Ethical dilemma

 

Many trusts are intended to provide financial benefit for significant periods of time (sometimes several generations). Therefore, investment strategy, execution and monitoring are some of the most important aspects of trusteeship. However, this is not well understood by many trustees and advisors in New Zealand. Trustees often accept property into a trust in a generic format and hold or invest in the same way as the settlor would have done if they had retained personal ownership.

There are many trusts in New Zealand that are highly concentrated in certain asset classes, especially real estate. In such cases, a market correction or significant event affecting the value of trust property could invite scrutiny from beneficiaries about the trustees’ investment strategy.

This risk is more manageable when the settlor is alive, closely involved with the trustees and creating wealth in their personal capacity. However, many trusts were set up decades ago, have experienced significant capital growth and have settlors who are older or deceased, leaving a rising generation of diverse, well-informed and expectant beneficiaries whose values and expectations may differ from those involved in the set-up of the trust.

Trustee powers of investment are regulated by duties

Re Whiteley held that the duty of a professional trustee is:^[1]

‘… not to take such care only as a prudent man would take if he only had himself to consider; the duty rather is to take such care as an ordinary prudent man would take if he were minded to make an investment for the benefit of other people for whom he felt morally obliged to provide’.

In other words, a trustee should be more cautious and take less risk than if they were investing in a personal capacity.

In Nestle v National Westminster Bank,^[2] it was held that prudence means so far as is reasonable and practical, not speculating but diversifying with the overriding objective of maintaining the capital value of the trust fund.

Trustees can be personally liable for breaching these duties

A good way to get the attention of trustees is to remind them that they can be personally liable for breaching their duties in relation to investment. Section 81(1) of the Trusts Act 2019 (the Act) provides that a trustee is personally responsible for a liability incurred by the trustee when acting as a trustee.^[3]

There are some limited protections for trustees under the law and in trust deeds. Section 81(2) confers trustees with limited protections from personal liabilities. The terms of a trust deed will typically also contain a widely drafted clause excluding trustees from liability arising out of their acts or omissions in dealing with trust property. However, such an indemnity is limited and the trust deed cannot exclude or indemnify a trustee’s liability for breaches of trust arising from the trustee’s dishonesty, wilful misconduct or gross negligence.^[4]

In an investment context, a trustee is at most risk from a claim by a beneficiary in circumstances where the value of the trust fund has declined. When considering whether a trustee has breached the duty to invest prudently, the court may consider whether the trust’s investments have been diversified appropriately and whether the investment was made in accordance with any properly formulated investment strategy.^[5]

A failure by a trustee to invest prudently could, in certain circumstances, meet the threshold for gross negligence and lead to personal liability. Section 44 applies when a court is deciding whether a trustee has been grossly negligent for the purposes of its duty to invest prudently.

The court must consider, having regard to the factors set out below, whether the trustee’s conduct (including any action or inaction) was so unreasonable that no reasonable trustee in that position and in the same circumstances would have considered the conduct to be in accordance with the role and duties of a trustee.

The relevant factors are:

• the circumstances, nature and seriousness of the breach of trust;
• the trustee’s knowledge and intentions relating to the breach of trust;
• the trustee’s skills and knowledge that are relevant to the role of trustee;
• the purpose for which the trustee was appointed;
• any other circumstances, including whether the trustee has been remunerated for the role, or characteristics of the trustee that are relevant to the role of trustee;
• the type of trust, including, without limitation, the degree to which the trust is part of a commercial arrangement, the assets held by the trust, how the assets are used and how the trust operates;
• the purpose of the trust, including, without limitation, what the trust is intended to achieve and whom the trust is intended to benefit and in what ways; and
• any other factor the court considers relevant.

The test of prudence is the touchstone for trustee investment duties

The ‘prudent person rule’ has its origins in US case law and has become a global standard for trustees.^[6] Since then, most case law and commentary in relation to trustee investment has focused on the question of prudence and what it means in practice. Prudence requires a higher standard of care than is expected from a person with little or no business experience managing their own property. When the plain meaning of prudence is applied, it seems that a trustee must:

• act with ‘caution and care’;
• act with ‘discretion’;
• act with ‘circumspection’;
• act ‘practically and carefully in providing for the future’; and
• ‘exercise good judgment’ in ‘managing the affairs of others’.

