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In a decision of major import to the banking industry and trustees, a New York appellate panel August 10 held that a bank is liable for its failure to diversify investments held in its trust. The critical threshold issue in the case, Matter of the Estate of John P. Saxton, Case No. 85993, was whether the trustee was shielded by the fact that the beneficiaries had not objected to a document stating that the investment would consist entirely of International Business Machines stock, and that the bank would be held harmless in the event of a decrease in value. Unanimously, the New York Appellate Division, Third Department, said the trustee bank cannot rely on the waiver to insulate it from liability. “Where a beneficiary has requested or consented to what essentially amounts to mismanagement by a fiduciary, equitable rather than contractual principles must govern,” the court said through Justice Karen K. Peters. Significantly, the panel held that in assessing damages the capital gains taxes that would have been paid had the stock been sold at the appropriate time must be deducted from the award. Further, it said that interest must be frontloaded and awarded based on the value of the trust had the stock been sold when, in the judgment of the trial court, it should have been sold. The decision arises out of the 1958 death of John P. Saxton and a trust established on behalf of his widow, Anna E. Saxton, and two daughters. The trust was funded entirely by IBM stock worth $569,853 when the estate was settled. Endicott Trust Co., which has since been acquired by Manufacturers and Traders Trust Co., was designated trustee. After the trustee was informed by bank examiners in 1959 that it could be liable for failure to diversify, the beneficiaries were presented with an “Investment Direction Agreement,” or IDA. The IDA, which was drafted with no input from the beneficiaries, immunized the bank from liability. In 1986, the stock was valued at more than $7 million. The beneficiaries, particularly Mary Rita Crittenden, the decedent’s daughter, urged the trust officer to prepare a diversification plan. However, the trust officer opined that IBM remained strong and that there was no need to diversify. Ms. Crittenden persisted in urging diversification, but the trust officer made no effort to diversify. IBM stock took a heavy hit in the crash of October 1987. By the time Mrs. Saxton died and the trust ended in 1993, the $7 million holding was worth about $2.9 million. The beneficiaries sued. Broome County Surrogate John M. Thomas ordered what is now Manufacturers and Traders Trust Co. to pay the beneficiaries a surcharge of $6,681,038.49, plus interest, and return the commissions that were paid over the life of the trust. Justice Thomas computed interest on the difference between the amount that would have been in the trust if 90 percent of the IBM stock had been sold on Sept. 10, 1987, and the amount that was in the trust when the stock was actually distributed in July 1993, minus dividends and other income realized by retention of the stock. TAXES AFFECT AWARD Among the issues raised on appeal was whether the IDA shielded the trustee, and if not, how damages should be assessed. On the liability issue, the Third Department said that a document such as the IDA is enforceable only upon a showing that the beneficiary had the intent to form such a contract and did so with “actual and full knowledge” of all implicated rights. Here, Justice Peters said, there is “not a scintilla of evidence” that the beneficiaries were apprised of the implications of holding the entirety of the trust’s corpus in IBM stock. “Further analyzing the IDA on equitable estoppel grounds — that which rests on the conduct of a word of one party upon which another justifiably relies and, in so relying, changes a position and incurs a detriment — we note that although the beneficiaries appeared to consent to the stock’s retention, such consent must be informed,” Justice Peters wrote. In that regard, the court upheld Judge Thomas. However, the panel ordered a recalculation of damages. “When executors retain a stock which they had a duty to sell, the amount of damages paid to a beneficiary should be reduced by the federal estate tax that the beneficiary would have had to pay if the stock had been sold,” the court said. Further, the justices held that Judge Thomas erred in computing interest. It said interest should have been based on the full value of the stock at the time when it should have been sold — minus the value at the time of distribution and dividends. Also, the court said, absent a showing of self-dealing or fraud, there was no basis for a denial of commissions. The case, argued March 28, was decided by a panel including Justice Peters and Justices Thomas E. Mercure, D. Bruce Crew III, Edward O. Spain and Victoria A. Graffeo. Appearing were Gandolfo V. Di Blasi of Sullivan & Cromwell in Manhattan, of counsel to Hodgson, Russ, Andrews, Woods & Goodyear of Buffalo, for the trustee; and Robert Kirchner, of Bond, Schoeneck & King in Syracuse for the beneficiaries. William S. Brandt of Nixon & Peabody LLP in Rochester filed an amicus curiae for the New York Banker’s Association. “The right to deduct the taxes is favorable and appropriate,” Brandt said of the ruling. “This ‘frontloading’ of interest is very, very troublesome and can greatly increase the potential damages.” Brandt said that under this decision, the preferred method for assessing damages is apparently to take the value of the stock at the time it should have been sold, deduct the capital gains that would have been incurred, calculate interest on the resulting sum and then subtract dividends and other proceeds and the residual value of the stock at the time of the accounting. Roberta Kotkin, general counsel for the New York Banker’s Association, said the decision was a mixed bag for her clients — with a positive result on the capital gains issue and a negative one on the interest frontloading. Regardless, she said the ruling should not affect the way bankers handle their fiduciary responsibilities. “I don’t think it is going to change the way in which banks make fiduciary decisions,” Kotkin said. “I think banks try to exercise prudent judgment, and that is not going to change.” Di Blasi declined comment. Kirchner was unavailable for comment. SECOND TRUST CASE In another case decided August 10, the Third Department upheld the removal of a trustee for its negligent conduct in failing to diversify a trust funded solely by 30,000 shares of IBM stock. Matter of the Estate of Frances E. Rowe, Case No. 86154, involves a charitable trust created in 1989. Wilber National Bank was the trustee. Under the terms of the trust, Wilber National Bank was required to make annual distributions of 8 percent of the estate tax value of the assets — $270,300 — to qualified charities. At the end of 15 years, the remainder was payable to Frances E. Rowe’s nieces. In August 1994, the nieces brought an action alleging that Wilber National Bank had imprudently failed to diversify the trust in violation of its own policies, the policy of the Comptroller of the Currency and regulations of the Federal Reserve Bank. Ultimately, Judicial Hearing Officer Richard Farley, acting as Otsego County Surrogate, revoked the trusteeship, ordered a refund of commissions and directed Wilber National Bank to pay damages of $496,259, plus $133,990 in interest. Yesterday, the Third Department unanimously affirmed. “We are not persuaded that Surrogate’s Court erroneously computed damages by adding compound interest to the value of the stock at the time it was sold or, if unsold, for the time of the accounting, rather than computing interest on the difference between the two values,” Justice Mercure wrote for the panel. Also on the panel were Justices Peters, Spain, Graffeo and Anthony J. Carpinello. The case was argued by David Wawro of Oneonta, NY for the trustee and John J. Barnosky of Farrell Fritz PC in Uniondale, NY for the beneficiaries.

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