Probate and Estate Planning
EPIC Article I, Part 5: The Prudent Investor Rule
The concept of the ‘‘prudent man’’ or ‘‘prudent investor’’ in fiduciary investing is similar to the ‘‘reasonable person’’ in tort law—it attempts to create an objective standard of behavior. Article I, Part 5 of Michigan’s Estates and Protected Individuals Code (EPIC) establishes Michigan’s new prudent investor rule. The prudent investor rule requires trustees to emphasize total return, not just preserving capital. Michigan’s rule follows closely the Uniform Prudent Investor Act adopted in 1994 by the National Conference of Commissioners on Uniform State Laws, but has a few refinements to tailor the rule to the rest of EPIC and other Michigan law.
Section 813 of Michigan’s Revised Probate Code of 1979 (RPC) directed trustees to invest as would a ‘‘prudent man dealing with the property of another.’’ Section 561 of the RPC required fiduciaries to invest in accordance with either the terms of the will or trust, the terms of a court order, or the terms of Michigan’s Trust Investment Act.2 That Act, adopted in 1937, set the default standard for fiduciary investment as investing in assets that
[T]rust property or funds shall within a reasonable time be invested...as an ordinary prudent person of intelligence and integrity, who is a trustee of the money of others, would purchase, in the exercise of reasonable care, judgment, and diligence, under the conditions existing at the time of purchase, having due regard for the management, reputation, and stability of the issuer and the character of the particular securities.3
This pre-EPIC rule is narrower than the classic statement of the traditional ‘‘prudent man’’ rule for fiduciary investment in
the United States found in Harvard College v Amory.4 The court in that case concluded that trustees should
observe how men of prudence, discretion and intelligence manage their own affairs, not in regard to speculation, but in regard to the permanent disposition of their funds, considering the probable income, as well as the probable safety of the capital to be invested.5
Under this standard, trustees are supposed to minimize risk, invest for the long-term, and generate reasonable amounts of income. Michigan’s law uses the more conservative standard of responsibility for other people’s money and requires analysis of the prudence of each security individually.
In 1992, the American Law Institute published the Restatement (Third) of Trusts: Prudent Investor Rule, updating that series’ fiduciary investment standard to incorporate modern portfolio theory. The National Conference of Commissioners on Uniform State Laws drew on that Restatement (Third) rule in promulgating the ‘‘Uniform Prudent Investor Act’’ (Uniform Act). The commissioners enhanced the final version of the Uniform Act after reviewing prudent investor rules enacted by a few states (including Florida and Illinois) prior to its final adoption.
The Prefatory Note to the Uniform Act states that it incorporates five ‘‘fundamental alterations in the former criteria for prudent investing from the Restatement (Third) of Trust: Prudent Investor Rule.’’ Those changes are:
1. The standard of prudence is applied to any investment as part of the total portfolio, rather than to individual investments. In the trust setting, the term ‘‘portfolio’’ embraces all the trust’s assets.
2. The trade-off in all investing between risk and return is identified as the fiduciary’s central consideration.
3. All categoric restrictions on types of investments have been abrogated; the trustee can invest in anything that plays an appropriate role in achieving the risk/return objectives of the trust and meets the other requirements of prudent investing.
4. The long-familiar requirement that fiduciaries diversify their investments has been integrated into the definition of prudent investing.
5. The much-criticized former rule of trust law forbidding the trustee to delegate investment and management functions has been reversed. Delegation is now permitted, subject to safeguards.
Michigan’s prudent investor rule incorporates the five Uniform Act criteria listed above almost without change, but adds certain refinements deemed especially appropriate to Michigan’s body of state fiduciary law. The remainder of this article discusses the EPIC prudent investor rule section by section.
(1)This part shall be known and may be cited as the ‘‘Michigan prudent investor rule.’’ This part prescribes the Michigan prudent investor rule.
(2)As used in this part:
(a)‘‘Governing instrument’’ includes, but is not limited to, a court order.
(b)‘‘Portfolio’’ means all property of every kind and character held by a fiduciary on behalf of a fiduciary estate.