Essentially, the prudent person rule says that although a person may be prepared to take risks with their own property (often in the hope of generating an above-average return), a trustee is a guardian of property belonging to other people and should exercise a higher degree of caution. A trustee should take a long-term, strategic view of the present and future needs of beneficiaries.

The English and Welsh case of Bartlett v Barclays Bank Trust Co Ltd (No 1) was one of the first to articulate this principle:^[7]

‘… a higher duty of care is plainly due from someone like a trust corporation which carries on a specialised business of trust management. A trust corporation holds itself out in its advertising literature as being above ordinary mortals ... a professional corporate trustee is liable for breach of trust if loss is caused to the trust fund because it neglects to exercise the special care and skill which it professes to have.’

Some of the practical requirements of this duty are that professional trustees should regularly review investment performance reports,^[8] be prepared to refuse to acquiesce with lay co-trustees^[9] and keep proper records of the trustee’s investment history.^[10]

At least in relation to investments, the law is conduct-orientated not result-orientated. Jones v AMP Perpetual Trustee Company NZ Ltd held that the trustee will not be held accountable if they lost money but rather if the loss resulted from improper conduct. ^[11] A trustee is not a guarantor or insurer of the trust fund. The fact that a trust fund lost value over time is not necessarily evidence of a breach of duty by the trustee. If the trustee can show that it acted prudently throughout its trusteeship and the trust fund lost value because of market circumstances beyond its control, then it will have a sound defence to claims against it for breach of duty. As with many aspects of trusteeship, the process is more important than the outcome.

The Act affirms common-law duties associated with investment by trustees. Section 30 requires a trustee, when investing trust property, to exercise the care, diligence and skill that a prudent person of business would exercise in managing the affairs of others. This includes having regard to any special knowledge or experience the trustee has or holds themselves out as having.

Section 30(b) places a higher level of skill on a professional trustee than is required of a lay trustee. Professional trustees are benchmarked against the knowledge and experience reasonably required of another professional person within that industry.

The duty of prudence can, in theory, be excluded

Some duties imposed on trustees by law are mandatory. This means they are unable to be excluded or modified by the trust deed. These duties include:^[12]

• knowing the terms of the trust;
• acting in accordance with the terms of the trust;
• acting honestly and in good faith;
• acting in the best interests of the beneficiaries of the trust or to further its permitted purpose; and
• exercising powers for proper purposes.

Other duties are default duties.^[13] These include:

• the general duty of care;
• investing prudently;
• not exercising a power for personal benefit;
• actively and regularly considering the exercise of power;
• not binding or committing to a future exercise of discretion;
• avoiding conflicts of interest;
• acting impartially;
• not profiting from the trusteeship of a trust; and
• not taking any reward for acting as a trustee.

The general duty of care is also relevant to investment by trustees. It should encourage trustees to take advice in relation to matters the trustee does not understand. This said, the trustee is not obliged to accept and act on that advice.^[14]

These default duties can, in theory, be excluded or modified by the trust deed. Often, trust deeds will contain an express statement that the trustees have no duty to invest prudently. Trustees should, however, be cautious about attempts to exclude or modify default duties. If the relevant wording in the trust deed refers only to the s.30 duty to invest prudently, then, arguably, the common-law duties remain in play.

In any case, many of the default duties (including investing prudently) are specific manifestations of mandatory duties (such as to act in the best interests of the beneficiaries). A trustee may have a false sense of security from a trust deed that says there is no duty to invest prudently.

If the trust fund suffered a momentous loss in value due to an investment decision, then a beneficiary may have a statutory claim against the trustee for breach of one or more of the mandatory duties, such as to act in good faith and in the best interests of the beneficiaries. They may also have a claim against the trustee at common law for breach of the overriding and immutable duty to perform their role ‘honestly and in good faith for the benefit of the beneficiaries’.^[15]

There are a range of factors a trustee can consider when making investments

Section 59(1) lists various factors the trustee can consider when exercising any power of investment.

