This recent failure-to-diversify case out of Ohio underscores the trustee-liability issues I wrote about here regarding the recent appellate-court reversal of a $24 million judgment against Chase Manhattan in New York. In both cases the bank’s liability (or lack thereof) for losses arising from the decision to hold family stock in trust for decades (versus selling the family stock and diversifying the trust’s stock portfolio) hinged on express exculpatory language incorporated into the governing trust agreement itself. In Natl. City Bank v. Noble, 2005 WL 3315034, 2005-Ohio-6484 (Ohio App. 8 Dist. Dec 08, 2005), the issue before the court was whether the corporate trustee, National City Bank (“NCB”), was liable for the alleged 52% drop in the trust’s portfolio value. The trust in question was created in 1965 by Welker Smucker, son of the founder of the J.M. Smucker Company. Among the assets originally funding the trust were over 1,000 shares of J.M. Smucker Company common stock. The following exculpatory language was incorporated into the trust agreement:
“2. The Trustees are empowered to retain as an investment, without liability for depreciation in value, any part or all of any securities * * * from time to time hereafter acquired by the Trustees as a gift, devise or bequest from the Grantor or any other person, * * * even though such property be of a kind not ordinarily deemed suitable for trust investment and even though its retention may result in a large part or all of the trust property’s being invested in assets of the same character or securities of a single corporation. * * *. Without limitation upon the generality of the foregoing, the Trustees are expressly empowered to retain as an investment, without liability for depreciation in value, any and all securities issued by The J.M. Smucker Company, however and whenever acquired, irrespective of the proportion of the trust properly invested therein * * *. The Trustees are empowered to invest and reinvest any part or all of the trust property * * * in such securities * * * as they may select, irrespective of any limitation prescribed by law or custom upon the investments of trustees and even though the trust property may be entirely invested in common stocks or other equities * * *.” Trust Agreement, at Section E(2)-(3).
Based on this language, the court ruled that NCB could not be held liable for any alleged losses resulting from the failure to diversify the trust’s portfolio.
The language contained in Welker Smucker’s Trust Agreement is clear on its face that the trustees could retain investments without liability or depreciation. The trust went even one step further to insulate NCB as the corporate trustee, providing specifically that it had no duty to review or to make recommendations without the specific request of the individual trustee.
Lessons Learned: In an excellent essay published online here by BNA, the trustee-liability issues alluded to above are discussed in great detail. The introductory paragraphs to the linked-to essay sum up nicely the lessons to be learned from the Smucker and Kodak failure-to-diversify cases:
Investment diversification, always important for trustees, has in the last ten years become more important than ever. The Restatement (Third) of Trusts – Prudent Investor (“Restatement”) and the Uniform Prudent Investor Act have made clear that a trustee’s duty with respect to trust investments is to view those investments as a portfolio (rather than viewing each asset in isolation), and to diversify that portfolio. However, these innovations raise a question: do trustees now have an absolute duty to diversify trust investments? To spoil the ending of this tale, the answer, of course, is no. The Prudent Investor Act states explicitly that a trustee is to diversify investments unless there is a prudent reason not to. The factors that might convince a trustee not to diversify can include language in the trust agreement directing the trustee not to do so, the particular situations of beneficiaries or the tax cost of selling an asset that dominates the portfolio. Nevertheless, case law indicates that the duty to diversify may, in certain circumstances, be given greater weight than the trustee or her advisors might expect. In light of this judicial gloss, a trustee should assume, almost regardless of the circumstances, that she has the duty to diversify, and act cautiously when deciding not to do so. Further, lawyers drafting trust agreements should take extra care when drafting instruments for grantors who want trustees not to diversify.