Trustees, Brokers, and Advisors Who Are Hired to Manage Trusts And Other Fiduciary Investment Accounts Must Act Like “A Prudent Investor”
These cases are governed by the “Prudent Investor Rule” because trustees and brokers or advisors who are given discretion and paid to monitor and manage trusts or investment accounts are “fiduciaries.” In some cases, the trustee is a financial professional who makes the investment decisions personally. In others, he or she is essentially an administrator who hires a qualified professional to manage the accounts. In the latter case, the broker or advisor hired becomes the “fiduciary,” the one held to the “Prudent Investor Rule” standard. In short, the Rule states that trustees or other fiduciaries must manage the accounts in a way that “a prudent investor” would manage his or her own money.
The “Prudent Investor Rule” is the modern version and derived from the “Prudent Man Rule” established in the early 1800s in a case brought by Harvard College against a trustee it alleged to have mismanaged a trust. Judge Putnam was the first to formulate the rule governing management of trusts:
Do what you will, the capital is at hazard. All that can be required of a trustee to invest is that he shall conduct himself faithfully and exercise a sound discretion. He is to observe how men of prudence, discretion, and intelligence manage their own affairs, considering the probable income, as well as the probable safety of the capital to be invested … .
This standard has not changed much in substance over two centuries and been codified in statutes, such as the Employee Retirement Income Security Act (ERISA) and Florida Statute 518.11 titled “Investments by Fiduciaries: Prudent Investor Rule.”
The modern statutory “Prudent Investor Rule” standard generally requires consideration of all of the “purposes, terms, distribution requirements, and other circumstances” of the trust or retirement plan. It requires the “fiduciary” to exercise “reasonable care and caution” in managing the “investment portfolio as a whole” and as part of “an overall investment strategy” that incorporates “risk and return objectives reasonably suitable to the trust, guardianship or probate estate” investment portfolio. And if the “fiduciary” has special skills, like a professional broker or advisor, he/she is “under a duty to use those special skills” and will be judged accordingly. The “Prudent Investor Rule” is a test of conduct at the time the investment decision is being made, not performance. The “fiduciary” has a general duty to diversify investments unless it is “reasonably” believed not to be in the “best interests” of the beneficiaries to do so. Ultimately, and consistent with the earliest “Prudent Man” standard, the “fiduciary” has the duty to follow a strategy that considers both the “reasonable production of income and safety of capital.”
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