocation Apply? Knowledgeable observers seem to take
the position that the trustee should follow a "process" of assessing the risk tolerance of each class of
beneficiaries, considering the family’s objectives and the language of the trust, if any; balance the interests
and risk tolerances of different classes of beneficiaries and arrive at an asset allocation balance that reflects
an average. (The trust may contain specific instructions as to which class of beneficiaries is to be favored.)
No Win. In many cases, the trustee is in a no-win situation, more so than before. Remember, individual
trustees are subject to the same law as corporate trustees, with all their professional staff. If the Prudent
Investor Rule is a trap for corporate trustees, it is mine field for individual trustees. If it is intended that there
be individual trustees, rather than a bank or trust company, I would recommend that the trust document
expressly state that the Michigan Prudent Investor rule shall not apply. This avoids any questions about farms,
residences, non-income producing real estate, etc.
Revocable Trusts. With the popularity of Revocable Trusts for the avoidance of probate, there are many
smaller trusts being activated daily upon the death of the Grantor. In many cases, individual trustees do not
seek legal counsel and are unfamiliar with the trust laws that suddenly apply to them. Many times there has
not been any specific thought given to the expansion or limitation of the investment powers of the trustee, and
an individual trustee or personal representative is thrown into the battle without adequate preparation. Does
the individual trustee hold securities or convert everything to cash immediately? If the individual trustee is not
an experienced investment manager, he or she is probably safer going to cash immediately, taking care of
debts and planning distributions accordingly. The risk and return objectives of the children may each be
different, to say nothing of the circumstances of the surviving spouse.
Conclusion. The Michigan Prudent Investor rule has yet to be tested in court, and there will probably be one or
two economic cycles before these cases reach the stage of judicial decision. Trustees will be further
challenged by the new Uniform Principal and Income Act (UPIA) currently winding its way through the
legislature. That will be subject of the next newsletter, but it also does not offer easy answers.
Family disagreements, conflicts, second marriages, are all factors which can complicate the administration
of a trust and create liability for a trustee. Your clients and their potential trustees need to be mindful of the
hazards. If you have clients who can benefit from professional, family oriented trust creation and
administration, please do not hesitate to Jim Modrall at 231-941-9660.
©BRANDT, FISHER, ALWARD & ROY, P.C.
This newsletter is provided for informational purposes and should not be acted upon without professional
advice.
| WEALTH CONSERVATION: PROFESSIONAL ALERT Brandt, Fisher, Alward & Roy, P.C. |
| June 2004 THE MICHIGAN PRUDENT INVESTOR RULE - TRUSTEE TRAP? by James R. Modrall III, J.D., C.P.A. |
| If you would like to receive future editions of the monthly Wealth Conservation Newsletter directly to your e-mail account, please e-mail our office using the following link: Estate Planning Newsletter |
| Brandt, Fisher, Alward & Roy, P.C. Attorneys at Law |