The definitions in this section are similar to those in the prudent investor rule adopted by the state of New York. They point out the first significant difference between the Uniform Act and the EPIC rule—the Uniform Act is limited to ‘‘trusts,’’ ‘‘trust documents,’’ ‘‘trustee,’’ and ‘‘trust assets.’’ EPIC’s prudent investor rule applies to all ‘‘fiduciaries,’’6 and uses the term ‘‘governing instrument.’’ Thus, the EPIC prudent investor rule applies to Michigan estates, guardianships, and conservatorships, as well as to trusts.
(1)A fiduciary shall invest and manage assets held in a fiduciary capacity as a prudent investor would, taking into account the purposes, terms, distribution requirements expressed in the governing instrument, and other circumstances of the fiduciary estate. To satisfy this standard, the fiduciary must exercise reasonable care, skill, and caution.
(2)The Michigan prudent investor rule is a default rule that may be expanded, restricted, eliminated, or otherwise altered by the provisions of the governing instrument. A fiduciary is not liable to a beneficiary to the extent that the fiduciary acted in reasonable reliance on the provisions of the governing instrument.
This section of EPIC combines Sections 1(b) and 2(a) of the Uniform Act, thereby stating both the prudent investor rule and its scope together. Note that like many other rules of trust law, EPIC’s prudent investor rule is a default rule. EPIC eliminates the potential difference in standards between investing for oneself and investing on behalf of others, referring instead to the governing instrument if the grantor/testator wishes to alter the standard of a prudent investor similarly situated.
(1)A fiduciary’s investment and management decisions with respect to individual assets shall be evaluated not in isolation, but rather in the context of the fiduciary estate portfolio as a whole and as a part of an overall investment strategy having risk and return objectives reasonably suited to the fiduciary estate.
(2)Among circumstances that a fiduciary must consider in investing and managing fiduciary assets are all of the following that are relevant to the fiduciary estate or its beneficiaries:
(a)General economic conditions
(b)The possible effect of inflation or deflation
(c)The expected tax consequences of an investment decision or strategy
(d)The role that each investment or course of action plays within the overall portfolio, which may include financial assets, interests in closely-held enterprises, tangible and intangible personal property, and real property
(e)The expected total return from income and the appreciation of capital
(f)Other resources of the beneficiaries
(g)The need for liquidity, regularity of income, and preservation or appreciation of capital
(h)An asset’s special relationship or special value, if any, to the purposes of the fiduciary estate or to one or more of the beneficiaries
(3)A fiduciary shall make a reasonable effort to verify facts relevant to the investment and management of fiduciary assets.
(4)A fiduciary may invest in any kind of property or type of investment consistent with the standards of the Michigan prudent investor rule. A particular investment is not inherently prudent or imprudent.
(5)A fiduciary who has special skill or expertise, or is named fiduciary in reliance upon the fiduciary’s representation that the fiduciary has special skill or expertise, has a duty to use that special skill or expertise.
Section 1503 of EPIC incorporates the rest of Section 2 of the Uniform Act, setting forth the elements of the prudent investor standard. Subsection (1) of EPIC Section 1503 incorporates the first overarching principle of the Uniform Act, that investments are to be reviewed as part of the total portfolio instead of individually. The list of factors that relate to risk/return preferences in fiduciary investing is non-exclusive. Tax considerations are expressly validated as a relevant factor, as are special (subjective) views of beneficiaries about specific trust assets.
Section 1503 of EPIC preserves existing common law fiduciary duties, including the duty to monitor investments and to use any special expertise the fiduciary may possess and/or market.7 Section 1503(4) eliminates the categoric restrictions (the so-called ‘‘legal lists’’ of permissible investments) that developed in case law over time as courts attempted to interpret the prudent man rule.
A fiduciary shall diversify the investments of a fiduciary estate unless the fiduciary reasonably determines that, because of special circumstances, the purposes of the fiduciary estate are better served without diversifying.