The relevant factors are the:

• objectives of the trust or the permitted purpose of the trust;
• desirability of diversifying trust investments;
• nature of existing trust investments and other trust property;
• need to maintain the real value of the capital or income of the trust;
• risk of capital loss or depreciation;
• potential for capital appreciation;
• likely income return;
• length of the term of the proposed investment;
• probable duration of the trust;
• marketability of the proposed investment during, and on the expiry of, the term of the proposed investment;
• aggregate value of the trust property;
• effect of the proposed investment in relation to the tax liability of the trust;
• likelihood of inflation affecting the value of the proposed investment or other trust property; and
• trustee’s overall investment strategy.

The list is non-exhaustive and a useful aide-mémoire, especially for lay trustees, but is not an official rulebook. This is an investment-specific version of the general rule of fiduciary decision making that a trustee should consider all relevant considerations and disregard irrelevant considerations.

Lessons learned

Some general lessons from court decisions relevant to investment by trustees are as follows:

• A trustee’s performance must not be judged with hindsight but by applying the standards of the relevant period, bearing in mind the investment philosophy and economic and financial conditions of the time.^[16]
• A trustee is expected to diversify investments and, when making investments, to be impartial and even-handed between income and capital beneficiaries.^[17]
• When a trustee makes investments, they have a duty to seek advice on matters that a trustee may not understand. It is not enough to act in good faith and with sincerity.^[18]
• It is accepted that there may be a fall in the value of trust investments:^[19]
  • ‘[I]t is clear that a trustee is neither an insurer nor guarantor of the value of a trust’s assets and that the trustee’s performance is not to be judged by success or failure, that is, whether he or she was right or wrong. While negligence may result in liability, a mere error of judgment will not. Neither prophecy or prescience is expected of trustees and their performance must be judged, not by hindsight, but by facts which existed at the time of the occurrence’.
• If a trustee applies to court under s.133 for directions about matters of investment strategy, it can limit its exposure to liability for imprudent conduct; although, in many situations this will not be necessary or appropriate.^[20]

Diversification can help manage fiduciary risk

One of the basic ways for a trustee to manage its duties to invest prudently is to diversify the trust fund.

Section 128 provides that when considering whether a trustee is liable, in respect of any investment made by that trustee, for any breach of trust in respect of any duty under s.30 (to invest prudently to the applicable standard), the court may consider whether the trust’s investments have been diversified, so far as is appropriate to the circumstances of the trust.

The theory of diversification is to reduce risk. Section 129 encourages diversification by confirming that, in any action against a trustee for breach of trust in relation to an investment by a trustee, if a loss has been or is suspected to have been incurred by the trust, the court may set off all or part of the loss resulting from the investment against all or part of any gain resulting from any other investment, whether in breach of trust or not.

Outside of the trust construct, there are different theories about the merits of diversification as an investment strategy. These include Harry Markowitz’s Modern Portfolio Theory (MPT), regarding how, by combining different investments, investors can hope to take the least amount of risk that is consistent with the level of return desired.^[21] This is achieved by constructing a portfolio of investments in a manner where the risk is less than holding any individual investment on its own.

A portfolio that is constructed according to MPT should comprise asset classes that are negatively correlated to each other; if one asset class (like bonds) goes down, the other (like equities) should, in theory, go up. An extremely simple example of negatively correlated investments could be securities in a fossil fuel extraction business and securities in a renewable energy producer. A trustee invested in these two sectors might reasonably expect the portfolio to be cushioned from volatility normally caused by a sharp fall in either of them. Tactical weightings within the asset classes can then be varied and rebalanced depending on the investment manager’s view of both macroeconomic and microeconomic circumstances.

Investments based on principles not fundamentals

As explained above, when individuals invest in their personal capacity they are free to select any investment strategy that suits them and are unconstrained by fiduciary responsibilities. But when trustees invest they are doing so as fiduciaries on behalf of the beneficiaries and are restricted by common-law rules of ‘prudence’, as interpreted by the courts.

An unintended consequence of the duty of prudence is that the law is less permissive of trustees taking an approach to investment that aligns with ethical or moral principles.

