November 18, 2019
Assume that a person dies with a multi-million dollar stock portfolio. One of the first things an executor should do is review the portfolio and decide whether to sell all of the securities, only some, or none. The law requires an executor to protect the estate’s value for the beneficiaries, and a prompt review of the securities is essential.
When must the review be done? There is no fixed date; the time can vary according to the size and the holdings in the portfolio. But what if there is a long delay or a review is never done; or is done but no action taken? What is the executor’s liability? What happens if the value of the portfolio declines?
The problem is particularly serious when the portfolio is concentrated in one or a few securities. With the enactment of the Prudent Investor Rule, effective in 1995, New York codified an almost unconditional duty to diversify concentrated positions. The resulting jurisprudence has created grave danger for fiduciaries who fail to diversify promptly. There are respectable expert witnesses who have been willing to testify that it is a breach of fiduciary duty, under certain circumstances, not to diversify immediately upon gaining control of the assets – in as little as a week or less. Courts have assessed damages against fiduciaries using a model where the portfolio’s actual performance is measured against what the estate would have received if the fiduciary had liquidated the concentration the very day of gaining control of the asset and then adding to the resulting difference interest compounded at 9% per annum. Since the estate’s assets received a date of death step-up in basis, there would be no concern regarding capital gains tax.
A recent example of the danger of failing to promptly diversify is the case of Matter of Kenney. This case dealt with the estate of Marjorie Kenney (“Marjorie”) who died in June, 2007. Both Marjorie’s husband and only daughter, Alice, predeceased her; and Marjorie left her estate to the Alice P. Kenney Memorial Foundation.
Marjorie’s investment portfolio was valued at approximately $4.7 million at the time of her death. About 86% of the securities in the portfolio, however, consisted of General Electric stock. The executor was the family’s long-time attorney and knew of the concentrated stock holding, but decided not to diversify. In fact, it was not until 2016 - nine year’s after Marjorie’s death - that he sold most of the stock for a loss compared with what he would gotten had he sold shortly after Marjorie’s death.
The New York State Attorney General, acting on behalf of the Foundation, objected to the executor’s failure to diversify, and sought to surcharge him, i.e., to charge him with damages attributed to the loss. The Attorney General noted that the nine-year return on the General Electric stock was negative. It was -.53% as compared to the stock market’s positive return of 5.9% (based on the S&P 500).
According to the Attorney General, the executor should have sold the GE stock far earlier. The Attorney General argued that the executor should have sold by September 7, 2007, which was just 2½ months after death, and which was when a small amount of the stock was sold. Coincidently, this was not long before the stock market crash in 2008-09. While courts say that fiduciaries are not held to a standard of foreseeing the future and are not to be judged with the benefit of hindsight, the unpredictability of securities markets makes it dangerous to hold concentrated positions, since diversified portfolios are much less vulnerable to retrospective attack when the whole market drops.
The Surrogate’s Court agreed that the account should have been diversified, and it accepted the Attorney General’s proposed deadline of 2½ months after death. The Court calculated that if the executor had sold 95% of the stock on September 7, 2007, the sales proceeds would have been approximately $3,350,000. The Court then imposed 9% compound interest on that sum, which amounted to approximately $3,400,000, for a total of $6,750,000 for which the executor was held responsible. This amount was offset by actual sales of General Electric and other adjustments, with the result that the executor was surcharged $3,513,800, for the total “lost capital damages.”
However, the Attorney General sought more. The office argued that by failing to sell the stock, the executor deprived the Estate (Foundation) from the benefit of reinvestment in a rising stock market. The Court stated that by retaining the GE stock, the estate “lost the opportunity to reinvest the proceeds during a time when there was significant growth in the market.”
This issue of this “lost opportunity cost” will be decided later, but whether or not the Court imposes an additional charge the message is clear: An executor acts at his or her own peril if he or she does not promptly diversify concentrated holdings in a decedent’s portfolio.
Click here for the article on wealthmanagement.com.