This investment principle was incorporated into the ‘‘Restatement (Third) of Trusts: Prudent Investor Rule (1992),’’ and was made part of the Uniform Act. Aimed at reducing uncompensated risk, this diversification requirement is consistent both with the diversification required under the Employee Retirement Income Security Act of 1973 (ERISA), and with case law developed under state fiduciary investment statutes. However, this duty to diversify is not absolute. The comments to the Uniform Act give examples of situations where the particular circumstances of a trust’s administration may outweigh the otherwise applicable duty to diversify. These include trusts holding low tax-basis securities, or holding a concentration of shares in a family business the beneficiaries wish to retain.
Within a reasonable time after accepting appointment as a fiduciary or receiving fiduciary assets, a fiduciary shall review the assets, and make and implement decisions concerning the retention and disposition of assets, in order to bring the fiduciary portfolio into compliance with the purposes, terms, distribution requirements expressed in the governing instrument, and other circumstances of the fiduciary estate, and with the requirements of the Michigan prudent investor rule.
This section of EPIC carries forward existing law by requiring fiduciaries to dispose of unsuitable assets within a reasonable time. The criteria and circumstances identified in Section 1503 of EPIC will also apply here, to the fiduciary’s decision on the prudence of retaining or disposing of assets received as part of the original trust corpus.
A fiduciary shall invest and manage fiduciary assets solely in the interest of the beneficiaries.
The first part of Section 1506 of EPIC is essentially verbatim from the Uniform Act. It continues the fiduciary’s ancient (and perhaps definitive) duty of loyalty toward the beneficiaries of the fiduciary estate. An amplification of this rule in a modern context comes in EPIC Section 1214, which addresses a fiduciary’s ability to act in multiple capacities.
If a fiduciary estate has 2 or more beneficiaries, the fiduciary shall act impartially in investing and managing the fiduciary assets, and shall take into account any differing interests of the beneficiaries.
The duty of impartiality derives from the duty of loyalty, and this section of EPIC follows the Uniform Act (and the (Second) and (Third) Restatements of Trust). ‘‘Multiple beneficiaries’’ means both successive beneficiaries (such as income beneficiaries and remaindermen), and beneficiaries with simultaneous interests (such as currently eligible ‘‘sprinkle’’ or ‘‘spray’’ income beneficiaries).
The prudent investor rule does not address the related issues of principal and income allocations. A bill to modernize Michigan’s Revised Uniform Principal and Income Act has been introduced in the Michigan Legislature.8
In investing and managing fiduciary assets, a fiduciary may only incur costs that are appropriate and reasonable in relation to the assets, the purposes of the fiduciary estate, and the skills of the fiduciary.
This section, which mirrors the one in the Uniform Act, recites the fairly noncontroversial position that wasting beneficiaries’ money is imprudent.
Compliance with the prudent investor rule is determined in light of the facts and circumstances that exist at the time of a fiduciary’s decision or action, and not by hindsight. The prudent investor rule requires a standard of conduct, not outcome or performance.
The first sentence of Section 1509 is Section 8 of the Uniform Act, which was based on a provision in the Illinois prudent investor statute.9 The second sentence was adapted from New York’s prudent investor statute.10 The comment to the Uniform Act’s Section 8 notes that, ‘‘Trustees are not insurers,’’ and that the standard for review of fiduciary investment decisions is ex ante, not ex post.
(1)A fiduciary may delegate investment and management functions provided that the fiduciary exercises reasonable care, skill, and caution in all of the following:
(a)Selecting an agent
(b)Establishing the scope and terms of the delegation, consistent with the purposes and terms of the governing instrument
(c)Periodically reviewing the agent’s actions in order to monitor the agent’s performance and compliance with the terms of the delegation
(2)A fiduciary who complies with the requirements of Subsection (1) is not liable to the beneficiaries or to the fiduciary estate for a decision or action of the agent to whom the function was delegated.
(3)In performing a delegated function, an agent owes a duty to the fiduciary estate to exercise reasonable care to comply with the terms of the delegation. If an agent accepts the delegation of a fiduciary function from a fiduciary that is subject to the laws of this state, the agent submits to the jurisdiction of this state’s court.
