Kodak. IBM. Coca-Cola.

The names are corporate icons. And these blue-chip stocks, if held in the portfolio of any trust, once meant a life of quiet contentment for both trustees and beneficiaries.

No more.

There's been a rise in lawsuits by beneficiaries claiming that trustees failed to diversify portfolios by holding onto vintage stocks such as Kodak, even as values plummeted. Diversification of risk is the mantra of modern-day investment and the law of “prudence” governing trustees has evolved to incorporate that knowledge.

A trustee who holds onto fading blue-chip stocks for too long will run afoul of the prudent investor rule. And a case pending in federal court in Atlanta puts this obligation in stark relief: Alexander Hitz and Thomas Shaw, two of the heirs to trusts established under the will of a prominent Atlanta physician, claim that SunTrust Bank, a financial institution with deep ties to the Cola-Cola Company, ignored their pleas to diversify by “sticking blindly” with Coca-Cola stock. Coke stock has accounted for as much as 90 percent of the trusts' assets, according to their complaint, and the value of that stock has declined by as much as 60 percent since 1998, at a loss of at least $15 million.

PUNITIVE DAMAGES

The suit, filed May 31, 2005 in the Northern District of Georgia,1 claims SunTrust should be punished at least 10 times $15 million (the loss caused by decline of Coke stock) in punitive damages and seeks an award of “at least $165 million” for its fiduciary breaches and conflicts of interest that put SunTrust's relationship with Coke before their interests.

SunTrust's ties to the Coca-Cola company run deep: The bank owns 48 million shares of Coke stock in its own name and executives from both companies serve on each other's board of directors. The bank holds another 68 million shares of Coke stock as a fiduciary for trust clients. The brothers' lawsuit claims these ties have created a conflict of interest that makes it impossible for the bank to carry out its fiduciary duties. SunTrust denies these claims in the federal case. In fact, the brothers have been poised to sue the bank since 2004, when the parties entered into an agreement that tolled the statute of limitations, in which the parties agreed to refrain from litigation. But the bank rushed into a Georgia state court last March, two months before the brothers' federal suit was filed, seeking to resign as trustee because, the bank said, “disagreement and conflict appear deleterious to the best interests” of the brothers' trusts. That request remains pending in Fulton County Superior Court.2

SUNTRUST GEARS UP

SunTrust appears to be bracing for a high-profile fight: In January the bank hired as its lead lawyer L. Lin Wood, a flamboyant trial lawyer who's just joined Atlanta's Powell Goldstein LLP. A frequent legal commentator on television, Wood's clients have included John and Patsy Ramsey, Richard Jewell, and Gary Condit, all of whom not only escaped criminal charges but even sued media outlets on defamation claims. Wood is best known for the $500,000 settlement that NBC paid to Richard Jewell, who was once suspected in the 1996 bombing of Atlanta's Centennial Olympic Park. He is representing the Ramseys, parents of JonBenet Ramsey, a six-year-old beauty pageant queen found beaten to death in December 1996 in the Ramseys' Boulder, Colo. home. The Ramseys were suspects in the murder investigation, which concluded in October 1999 with no indictments. Condit is a former U.S. congressman who was questioned by police in the unsolved murder of Chandra Levy, a 24-year-old congressional intern who disappeared in May 2001. He sued Vanity Fair writer Dominick Dunne for defamation and settled those claims for an undisclosed sum last May.

The website that Wood maintained for his law practice before joining Powell Goldstein was not subtle. “Meet L. Lin Wood, ‘attorney for the damned,’ who's just dying to sue you,” it read. Until now, SunTrust has deferred questions about the case to a bank spokesman, but Wood agreed to talk about the case with Trusts & Estates.

BE AFRAID

The case of Hitz v. SunTrust has attracted keen interest among trusts and estates lawyers, who expect to see more lawsuits like it. “It's coming up more and more often, there's no question about that, because you have these large blue chips that people held onto for a long time,” says Maureen Bateman, a partner with the New York office of Holland & Knight LLP. Even so, there aren't too many precedents on this issue: The key cases come from New York, and involve trusts with large concentrations of Kodak stock.

