Madison Trust Case Creates Legal Stir
The Birmingham News
It was one of those things you wouldn’t think could happen but it did.
Under the management of First Alabama Bank of Huntsville, the value of a family trust went from $536,000 in 1974 to $776,168 in 1983- almost a 45 percent increase of $240,168.
During that same period, the trust fund generated an additional $227, 456 in earned income, primary divided payment on stock held in the trust, according to Southern Reporter, a legal journal.
Yet, by the early 1980’s, beneficiaries of the trust had grown dissatisfied with its management and were in court, suing First Alabama for damage.
Last October, the Alabama Supreme Court upheld a Madison County court’s ruling and granted the beneficiaries almost $765,000 in damage and interest.
That settlement came despite the fact that the trust did not lose money-despite the fact that the trust made almost $470,000 under the bank’s management.
“It’s sort of incredible really, that the bank would be made to pay when the trust did not lose money.” said N.Lee Cooper, an attorney with Maynard Cooper, an attorney with Maynard, Cooper, Frierson & Gale in Birmingham. “Not only did it not lose money, it made money…”
The case and its settlement have promoted Alabama’s largest banks to begin pushing for legislation that would provide more guidelines on trust managers on the hot seat, and the other beneficiaries may begin filing-possible winning-similar lawsuits.
But some say it has also put trust managers on the hot seat, and that other beneficiaries may begin filing-possibly winning-similar lawsuits.
“I think we’re going to see a lot of litigation come out of this” Cooper said “This has opened up Pandora’s box by saying you can sure even though you made money…..I think this case could be expanded to include brokerage houses and other financial institutions.
“People managing these trust funds are going to be damned if they do and damned if they do and damned if they don’t,” said Cooper, who served as chairman of the Litigation Section of the American Bar Association in 1985-1986.
The somewhat bizarre case involves the beneficiaries of Marion Berine Sparagins Sr., himself a former chairman and president of First American bank of Huntsville.
Spragins was worth more than $4.1 million when he died in 1973. His estate was divided into three trusts, and the beneficiaries of one of those trusts eventually sues First Alabama, said J. Allen Brinkley, an attorney with the Huntsville law firm of Brinkley & Ford.
Brinkley represented the Spragins beneficiaries who sued.
According to Southern Reporter; the net value of the trust in the case was $556,881 when Spragins’ estate was settled in early 1974. In 1975, after a stock market plunge, the trust value plummeted to about $200,000, but by 1983 it was worth $776,168.
In 1981, when the Spragins beneficiaries first filed suit the principal of the trust was worth about $500,000. The beneficiaries sued, in part, because they believed investments in the trust should have been diversified.
The bank had placed about 75 percent of the trust funds in First Alabama stock, and kept the money invested in the bank’s stock when it should have been invested elsewhere, Brinkley said.
According to Southern Reporter, the state Supreme Court found that “at a time when the trustee bank’s own investment advisory service was recommending that investment in bank stock be limited to 5 percent of a trust’s portfolio approximately 75 percent of the Spragins’ trust assets were invested in First Alabama Bankshares.”
In addition, the state Supreme Court determined that “testimony by the bank’s senior trust officer revealed that eight years after the bank had assumed administration of the trust, the needs of (Spragins Sr.’s) grandchildren had still not been determined by the trustee, a basic step which should have preceded formulation of a prudent plan for management of the trust property.”
Differing views about fund growth
Brinkley said the trust’s stock value did not keep up with inflation from 1977 through 1980, and that it only matched inflation in 1981.
But, “The problem was that very few investments kept up with inflation during that time,” said Frank Noojin Jr., a Huntsville attorney who represented First Alabama during the case. “ The bank said the trust increased and made a profit. There was no loss, so there should be no complaint.”
But Brinkley sees it much differently. “Basically what it came down to was this,” Brinkley said. “They said the trust (including the additional earned income) doubled in the time they managed it. We said it should have tripled.” “They said it went from $556,000 in 1974 to about $1 million. What we said was, “Well good grief, inflation was 100 percent during that time. You have done nothing.”
Of particular interest in this case was the testimony of James C. King, described in Southern Reporter as the leading trust manager in North Alabama from 1965 to 1973. King presented a hypothetical model of how the beneficiaries’ trust funds could have been invested to yield a higher return.
King said that the trust portfolio should have been diversified, with less First Alabama stock and more investments in treasury bills and Standard & Poor’s 500 stocks.
