An example of flexibility in modern prudent fiduciary investing.
In last month’s column, I explained that one of the fundamental, underlying goals of the great reformation of American trust investment law that began in the 1980s was to restore flexibility and generality to the Prudent Man Rule through creation of the Prudent Investor Rule. This was achieved with promulgation of the Restatement (Third) of Trusts (Restatement) in 1992 (with various refinements in subsequent volumes) and the Uniform Prudent Investor Act (UPIA) in 1994. Since then, the UPIA has been enacted into law by nearly every state in the Union, as well as the District of Columbia and the U.S. Virgin Islands.
Regular readers of this column will know that one of the virtues of prudent investing that I regularly preach is to provide portfolios that are broadly (across the funds comprising a portfolio) and deeply (within each fund in a portfolio) diversified to reduce risk (and enhance return). Such portfolios may contain thousands of securities from dozens of countries and include all the world's major asset classes.
Surely, then, a multimillion-dollar portfolio holding a single, measly stock must be imprudent per se, right? Well, maybe not.
I sometimes do expert witness and consulting work on the side in addition to my day job as a principal in a registered investment advisory firm. Over the years, I have been asked to take on cases in which I would need to opine about the prudence of nondiversified portfolios. In most of these instances, the side seeking to preserve such a portfolio as is has asked me to render an opinion that would justify its retention. I have always declined since I believe that, say, 75% of the value of a portfolio invested in one stock--without relevant supporting facts and circumstances--cannot be prudent or diversified.
There was, however, a case that I was asked to take on where the portfolio was invested 100% in one stock only. You cannot get a portfolio more underdiversified and imprudent, on its face, than that, in my view. This case actually involved 14 different portfolios held by a prominent family still very much involved in a product that its forebears began providing to consumers more than 135 years ago. (I have changed the facts of the case to protect the innocent but the issues raised in this discussion remain the same; still, all the portfolios involved here actually held only a single stock.)
Each of these portfolios was held by a separate family irrevocable trust. (Don't forget, the Restatement and the UPIA apply to the investment conduct of fiduciaries of private family trusts.) I had my hands full analyzing the terms of 14 family trusts--expressed by different attorneys in varying degrees of precision--drafted over a period of nearly a century.
After an intensive review of the facts and circumstances of the case, I decided to accept the charge--and the challenge--to justify that a portfolio, based on relevant supporting facts and circumstances, could hold but a single stock and yet legally be diversified prudently according to the tenets of modern prudent fiduciary investing.
Like any issue, there were two sides here. One side of the family wished to hang on to the stock while the other wanted to sell it and diversify the portfolios. How to analyze this and where to start? Well, the place to start an analysis of this type must be the trust instrument (i.e., the private family trust) in question. It is there that the trustor (i.e., the person, also known as the settlor in some states, who set up and funded the trust for the benefit of certain beneficiaries) presumably has expressed his or her wishes in establishing the trust clearly enough so that succeeding generations of trustees (i.e., fiduciaries) will be able to carry them out faithfully for the benefit of the trust’s beneficiaries (i.e., those who benefit from the largesse of the trustor’s trust property and/or income).