Alexander Hitz and Thomas Shaw are half-brothers who began receiving income from the trusts in 1995, after the death of their mother, Caroline Sauls Hitz Shaw. Her father and the originator of the family fortune, H. Cliff Sauls (who died in 1947), was “a true believer in Coca-Cola stock,” Wood claims. The trusts have another living beneficiary, Laura Sauls Wallace, Caroline's sister, who does not contest SunTrust's investment in Coca-Cola. According to the brothers' suit, the two men “implored” SunTrust about the concentration of Coca-Cola stock in the trusts since their mother's death. Those concerns reached a “crescendo” in July 1998, the complaint says, when the price of Coke stock reached an all-time high of $88.94.

The lawsuit quotes from several letters of complaint to bank management from 1998 to 2001. On March 26, 2001, SunTrust Vice President Dameron Black wrote back to the brothers that the bank was “surprised at the tone” of a letter from Hitz. Black stood by the Coke investment: “The legacy of the Coca-Cola investment has served the trusts well… Over time, Coca-Cola's financial strength and ability to generate above-average growth in profits and dividends has resulted in substantial appreciation.” On June 28, 2001, when the brothers pleaded for a third time to diversify the Coke holdings, Coca-Cola stock closed at $45.35 per share, about half of its July 1998 peak value. Over time, the brothers were told repeatedly that diversification wasn't necessary because Coca-Cola was, in SunTrust's words, a “good company,” a “diversified company” and because its stock would “come back.” Black's faith has yet to be justified. On Feb. 6, the price of Coke stock closed at $41.38 a share.

ARGUMENTS

SunTrust is the second largest holder of Cola-Cola stock; Warren Buffett's holding company, Berkshire Hathaway Inc. is the largest. The 48.3 million shares that the bank holds for itself had a market value of more than $2 billion when the brothers filed the complaint in May 2005. The bank reported dividend income of $43 million from Coca-Cola stock holdings for 2004, also duly noted by the lawsuit. The 68 million shares that SunTrust holds for its trust clients have been held hostage to the bank's own financial gain, the suit claims: “SunTrust is subject to the natural temptation to retain all 68 million shares of Coca-Cola stock that it holds in a fiduciary capacity, in order to protect the value of the 48 million shares that it holds for its own account,” according to the complaint.

This contention defies common sense, says Wood, the bank's lawyer. The sale of six or seven million shares of stock in a company with outstanding shares of more than 22 billion “would not impact the price of shares of Coca-Cola at all,” he says. “I'm confident that the evidence in this case will show that the fundamental premise of the plaintiffs is flawed.”

In 1997, SunTrust responded to concerns of the brothers and sold about 9 percent (27,600 shares) of the Coca-Cola stock in the trusts. The bank also responded to the brothers' desire for additional income by seeking a court order to split the trusts into eight sub-trusts to provide Hitz and Shaw with additional income. The bank also has entered into distribution agreements that allow the brothers to draw on principal, Wood says.

The elder brother, Alex Hitz, has always pressed the bank to receive more income, Wood claims. “His spending requires money; historically he has always needed money — more income than the other beneficiaries,” says Wood. “He has a lifestyle that demands he maximize the income in this trust.” Wood did not elaborate.

Both brothers live in Manhattan. Hitz, the elder of the two, hobnobs with the city's cultural elite, as documented by its paparazzi. Celebrity photographer Ron Galella captured him on the arm of Vanity Fair correspondent Amy Fine Collins at the annual spring gala of the American Ballet Theatre in May 2005. Hitz also appears regularly in David Patrick Columbia's “New York Social Diary,” a society website (www.newyorksocialdiary.com). The site featured the luncheon party at Swifty's — an Upper East Side restaurant known as a canteen for Manhattan's bold-face names — that Hitz threw for his 35th birthday in February 2004, attended by gossip columnist Liz Smith, society orchestra leader Peter Duchin, and the socialite Nan Kempner.

Hitz's younger brother is the son of Robert Shaw, a renowned choral conductor who won 17 Grammys in his storied career; he was director of the Atlanta Symphony Orchestra from 1967 to 1988. Shaw died in 1999 from a stroke while sitting in the audience at Yale University watching a Beckett play that was student Thomas Shaw's senior theater studies project.

Eric C. Lang of Atlanta, who represents the brothers, declined comment on his clients' lifestyles. Still, he did suggest that how they choose to spend their money is irrelevant and he noted: “This lawsuit was filed because the value of these trusts dropped 50 to 60 percent; because the value of the trusts' largest asset also dropped 50 to 60 percent. The issue in this case is how SunTrust let that happen — and nothing else.”