Investment experts argue about the merits of different investment theories. The professional fiduciary services industry has, for the most part, adopted MPT. It is even possible that this general acceptance may have metamorphosed into a duty on a trustee to make investment decisions consistent with MPT.^[22] Lay trustees and even many lawyers are often not well informed about these matters.

MPT and the wider duty of prudence, however, may be inconsistent with the settlor’s intention or beneficiaries’ desire that the trust adopts an ethical investment strategy. A recent study, conducted by international law firm Taylor Wessing, indicated that around 77 per cent of high-net-worth individuals are focused on using their wealth to create positive long-term impacts on society.^[23]

A trustee could therefore find itself in a position of conflict between the wishes of the settlor, the discretionary terms of the trust and the law, which requires it to invest prudently and, arguably, to follow MPT.

Traditional trust law discourages ethical investment strategies

Traditionally, trustee investments have focused on financial returns and reducing risk. Scant concern, if any, was given to the investment’s impact on societies or the environment.

The law itself was interpreted this way, with the former Vice Chancellor of the Chancery Division, Sir Robert Megarry, stating in Cowan v Scargill that where unethical investments ‘would be more beneficial to beneficiaries than other investments, the trustees must not refrain from making the investments by virtue of the views they hold’.^[24]

Cowan concerned a mineworkers’ pension scheme. The union appointees on the board of management objected to investment in oil companies and overseas investments based on union policy. Megarry VC explained:

‘Trustees must do the best they can for the benefit of their beneficiaries and not merely avoid harming them. I find it impossible to see how it will assist the trustees to do the best they can for their beneficiaries by prohibiting a range of investments that are authorised by the terms of the trust … It is the duty of trustees, in the interests of the beneficiaries, to take advantage of the full range of investments authorised by the terms of the trust, instead of resolving to narrow that range.’

In Martin v City of Edinburgh DC,^[25] a decision by trustees to divest from investments held in South Africa based on political, rather than financial, considerations was held to be a breach of trust.

In New Zealand, a similar view was taken by the Māori Land Court in Re Tawhai where Judge Ambler said:

‘In particular, the problem is that trustees have invested in businesses for reasons that appear to be more to do with community, social or historical imperatives than because they will produce the best financial returns for the owners. That is not to say that the Trust cannot have community purposes in mind in making investments, but their primary duty is to ensure that they are building up the assets and income for the owners. If trustees have particular pet projects for their community, then they should pay for them themselves out of their own money and not the owners’ money.’^[26]

Harries v Church Commissioners for England concerned ethical investments in relation to trusts. ^[27] The then-Bishop of Oxford, Richard Harries, sought a declaration that the Church Commissioners (the Commissioners) were required to consider the objects of the trust when making investments. The Commissioners’ purpose was to provide ‘financial assistance for clergy of the Church of England’.^[28] To do this, the Commissioners were investing in various companies to produce income based on an investment policy they had developed. The investment policy allowed for the exclusion of certain investments including gambling and armaments.^[29] However, some of the companies the Commissioners were investing in were based in South Africa, which, at the time, was still transitioning to a democracy from the authoritarian and racist apartheid regime. The Bishop of Oxford argued that investing in such a morally compromised country was inconsistent with the underlying purpose of the trust.

The Bishop of Oxford sought declarations that:

• the Commissioners were ‘obliged to have regard to the object of promoting the Christian faith through the established Church of England’;^[30] and
• when the Commissioners were exercising their powers, they ‘must not act in a manner which would be incompatible with that object’.^[31]

Ultimately, Sir Donald Nicholls VC refused to make the declarations as he felt they were too ambiguous and largely unnecessary.^[32] Further, the second declaration would not assist the Commissioners when there were differing views on whether an investment ‘conflicted’ with the charity’s purposes.^[33]

The case is notable for its obiter dicta comments on trustees of charities and their powers of investment. It was stated that the starting point for all charities is to maximise financial return.^[34] Charities need money to be able to further the purposes of the trust, and the more money they have, the more they can fulfil these purposes. However, there are three general ‘exceptions’ to this rule where non-financial considerations can come into play:

