The recent New York Court of Appeals decision (issued June 19, 2012) about the performance of HSBC Bank USA, N.A., as trustee of a trust for the issue of Seymour H. Knox, III, should give some peace of mind to fiduciaries everywhere—or should it?  The decision reversed nearly all of the surrogate court’s judgment against HSBC, which totaled about $24 million in damages, interest and attorneys’ fees.  However, the litigation spanned six years, and HSBC’s attorneys’ fees probably exceed the balance remaining in the trust.  Plain and simple, this case illustrates the dangers that a trustee necessarily faces when retaining concentrated positions, even when those investments represent family tradition or settlor sentiment.

Seymour Knox, II established the trust in 1957 for his son’s issue.  The original corpus included stock in F.W. Woolworth Company, which the Knox family had co-founded, and stock in HSBC’s predecessor (Marine Bank), for whom the settlor had served as chairman of the board.  The trust agreement expressly allowed the trustee to invest and reinvest, “without regard to diversification or to limitations or restrictions of any kind.”  The trust agreement also included language permitting the trustee to hold its own stock as an investment and purporting to relieve the trustee of liability for actions taken in good faith in accordance with the opinion of “counsel.”  While managing the trust’s portfolio, HSBC consulted with Knox III, who was the son of the settlor, the father of the income beneficiaries and a co-trustee on other family trusts. 

On July 13, 2006, HSBC filed a petition with respect to its resignation as trustee and seeking acceptance of its accounts for essentially the full period of administration.  According to HSBC’s accounts, trust principal had increased in value a net $1.75 million and generated income of $1.5 million over the trust’s term.  The final account showed $1.28 million in trust principal on hand. 

In response to HSBC’s petition, the four adult income beneficiaries and a guardian ad litem (GAL) for the minor remainder beneficiaries filed, in the aggregate, ten objections to HSBC’s accounts, primarily asserting that HSBC had breached its fiduciary duty of care with respect to how it managed trust investments.  In particular, the objectants argued that HSBC should not have held the concentrated positions in Woolworth and Marine stock as long as it did.  The surrogate court agreed, finding that HSBC’s failure to timely sell the Woolworth stock cost the trust more than $11 million, and HSBC’s failure to timely sell the bank stock cost the trust almost $8 million.  The surrogate court even surcharged HSBC for the objectants’ attorneys’ fees, including a GAL fee that exceeded the reported value of remaining trust principal.

These facts reflect a fairly common problem for fiduciaries: How should they treat investments that represent the settlor’s personal business accomplishments after the settlor has died?  Many entrepreneurs and executives fund trusts for their families with concentrated positions in companies that they founded or managed successfully.  In part, this is because the settlor continues to believe in the company and its strength as an investment.  However, it’s often also because the company carries the settlor’s name or represents his legacy in business.  Fiduciaries then face the difficulty of trying to honor the settlor’s (sometimes unstated) intentions to hold the stock, while still being held to an essentially quantitative standard of investment performance by beneficiaries who do not share the settlor’s reverence for the company that he created or helped to build. 

Fortunately, for HSBC, the Court of Appeals reversed the surrogate’s decision on almost every point. Unfortunately, for fiduciaries in general, the decision does not substantially address the concept of settlor legacy as a factor in fiduciaries’ investment decision making.  Instead, the Court relied on reasoning based in economics and process to reject most of the allegations that HSBC had been imprudent.

The Court of Appeals decision articulates and elucidates a number of key concepts for the guidance of fiduciaries that find themselves holding concentrated positions, generally.  For example, holding a concentrated position is not, in itself, a failure to diversify; a fiduciary’s conduct is to be judged based on prudence, not performance; and retaining an investment received from the settlor may be prudent, even if purchasing the investment would not be. The Court also held that, for purposes of the trust provision relieving the trustee of liability for acts undertaken in good faith based on advice of counsel, the term “counsel” was not limited to legal counsel, but included Knox, III, because he was a “savvy investor” and served as a co-trustee with HSBC on other Knox family trusts.  

However, it does not appear that the Court of Appeals gave any deference to the settlor’s business legacy in its decision.  The Court upheld the surrogate’s judgment of liability against HSBC for failing to sell Woolworth stock only when the company stopped paying dividends, because, the Court held, the purpose of the trust was to generate income for the children of Knox, III.  Further, the Court cited the widespread rule, which is codified in New York as to some trusts, that it’s against public policy for a trust instrument to exonerate the trustee for failure to exercise reasonable care, prudence and diligence.

More and more settlors are turning to concepts like special trust language, trust protectors and directed trusts to address the problem of preserving their business legacy in spite of traditional standards of fiduciary investment performance.  Despite the overall favorable result for the fiduciary under the Court of Appeals decision, the Knox litigation serves as an illustration of the reality and importance of that problem.