Prudent Investor Rule

The Prudent Investor Rule generally provides that a fiduciary shall invest and manage property held in a trust as a prudent investor would, by considering the purposes, terms, and other circumstances of the trust and by pursuing an overall investment strategy reasonably suited to the trust. A person who holds property for the benefit of another is said to hold that property in trust and is known as a fiduciary. The terms prudent and discretion and intelligence were first applied to trustee decisions in an 1830 Massachusetts court case, in which the court first established a “Prudent Man Rule” by determining that trustees must take their investment cues from “men of prudence, discretion and intelligence.”

State statutes setting forth prudent investor rules have varied in their application of the general rules of trust management. The concepts originally established by the Prudent Man Rule became limited over the years as states began enacting “legal list” statutes specifying the types of investments in which trustees were permitted to invest. The Restatement of Trusts (Second) codified the principles of the Prudent Man Rule and broadened the permissible investment strategies but still prohibited any “speculative” or innovative investments. In addition, the application of the Prudent Man Rule was extended beyond the rule's origins in income trusts to a greater variety of situations involving charitable trusts, public funds, and pensions. Each situation bears its own particular complexities with respect to trustee obligations. For example, pension fund management's additional conflict lies in the reconciliation of the trustee's duties to the employer and employees when the effect of the decisions made may differ dramatically depending on whether the employees are current or retired. Likewise, remainder trusts pay income to the initial beneficiary for a period of time and ultimately pay out the remainder or residue of the trust property to a second party. Given the tension inherent in such competing ownership interests of successive beneficiaries, the investor must maintain a balance between all relevant interests in arriving at the best course of action, requiring greater flexibility in trust investment principles.

The criticisms of the Prudent Man Rule were addressed in the revision of trust legal principles set forth in the Restatement of Trusts (Third) in 1992, which attempted to reconcile trust investment law with ongoing investment practices. The revised principles of the Restatement of Trusts (Third) then gave rise to the promulgation of the Uniform Prudent Investor Act (UPIA) in 1994. UPIA has been adopted by a significant majority of states.

In contrast to traditional trust management principles, the Prudent Investor Rule as stated in the Restatement of Trusts (Third) and UPIA adopts the revised principles of trust law, requiring the trustee to justify the reasonableness of each investment rather than demonstrating avoidance of all speculation, and serves to provide consistent application of a more process-oriented trust investment law. The Prudent Investor Rule and UPIA incorporate Markowitz's modern portfolio theory, which provides that trust management must reduce risk by mathematically diversifying assets across a spectrum of classes of assets as well as within each individual asset class to reduce risk and maximize reward.

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