Climbing Mount Everest; Or, The Difficulty Trustees Face In Proving Ratification of Imprudent Investment Decisions
rustees who have invested imprudently sometimes argue that the trust beneficiaries have accepted, or "ratified", their imprudent actions because the beneficiaries have remained silent or have not objected. That argument will fail, however, unless the trustee proves that the beneficiary unequivocally assented, with full knowledge of all material facts and with full knowledge of his or her legal rights. Likewise, the law is well settled that a beneficiary's consent to imprudent action is voidable if the trustee or a third person obtained it through concealment, misrepresentation, mistake, duress, or undue influence.
Several court opinions illustrate this ratification hurdle. In First Alabama Bank of Montgomery v. Martin, 425 So.2d 415 (Ala. 1982), the complaint alleged that the trustee invested imprudently because it ignored its own minimum investment safety standards. There the trustee invested in stocks and bonds that were rated below the trustee's internal "B+" safety standard. However, the trustee pointed out that the trust beneficiaries knew of these purchases, had received annual statements showing all purchases and sales in the account, and had not objected until the lawsuit was filed. Insufficient, ruled the court. The court stated that it was the trustee's burden to demonstrate that the trust beneficiaries had full knowledge of all material facts and circumstances. That knowledge must include the risks of purchasing the stocks and bonds, and the fact that the stocks and bonds fell below the trustee's own minimum investment safety standards.
In re. Cook's Trust Estate, 20 Del.Ch. 123, 171 A. 730 (1934), involved the trustee's purchase of four bonds, all of which had received poor investment ratings. In that case, the court rejected the argument that the beneficiary knew of the bond investments but failed to object. Moreover, the court stated that a trust beneficiary has "no duty to act as adviser to his trustee." That principle was reiterated in Rothermel's Estate, 47 Pa.D. & C. 478 (1943). The court in that case found irrelevant the fact that the beneficiary had access to the trustee's books and records, such that inquiry and investigation might have revealed the impropriety at issue. That fact did not suffice to show ratification, or the related defense of acquiescence.
In Gould v. Gould, 126 Misc. 54, 213 N.Y.S. 286 (1925), a trust beneficiary even had countersigned certain checks for disbursements from the trust. The trustee claimed that such signing off on the transactions constituted ratification. The court rejected that argument, describing the activity as merely clerical. Indeed, the trustee allegedly had accepted secret commissions and had commingled funds. The court reiterated that full knowledge is required, not only of the material facts but also of the legal effects of the acts ratified.
On the other hand, the law is clear that trustees need not disclose all of the minute details of a transaction to demonstrate ratification. In Bowman v. Swanwood Coal Co., 207 N.W. 591, 201 Iowa 1236 (1926), the court found that the trust beneficiaries had known of all of the important features of the transaction at issue. Hence, the court ruled that they ratified the transaction and thus were estopped from claiming damages. Likewise, of course, a judicial proceeding such as an accounting, or request for court approval of a proposed transaction, normally will suffice, provided the trust beneficiaries have received due notice.
Overall, the ratification defense is difficult to prove, and it should be. After all, trust beneficiaries do and should be able to place their trust and confidence in their trustees to act in their best interest and, in particular, to make prudent investment decisions.
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James J. Eccleston is a securities attorney, representing customers as well as brokers and brokerage firms nationwide in arbitration, litigation and regulatory matters. He maintains an informative website at www.FinancialCounsel.com. He is an equity partner with Shaheen, Novoselsky, Staat, Filipowski & Eccleston, and can be reached at 312-621-4400.
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