Trust Administration, Tax and Compliance for Fiduciaries in Minnesota: Fiduciary Investment Management

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August 16, 2018
Author: David J. Bromelkamp
Organization: Allodium Investment Consultants


I. Prudent Investment Practices: Introduction

Fiduciary entities are often managed by trustees who are generally well-intentioned but not always familiar with the best practices for investment fiduciaries. This presentation will address the developing standards for investment fiduciaries and how they can be applied to improve the investment decision-making process for a fiduciary entity. We will review the development of the Prudent Investment Practices handbook that was published in 2003 by the Foundation for Fiduciary Studies and edited by the American Institute of Certified Public Accountants. We will address how these investment practices can be used by trustees of irrevocable trusts to improve their investment decision-making process. We will also define the multiple roles of the legal advisor and identify practical actions that you can take to help you and your clients to make better investment decisions. We will describe fiduciary investment management for irrevocable trusts that is based on the adoption of the Global Fiduciary Standards of Excellence.

In the current regulatory environment, fiduciary investors are becoming increasingly concerned about their legal obligations and are looking for help in understanding how to fulfill their fiduciary responsibilities. A helpful resource has been published that documents the most basic elements of the investment decision-making process for fiduciary investors. Prudent Investment Practices: A Handbook for Investment Fiduciaries was originally published in 2003 by the Foundation for Fiduciary Studies (now fi360) and edited by the Personal Financial Planning Division of the American Institute of Certified Public Accountants. fi360 has developed the investment profession’s first practice standards of care for investment fiduciaries. We will focus on how the legal advisor can use these developing investment standards to help to develop a disciplined investment decision-making process.

II. fi360

The Foundation for Fiduciary Studies was established in 2000 for the purpose of developing and promoting the practices that define a prudent process for investment fiduciaries. Under the leadership of Donald Trone, a veteran investment management consultant, the Foundation delineated prudent investment practices based on current fiduciary investment law. They also identified seven Uniform Standards of Care (legislated standards) that are common to the major fiduciary investment laws. To help put these ideas into practice they defined a four step investment process that helps to fulfill the fiduciary obligation for a disciplined and prudent investment process.

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fi360 is associated with the Joseph M. Katz Graduate School of Business at the University of Pittsburgh. fi360 teaches the four step fiduciary investment process, the application of the twenty-one prudent investment practices and also offers programs leading to the designations of Accredited Investment Fiduciary™, for those who manage investments, and Accredited Investment Fiduciary Auditor™, for those who report on adherence to practice standards. fi360 has also defined an auditing process to determine if a fiduciary has satisfied the requirements of the twenty-one prudent investment practices. They are currently training fiduciary auditors who will be looking for the evidence that a fiduciary has satisfied the twenty-one prudent investment practices. Further information, articles on the fiduciary investment issues, and further legal analysis of the practices, can be obtained on the fi360 website.

III. Handbook

The Prudent Practices for Investment Stewards (Appendix B) are for persons who have the legal responsibility for managing investment decisions. Investment Stewards include trustees, plan sponsors, and investment committee members. You can view the Prudent Investment Practices in the Periodic Table of Global Fiduciary Practices for Investment Stewards (Appendix C).

Each Practice has been substantiated by applicable legislation, regulation, and/or case law to ensure compliance. Full citations, as well as detailed Criteria, narrative discussion, practical application, and suggested procedures can be found in the Prudent Practices for Investment Stewards handbook (Appendix B). A major revision to the Practices and the associated handbooks was released in May 2013. All of this information has been incorporated into the updated Prudent Practices for Investment Stewards handbook. The Handbook can be purchased from fi360 at www.fi360.com, the American Institute for Certified Public Accountants (www.aicpa.org) or the National Association of College and University Business Officers (www.nacubo.org).

IV. American Institute of Certified Public Accountants

The American Institute of Certified Public Accountants jointly published, with the Foundation for Fiduciary Studies, Prudent Investment Practices: A Handbook for Investment Fiduciaries (Handbook) which was originally released in 2003. The purpose of the Handbook is to set forth the practices, for all phases of the investment management relationship that meet the specific requirements of certain laws and, implicitly, a fiduciary standard of care. The Foundation itself was organized to develop and promulgate investment management practices that address these legal and regulatory responsibilities.

