It has been well over a decade since the National Conference of Commissioners on State Laws approved a model state stature incorporating the principles of the Uniform Prudent Investor Act (UPIA).  This removed much of the common law restriction upon the investment authority of trustees and like fiduciaries of trusts and encouraging sophisticated risk-return analysis to guide investment decisions reducing portfolio volatility and losses.  While the UPIA followed the precepts of the Employee Retirement Income Security Act (ERISA) and the American Law Institute’s 1992 Restatement of the Law Third, it allows delegation of investment decisions to qualified and supervised agents.  It is a testament to the success of this approach that forty-four states including the District of Columbia have adopted the Act as of June 2007.

The UPIA and its ‘Prudent Investor Rule’ fundamentally changed trust investment law with its new emphasis on the portfolio as a whole rather than on individual assets and its rejection of emphasizing strict avoidance of ‘risky or speculative’ investments.  Under the new rules no specific investment is inherently prudent or imprudent. Instead, suitability to the trust account's purposes and beneficiaries' needs is considered the determinant.  It grants broad investment powers to professional trustees, but at the same time, imposes significant new duties upon them, which, if inadequately performed, could result in liability to the trustee regardless of positive returns of trust portfolios. 

The prior law stressed diversification, but only on a limited basis, stressing diversification within an asset class. The UPIA stresses diversification across asset classes.  Under the Prudent Investor Act standard, a fiduciary would not be held liable for individual investment losses, so long as the investment, at the time of acquisition, is consistent with the overall portfolio objectives of the account.

A corporate fiduciary or paid professional advisor is held accountable under the special investment skills standard and protection from liability depends upon the trustees ability to prove that they have elevated UPIA standards. A trustee who cannot prove that they have implemented a thorough on-going investment process will not be protected under UPIA standards which means a positive return does not automatically protect a trustee from liability. 

Where ERISA, seen as process-oriented rather than rule-oriented, provides a safe harbor from liability if the fiduciary has given ‘appropriate consideration’ to an investment and its relationship to the needs of the plan, UPIA holds that a fiduciary’s performance is measured on the performance of the whole portfolio, not upon the performance of each single investment. 

Under the old Prudent Man rule, trustee’s analyzed investments on an individual basis, keeping in mind their duty was to preserve principal at all costs and to avoid risk without regard to the total return of the portfolio.  The standard of prudence now applied to the trust means that individual investments that would have been viewed as speculative or risky and subject to surcharge under the old trust laws may be seen as sensible, risk-reducing additions to a portfolio when viewed as a whole.  The UPIA considers that the key task of the trustee is to manage risk in order to realize the trust’s objectives and justify investments in relation to a comprehensive portfolio strategy that has been developed as suitable for appropriate risk levels. 

Concerning the investment process the following are some guidelines from the Uniform Prudent Investor Act:  A trustee can choose any investment for a trust and not be liable for negative performance of the investments if he or she has properly conducted the process required by the UPIA. 

Step One, the trustee must evaluate the needs and purposes of the trust and determine the appropriate risk level. 

Step Two, the trustee must determine an appropriate long-term investment policy appropriate to the determined level of risk.

Step Three, the trustee must implement that investment policy and document that strategy. 

The fact that a trustee used careful deliberation is no longer sufficient.  The UPIA requires that trustees be familiar with modern portfolio theory and incorporate its principles into their investment strategies and documentation of their actions. 

Protection from liability depends upon trustees’ ability to prove that they have met this elevated UPIA standard.  A trustee who cannot prove that he or she implemented a thorough and ongoing process for each trust, incorporating the current standards in the investment management industry will not be protected under UPIA standards.

About the Author
Ken Ziesenheim, JD, LLM, CFP is a Managing Director of Thornburg Investment Management, President of Thornburg Securities and a past Chairman of the National Endowment for Financial Education (NEFE). He also served as Chairman of NEFE’s investment committee. In addition, Ken is the author of Understanding ERISA – A Compact Guide to the Landmark Act, Marketplace Books, 2002. 

The views expressed by the author reflects his professional opinions and should not be considered buy or sell recommendations. These views are subject to change.

This material is for financial advisors and institutional clients only.