• First, where the investment is in direct conflict with the charity’s purposes.^[35] An example given in this category is a cancer research charity investing in tobacco companies. This is clearly in direct conflict with the charitable trust and the trustees would be entitled to not invest in those companies, even if this did cause significant financial detriment.
• Second, where the investment conflicts indirectly with the purposes of the charitable trust.^[36] In this situation, Nicholls VC noted that trustees would need to balance the potential financial loss against the other disadvantages the charity would sustain (e.g., loss of support). When there is a risk of significant financial loss, the trustees should be certain that the consequential disadvantages would be substantial.
• Finally, where the trustees are justified in departing from what would otherwise be their starting point.^[37] This was a vague category put forward by Nicholls VC, who did not explain what this would look like in practice. However, it was noted that trustees must not make moral statements at the expense of a charity when looking to invest trust property.^[38]

Traditional trust law is evolving

Butler-Sloss v Charity Commission is a recent England and Wales judgment that considered ethical investments and revisited the precedent set in Harries.^[39]

In this case, the trustees of two charitable trusts, Ashden Trust and Mark Leonard Trust, sought declarations that would allow them to adopt an investment policy that excluded investments inconsistent with the goals of the Paris Agreement, even if this resulted in financial detriment.^[40]

The Paris Agreement is a legally binding international treaty on climate change. It was adopted by 196 parties at the UN Climate Change Conference (COP21) in Paris, France, on 12 December 2015. It entered into force on 4 November 2016.

Both trusts in this case had general charitable purposes but with a focus on environmental preservation. Although they were under no obligation to comply with the Paris Agreement, the charities had decided to use it as the basis for their proposed investment policy.

The trustees applied to the court for a declaration that adopting and executing their proposed investment policy would be a lawful exercise of their powers of investment. The Charity Commission for England and Wales (the Commission) and the Attorney General of England and Wales opposed the application on the basis that the trustees had not sufficiently taken into account the potential detrimental financial impacts of such a restrictive investment policy.^[41]

Justice Michael Green was left to address a question raised by the judgment in Harries of whether a charity can lawfully invest in a particular investment that directly contravenes the charity’s purpose. Green J concluded there was no absolute prohibition on making such investments due to the practical difficulty of ascertaining when such conflicts exist.

The England and Wales High Court (the EWHC) in Butler-Sloss reaffirmed the position that charitable trustees owe duties to further the charitable purposes, which usually occurs through maximising financial returns. However, if a trustee wishes to exclude an investment (or class of investments) due to a potential conflict with their charitable purposes, then they may exercise their discretion to exclude such investments. This discretion must be exercised by reasonably balancing all competing factors including, but not limited to, financial impact, donor support, reputation and wishes of beneficiaries. Trustees should exercise extra caution when making decisions on moral grounds as these can be subjective.

As stated by Green J:

‘where trustees are of the reasonable view that particular investments or classes of investments potentially conflict with the charitable purpose, the trustees have a discretion as to whether to exclude such investments and they should exercise that discretion by reasonably balancing all relevant factors including, in particular, the likelihood and seriousness of the potential conflict and the likelihood and seriousness of any potential financial effect from the exclusion of such investments’.^[42]

If a balancing exercise is properly conducted with all of the due care and skill expected, and a reasonable and proportionate policy is adopted, then the trustees have discharged their duties and cannot be criticised even if the court or another trustee may have come to a different conclusion.^[43]

However, the EWHC warned that charitable trustees do not have unfettered discretion to choose investments. Trustees should ensure they act responsibly, conduct due diligence and set out their reasons for investments in writing. It is also important for trustees to consider divestment when making decisions, especially the risk that failing to divest could cause to the charity’s reputation.

In summary, Butler-Sloss provides the following guidance to charitable trustees:

• There is no obligation on trustees to exclude financially sensible investments that contravene their charitable purpose, particularly given the element of subjectiveness inherent in determining a conflict. Further, trustees are cautioned from making investment exclusion policies based on moral judgement.
• Trustees can adopt investment policies in line with their charitable distribution policy, even if that is more specific than their more general purposes.
• Trustees have the power to create investment policies that exclude potentially lucrative investments so long as the decision to do so is properly and reasonably considered, having taken into account all relevant factors.
• What the impact of this means will depend on the charity itself. If a charity has a relatively small asset pool, it may need to be less exclusive with its investments than another charity that can afford to return lower percentages on some investments.

