Johnston, Charles F.

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The New Limited Prudent-Man Rule in OhioBY CHARLES F. JOHNSTON*On August 7, 1953, over the veto of Governor Lausche, theOhio General Assembly passed Amended House Bill No. 138 whichwill permit fiduciaries to invest 35% of trust funds in securitiesother than those provided for in the so-called "legal" list in Sec-tion 2109.37 of the Ohio Revised Code.' The new law, effectiveNovember 7, 1953, represents a very limited acceptance of thePrudent-Man Rule in Ohio.Since, the inception of the modern trust into our society, therehas always been the open question as to the proper investmentselections for a trust corpus. Since a trustee was generally undera duty to make the trust property productive while conserving theprincipal, the trustee faced the task of combining "safety" with"income" in the same investment. After a period of liberality intrust investments, necessitated by the need of capital in earlyAmerican business, the states caused the forms of investment tocrystallize in governmental bonds and real estate mortgages. By1900, the vast majority of states were legal list states following theso-called New York rule which permitted fiduciaries to investonly in securities prescribed by statute. Often such statutes didnot allow investments in corporate securities. The role of a trusteeduring this era was mainly that of a conservator of principal.2With the growth and expansion of our nation since 1900, thesize of trust assets has grown to high figures and has called fora revaluation of trust investments in the light of a modern econ-omy. Since 1937, there has been a rapid change by most states fromthe legal list to the "Massaschusetts" or "Prudent-Man Rule" forfiduciary investments. Under this rule, the trustee is bound by nolist of investments and may invest in corporate stocks and bondsas long as it is a prudent investment. Prior to 1940, only ninestates followed the Prudent-Man Rule; now about 32 states have asimilar rule in operation.3 Even New York, which has been con-servative since the days of King v. Talbot,4 has accepted a modified* Member of the Editorial Board, Ohio State Law Journal, The Ohio StateUniversity.1 OHIo RaV. CODE § 2109.371.2 Shattuck, The Development of the Prudent Man Rule for Fiduciary In-vestment in the United States in the Twentieth Century, 12 OHIo ST. L. J.491 (1951).3 Ibid; see also Torrance, Legal Background, Trends, and Recent Develop-ments in the Investment of Trust Funds, 17 LAw AND CoNTrol. PnoB. 128 (1952).4 40 N.Y. 76 (1869).NEW LIMITED PRUDENT-MAN RULE35% Prudent-Man Rule in 1950.1 During the depression, states withlegal lists fared no better than those with the Prudent-Man Rulesince municipal obligations and real estate mortgages held up nobetter than equity securities. As stated in Harvard College v.Amory,6 the capital is always a hazard.Since World War 11, the cry by fiduciaries for further avenuesof investment forced most states to adopt the Prudent-Man Ruleor to widen "legal" lists to the breaking point. Funds caught inlegal list investments during the last 15 years have returned muchlower income and growth than in Prudent-Man Rule states becauseof the inability of the trustee to balance a portfolio with invest-ments in corporate stocks. In recognition of this handicap, almostall trust indentures today contain clauses giving the trustee dis-cretionary investment powers. Advocates of the rule feel that theyhave better opportunity for diversification, more income yield,more flexibility, and better ability to change investments witheconomic conditions.Governor Lausche and other opponents of the Prudent-ManRule feel that though stocks produce greater income, there is a cor-responding insecurity in the investment which is overlooked inboom periods.7 They also feel that there is no need for the ruleunder legal lists, since a settlor can provide for non-legal in-vestments by expressing such intention in the trust agreement.The duty of a trustee under the Prudent-Man Rule is bestexemplified by the classic statement from Harvard College v.Amory: 8All that can be required of a trustee to invest, is, that heshall conduct himself faithfully and exercise sound dis-cretion. He is to observe how men of prudence, discretion,and intelligence manage their own affairs, not in regard tospeculation, but in regard to the permanent dispositionof their funds, considering the probable income, as well asthe probable safety of the capital to be invested.Generally, he is under a duty to combine safety with productivity,to avoid speculation, to diversify the risk, to exclude his selfish in-terest, and to turn to a court of equity for advice if needed.9 Instates that have recently accepted the Prudent-Man Rule, fiduci-aries have realized that with the greater freedom in investments,S N.Y. Pmis. Psop. LAW § 21 (1).6 9 Pick. (Mass.) 446 (1830).7 Senate Journal, 100th General Assembly, August 7, 1953 p. 1.8 9 Pick. (Mass.) 446, 461 (1830).93 BoGERT, TRUST AND TaUSTS, § 611 et seq.; see also a collection ofauthorities upon the operation of the Massachusetts Prudent Man Rule givenby Mayo A. Shattuck in 25 B.U.L. REv. 307 (1945) and 12 Omro ST. L.J. 509(1951).1953]OHIO STATE LAW JOURNALthey face greater pitfalls and have, therefore, been cautious in usingtheir new discretion. 10For many years in Ohio, the rule has been that a trustee iswithout authority to place the funds in other than legal list in-vestments, except where a trustee is given discretion as to choiceof investments or is given definite instructions to place them innon-legal investments by the trust instrument." The legal list inOhio has generally consisted of various types of governmental ob-ligations and bonds, bonds issued under various Federal home loanacts, and first mortgages on real estate. 