Lecture 2: The Prudent Man Rule Professor Linda Allen Foundations of Finance C

Case Study: The Museum n What is meant by lack of prudence? n Who has fiduciary responsibility? n Who brought the case against CBH? u The Museum Directors u Museum Benefactors

The Prudent Man Rule n 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. u Does not guarantee that the fund will grow in value. u Actions are judged by the facts which existed at the time decisions were made to buy, sell, or retain securities in the fund. u Irrelevant that the fund as a whole has done well.

Duty to Diversify n Beneficiary is interested in portfolio, not individual assets. n Can achieve S&P500 performance with passive, diversified fund. n S&P500 does well relative to active money management. n Trustee should always diversify unless under the circumstances it is clearly prudent not to do so. n Duty of loyalty is reinforced in the Employee Retirement Income Security Act of 1974 (ERISA)

Pension Funds u Beneficiaries lack information/skill to look after their own interests. u More opportunities for conflict. n Prohibited transactions. n Duty to diversify. n Revised Prudent Person Rule u 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.