EGGS IN ONE BASKET

The complaint Lang crafted seeks to force SunTrust to eat its own words. The bank's written materials on its website describe diversification as a “critical component of long-term investing” to lower risks. “Diversification is analogous to not putting all of your eggs in one basket. Holding a diversified portfolio is a basic principle of investing.” The lawsuit also quotes from a January 2004 letter to the brothers from Michael Woocher, a SunTrust first vice president, who admitted, “an asset represents a concentration if it accounts for more than 10 % of the market value of the portfolios.” The bank does not dispute that Coke stock has accounted for the bulk of the trusts' holdings.

Wood concedes that it is “a generally correct” principle to avoid putting all eggs in one basket, but adds that this principle “does not, number one, apply in each and every instance.” The jury will be required to examine the “totality of the circumstances” in SunTrust's management of the assets over 50 years; and that, Wood says, will show that the trusts “made them very wealthy young men.”

Some observers say SunTrust's close ties to Coca-Cola bode poorly for it in a jury trial. SunTrust touts the underwriting services the bank provided to the Coca-Cola Company for its initial public offering in 1919 as one of its “Historical Highlights” on its website. Since 1919, SunTrust has not sold a single share of its Coca-Cola stock, says bank spokesman Barry Koling. The bank's disclosure of risks on its Form 10-K filing, notes that it is “subject to risk from changes in equity prices that arise from owning The Coca-Cola Company stock.” (Local legend has it that a SunTrust safe-deposit vault holds the only written copy of the Coke secret formula — a possibility that Koling would not confirm or deny.)

The SunTrust-Coke ties extend to the boardrooms of the pillars of Atlanta's business community. SunTrust's former chief executive, James B. Williams, is a member of the Coca-Cola board, and M. Douglas Ivester, Coke's former chief executive sits on SunTrust's board. E. Neville Isdell, Coke's current CEO, is also a member of SunTrust's board. The shared directors, combined with SunTrust's massive Coke holdings, will “ simply look bad” to a jury, says William P. LaPiana, a trusts and estates professor at New York Law School who keeps tabs on developments in this area of the law for the American Bar Association's Probate and Property Section.

But there is no bright-line rule establishing how much diversification is enough. “One of the things that trust law sort of resists is that you can set down hard and fast rules; it comes down to a case-by-case basis,” says LaPiana. LaPiana and other experts who follow the case law cite a series of notorious New York cases known as Matter of Janes, which found that Lincoln First Bank of Rochester, N.Y. failed to diversify by holding onto stock of the Eastman Kodak Company. When Rodney Janes died in May 1973, he owned 13,232 shares of Kodak stock, representing more than 71 percent of his estate's portfolio. His will set up three trusts for the benefit of his wife and charity. At that time, Kodak stock's value was $135 per share. Shortly after Janes' death, a Lincoln investment officer recommended the sale of 1,232 shares of Kodak to generate cash to pay debts and attorney fees incurred by the estate. The trust retained 12,000 shares, representing more than 60 percent of the portfolio. At the time, Cynthia W. Janes, Janes' widow, agreed. The bank's officer testified that the wife agreed with the recommendations and said she “loved Kodak” and her husband “loved” Kodak too.

In the year following Rodney Janes' death, an OPEC oil embargo triggered a rapid decline in the stock market. In that year, Kodak stock dropped from about $115 a share to $60 a share. During the eight years that Lincoln administered the trust, Kodak's stock dropped to about $45 a share from a high of $148. “[T]he bank's responsiveness to the admittedly turbulent and precipitous tenor or the times (1973) was to do nothing,” observed the surrogate judge who presided over the case. He decided that love of Kodak stock was not enough, and found that Kodak's yield of 1.1 percent income for the trust was “insufficient and unacceptable.”3 The surrogate agreed with the opinion of an investment manager who testified that Kodak holdings should have been sold to bring the stock down to 5 percent of the portfolio in the Janes' estate. In 1997, New York's highest court affirmed his decision, but did not establish an absolute rule: “The inquiry is simply whether, under all the facts and circumstances of a particular case, the fiduciary violated the prudent person standard in maintaining a concentration of a particular stock in the estate's portfolio investments.”4

A June 2004 decision interpreting the Janes precedent sent alarms through the trusts-and-estates bar: A New York surrogate found Lincoln First Bank liable for more than $21 million for failing to sell Kodak stock in another estate, despite express language by the grantor that the estate, comprised entirely of Kodak stock, for retaining that stock. Charles Dumont, in the “Lastly” paragraph of his will, noted that “either my Executors or my said trustee shall dispose of such stock for the purpose of diversification of investment and neither they nor it shall be held liable for any diminution in the value of such stock.” Despite that, the clause allowed the trustee to sell all or part of the Kodak stock “in case there shall be a compelling reason other than diversification of investment for doing so.”