This section eliminates the rule that Michigan fiduciaries could not delegate any ‘‘discretionary’’ functions. The new rule is consistent with ERISA’s approach to fiduciary duty, and attempts to balance flexible trust administration with protection of beneficiaries’ interests. (For example, the comment to this section of the Uniform Act suggests a heightened duty to avoid ‘‘double dipping’’ on fees if delegation is utilized.) This section of EPIC also expressly addresses the agent’s responsibility for delegated fiduciary powers.
The following terms or similar language in a governing instrument, unless otherwise limited or modified, authorize any investment or strategy permitted under the Michigan prudent investor rule:
(a)‘‘Investments permissible by law for investment of trust funds.’’
(d)‘‘Using the judgment and care under the circumstances then prevailing that persons of prudence, discretion, and intelligence exercise in the management of their own affairs, not in regard to speculation but in regard to the permanent disposition of their funds, considering the probable income as well as the probable safety of their capital.’’
(e)‘‘Prudent man rule.’’
(f)‘‘Prudent trustee rule.’’
(g)‘‘Prudent person rule.’’
(h)‘‘Prudent investor rule.’’
The Uniform Act imported this provision from Illinois’ prudent investor rule. It serves to apply EPIC’s prudent investor rule to virtually all existing trusts and estates, whether or not they expressly incorporate the prudent investor rule. As noted below, this ‘‘deemed incorporation’’ applies to existing governing instruments only for fiduciary investment decisions made after EPIC’s effective date, so it does not retroactively authorize or ratify any transactions.
The Michigan prudent investor rule applies to a fiduciary estate that exists on or is created after this Act’s effective date. As applied to a fiduciary estate that exists on this Act’s effective date, the Michigan prudent investor rule governs only a decision or action that occurs after that date.
This section follows the Uniform Act, applying the EPIC rule to all fiduciary accounts, but only for transactions that occur after April 1, 2000.
The EPIC prudent investor rule will not appear new to experienced fiduciaries. The intent of the Uniform Act (and the resulting state prudent investor rules) was to provide a means to bring the law up-to-date with long-practiced ‘‘modern portfolio theory.’’ The adoption of the Michigan prudent investor rule, Sections 1501 through 1512 of EPIC, has modernized Michigan’s rules for fiduciary investing, providing significantly increased clarity and protections for both fiduciaries and beneficiaries.11
1. The outline from which this article is derived first appeared in ‘‘EPIC Preview: Planning and Drafting in Anticipation of the New Estates and Protected Individuals Code,’’ copyright 1999 by the Institute of Continuing Legal Education (ICLE), Ann Arbor, Michigan, (877) 229-4350.
2. Public Act 177 of 1937, Michigan Complied Laws (MCL) §§ 555.201-555.203.
3. MCL 555.201(1).
4. Harvard College v Amory, 9 Pick. (26 Mass.) 446 (1830).
5. Id., at 461.
6. EPIC’s definition of ‘‘fiduciary’’ is the following: ‘‘‘Fiduciary’ includes, but is not limited to, a personal representative, guardian, conservator, trustee, plenary or partial guardian appointed as provided in Chapter 6 of the Mental Health Code, 1974 PA 258, MCL 330.1600 to 330.1644, and successor fiduciary.’’ EPIC Section 1104(e).
7. See also EPIC Section 1506, for reiteration of the fiduciary’s traditional duty of loyalty.
8. But see ‘‘The Uniform Principal and Income Act (1997): Look Before You Leap,’’ Alexander P. Misheff, American Bankers Association Trust Letter, March 1998, pp 10-12.
9. Illinois prudent investor rule, 760 ILCS 5/5 (a)(2).
10. New York prudent investor rule, EPTL 11-2.3 (b)(1).
11. For a discussion, including sample provisions, of the drafting implications of the prudent investor rule in general, see Jerold I. Horn, ‘‘The Prudent Investor Rule—Impact on Drafting and the Administration of Trusts,’’ 20 ACTEC Notes 26-42 (1994).