Following the judgment in Butler-Sloss, the Commission updated its investment guidance.^[44] The Commission regarded the decision as providing welcome guidance on trustee discretion, but that it did not fundamentally change the law. It affirmed charities could rely on their existing guidance when making investment decisions.^[45]

The Commission has indicated it is looking to update its guidance after consultation, to give trustees more confidence in their ability to make responsible and environmental, social and governance- (ESG-) focused investments, as well as simplifying the language used to make the guide more accessible. They intend for this to be released by the end of 2023.

The Commission also endorsed in full the framework provided by Green J in para.78 of the judgment and stated it will consider the framework in its future guidance.

The UK Association of Charitable Foundations (the ACF) also commented in response to the judgment.^[46] The ACF noted the variation in interpreting the significance of the decision, in that some commentators see the decision as a marked shift towards ethical and moral investment policies, whereas others see it as a simple reconfirmation of the law. The ACF spoke to Luke Fletcher of Bates Wells, the lawyer who represented the two trusts in Butler-Sloss, who stated that the balancing exercise described by the court that trustees needed to undertake would develop over time. The court provided little guidance on how factors should be weighed but indicated that where there is an obvious conflict with the charitable purpose of the trust then there is more likely to be a basis for exclusion.

Fletcher is quoted by the ACF:

‘The judge said that trustees should aim to develop a “reasonable”, “proportionate” and “appropriate” investment policy, which suggests that different foundations with different levels of assets and capacity might come to different conclusions in light of what is proportionate and appropriate to the size and sophistication of the foundation. There is no single “right” investment policy for foundations to adopt. Ultimately, it is for trustees to determine what is in the best interests of each foundation’s purposes.’

ESG is becoming mainstream

ESG investment is a subset of ethical investment. ESG refers to a set of standards for a company’s behaviour used by socially conscious investors to screen potential investments.^[47] There are three limbs to ESG:

• Environmental: considers how a business safeguards the environment, including, for example, corporate policies addressing climate change.
• Social: examines how a business manages relationships with employees, suppliers, customers and the communities where it operates.
• Governance: deals with business leadership, executive pay, audits, internal controls and shareholder rights.

ESG investment strategies screen investments based on corporate policies and encourage businesses to act responsibly. Many mutual funds, brokerage firms and wealth managers now offer investment products that adhere to ESG principles.

There is a school of thought that investors can benefit from ESG-aligned investment strategies regardless of any ethical or moral views. This is because if a particular industry (e.g., mining) is likely to be viewed disapprovingly by the public and regulators then investments in that industry could underperform relative to other more socially acceptable industries (e.g., renewable energy). On this basis it could be argued that there is no need for a trustee to take specific or additional steps to accommodate an ESG-focused investment strategy. However, at least at this point in time, a trustee should do more to ensure it can safely and confidently embrace an ESG-aligned investment strategy.

Uncertainty remains

Caution and expert advice is often necessary due to the rapid growth of ESG investment funds in recent years, which has led to claims that businesses are insincere or misleading in touting their ESG accomplishments. Some experts argue that excluding pollutive companies from investment portfolios altogether does not help them transition to sustainable business practices because it constrains them of capital, limiting their ability to invest in new technologies and markets. Aligning to an ESG benchmark can disincentivise activities that actually help with the energy transition.

Similarly, although the EWHC in Butler-Sloss confirmed that in certain circumstances purpose can take primacy over profit in trustee investment strategies, the judgment related to investment by charitable trusts and, as far as the authors are aware, the issue has not been considered by a court in the context of a private family trust. It is undoubtedly an important judicial decision that has the potential to influence fiduciary investment strategy and will likely be followed in other jurisdictions. However, the law is still evolving in this area and the usual rules of diligence apply.

Where trustees are especially motivated to implement an ethical investment strategy, they should consider the guidance in Butler-Sloss and the methods suggested in the following paragraphs to manage their fiduciary risk.

Bespoke trust deed drafting

As a bare minimum, the trust deed should disapply the s.30 duty and the associated common-law duties to invest prudently. However, for the reasons given in previous paragraphs, this could be insufficient to protect a claim if the investment losses are significant and the net value of the trust fund is consequently affected.