The surrogate found the bank hewed too closely to protecting Kodak, rather than protecting the interests of the trust's beneficiaries. “The bank's focus upon Kodak suggests to the court that the bank adhered to the proposition that the Kodak retention itself was the purpose of the trust,” wrote Surrogate Edmund A. Calvaruso.5 But Dumont also added that his “Lastly” note should not “prevent” the trustee from disposing of Kodak stock “shall there be some compelling reason other than diversification of investment for doing so.” Dumont never spelled out what “compelling reason” meant, but the surrogate found “[p]rudent management of the trust would dictate that the trustee was not to blindly mange the corpus but hold the Kodak stock, keeping an eye on the Kodak company, the market, and the needs of the beneficiaries, to continually ensure that the trust was accomplishing its purpose. Sale was not prohibited, but just was not to be pre-emptively or lightly undertaken.” Instead, management never monitored the Kodak stock. In a footnote, the surrogate intimated that the close relationship between two prominent Rochester, N.Y. companies could have impacted its decisions: “Interpretations which could in any way reflect negatively on Eastman Kodak very well could have been discouraged at the bank. Both were local companies, and there was an overlap between the board of Eastman Kodak and the board of the bank, as well as familial connections between the two.”

The bank appealed Calvaruso's decision, and on Feb. 3, the Appellate Division's Fourth Judicial Department reversed his ruling-without examining his reasoning on a trustee's duties. The appellate court's decision was based on a technicality: the surrogate's decision that the trustee should have sold Kodak stock in January 1974 — a year later than the beneficiaries alleged and offered proof upon.6 Dumont's heirs are seeking an appeal to New York's highest court.

GEORGIA IS DIFFERENT

Like the Lincoln bank, SunTrust appears to have held onto stock for 30 years — inaction that would raise questions about diversification under the Janes line of cases. But the Hitz case is being litigated not in New York but in Georgia, where the law is arguably very different.

A trustee's duty to diversify arguably dates back to Harvard College v. Amory, the 1830 case that first said trustees should “observe how men of prudence, discretion and intelligence manage their own affairs, not in regard to speculation, but in regard to the permanent disposition of their funds, considering the probable income, as well as the probable safety of the capital to be invested.” This standard, known as the Prudent Man Rule, evolved over time and is codified in the Uniform Prudent Investor Act (UPIA), a 1995 law that has been adopted by 42 states. There's wiggle room for a trustee. It states that a trustee “shall diversify the investments of the trust unless the trustee reasonably determines that, because of special circumstances, the purposes of the trust are better served without diversifying.”

But Georgia has not adopted the UPIA, and Hitz's case may hinge on parsing the language of two state statutes governing trustees. Georgia law says a trustee shall “exercise the judgment and care” of a “prudent person.” But Georgia law also authorizes trustees to “retain” property received by them and shall not be liable for that retention, “except for gross neglect.” In fact, the lawsuit claims SunTrust's failures to sell off Coke stock amounted to “gross neglect.” Nicole Jennings Wade, a trusts and estates litigator at Powell Goldstein LLP who is working with Wood on the SunTrust case, says, “New York has always had more of a requirement” for trustees to diversify assets. “But Georgia has just never had that.” And Wade says, “there's not really any case law” interpreting Georgia's ‘“gross neglect” standard for stock retained by a trustee.

For now, local trusts and estates experts seem loath to venture an opinion. “This may be the case that answers the question,” says Sarajane N. Love, a professor at the University of Georgia's School of Law. “We're all out here, sitting here watching this case with great interest. I think it's fascinating.”

Endnotes

  1. Hitz v. SunTrust Bank, 05-CV-1413 (N. D. Ga. 2005).
  2. SunTrust Bank v. Hitz, Civil Action No. 200-SCV-98992 (Fulton Cnty Sup. Ct. 2005).
  3. Matter of Janes, 165 Misc. 2d 743 (Monroe Cty, Surr. 1995).
  4. Matter of Janes, 90 N.Y.2d 41 (1997).
  5. Matter of Dumont, 4 Misc. 3d 1003(A) (N.Y. Surr. 2004).
  6. Matter of Dumont, CA 04-02319, 2006 N.Y. Slip Op. 00866 (N.Y. App. Div. 2006).