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    Flexibility's Role in Modern Prudent Fiduciary Investing

    Since all investments place capital at risk, it's impossible to provide absolute safety from the capriciousness of financial markets.

    W. Scott Simon, 06/01/2017

    In last month's column, I cited Tibble v. Edison International, the 2015 U.S. Supreme Court case decided unanimously, in which the court reminded all that the fundamental, underlying foundation of the Employee Retirement Income Security Act of 1974, as amended (ERISA), is the common law of trusts. The court observed: "We have often noted that an ERISA fiduciary's duty is 'derived from the common law of trusts…'" In effect, then, ERISA "federalized" the common law of trusts.  

    Twenty years later, the National Conference of Commissioners on Uniform State Laws (NCCUSL) promulgated the Uniform Prudent Investor Act (UPIA). The NCCUSL, founded in 1892, is a confederation of state commissioners on uniform laws. Its membership is comprised of hundreds of attorneys, judges, and law professors who are appointed by each of the 50 states, the District of Columbia, Puerto Rico, and the U.S. Virgin Islands, to draft uniform and model laws and work toward their enactment.

    The NCCUSL has promulgated more than 200 uniform and model laws during its existence, including the Uniform Commercial Code, a well-known example of a uniform law. Other examples of such uniform laws are those in the investment field, all of which sprang from the UPIA which, in turn, was birthed by the Restatement (Third) of Trusts (Restatement). These include the 1997 Uniform Management of Public Employee Retirement Systems Act, which governs the investment conduct of fiduciaries responsible for municipal, county, and state public employee pension plans; the 1997 Uniform Principal and Income Act, which helps to coordinate the implementation of Modern Portfolio Theory and prudent investing with rules pertaining to principal and income allocation for private family trusts; the 2000 Uniform Trust Code; and the 2006 Uniform Prudent Management of Institutional Funds Act, which governs the investment conduct of the fiduciaries (e.g., directors and trustees) serving as stewards of the portfolios (e.g., institutional funds) of charitable organizations.

    The UPIA governs the investment conduct of fiduciaries of private family trusts. The 23-page UPIA, as noted, is derived from the 300-plus page 1992 Restatement--successor to the 1932 Restatement of Trusts and the 1959 Restatement (Second) of Trusts--all promulgated by the American Law Institute (ALI). In existence since 1923, the ALI is an influential group of attorneys, law school professors, and judges that formulates statements of legal principles which often become sources of authority followed by courts and legislatures.

    The purpose of the ALI, as stated in its charter, is to "promote the clarification and simplification of the law and its better adaptation to social needs, to secure the better administration of justice, and to encourage and carry on scholarly and scientific legal work." (Examples of Restatements--which are legal treatises--include the Restatement of Remedies and the Restatement of Criminal Law.)

    Every Restatement has a Reporter who is typically a distinguished professor of law in his or her relevant field. The Reporter, aided by input from other distinguished law professors, jurists, and attorneys, coordinates and drafts the respective Restatement and commentary. The Reporter for the Restatement was Edward C. Halbach Jr., the Walter Perry Johnson professor of law emeritus at Boalt Hall, the University of California, Berkeley law school.

    Halbach, appointed dean at Boalt Hall at age 33, completed his monumental four-volume work--first promulgated in 1992 (which incorporated previous drafts going back to the late 1980s)--only in 2007. The Restatement revises and supersedes the 1959 Second Restatement by incorporating modern principles and theories of investment and finance into the basic text of the Prudent Investor Rule and its supporting commentary.

    The Need for Flexibility
    A primary purpose in promulgating the Restatement was to restore the flexibility and generality of the Prudent Man Rule which had been set forth by the Massachusetts Supreme Judicial Court in the 1830 case of Harvard College v. Amory. Dictum in that case--which forms the foundation of trust investment law in America--admonishes 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."

    W. Scott Simon is an expert on the Uniform Prudent Investor Act and the Restatement 3rd of Trusts (Prudent Investor Rule). He is the author of two books, one of which, The Prudent Investor Act: A Guide to Understandingis the definitive work on modern prudent fiduciary investing.

    Simon provides services as a consultant and expert witness on fiduciary issues in litigation and arbitrations. He is a member of the State Bar of California, a Certified Financial Planner, and an Accredited Investment Fiduciary Analyst. Simon's certification as an AIFA qualifies him to conduct independent fiduciary reviews for those concerned about their responsibilities investing the assets of endowments and foundations, ERISA retirement plans, private family trusts, public employee retirement plans as well as high net worth individuals.

    For more information about Simon, please visitPrudent Investor Advisors, or you can e-mail him at wssimon@prudentllc.com

    The author is not an employee of Morningstar, Inc. The views expressed in this article are the author's. They do not necessarily reflect the views of Morningstar.