Prudent man rule
The Prudent Man Rule is based on common law stemming from the 1830
Massachusettscourt decision - Harvard College v. Armory, 9 Pick. (26 Mass.) 446, 461 (1830). The Prudent Man Rule directs trustees "to observe how men of prudence, discretion and intelligence manage their own affairs, not in regard to speculation, but in regard to the permanent disposition of their funds, considering the probable income, as well as the probable safety of the capital to be invested". A copy of the Prudent Man Rule is also known as the Restatement of Trusts 2d.
Under the Prudent Man Rule, when the governing trust instrument, state law is silent concerning the types of investments permitted. The
fiduciaryis required to invest trust assets as a " prudent man" would invest his own property with the following factors in mind: the needs of beneficiaries, the need to preserve the estate (or corpusof the trust) and the amount and regularity of income. The application of these general principles depends on the type of account administered. The Prudent Man Rule continues to be the prevailing statute in a small number of states.
The Prudent Man Rule requires that each investment be judged on its own merits. Isolated investments in a portfolio may have been imprudent at the time of acquisition. However, as a part of a portfolio designed under a strategy, e.g. a
hedge fund, the investment could be prudent. Thus, a fiduciarymay not be held liable for a loss in one investment.
Under the Prudent Man Rule, speculative or risky investments must be avoided. Certain types of investments, such as second
mortgagesor new business ventures, are viewed as intrinsically speculative and therefore prohibited as fiduciary investments. As with any fiduciary relationship, marginaccounts and short sellingof uncovered securities are also prohibited.
Since the Prudent Man Rule was last revised in 1959, numerous investment products have been introduced or have come into the mainstream. For example, in 1959, there were 155 mutual funds with nearly $16 billion in assets. By year-end 2000, mutual funds had grown to 10,725, with $6.9 trillion in assets (as reported by CDA/Wiesenberger). In addition, investors have become more sophisticated and are more attuned to investments since the last revision of the Rule. As these two concepts converged, the Prudent Man Rule became less relevant...ADDITIONAL COMMENTARY...This discounting of the relevance of the prudent man rule is more the result of market forces than it is of the needs of individuals for "safety of capital". The 10,000+ mutual funds of 2000 have grown to over 15,000 mutual funds in 2006. Does any advisor claim to be expert on all of these funds? Does any one of the rating agencies promise that the funds they rate highly will perform better than those they don't? The Prudent Man Rule is even more important today than it was in 1830 if for no other reason than that the market has become so complex and no individual advisor or advisory firm can claim to be fully informed about the investments they recommend. Remember, ENRON, WORLDCOM, QWEST?
The modern interpretation of the "Prudent Man Rule" goes beyond the assessment of each asset individually to include the concept of diversification. This is referred to as the “Prudent Investor Rule”. The logic is this: an asset may be too risky to put all your money in (thus failing the Prudent Man Rule) but may still be very diversifying and therefore beneficial in a small proportion of the total portfolio.
* [http://www.fdic.gov/regulations/examinations/trustmanual/section_3/fdic_section_3-asset_management.html FDIC Trust Manual]
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Look at other dictionaries:
prudent man rule — n: a rule giving discretion to a fiduciary and esp. a trustee to manage another s affairs and invest another s money with such skill and care as a person of ordinary prudence and intelligence would use in managing his or her own affairs or… … Law dictionary
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prudent-man rule — A US criterion for managing investments, especially in relation to pensions, that is designed to avoid reckless speculation. It requires that a fiduciary behave as a notional prudent man or woman would when making an investment … Big dictionary of business and management
prudent-man rule — U.S. legal standard for the actions of someone charged with investing funds in trust for others. The administrator of the funds is expected to ask, “Would a prudent man or woman make this investment?” … American business jargon
prudent man rule — /ˌpru:d(ə)nt mæn ru:l/ noun a rule that trustees who make financial decisions on behalf of other people should act carefully (as a normal prudent person would) … Dictionary of banking and finance
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prudent-man rule — A common law standard against which those investing the money of others fiduciaries are judged. Bloomberg Financial Dictionary … Financial and business terms
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prudent operator rule — The rule that a stipulation in an oil and gas lease on a royalty basis that development shall be at the discretion of the lessee does not leave development to the uncontrolled will of the lessee, he being required to do by way of development that … Ballentine's law dictionary