He said the principal of the trust, managed according to his model, would have increased to $1.2 million, which would have been roughly $400,000 more than it actually increased during the time the bank managed the trust. Earned income generated by his plan would have been $455,076, compared with the actual figure of $227,456.
But King testified that his model’s investments in treasury bills and Standard & Poor’s stocks would have had to be made at specific times, depending on market fluctuations, to yield what he said would have been possible.
Also, for the trust to have yielded what King said was possible, all of the trust would have to have been invested in either treasury bills or Standard & Poor’s stocks at all times during the 10 years First Alabama managed the trust.
First Alabama argued that for the trust to have earned what King said was possible, the bank would have needed the foresight to switch the trust’s money back and forth between treasury bills and S&P 500 stocks at precisely the right time for an entire 10-year period.
Switching investments in such a manner is known as market timing, and First Alabama contended that King had the luxury of hindsight in determining the proper market timing for investments in the Spragins trust.
Outperformed T-bills, witness said
One witness testifying for the bank said that during the period in question, First Alabama stock, on average, out-performed treasury bills, bonds, corporate bonds and the S&P 500 stocks.
Thus, the yields King said his hypothetical model would have given would all have depended on when First Alabama would have switched the trust funds form one investment to another, Southern Reporter said.
Alabama’s Chief Justice C.C. Torbert said in the case’s dissenting opinion that investing as King suggested is “an arguably risky investment philosophy.”
“My real concern about all this is the way King testified,” Cooper, the Birmingham attorney, said “Market timing (as a way of making investment decisions) has proved to be a notoriously poor performer over time.
“But if you let someone testify like this (in hindsight), they’re going to beat the trust manager no matter how well he’s done. You can always go back and find something that would have done better.”
Torbert further wrote in his dissenting opinion: “Simply put, the majority’s opinion says that if a trustee…makes some error in judgement, even if it results in no actual loss, the trustee is nonetheless liable for profits that might have arisen if the trustee had been fortunate enough to accurately call every major turn in the stock market for a 10-year period.
“As this is now the law, I suspect that Mr. King will be a very busy and prosperous witness.”
Birmingham’s largest banks are now pushing for legislation that would more clearly define the responsibilities of trust managers. One such proposal was submitted to the Alabama legislature during its last session, but no action was taken on it.
The proposed legislation that has gained the support of Alabama’s banks would require that a trust’s performance be based on its overall performance. As long as a reasonable return was achieve, a bank managing a trust would not be required to pay beneficiaries for profits that could have been made – but weren’t – because of the way in which the trust’s money was invested, Cooper said.
In addition, the proposed legislation would define what a “reasonable return” is, Cooper said.
“Unfortunate Precedent,” exec says
D. Paul Jones Jr., vice chairman of Central Bancshares of the South Inc. and first viced president of the Alabama Bankers Association, said, “(The Spragins case) was an unfortunate precedent for the trust business in Alabama. It may have resulted from the court not fully understanding the trust business or the impact of (the court’s) decision. It is likely that the legislation will be needed to effect the court’s decision.
“The trust law in Alabama is is antiquated and needs review by the legislature. Other states have acted on this, and Alabama needs to. Legislation should be enacted that would sufficiently clarify the trustee’s role so that he that he could prevent such a result as came from the Spragins case. He should know what the ground rules are and where the customer stands…”
According to Huntsville attorney Noojin: “(The Spragins settlement) is a very difficult precedent for anyone who manages money to live with,” especially if trustees’ performances are to be compared with hypothetical investment models such as the on presented by King in his testimony.
Noojin said he has mixed feelings about whether the Spragins case will spark a host of similar lawsuits. Such lawsuits – the Spragins case was in the courts seven years – are expensive to stick with, he notes.
“But obviously, (more lawsuits) might happen,” Noojin said.
In a recent article, Forbes magazine called for the Spragins case settlement “stupid” and said “managers of trusts are about to be besieged by suit-happy lawyers.”
But Brinkley, who contends that First Alabama kept the Spragins trust money invested primarily in the bank’s stock to help protect the stock’s value has his own opinion on the matter.
He sees the case as putting more pressure on trust managers who invest trust funds in their own company’s stock, and he does not see it leading to a host of frivolous lawsuits.
“I don’t think this was in any way, shape, form or fashion a frivolous lawsuit or that it will open the door for frivolous lawsuits.” Brinkley said.
“What this case means is that any trustee who self-deals with his own funds had better beware.”