The American Institute of Certified Public Accountants has committed substantial resources to a marketing campaign to make all financial advisors, and the public, aware of the promulgation of these standards. Through industry dialogue, publicity campaigns and court tests, the practices may evolve as benchmarks for prudent discharge of fiduciary investment management duties.

Acceptance and endorsement by the American Institute of Certified Public Accountants, the Certified Financial Planning Board of Standards, the American Bar Association, the Financial Planning Association, and other organizations may accelerate this process. As acceptance of these practice standards develops, Certified Public Accountants may be able to provide a new assurance service, by examining and reporting on investment advisory firms' adherence to them. Many different stakeholders will have an interest in this reporting, since the practice standards not only demand the highest level of care, but also provide a framework for realizing the particular investment goals of each client.

The first structured, legally annotated, comprehensive set of practices for determining and implementing long-term investment goals now is available. Certified Public Accountants in public practice should welcome the development as an emerging assurance services opportunity.

For those Certified Public Accountants who offer investment advisory services, it may provide a way to limit exposure to various legal claims arising from these services. Certified Public Accountants in the private sector who are involved in managing their organizations' investments, or the investments of retirement plan assets, should also be gratified that specific, rigorous standards can now be used to guide the process.

V. Investment Fiduciary

Many investors do not understand the definition of fiduciary. I would think that your clients might be similarly confused. The first step to eliminate this confusion is to define who is a fiduciary. I like to describe the fiduciary as someone who is acting in a position of trust on behalf of, or for the benefit of, a third party. fi360 estimates that there are approximately five million investment fiduciaries in the United States who in turn manage 80 to 90 percent of the nation’s investable wealth. Clearly it is important to define who is a fiduciary as it pertains to investment management.

A fiduciary is anyone charged with managing money or property for another, who, by virtue of the trust reposed in him or her, has the duty to act primarily for that other's benefit in managing the subject property. Legally, a fiduciary is held to the highest possible standard of care in the undertaking. The property must be managed as if it were the fiduciary's own.

The primary role of the fiduciary is to manage a prudent investment process without which the components of an investment plan cannot be defined, implemented, or evaluated. Many fiduciary investors confuse investment performance with successful fulfillment of their fiduciary obligations. fi360 teaches the critical concept that “liability is not determined by investment performance, but rather by whether prudent investment practices were followed. It’s not whether you win or lose – it’s how you play the game.”

An estimated five million people in the United States have legal responsibility for the investable assets of others. But there is no industry consensus, or bright-line test in statute or case law, to determine when investment services create a fiduciary relationship. For instance, where a financial advisor serves as both the trustee and as investment manager of a private trust, the advisor is clearly a fiduciary. But if the advisor is not the trustee, depending on how much reliance for investment management is placed on him, the advisor may or may not be a fiduciary.

In the same way, advisory services provided to the trustee of a qualified retirement plan, or to an endowment fund of a nonprofit organization, or to an individual investor, may or may not create a fiduciary relationship.

However, the authors of the Handbook believe that investment management services do create a fiduciary relationship when they are comprehensive in nature and continuous over time. (By contrast, the simple execution by a brokerage firm of an individual securities transaction may not create a fiduciary relationship.) As a result, the practices in the Handbook address each step of the investment management process. Each practice derives in large part from three specific legal sources: the Employee Retirement Income Security Act (ERISA), the Uniform Prudent Investor Act, and the Uniform Management of Public Employee Retirement Systems Act. Each practice is annotated by specific mandates of these laws and certain other case law. Whether a fiduciary relationship can or cannot be inferred in every case, the legal references clearly dictate very high standards of care.

The legal references in the Handbook are doubly significant, because there is also no industry consensus about what constitutes prudent discharge of fiduciary duties, where a fiduciary relationship does exist. Because it develops the practices from specific mandates in law, the Handbook may become a yardstick for prudent observance of fiduciary obligations. Adherence to the practice regime can only enhance public confidence in an advisor's integrity and commitment to each client's best interests, in addition to providing support of the advisor's discharge of fiduciary standards of care.

