Lecture 2: The Prudent Man Rule

Professor Linda Allen

Foundations of Finance

C15.0025.00

Case Study: The Museum What is meant by lack of

prudence? Who has fiduciary responsibility? Who brought the case against

CBH? The Museum Directors Museum Benefactors

The Prudent Man Rule A fiduciary may invest only in such securities

as would be acquired by persons of discretion and intelligence in such matters who are seeking a reasonable income and preservation of their capital. Does not guarantee that the fund will grow

in value. Actions are judged by the facts which existed

at the time decisions were made to buy, sell, or retain securities in the fund.

Irrelevant that the fund as a whole has done well.

Duty to Diversify Beneficiary is interested in portfolio, not

individual assets. Can achieve S&P500 performance with

passive, diversified fund. S&P500 does well relative to active money

management. Trustee should always diversify unless under

the circumstances it is clearly prudent not to do so.

Duty of loyalty is reinforced in the Employee Retirement Income Security Act of 1974 (ERISA)

Pension Funds Beneficiaries lack information/skill to

look after their own interests. More opportunities for conflict.

Prohibited transactions. Duty to diversify. Revised Prudent Person Rule

“Fiduciary must act with the care, skill, prudence and diligence under the circumstances then prevailing that a prudent person acting in like capacity and familiar with such matters would use in conducting an enterprise of like character and like aims.”