OnBank & Trust Co., Matter of

• Decision Date: 08 November 1996
• Citation: 227 A.D.2d 20,649 N.Y.S.2d 592
• Court: New York Supreme Court — Appellate Division
• Parties: Matter of Judicial Settlement of Fifth Account of Proceedings of ONBANK & TRUST CO., as Trustee of Discretionary Common Trust Fund "A" (Equities) of OnBank & Trust Co., Appellant-Respondent. Matter of Judicial Settlement of Fifth Account of Proceedings of ONBANK & TRUST CO., as Trustee of Discretionary Common Trust Fund "B" (Fixed Income) of OnBank & Trust Co., Appellant-Respondent. Elizabeth A. Hartnett, Robert L. Jokl, Jr., Peter E. McLellan and Michael E. O'Connor, Respondents-Appellants.

Page 592

649 N.Y.S.2d 592

227 A.D.2d 20

Matter of Judicial Settlement of Fifth Account of Proceedings of ONBANK & TRUST CO., as Trustee of Discretionary Common Trust Fund "A" (Equities) of OnBank & Trust Co., Appellant-Respondent Matter of Judicial Settlement of Fifth Account of Proceedings of ONBANK & TRUST CO., as Trustee of Discretionary Common Trust Fund "B" (Fixed Income) of OnBank &amp Trust Co. Appellant-Respondent Elizabeth A. Hartnett, Robert L. Jokl, Jr., Peter E. McLellan and Michael E. O'Connor, Respondents-Appellants.

Supreme Court, Appellate Division, Fourth Department.

Nov. 8, 1996.

Carter, Ledyard & Milburn (Richard B. Covey, Jack Kaplan, of counsel), New York City, Melvin & Melvin (Richard M. Storto, Kenneth J. Bobrycki, of counsel) Syracuse, for Petitioner-Appellant, OnBank & Trust Co.

Elizabeth A. Hartnett, Syracuse, for Respondent-Appellant, Guardian Ad Litem for Fund A Income Beneficiaries.

Robert L. Jokl, Jr., Syracuse, for Respondent-Appellant, Guardian Ad Litem for Fund A Principal Beneficiaries.

Peter E. McLellan, Syracuse, for Respondent-Appellant, Guardian Ad Litem for Fund B Income Beneficiaries.

Michael E. O'Connor, Syracuse, Guardian Ad Litem for Fund B Principal Beneficiaries.

Dennis Vacco, Albany, for amicus curiae NYS Banking Department by Michael Nicholson.

Sullivan and Cromwell, New York, for amicus curiae NY Clearing House Association by John Warden.

Kramer, Levin, Naftalis & Frankel (Marvin E. Frankel, E. Lisk Wyckoff, Jr., Carol A. Ensalaco, Ashley A. Roberts, of counsel), David L. Glass, New York City, for amicus curiae, New York Bankers Assn.

Before PINE, J.P., and LAWTON, CALLAHAN, DOERR and BOEHM, JJ.

BOEHM, Justice.

Petitioner, OnBank & Trust Co. (OnBank), appeals from so much of the order of Onondaga County Surrogate's Court (Wells, S.), entered January 18, 1996, requiring OnBank, as trustee of two discretionary common trust funds, to reimburse the trusts for the management fees of mutual funds in which common trust funds were invested and ordering a hearing to determine the amount to be surcharged against OnBank. Respondents, Elizabeth A. Hartnett, Robert L. Jokl, Jr., Peter E. McLellan and Michael E. O'Connor, the four guardians ad litem representing the beneficiaries of the trusts, separately cross-appeal from that part of the same order that determined that OnBank did not violate Banking Law § 100-c (3), 3 NYCRR 22.20 (Regulation 22.20) and the trust funds' own Plans of Operation by investing common trust assets in mutual funds. The New York State Banking Department, the New York Bankers Association and the New York Clearing House Association have appeared as amici curiae.

I

Pursuant to Banking Law § 100-c (6), OnBank commenced these proceedings in Surrogate's Court for the judicial settlement of its accounts as trustee of two common trust funds: Discretionary Common Trust Fund "A" (Equities) and Discretionary Common Trust Fund "B" (Fixed Income). Those accounts cover the period from December 1, 1984 through September 31, 1993.

The funds were established in 1967 as discretionary common trust funds by the former Merchants National Bank & Trust Company of Syracuse, a national bank. On January 1, 1993, it converted its charter and merged with OnBank, a State savings bank, which became OnBank & Trust Company, a State-chartered commercial bank and trust company. During the accounting period, OnBank invested some of the assets of the funds in four mutual funds, each of which is a registered investment company under the Investment Company Act of 1940, as amended (15 U.S.C. § 80a-1 et seq.). As of December 31, 1993, Fund "A" had a total principal asset value of approximately 13.4 million dollars, with 33 stocks in its portfolio, and Fund "B" had a total value of 16.4 million dollars, with 66 securities in its portfolio. The common trust funds held a total investment of $1,096,436 in mutual funds and during the accounting period its largest holding in mutual funds was approximately $2,000,000. OnBank calculated that the total mutual fund management fees during the accounting period approximated $50,000.