12 The Ohio legal list wasunder considerable attack during the last decade and a limitedPrudent-Man Rule bill was passed in 1950 but vetoed by Gov-ernor Lausche.The new law, Section 2109.371 of the Ohio Revised Code, willallow trustees, administrators, executors, and guardians, otherthan guardians bound by the Uniform Veterans' GuardianshipAct,13 to invest in stocks, bonds, debentures, notes, equipment trustobligations, or other evidences of indebtedness of a corporationorganized and existing under the laws of the United States, Dis-trict of Columbia, or of any state of the United States and in certaingovernmental obligations not eligible under the "legal" list up toa limit of 35% of the aggregate market value of the trust fund.'4Once the 35% is determined, the fiduciary need not sell becauseof a change in relative market value of such investments either inlegals or non-legals. An executor or administrator must obtain theapproval of a court for such investments in absence of permission inthe instrument creating the trust. The new law does not affectthe right of a fiduciary to retain investments in non-legals receivedby him in the creation of the trust, though such non-legals willnecessarily be required to be computed in determining the 35%limit.15The investment should be made in such securities "providedthe same may be lawfully sold in Ohio" and as "would be acquiredby prudent men of discretion and intelligence in such mattersseeking a reasonable income and the preservation of their capital."1OMacNeill, How New York Trustees Invest under Modified Prudent-Man Rule, 96 TRusTs & EsTATES 432 (1951); and Torrance, Investing UnderPrudent Man Rule, 91 Tausrs & EsTATeS 838 (1952).11 Home Saving & Loan Co. v. Strain, 130 Ohio St. 53, 196 N.E. 770, 99A.L.R. 903 (1935).12Former Omo Grs. CODE § 10506-41.13 OIO Ruy. CODE § § 5905.01 to 5905.19 inclusive.14See Sater, Liberalization of Ohio's Legal List for Fiduciary Investment:"Prudent Man" Standard Engrafted, 26 OHio BAR 749 (1953), for a more ex-tensive discussion of investments under the new statute.15 Omo REv. CODE § 2109.38.[Vol. 14NEW LIMITED PRUDENT-MAN RULEThough "lawfully sold in Ohio" probably refers to securities ex-empted or registered under the Ohio "Blue Sky" laws,16 the lan-guage could stand to be more explicit as in the New York law.17The new law also allows investment in securities of any open-end and closed-end management type investment trust companywithin the 35% limitation. Such a clause has been recently addedby Mayo A. Shattuck to the Model Prudent-Man Rule Statute andpassed in a few states.' 8 For small trusts such investments havebeen advised for diversification of the risk. Though such statu-tory authorization would probably not be needed under discre-tionary clauses or the Prudent-Man Rule, most fiduciaries favorsuch statutory permission to delegate their authority to trust com-panies.1 9Though the new law provides for investment trusts, it fails toprovide for the increasingly popular common trust fund whichhas been valid in Ohio since 1943.20 Though such funds are in theirinfancy in Ohio and there is no case law on the subject, most stateswhich have a modified Prudent-Man Rule like New York and NewJersey have had to correlate the two statutes.2' In computing the35% which a trustee may invest under the New York law, thetrustee should exclude the value of any investment made in a legalcommon trust fund.2 2 If the use of the legal common fund trust doestake place in Ohio, the statutes should be correlated or clarifiedin the future. Such difficulties as correlation with common trustfunds, difficulties in valuation, and restrictions on diversificationhave lead to attacks on the limited Prudent-Man Rule.2 3Unless the trust instrument limited the trustee to legals at thetime the trust was created, changes in investment statutes arevalid to previously created trusts. 24 The courts of New York havetended to be liberal in extending the provisions of their new statuteto existing trusts which are silent as to investments while to the16 Omo REV. CODE §§ 1707.01 to 1707.99 inclusive.17 N.Y. PERS. LAW § 21 (1).18 N.H. LAWS 1949, c.134; M. LAWs 1951, c.24; WAsH. LAws 1951, c.218.19 In re Estate of Rees, 53 Ohio L.Abs. 385, 85 NX..2d 563 (1949); Steven-son, Investment Company Shares, 89 ThusTs & ESTATES 228 (1950).20 OMO REV. CODE § § 1117.01 to 1117.07, inclusive.21 N.Y. Pims. Psop. LAw § 21; N.Y. Bnx LAw § 100(c); N.J.S.A. § 17:9A-36et seq.22 In re Prime's Will, 107 N.Y.S2d 19, 200 Misc. 410 (1951).23 Shattuck, the Fallacies of a Modified Prudent-Man Rule, 89 TRusTs &ESTATES 848 (1950).24 Ritchie v. Farrelly, 16 N.J. Super. 214, 84 A.2d 468 (1952); In re Jones'Will, 221 Minn. 524, 22 N.W.2d 633 (1946); and Reiner v. Fidelity Union TrustCo., 126 N.J. Eq. 78, 8 A.2d 175 (1939), rev'd. on other grounds, 127 N.J. Eq.377, 13 A.2d 291 (1940).1953]OHIO STATE LAW JOURNALcontrary have been strict in extending it to trusts with special in-vestment provisions.25The new Ohio law is definitely a welcomed step forward, butwas taken with great conservatism. Since the fiduciary is stillbound to a legal list, the new law is only a liberal extension of theold legal list to new securities and not a true Prudent-Man Rule.As in other states, the new discretion probably will be taken withcaution, and, if good times persist, there undoubtedly will be newefforts to pass a 100% Prudent-Man Rule in Ohio.2STorrance, see footnote 10, supra.[Vol. 14

The New Limited Prudent-Man Rule in Ohio

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The New Limited Prudent-Man Rule in Ohio

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