Before the invention of computers, financial practices were conducted with reliance upon tangible forms of security and personal insights into the character of those who were pledging collateral. Digitization of securities, currencies and recordkeeping has created new traditions, with new regulations. Examining the evolution of financial market traditions over time helps us understand how we should conduct business in the 21st Century realm of digital innovations like blockchain and distributed ledgers.


Tuesday, May 12, 2015

The Origins of Trusts and Fiduciary Duties

Foundations of Capital Markets

Author: David Schwartz J.D. CPA

A trust is a fiduciary arrangement that allows a one party to transfer assets to a third party, or trustee, to hold assets on behalf of a single beneficiary or a number of beneficiaries. Trusts have myriad uses and are employed across a wide variety of property transfers, transactions, testamentary bequests, and business arrangements.  They are so useful because they are so very flexible and can be custom tailored to restrict exactly how the assets are to be managed during the life of the trust, as well as how, when, and in what form the assets pass to the beneficiaries.  Because trusts have such utility and so widely used, a large body of law has grown up around them. And since a key aspect of trusts is the placement of things of value in the care of a third party, the trustee, a corollary concept, fiduciary duty, has also grown to address the rights and responsibilities of trustees with respect to the property in their care, and with respect to the trust’s beneficiaries. Because of their importance to modern commerce and life events in general, over the course of three short posts, we will examine the history of trusts and the development of fiduciary duties, application of trust and fiduciary principles to investment funds, and we will explore some of the powers and duties of fund trustees. In this first post, we examine the historical development of trusts and the fiduciary concept.

Trusts as we know them today have a long and storied history.  The modern concept of trust law has its roots in English law arising from notions of feudal land ownership in the twelfth century and Henry VIII’s “Statute of Uses” in the sixteenth century.  In medieval England, landowners employed trusts (called “uses”) like the cestuy que use to grant land to others for the use of an intended beneficiary for a limited time.  In this way original ownership could be preserved by transferring land to others to avoid “feudal incidents” (fees or taxes payable to the king).  Uses were also commonly employed to circumvent the rule against wills of land. This went on for centuries until, 1553, when Henry VIII tried to stamp out uses as a method of avoiding taxes payable to the British Crown, and forced through the English Parliament the “Statute of Uses” which ended the practice of creating uses in real property.  While the Statute of Uses succeeded in eliminating uses, it ultimately resulted in English courts developing a body of land trust law whereby one person holds full title to a property for the benefit of another person, who may direct the management and use of the property, which forms the basis of trust law today.[1],[2]

The novel separation of legal and equitable title in turn gave rise to the concept of a fiduciary and the associated duties and responsibilities recognized today across the spectrum of common law, statute, and jurisprudence. As Western economies developed, the mechanics and legal principles behind land trusts became more broadly useful in the context of commercial transactions and investments.[3]

Modern trusts range from the traditional gratuitous trust useful in estate planning to a variety of more complex commercial trusts. Accordingly, the body of common law governing commercial trusts has developed to accommodate more specialized trust and fiduciary relationships, and governments have, to some extent, codified many of these principles. Amid this modern framework of common law and statute, collective investment vehicles (investment funds) have become commonplace uses of commercial trusts to allow investors to pool their money, and have it managed professionally by a trustee or someone hired by the trustee to do so.[3]

In part II of this series, we will explore how trust and fiduciary principles apply in the context of investment funds.


[1] David J. Seipp, Trust and Fiduciary Duty in the Early Common Law, B.U. L. Rev., 1011 et seq.
[2] Graham Moffat, Gerry Bean, Rebecca Probert, Trusts Law, Fifth Edition, 2009 at p. 41 et seq.
[3] John H. Langbein, The Contractarian Basis of the Law of Trusts, Dec. 1995, Yale L. J. p. 625-631. 
[4]  K. Geert Rouwenhorst, The Origins of Mutual Funds, Dec. 12, 2004 (accessed May 7, 2015).