Wood v. U.S. Bank, N.A. , 160 Ohio App.3d 831, 828 N.E.2d 1072, 2005-Ohio-2341 (Ohio App. 1 Dist. May 13, 2005)
Suppose you are a bank officer and one of your large shareholders wants to appoint you as corporate trustee of his trust and, because this shareholder became wealthy owning your bank’s stock, he wants to make sure his trust can continue holding shares of stock of your bank after his death.
[Q.] What issues should the bank be thinking about to make sure that it can both comply with the testator’s wishes and avoid getting sued in the process?
[A.] The bank’s fiduciary duty of loyalty (in connection with acting as trustee of a trust holding its own stock) and the bank’s fiduciary duty to diversify the trust’s assets (in connection with retaining a large block of the bank’s stock).
This case is a good example of what can go wrong if the bank fails to think about these fiduciary duties (and liabilities). Here the grantor created a trust worth over $8 million, naming Firstar Bank of Cincinnati its corporate trustee. Nearly 80% of the trust assets were in the bank’s own stock. Not surprisingly after the grantor’s death when the bank’s stock plunged in value from a high of $35 per share to a low of $16 per share, the trust’s beneficiaries sued the bank. As summarized by the appellate court, at trial the bank pointed to the following exculpatory language as part of its defense:
"The language of John's last trust was unambiguous. It granted Firstar the power to retain its own stock in the trust even though Firstar would ordinarily not have been permitted to hold its own stock. Specifically, Firstar had the power '[t]o retain any securities in the same form as when received, including shares of a corporate Trustee * * *, even though all of such securities are not of the class of investments a trustee may be permitted by law to make and to hold cash uninvested as they deem advisable or proper.'"
On appeal the Ohio appellate court ruled that although this exculpatory language might get the bank off the hook with respect to its duty of loyalty, it in no way relieved the bank of its duty to diversify. Here is how the appellate court explained its rationale:
"The retention clause merely served to circumvent the rule of undivided loyalty. The trust did not say anything about diversification. And the retention language smacked of the standard boilerplate that was intended merely to circumvent the rule of undivided loyalty-no more, no less. There were significant tax consequences that precluded John from diversifying by selling the Firstar stock during his lifetime, but that hurdle was removed upon his death. Had John wanted to eliminate Firstar's duty to diversify, he could simply have said so. He could have mentioned that duty in the retention clause. Or he could have included another clause specifically lessening the duty to diversify. But he did not. We hold that the language of a trust does not alter a trustee's duty to diversify unless the instrument creating the trust clearly indicates an intention to do so."
Good drafting could have allowed the bank to both carry out the grantor’s wishes and avoid getting sued. The best way to make this point is to actually look at examples of proper trust provisions for this type of scenario. With respect to authorizing the bank to hold its own stock in trust, here is a sample clause (I’ve italicized the key terms):
Waiver of Duty of Loyalty:
The Trustee is authorized to invest in assets, securities, or interests in securities of any nature, including (without limit) commodities, options, futures, precious metals, currencies, and in domestic and foreign markets and in mutual or investment funds, including funds for which the Trustee or any affiliate performs services for additional fees, whether as custodian, transfer agent, investment advisor or otherwise, or in securities distributed, underwritten, or issued by the Trustee or by syndicates of which it is a member; to trade on credit or margin accounts (whether secured or unsecured); and to pledge assets of the Trust Estate for that purpose.
With respect to authorizing the bank to retain a highly concentrated stock position, in other words relieving the bank of its duty to diversify, here is a sample clause (I’ve italicized the key terms):
Waiver of Duty to Diversify:
I authorize the Trustee to retain the assets that it receives, including shares of stock or other interests in XYZ Corp., or its successors in interest, or any other company or entity carrying on or directly or indirectly controlling the whole or any part of its present business (collectively referred to as "XYZ Corp."), for as long as the Trustee deems best, and to dispose of those assets when it deems advisable. I prefer that the Trustee not sell shares of stock or other interests in XYZ Corp. because I believe that the best interests of the beneficiaries will be served by retention of those interests in the Trust’s portfolio. I intentionally excuse the Trustee from the duty to diversify investments by the sale or other disposition of interests in XYZ Corp. that ordinarily would apply under the prudent investor rule, and I direct that the Trustee not be held liable for any loss or risk (even so-called "uncompensated risk") incurred as a result of this failure to diversify. I realize, however, that circumstances may change, and that the Trustee may determine it to be advisable to sell some or all of the interests in XYZ Corp., and nothing in this paragraph will be interpreted in any manner to limit the Trustee’s authority to do so.