After determining who is a fiduciary, you need to determine which fiduciary laws apply to your fiduciary entity. Some of the obvious categories of fiduciaries by the relevant fiduciary laws include ERISA plan sponsors, board members of foundation and endowment funds, trustees of irrevocable trusts and the trustees of public funds like school district retirement funds, fire relief pension plans and police relief pension plans. In the post-Enron regulatory environment there is proposed pension reform legislation that increases the pool of ERISA plan fiduciaries to include accountants, attorneys, employee benefits administrators and many other professionals who assist in the management of ERISA plan assets. This particular legislation uses the phrase “generally accepted investment principles” to describe what Congress believes is necessary to help monitor fiduciary investment pools. Obviously both the investment fiduciary, their investment management consultant and their legal advisors have to understand and monitor the relevant fiduciary laws that apply to their specific fiduciary entity.

fi360 defines an investment fiduciary as someone who is providing investment advice or managing the assets of another person and stands in a special relationship of trust, confidence, and/or legal responsibility.

Investment fiduciaries can be divided generally into three groups: Investment Stewards, Investment Advisors, and Investment Managers. An Investment Steward is a person who has the legal responsibility for managing investment decisions, including plan sponsors, trustees, and investment committee members.

An Investment Advisor is a professional who is responsible for providing investment advice and/or managing investment decisions. Investment Advisors include wealth managers, financial advisors, trust officers, financial consultants, investment consultants, financial planners, and fiduciary advisers.

An Investment Manager is a professional who has discretion to select specific securities for separate accounts, mutual and exchange-traded funds, commingled trusts, and unit trusts.

VI. Investment Process

i. Step 1: Organize
Fiduciary Investing Under the Uniform Prudent Investor Act


ii. Step 2: Formalize
Sample Investment Policy Statement for Trusts (Appendix F)

iii. Step 3: Implement
Modern Portfolio Theory and the Science of Investing

iv. Step 4: Monitor
Self-Assessment of Fiduciary Excellence (Appendix D)

VII. Investment Advisor

If the primary role of the fiduciary is to manage a prudent investment process, it will be critically important for someone to document the fiduciary’s investment decision-making process. This will become more apparent to the fiduciary in the event that a fiduciary auditor makes a future visit to audit their decision-making process. Fiduciary auditors could be coming from the regulatory authorities (i.e. the State Auditor wanting to audit the investments of a public fund) or the fiduciary audit could be ordered by the fiduciary entity itself to identify weaknesses in their current investment management process. Either way, the fiduciary auditor always asks for the documentary evidence to make a determination about any gaps in the investment process.

Most fiduciary clients want help in the documentation of their decision-making process. Examples of these documents include the documentation of the asset allocation decision, the written investment policy statement, due diligence research on investment managers, service agreements with the investment managers and quarterly performance reports. Fiduciary auditors are currently being trained to look for specific evidence of the fiduciary’s investment decision making process. The documents most likely to be requested by a fiduciary auditor are included and outlined in great detail in the Self-Assessment of Fiduciary Excellence (Appendix D) which is published by fi360. The investment management consultant is the most logical financial professional to assist the client with the preparation and organization of these documents that record the fiduciary’s investment decision-making process.

Definition of advice: an opinion given about what to do or how to behave. Advice can come from many sources: friends, family, co-workers and neighbors, among others. In general, investors are eager to get advice on how to invest their money for a desired return. The prudent investor recognizes the value of professional investment advice and they seek out trusted advisors to help them make sound decisions related to their investment portfolios. Studies show that investors with portfolios in excess of $1 million overwhelmingly turn to investment professionals for advice. Professional investment advice can come from bankers, brokers and advisors. We believe it's important for investors to understand the nuances of the advice providers in the field of professional investment advice. Therefore, we encourage the savvy investor to learn more about how to retain investment professionals that are best qualified to meet their specific needs. The three main providers of investment advice are bankers, broker and advisors.

