When Dr. Cliff Sauls asked the Trust Co. of Georgia to manage a trust of Coca-Cola stock for his heirs in 1947, he knew his money was in friendly hands. Now known as SunTrust Bank, the Trust Co. had helped underwrite the fledgling soft drink company in 1919, held some of Coke's first publicly traded stock and even keeps the original Coke formula in one of its safes in Atlanta.
Today SunTrust owns 48.3 million shares of Coke stock worth about $2 billion, and Coca-Cola executives sit on SunTrust's boards of directors.
The close ties to Coke were a boon to the bank and Sauls' heirs for decades.
But in the 1990s Coke's stock price began to plummet.
Sauls' grandsons--now heirs of the trust--begged the bank to diversify their holdings, but SunTrust refused and kept nearly all of the money invested in Coke. Eventually the heirs sued SunTrust on May 31 in federal court in Atlanta, alleging mismanagement of their trust and a conflict of interest.
The case, Hitz v. SunTrust, highlights the need for ongoing dialogue between trust managers and their clients. General counsel need to be aware of the potential liability their company may face for failing to diversify trusts, particularly when there is a sudden downturn in stock value.
"It is precisely because investors cannot protect themselves from such events by research or shrewd stock selection that the law of trusts has for more than a century insisted on broad diversification of investments," says John Langbein, a Yale professor of law and legal history, and an expert on trusts.
Close Ties
Alexander Hitz and Thomas Shaw, Saul's heirs and half-brothers who live in New York, became the beneficiaries of the trust in 1995. They are suing SunTrust for pursuing what they call an "all eggs in one basket" approach to managing the trust and are seeking $165 million in compensatory and punitive damages.
They claim the Coke stock comprised 90 percent of the trust at one point, and that SunTrust ignored their repeated requests to diversify, beginning with a letter Hitz sent in 1998. They also claim they suffered actual damages of $15 million, including the loss of $8 million in stock value and lost investment opportunities. Furthermore, they are seeking punitive damages in the amount of 10 times the alleged actual damages. The heirs allege SunTrust's close relationship with Coke was the reason for the bank's refusal to diversify as the trust's value dropped.
"This is a lawsuit arising out of a conflict of interest," says Eric Lang, attorney for the plaintiffs and founder of The Lang Legal Group in Atlanta. "Even without the conflict, the failure to diversify cost the beneficiaries millions of dollars."
SunTrust spokesman Barry Koling declined to comment other than to say, "We believe that the allegations are without merit." The bank filed to resign as trustee on March 30 when discussions between the parties broke down.
Experts say that the close ties between SunTrust and Coke are interesting but won't be the deciding factor in determining the bank's liability for a failure to diversify. The conflict of interest could come into play in assessing damages if the plaintiffs win.
"The implication of a conflict of interest would be germane if the complaint alleges a breach of the duty of loyalty, and the conflict also would be relevant for punitive damages," Langbein says.
But before there is any talk of damage awards, legal experts argue that the plaintiffs have to prove that when he created the trust, Dr. Sauls didn't leave specific directions for how the trustees were to invest it.
"The key issue in such a case is the language of the trust," Langbein says. "If the trust directs that the trust fund be invested only in Coca-Cola stock, then the case is much harder for the plaintiffs."
Georgia In Mind
Legal experts argue that if Dr. Sauls never instructed the trustees to hold onto the Coke stock, as the plaintiffs allege in their complaint, then a failure to diversify makes the case quite clear.
"The law says trustees shall diversify trust funds, and when they neglect to do so, it does not matter whether they were corrupt, or merely lazy or ignorant," Langbein says.
That law, which 42 states have adopted, is the Uniform Prudent Investor Act of 1995. According to the Act, a trustee has to diversify investments of a trust unless the trustee determines that the trust would perform better without diversification.
"The suggestion that under-diversification is OK because Coke is a good company is a profound error on the part of a professional investor," Langbein says. "Even very good companies can suffer sudden and catastrophic reverses, as has happened lately with Merck, and before that, with Enron and Williams and WorldCom."
However, if this court applies precedents in Georgia law to this case, the outcome could swing in favor of SunTrust. Georgia hasn't adopted the Uniform Prudent Investor Act, rather the state has its own statutory prudent investor rule.
The Georgia statute specifically authorizes trustees to hold assets that the trust's creator placed in the trust. Because the Coca-Cola stock was in the trust when Sauls created it, SunTrust may legally keep the trust invested in the Coke stock. Under the Georgia law, SunTrust won't be held liable unless the plaintiffs show SunTrust engaged in "gross neglect."
"Although I personally would consider a failure to diversify such as in Hitz v. SunTrust such a poor investment strategy that it constitutes 'gross neglect,' I expect that Georgia courts would disagree with me and find in favor of SunTrust on the diversification issue," says Professor James Lindgren, a law professor at Northwestern University who reviewed the complaint.
If SunTrust can show that there was no gross neglect and use the Georgia loophole in federal court, the company may want to take this case as a lesson learned and let the fizz out of the their trust managers' allegiance to Coke for a while.
A date for the trial has not been set.