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Fiduciary Focus: A Commonsense Approach to Investing

How to stay on the high road to fiduciary responsibility.

W. Scott Simon, 01/05/2005

Among the first of my monthly columns for MorningstarAdvisor.com were two that focused on the notion that the prudence of a fiduciary is determined by its conduct, not the performance of the portfolio for which it is responsible. This is one of the fundamental, underlying principles of modern prudent fiduciary investing as discussed in the Restatement 3rd of Trusts (Prudent Investor Rule) and as codified in the Uniform Prudent Investor Act.

The Restatement was promulgated in 1992 and the Act in 1994. To date, the District of Columbia and 42 states, and the U.S. Virgin Islands, have adopted the Act into law. It is, therefore, jarring to hear that 13 years after the Restatement appeared and 11 years after the Act even highly sophisticated and knowledgeable investment professionals focus on portfolio performance. They completely ignore the bedrock standard by which they are judged as fiduciaries: their own conduct as reflected in their investment and management decision-making process that generates portfolio performance.

John H. Langbein, the Reporter for the Uniform Prudent Investor Act and Chancellor Kent Professor of Law and Legal History at Yale University Law School, has emphasized: "In drafting the Uniform Prudent Investor Act, we went to extraordinary lengths to remind courts that the standard of prudence is not [portfolio] outcome but [fiduciary] process." In short, as my earliest columns emphasized: "It's process, stupid!"

In a case where I was retained as an expert witness, the CFO of one of the largest, oldest, and most prestigious trust companies in America (nay, the world) was deposed to testify about the investment practices of his firm. His testimony centered on the fact that the performance of the plaintiff's portfolio was in the second decile. He tried (unsuccessfully) to keep the spotlight on portfolio performance rather than on his firm's failure to engage in a prudent investment and management process.

In another case where I was retained as an expert witness last year, yet another big, old, and prestigious trust company attempted to steer the inquiry away from fiduciary conduct. On direct examination at trial, I testified that I found little evidence that the trust company engaged in any process at all when investing and managing the plaintiff's portfolio, much less a prudent one.

I then referred to pertinent portions of the California Uniform Prudent Investor Act (the state in which the trial occurred) and testified that the trust company had not really complied with any of them. You would think that this firm which (according to its own website) manages hundreds of billions of dollars for tens of thousands of beneficiaries, custodies trillions of dollars and has thousands of fiduciaries on staff has the resources to implement at least some of the prudent process described in the Act--particularly now that the Act has been law in California for nine years.

Opposing counsel was clearly disconcerted by my testimony--not because it had any originality about it but because I simply went through some of a trustee's duties under the Act and noted the failure of the trust company to fulfill them. She deflated a bit in her cross examination, as a result, allowing me to escape relatively unscathed and live yet another day.

The following are some of those duties that I cited in my testimony. You may want to adapt the following discussion of them as a guide to help make sure that you are on the high road to fiduciary responsibility.

W. Scott Simon is an expert on the Uniform Prudent Investor Act and the Restatement 3rd of Trusts (Prudent Investor Rule). He is the author of two books, one of which, The Prudent Investor Act: A Guide to Understanding is the definitive work on modern prudent fiduciary investing.

Simon provides services as a consultant and expert witness on fiduciary issues in litigation and arbitrations. He is a member of the State Bar of California, a Certified Financial Planner, and an Accredited Investment Fiduciary Analyst. Simon's certification as an AIFA qualifies him to conduct independent fiduciary reviews for those concerned about their responsibilities investing the assets of endowments and foundations, ERISA retirement plans, private family trusts, public employee retirement plans as well as high net worth individuals.

For more information about Simon, please visitPrudent Investor Advisors, or you can e-mail him at wssimon@prudentllc.com

The author is not an employee of Morningstar, Inc. The views expressed in this article are the author's. They do not necessarily reflect the views of Morningstar.

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