Prudent man rule

The Prudent Man Rule is based on common law stemming from the 1830 Massachusetts court formulation, Harvard College v. Amory 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."

Under the Prudent Man Rule, when the governing trust instrument is silent concerning the types of investments permitted, the fiduciary is required to invest trust assets as a "prudent man" would invest his own property with the following factors in mind:

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, in particular with regards to investments permitted by mutually-chartered institutions such as savings banks and insurance companies.

The Prudent Man Rule requires that each investment be judged on its own merits and that speculative or risky investments must be avoided. Under the Prudent Man Rule, certain types of investments, such as second mortgages or new business ventures, are viewed as intrinsically speculative and therefore prohibited as fiduciary investments. As with any fiduciary relationship, margin accounts and short selling of uncovered securities are also prohibited.

In contrast with the modern Prudent Investor Rule, isolated investments in a portfolio may be imprudent on individual merits at the time of acquisition, however, as a part of a portfolio, the investment could be prudent. Thus, a fiduciary may not be held liable for a loss in one investment.

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. 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. 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.

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