The guardians ad litem appointed by the Surrogate to represent the interests of the principal and income beneficiaries of the funds raised objections to the accounts on the grounds that the investment of common trust fund assets in mutual funds was an improper delegation of management duty and that investment in mutual funds subjected the common trust funds to an additional layer of management fees.

Hearings were held on June 13, 1995 and September 13, 1995, at which OnBank introduced in evidence a State Banking Department letter, dated May 15, 1995, setting forth its opinion that investment of the assets of common trust funds in mutual funds is not an improper delegation of the management of a common trust fund and that a trustee of a common trust fund is not required to absorb the fees charged by mutual funds. In addition, Barbara Kent, an associate attorney in the legal division of the State Banking Department, the author of the letter, testified that investment in mutual funds was an accepted practice in the hundreds of common trust funds in New York and that, in the opinion of the Banking Department, the investment of common trust fund assets in mutual funds violated neither the Banking Law nor the Banking Board regulations established thereunder; therefore, such investment should not subject a trustee to a surcharge for the mutual fund fees. Eugene F. Maloney, Vice President and Corporate Counsel of Federated Investors, Inc., sponsor of one of the mutual funds invested in by OnBank, testified that at least 50 bank trust departments in New York invest common trust fund assets in mutual funds sponsored by Federated Investors alone. The guardians submitted expert testimony in support of their objections.

On January 18, 1996, the Surrogate in a decision and order determined that investment in mutual funds by the trustee of a common trust fund does not constitute an improper delegation of its management duties, but that investment in a mutual fund imposes upon the common trust fund an additional layer of management costs, represented by the mutual fund's fees, in violation of the Banking Law, the regulations thereunder and the common trust fund's Plans of Operation. The Surrogate elaborated on his decision by further decision and order, dated March 22, 1996, denying the parties' motions for reargument.

II

The trustee of the common trust funds was, for the greater part of the accounting period, a national bank organized under the National Bank Act and, as such, was subject to the regulations of the Office of the Comptroller of the Currency (OCC). The parties agree, however, that this case is governed by New York law. The OCC regulations in any event require compliance with State law. Those regulations provide that investment by national banks of common trust fund assets in mutual funds is permitted, provided such investment is permitted for State banks organized under the laws of the State in which the national bank maintains its headquarters, in this case New York (OCC Trust Banking Circular No. 4 [Revised] [Sept. 29, 1976] ).

The trust funds here were established as discretionary common trust funds in order to distinguish them from those funds that were required to limit their investments to the so-called "legal list". After New York enacted the "prudent man rule" to govern the investments of fiduciaries (EPTL 11-2.2) and abolished the legal list, Banking Law § 100-c was amended in 1972 to eliminate the distinction between discretionary and legal list common trust funds (L 1972, ch. 805). Under the statutory framework, all common trust fund trustees were authorized to invest trust assets in "such investments as [the trustee] may select in its discretion" (ibid.; see, Matter of Bank of N.Y. [Spitzer-Koenig], 43 A.D.2d 105, 107, 349 N.Y.S.2d 747, affd. 35 N.Y.2d 512, 364 N.Y.S.2d 164, 323 N.E.2d 700). ¹

Consistent with the language of the statute, courts have applied EPTL 11-2.2 to trustees of common trust funds (see, Matter of Bank of N.Y. [Spitzer-Koenig], supra, 35 N.Y.2d, at 518-519, 364 N.Y.S.2d 164, 323 N.E.2d 700; Matter of Bankers Trust Co., 219 A.D.2d 266, 636 N.Y.S.2d 741, lv. dismissed 87 N.Y.2d 1055, 644 N.Y.S.2d 146, 666 N.E.2d 1060; Matter of Morgan Guar. Trust Co., 89 Misc.2d 1088, 1091, 396 N.Y.S.2d 781).

EPTL 11-2.2(b)(1) expressly authorizes fiduciaries to invest "in securities of any management type investment company [mutual fund]." This authorization applies if the instrument defining the powers of the fiduciary permits the investment of trust funds, either in (a) "[s]uch investments as the fiduciary may, in his discretion, select" or (b) "investments other than those in which fiduciaries are by law authorized to invest trust funds" (EPTL 11-2.2[b][1] ). ²

OnBank's Plans of Operation, the instruments defining OnBank's powers, authorize OnBank to make such investments "as it may select in its discretion." The guardians did not submit evidence of any prohibition against investing in mutual funds in the underlying trust instruments. Nevertheless, the guardians contend that OnBank violated the Plans of Operation by investing common trust funds in mutual funds because the Plans of Operation specifically limit investment to "equity type investments" in Fund "A" and to "fixed income investments" in Fund "B". We see no difference, however, between such investments held as individual securities and the same investments held in mutual funds.

The guardians also argue that, under the Banking Law, OnBank is prohibited from delegating its managerial responsibilities by shifting them to a mutual fund. Banking Law § 100-c (2), as originally enacted, provided that "[e]ach common trust fund shall subject to law, be under the exclusive management and control of such trust company" (L 1937, ch. 687, at 1562). One commentator wrote that...