A New York Appellate Court recently reversed a lower court decision that had ordered a trustee to pay a surcharge of over $24 million based upon the court’s determination that the trustee should have divested the trust of a concentration of Eastman Kodak stock. Chase Manhattan Bank v. Hunter, N.Y. App. 4th Feb. 3, 2006.
The trust in question was funded in 1958 and had large holdings of Kodak stock The trust expressed a preference that these holdings be maintained, but did allow for sale of the stock if there was a “compelling reason…for doing so.” The trustee, Chase Manhattan, essentially interpreted this language as a virtual requirement that the stock holdings be maintained. Accordingly, despite a precipitous drop in the value of the stock in the 1970’s, the trustee did not begin to signi?cantly reduce the concentration of Kodak stock until late 2001.
The lower court was deeply critical of the trustee’s conduct, citing a variety of problems: there was no early documentation of the investment strategy or stock performance; no legal opinion was sought regarding the meaning of the words “compelling reason”; one inexperienced trust of?cer was given sole responsibility for the trust; and the Investment Review Committee was a “rubber-stamp process.” Ultimately, the court found that a “compelling reason” to diversify existed on or before January 31, 1974.
The appellate court reversed, holding that there was no evidence that the trustee acted imprudently by failing to diversify by January 31, 1974 because of price reductions of the Kodak stock. The court characterized the lower court’s decision as based on “nothing more than hindsight” and noted that “courts do not demand investment infallibility, nor hold a trustee to prescience in investment decisions.” Of particular importance to the appellate court was the fact that Kodak stock had outperformed the S&P 500 index by nearly 3 to 1 prior to January 1973 and was still viewed as a stock that would keep pace with market averages. The appellate court found that ?uctuations in the stock price did not constitute a “compelling reason” to sell, particularly in light of what it characterized as an “expansive retention clause.”
While the appellate court’s reversal in this closely-watched case provides a measure of relief for trustees concerned about second-guessing from disgruntled bene?ciaries, this case still illustrates the potential perils and pitfalls associated with concentrated portfolios. Trustees should closely examine and analyze the governing trust language and pursue thoughtful and careful diversi?cation strategies, where appropriate. The use of appropriate documentation and procedures will reduce potential exposure and make a court less likely to second-guess the trustee’s exercise of discretion.
Also in this newsletter...
A New Standard for Forfeiture of Trustee Fees?
Agreement of Beneficiaries May Not Be Sufficient to Terminate Spendthrift Trust