The Maryland Prudent Investor Rule

Posted on by Thomas Schetelich in Uncategorized.

The Prudent Investor Rule was codified in Maryland in 1994, by §15-114 of the Estates & Trusts Article. The statute allows a fiduciary to utilize Modern Portfolio Theory in making investment elections for a trust, an estate or other beneficiary investments.

Modern Portfolio Theory frees a trustee from rigid and outdated trust investment practices, and allows use of the full range of modern investment tools in selecting and managing portfolios for trust beneficiaries. The Prudent Investor Rule, however, only applies to a fiduciary that is a trust company or an investment advisor, or an individual trustee who makes a valid §15-114(g) election to be governed by the statutory standards for investing.

A fiduciary that is not a corporate trust company or who does not make a §15-114(g) election is instead governed by the older Prudent Man Rule, which was the rule at common law. The Prudent Man Rule requires a fiduciary to invest trust assets as a prudent man would invest his own property. Under this rule, a fiduciary could be held liable for a loss in any one single investment, regardless of whether the investment may have been prudent in the context of the portfolio taken as a whole. Under the old Prudent Man Rule, investments such as hedge funds and aggressive stocks are considered inherently speculative and therefore inappropriate as fiduciary investments. With the appropriate election, such investments may be appropriate as part of a larger investment profile under the Prudent Investor Rule.

Supporters of the Prudent Investor Rule believe that when various uncorrelated assets are combined in a portfolio, the return is improved and the risk is lowered. The risk level of an individual security is offset by its qualities of blending the risk of return with the other securities in the portfolio, thereby reducing the overall risk to the beneficiary.

A private trustee who wants to utilize a broadly diversified portfolio would be wise to make a §15-114 filing with the Maryland State Department of Assessments and Taxation.  The trustee can then act under the Maryland Prudent Investor Rule, which benefits the fiduciary with greater protection and benefits the beneficiary with better investment returns.

Of course, although Modern Investment Portfolio Theory is widely accepted and applied by investment institutions, there is no guarantee of investment success, and every portfolio needs to be carefully administered for the individual purposes.