How to handle other people’s money

We’re all aware it’s crucial for advisors to know their clients. To properly serve a client—not to mention comply with all legal and regulatory requirements—an advisor must know about the client’s assets and liabilities, lifestyle, tax situation and stage of life. A client’s investment objectives and risk tolerance are also key to this understanding.

But what if your client is a trustee?

Read: Demystifying trusts

The management of other people’s money is an integral aspect of a trustee’s role. (Attorneys [mandataries in Quebec] and executors [liquidators in Quebec] are also responsible—whether for the long or short term—for the management of property on behalf of others). It’s important for both trustees and their advisors to understand the unique rules at play, and their respective roles and responsibilities, with regards to the investment of other people’s money.

Although a trustee is the legal owner of trust property and the person (or entity) authorized to provide instructions in the management of the property to an advisor, she is not the client in the usual sense. So the advisor can’t get to know the trustee in the typical manner.

This is because it’s not the standard profile (e.g. age, income needs, time horizon) of the trustee that matters. Instead, trust investing involves an appreciation of:

• the fundamental duties and powers of the trustee;
• the terms of the trust;
• the applicable law (both common and statute); and
• the attributes of the beneficiary or beneficiaries.

Defining the role the investment professional is to play in the process is equally critical.

Trustee investment powers

Historically, a trustee’s investment powers were derived solely from the governing trust document (trust deed or will). The only lawful investments were those stipulated in that document, so to invest in other assets constituted a breach of trust.

Where the trust deed failed to provide investment powers, the trustee simply had no power to invest. This historical common-law lacuna has been filled by legislation that both grants and may define a trustee’s power to invest. While the terms of the applicable provincial legislation are important, the terms of the governing trust deed remain the starting point.

The trust deed

Today, most well-drafted trust deeds contain fulsome trustee powers, including powers in respect of the investment of the trust assets. A settlor or testator (i.e. the person who established the trust) may choose to limit their trustee to certain types of investments. An oft-seen example of this type of restriction is a direction to invest only in bonds. Some testators may go further and specify only “bonds issued or guaranteed by the Government of Canada.” Properly structured, such restrictions are binding on the trustee.

Typically, however, the trustee will be granted broad investment powers. For instance, “My trustees may make any investments that my trustees in their discretion consider advisable.”

Where the trust holds an interest in unique assets, such as a private company or commercial property, special additional investment powers may be provided. Another example of a special investment power may be an expression of the settlor’s wish that a particular investment advisor be named to act as investment advisor to the trust.

The Trustee Act

Next, the trustee must consider the relevant provisions of the applicable provincial trustee legislation. Note where the governing document is silent with respect to investments (an increasingly less frequent scenario in professionally drafted wills/trust deeds), this legislation will be the sole source of a trustee’s investment powers.

The legislative provisions governing trustee investments provide the requisite power to invest, while at the same time defining the expected duty of care. Depending on the province, the duty of care is defined as that of either the prudent investor or prudent person. In Quebec, prudent investor type rules are detailed in the Civil Code.

Also, the legislated standard of care applies whether the trust deed is silent with respect to investments, or sets out investment powers, broad or narrow. In other words, in all cases a trustee should reference the terms of the applicable provincial legislation.

In Ontario, the starting point is sub-section 27. (1) of the Trustee Act (the “Act”):

Standard of Care – In investing trust property, a trustee must exercise the care, skill, diligence and judgment that a prudent investor would exercise in making investments. The Act also provides guidance in the form of mandatory considerations. Sub-section 27. (5) reads:

Criteria – A trustee must consider the following criteria in planning the investment of trust property, in addition to any others that are relevant to the circumstances:

• General economic conditions
• The possible effect of inflation or deflation
• The expected tax consequences of investment decisions or strategies
• The role that each investment or course of action plays within the overall trust portfolio
• The expected total return from income and the appreciation of capital
• Needs for liquidity, regularity of income and the preservation or appreciation of capital
• An asset’s special relationship or special value, if any, to the purposes of the trust or to one or more of the beneficiaries

Note trustees and advisors in other provinces should review the applicable law. All trustees are encouraged to seek professional advice in respect of their role.

Other relevant criteria

This statutory list is not exhaustive. A trustee must also consider other criteria relevant to the circumstances, which are determined by the terms of the trust and the beneficiaries.

Read: 5 tax benefits of testamentary trusts

The trustee must understand the terms of the trust and the beneficiaries on whose behalf they’re acting. The answers to the following questions are all relevant.

• Are the income and capital beneficiaries the same or different people? If different people, to what extent does the even-hand rule (which means a trustee may not favour one beneficiary over another) apply?
• Is income production or capital preservation the paramount concern?
• What is the investment time horizon? Is this a fixed date or an actuarial estimate?
• Are income payments fixed, discretionary or a combination of both?
• Where payments are discretionary, what are the beneficiary’s income requirements? What if any other income sources are available to the beneficiary? Is the trustee mandated to consider other income sources?
• Is there a power to encroach on capital?
• Are there any charitable beneficiaries?
• Are all beneficiaries sui juris (competent enough to manage their own affairs), or are there minor beneficiaries or beneficiaries under a disability?
• What is the size of the trust and to what extent does volatility matter to the beneficiaries?

The advisor’s role

When it comes to investing trust assets, both the trustee and her advisor should understand and appreciate their respective roles and responsibilities.

Historically, at common law, a trustee was not allowed to delegate the performance of their powers or duties to others. This prohibition applied equally to the investment of trust assets. Not so long ago, the duty not to delegate was stringently applied. In the mid-1990s, two Ontario cases (Haslam v. Haslam and Central Guaranty Trust Company v. Sin-Sara) concluded that it was a breach of the duty not to delegate for a trustee to invest trust assets in mutual funds or other types of pooled funds managed by third parties, unless specifically authorized in the trust agreement. No doubt, a considerable portion of trust investments were technically offside during this period.

Legislation has since loosened this specific restriction. The Act now authorizes trustees to invest in mutual funds and pooled funds and authorizes co-trustees to invest in a trust company’s common trust funds. The more general prohibition against delegation has also been relaxed. The Act now provides explicit direction with respect to delegation (i.e. the rules around retaining an investment advisor to act as agent). Pursuant to subsection 27.1 (1), a trustee may delegate “to the same extent that a prudent investor, acting in accordance with ordinary investment practice, would authorize an agent to exercise any investment function.” When a trustee chooses to delegate, it’s in the best interest of both the trustee and the investment advisor to understand what’s involved.

The Act also sets out the trustee’s duty in terms of selecting an agent and monitoring the agent’s performance, and helps define what prudence in selecting an agent looks like.

It requires a written plan or strategy that “is intended to ensure all functions will be exercised in the best interests of the beneficiaries.” So there must be a written plan that takes into account both the legislated criteria and all other relevant considerations.

Responsibility does not rest solely with the trustee. The advisor must act in accordance with their agreement with the trustee and with this written plan or strategy. The potential consequences of a breach that results in a loss are also explained.

Read: 5 reasons trusts work for incapacity planning

When your client is a trustee and responsible for investing other people’s money, remember the special rules involved. A trustee may ask you to provide advice and, ultimately, provide you with instructions or, where authorized, you may be retained by the trustee to provide discretionary investment management services. Either way, when it comes to investing other people’s money, to ensure all parties are protected, and the best interests of the beneficiaries realized, it’s crucial for you and your client to appreciate the unique responsibilities involved.

Elaine Blades is director, fiduciary services at Scotia Private Client Group.