Advisors: The SEC regulates investment advisors. The primary mission of the U.S. Securities and Exchange Commission (SEC) is to protect investors and maintain the integrity of the securities markets. www.sec.gov . There is considerable confusion in the industry and among the investment public related to the term \"investment advisor\" and the SEC is aware of this confusion. Currently the term \"investment advisor\" applies to both investment managers (the people managing the selection of individual securities) and the investment consultants (the people giving advice to investors on the high level investment policy decisions).

  • Investment Managers are generally defined as the type of investment advisor that is delegated the authority to make investment decisions relative to individual securities. The investor usually grants discretion over their account to the investment manager which allows the investment manager to make timely decisions related to purchases and sales of individual securities in the investor's portfolio.
  • Investment Consultants are generally defined as the type of investment advisor that provides advice to the investor on the high level investment policy decisions related to asset allocation strategy, investment manager search and selection, performance monitoring and evaluation and other strategic decisions. The investor usually does not grant discretion to the investment consultant but retains control over the high level investment policy decisions and relies on the investment consultant for ongoing strategic advice and direction.

Generally, legal advisors recognize the value of investment advisors that are registered with the Securities and Exchange Commission and recommend that their clients seek out such advisors over bankers and investment brokers. One of the biggest challenges for the legal advisor is to clearly differentiate the investment managers from the investment consultants. The two primary players in the fiduciary investment management process that need to be defined for the fiduciary client are the professional investment manager(s) and the professional investment management consultant. We like to use the medical profession as an example of the generalist-specialist relationship that is used in the fiduciary investment management process. The investment management consultant is the “generalist” who works with the fiduciary investor on the overall investment process which includes the twenty-one prudent investment practices, while the professional investment managers are the “specialists” who focus their attention on a specific asset class or a specific style of investment management. The professional investment managers focus their attention on specific security selection and also on the various sectors of the market that they want to overweight or underweight based on the market outlook.

Most fiduciary investors understand that they are not prudent experts when it comes to security selection so they wisely choose to hire professional investment managers to select individual securities for their portfolios. But a common problem develops when a fiduciary client hires a professional investment manager directly without the assistance and expertise of a professionally-trained investment management consultant. The fiduciary’s inevitable unhappiness with the professional investment manager has nothing to do with the expertise and competence of the manager but everything to do with the missing steps of the investment process and the related twenty-one prudent investment practices. Often the client chooses to hire the professional investment manager directly because they do not see the value provided by the professional investment management consultant.

The professionally-trained investment management consultant adds a great deal of value to the fiduciary investor. The role of the professional investment management consultant is to guide the fiduciary client through each of the four steps in the investment process. The investment management consultant is the only investment professional that is in the position to help the fiduciary investor with all twenty-one of the prudent investment practices. The sophisticated investment fiduciary will be searching for the professional investment management consultants who are knowledgeable about the twenty-one prudent investment practices and have developed an investment consulting practice that helps the fiduciary to meet their fiduciary obligations.

In contrast, the investment manager has a narrowly-defined role to select market sectors and individual securities for the fiduciary’s investment portfolio. It would be foolhardy to suggest that the professional investment manager could objectively complete due diligence research on themselves, objectively determine the appropriate asset allocation if they are to manage only a portion of the portfolio or to objectively perform the monitoring function of their own investment performance relative to the market and relative to their peer group. In addition, if you do not separate the asset allocation decision from the security selection activity you will not be able to analyze the quality of the security selection – it will be difficult to determine the value added by the investment manager’s stock-picking prowess. Clearly these macro level tasks are more efficiently and objectively performed by a professionally-trained investment management consultant.

Another complicated (but prevalent) issue is the role of the traditional investment broker (stockbroker) in the world of fiduciary investment management. There are well over 600,000 Registered Representatives (investment securities brokers registered with the NASD) in the United States who are interested in providing investment advice to fiduciary investors. The difference between the traditional transaction-oriented stockbroker and the professionally-trained investment management consultant is the fiduciary process – the four step investment management process. When you explain the role of the investment management consultant to a fiduciary investor you have to remember that they probably do not know how to differentiate between the many different types of investment advice providers. They may assume that all investment advice providers know the various fiduciary investment laws and the twenty-one prudent investment practices.

