Investment Audits

Typically, trustees have an obligation to have an investment policy that includes scheduled periodic audits of a trust’s investments. Usually, the default for a trust is that the trustee has to meet the highest “prudent man” standards in the investment of assets, which means they should not be used for entrepreneurial purposes.

Trustee Should Be "Prudent Man" with Investments

The "prudent man" is a standard that prohibits entrepreneurial or risky investments. Frequently, money gets trapped and unproductive in trusts, because it needs to be invested purely in a prudent manner. Under these standards, a trustee normally would not lend money for business purposes that have risks involved, unless they are secured.

For example, a prudent trustee would not invest in 3-D printing technology, because even though the potential for profit is huge, it is not here yet. There is no way to know which companies can make it in that emerging industry and which companies will survive long.

Investment Goal Conflict

Many entrepreneurs makes money, and hope their children make money, by adding value in the society and by growing their wealth through investments. However, in opposition to that formula for success, they lock the money up in trusts and they don’t clearly document that it can be used for business purposes, in which case a business-purpose standard will be applied to the trustee.

What typically happens is, without documented intentions otherwise, a highest prudent man standard is applied by default at law, so the trustee needs to have a prudent investment policy statement. It ensures that trustees are investing consistent with the standards to which they are going to be held, or otherwise they are going to be sued and have personal liability of their own assets.

Then family members get appointed into these trust positions where they don’t know where their exposure is and they don’t know what the standards are for their liability, if they don’t know what the trust says compared to what their obligations are. It’s a big setup for litigation, and a trustee in that position becomes a target.

The Importance of Investment Audits

An investment audit should be conducted to ensure the performance of the trust is consistent with, and at least equal to, the market standards. You would almost question if the performance is above the market, because that might indicate the trustee is taking on too much risk, or that the investments are severed from the bond market (e.g., government securities and corporate secure bonds). You would also want to make sure that it is consistent with the language that the trust says. These are the standards to be applied for investments.

So, looking objectively, how are the investments performing compared to other investments in a similar class, and are they being invested in a way that’s consistent with what the trust says, so the trustees themselves are protected in terms of the job that they are doing.

What About Insurance Audits?

Separately, there are insurance audits. Insurance policies are sold based on projections, but things change over time. So, is the policy performing over time according to projections? Is the policy going to have extra cash in it, or too little cash in it? If you need cash, will the policy continue to have a reserve available based on changes in health or improvement in health care and life expectancy? Is the policy still the best investment for those assets or should you consider rolling over the assets into another investment?

These are all matters that are important to consider in an insurance audit. A trustee has an obligation, if there is insurance in the trust, to periodically review the trust and do an insurance audit to make sure that the investment is still prudent.