The Uniform Prudent Investor Act (“UPIA”), which has been enacted in Illinois and many other states, recognizes that under modern investment theory, diversification and managed risk play important roles in asset management, and therefore recognizes the duty of a fiduciary to diversify a portfolio. In one recent case brought under ERISA laws, a fiduciary was found liable for failure to diversify a portfolio because the trustee invested 70% of the portfolio in US treasury bonds. The court ordered the plan trustee to refund its fees, and ordered the payment of damages based on the return a well-diversified portfolio would have achieved.
Further, if a portfolio is concentrated in a particular asset or assets that cannot be sold for one reason or another, hedging strategies should be considered in order to reduce risk. In another case, a plaintiff held $8,000,000 of a publicly-traded stock in his portfolio, but the stock was subject to restrictions resulting from a merger. The shareholder asked the trustee about hedging the position against the volatility of the stock, but was told it was not possible because of the restrictions. After the stock’s price dropped precipitously, the shareholder sued the trustee. The court awarded the shareholder damages, noting that the trustee could have instituted hedging strategies, such as a “collar,” to limit the downside risk.
The UPIA has several requirements of which fiduciaries must be cognizant, including:
• The fiduciary is required to consider tax consequences of investment decisions and strategies.
• The trustee must exercise reasonable efforts to determine the facts relating to the investment and management of the trust assets.
• Trustees who have special expertise must use it in the management of the assets.
• All fiduciaries have a duty of loyalty, by which they are required to serve the best interests of their beneficiaries. Trustees must seek the most advantageous pricing and terms for administrative services.
• All costs related to the portfolio must be appropriate and reasonable under the circumstances.
Please do not hesitate to call us if you have any questions about a trustee’s obligation to diversify an asset portfolio or fiduciary duties in general.