The recently developed designations from fi360 show the innate demand for specialized professional investment training for both fiduciary investors and the investment professionals who advise them. Helping investors understand the subspecialty of fiduciary investment management will help them understand the relevant professional training and designations they should be looking for in a professional investment management consultant.

VIII. Role of the Legal Advisor

The average fiduciary client is overwhelmed by the many various sources of investment advice. You can add value to your client relationship by helping them to understand the important questions and decisions.

“Society depends upon professionals to provide reliable fixed standards in situations where the facts are murky or the temptations too strong. Their principal contribution is an ability to bring sound judgment to bear on these situations. They represent the best a particular community is able to muster in response to new challenges.”
- Dr. Robert Kennedy, “Why Military Officers Must Have Training in Ethics”

How can these investment practices be used by private foundations, public charities, charitable trusts and other charitable entities to improve their investment process? What is the role of the legal advisor? What are the practical actions that you can take to help your clients make better investment decisions? The attorney is often one of the most respected and credible sources of advice and information to the fiduciary entity and you have the opportunity to influence the investment decision-making accordingly. There are a few major categories of opportunities for you as a legal advisor to help your clients with these critical fiduciary investment management issues:

  • Initial advice upon the establishment of a new fiduciary entity
  • Ongoing advice to an existing fiduciary entity
  • Your personal role as a fiduciary investor

Legal advisors are in a unique role upon the establishment of a new legal entity because the client has to make a choice about investment management for the new entity. You may be involved in the establishment of a new legal entity that will be subject to the fiduciary investment laws that are applicable to that charitable entity. Often the client may turn to you for advice relative to the investment management for the portfolio of the charitable entity you have just established. You can be influential in the client’s decision-making process relative to investment advisors at the outset of the entity’s existence. You might also expose yourself to the risk of becoming a fiduciary relative to the investment portfolio due to how you handle your advice to the client when they ask you for help in this area.

Legal advisors are respected advisors to established legal entities including charitable entities and charitable trusts and clients often will turn to their attorney for advice about investment management. Clients are concerned about the following issues related to corporate governance as it applies to fiduciary investment management:

1. Corporate governance and selecting trustees and board members.
2. Educating trustees and board members. Help your clients learn about the fiduciary investment laws that apply to their organization and entities and how they might be able to adopt the prudent investment practices.
3. Creating and defining trustee and investment committee roles and responsibilities.

Help your clients learn how to select competent and objective trustees and investment committee members.

4. Conflicts of interest and self-dealing. Develop conflict of interest policies for you clients that address all parties related to the investment management process (including board members, committee members, volunteers, service vendors, investment advisors and any other individuals involved with the investment decision making process).

5. Support the general concept of fiduciary investment standards and advocate “best practices” for your fiduciary clients. Support the investment advice providers that provide an objective and comprehensive investment approach based on prudent investment practices.

6. Identifying the sources of objective investment advice. Help your clients search for and find the objective providers of investment advice.

7. Document the investment decision-making process.

Your role as a fiduciary investor may be one of the most important ways that you can have an impact on the charitable entities in your community. As a volunteer board member for a nonprofit organization, as a member of an investment committee or as a trustee for a charitable trust you can influence other investment decision-makers to improve their investment process by incorporating the Prudent Investment Practices into your daily activities. Many attorneys are asked to join nonprofit boards to lend their legal expertise to the board to help the organization stay abreast of current legal issues.

IX. Summary

The twenty-one prudent investment practices are published and available. Your fiduciary clients are stressed out about the fiduciary scandals they are reading about in the newspapers. You are being presented with an opportunity to provide incredible value to fiduciary investors including yourself. Adopt an approach to investment management that incorporates these fiduciary best practices into your investment decision-making process. Buy the Handbook, study the Practices, and incorporate this fiduciary investment process and the twenty-one prudent investment practices into your practice. Help your fiduciary clients by giving them the information they need to make prudent decisions about their fiduciary investment management process.


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