Prudent Man Rule Definition and Legal Meaning
On this page, you'll find the legal definition and meaning of Prudent Man Rule, written in plain English, along with examples of how it is used.
What is Prudent Man Rule?
It is a rule which directs the trustees or fund managers to invest the funds in the securities in which any level headed, prudent man who desires to make reasonable profit from his/her investment, will be intersted in.
History and Meaning of Prudent Man Rule
The Prudent Man Rule is a legal principle which states that fiduciaries must act with prudence and diligence, and invest trust funds as a "prudent man" would do under comparable circumstances. It has its roots in English Common Law and evolved from the traditional approach to trust management. It was initially applied to trusts for charitable purposes, but later extended to any kind of trust in need of investment.
The rule is also known as the "prudent person rule" and is designed to protect trust beneficiaries from risky, speculative, or otherwise unsound investments. Trustees and fund managers are required to invest in securities that are reasonably safe, capable of producing reasonable returns, and are diversely invested. The rule has been incorporated into the legal codes of many states in the United States and is recognized by federal law.
Examples of Prudent Man Rule
A trustee of a pension fund who invests the fund's assets in high-risk stocks may be found to have violated the Prudent Man Rule if the investments result in significant financial loss to the pension fund.
A trustee of a charitable trust invests its funds in real estate without investigating the market and local conditions. The real estate market crashes, and the trust loses a significant portion of its value. The trustee may be found to have violated the Prudent Man Rule.
A mutual fund manager invests in complex financial derivatives without properly analyzing their risks and rewards. This may constitute a violation of the Prudent Man Rule if the mutual fund's returns are adversely affected.
Legal Terms Similar to Prudent Man Rule
Fiduciary Duty - A legal obligation that requires a person to act in good faith, honesty, and loyalty towards another person or entity.
Duty of Loyalty - A legal requirement that fiduciaries must act in the best interest of their beneficiaries and not their own interests.
Duty of Care - A legal requirement that fiduciaries must act with care, skill, and diligence when performing their duties.
Uniform Prudent Investor Act - A modernization and expansion of the Prudent Man Rule that has been adopted by many states in the United States. It requires fiduciaries to consider the overall portfolio and risk tolerance of the trust when investing.