One of the mandatory duties of a trustee is to administer the trust in accordance with its terms. This mandatory duty can be helpful when drafting trust deeds because it provides options for bespoke drafting for specific circumstances.

If a trust is intended to invest ethically, the trust deed could be drafted to accommodate this. For example, the trust deed could impose restrictions on investing in certain types of investments, mandate a prescribed list of investments, require the consent of a third party to an investment strategy or specific investment decision, or impose other conditions around the investment process.

A variation on this suggestion is to include a statement about the intended investment strategy in the recitals or letter of wishes to the trust.

Investment powers can be reserved to third parties

Another option is to remove the powers of investment from the trustee altogether and interpose a third party (such as a protector) who has the power to direct the trustee in relation to ethical investment strategy and execution.

This puts the trustee in an execution-only position as far as investments are concerned but otherwise in control of every other aspect of trusteeship. That is unorthodox in New Zealand but is common in offshore jurisdictions. In many situations, it is appropriate and will improve trust governance because most trustees are not (and should not be) appointed because they are investment experts but rather because of their governance skills.

Investment policy statements

As a rule, all trusts should have an investment policy statement (IPS) that outlines the reasons for and practical steps involved in an ethical investment strategy.

An IPS is a formal document that outlines general principles for the investment of the trust fund. This statement could be developed in consultation with the beneficiaries and should set out the general investment goals and objectives of the trust, as well as describing the strategies that the trustee should employ to meet these objectives. Specific information on matters such as asset allocation, risk tolerance and liquidity requirements are included in an IPS.

An IPS generally enshrines principles rather than rules, and is not normally written into the trust deed to preserve some flexibility. A well-conceived IPS guides and protects the trustees and empowers them to stay focused on the long-term objectives rather than quarterly portfolio performance.

If an IPS has been thoughtfully developed then it may protect the trustee from claims as it proves that the trustee has taken its investment duties seriously and has adequately considered s.59(1) (factors the trustee can consider when exercising any power of investment).

Section 128 provides that when considering whether a trustee is liable, in respect of any investment made by that trustee, for any breach of trust in respect of any duty under s.30 (to invest prudently to the applicable standard), the court may consider whether the investment was made in accordance with any investment strategy.

Trustees should use investment experts

Today, investment management is a specialised profession and the investment universe is much more extensive and complex than it was when many trusts were created. This is exacerbated when ethical investment imperatives are added to the mix of fiduciary considerations.

A trustee should procure the services of independent, qualified, reputable and competent investment experts. A trustee’s duty of prudence imposes a duty on trustees to seek advice on matters it does not understand, such as the making of investments. A trustee is not bound to follow such advice but its decision to follow or reject advice must be based on proper considerations and purposes.

Evidence that advice from a reputable and qualified expert was taken and followed will support a trustee facing a claim for breaching its duty of prudence. Many financial institutions and advisors now profess some expertise in ethical investing and can guide trustees on strategy and execution. These experts can provide both advice and discretionary investment management, both of which have important roles to play in the administration of trust funds comprising financial assets.

Concluding comments

The role of the modern professional trustee is complex. Never has this been more true, as significant wealth that has accumulated in many trusts in recent decades transitions between generations. Often, planning around trusts has been short-sighted and focused on the wealth creator rather than the future generations. Today, beneficiaries are often socially conscious and have views on ethical investment strategies.

Ethical investment opportunities and trends have evolved rapidly, but the law as it applies to trustees is relatively static. Trustees need to be alive to the risks and opportunities associated with the powers and duties of investment as they apply in an ethical investment context.

When setting up a new trust, advisors must consider whether bespoke investment terms are needed or desirable to accommodate an ethical investment strategy. In some cases, an existing trust may not be designed for anything other than a traditional investment strategy and an ethical investment approach may require consultation, due diligence and supplemental documentation before it can be safely implemented.

In other cases, the trustee may need to protect itself through letters of wishes, beneficiary consents and indemnities. In nearly all cases, there should be an investment policy statement where independent investment experts have an important role in the process.