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Lecture 2: The Prudent Man Rule

Lecture 2: The Prudent Man Rule. Professor Linda Allen Foundations of Finance C15.0025.00. Case Study: The Museum. What is meant by lack of prudence? Who has fiduciary responsibility? Who brought the case against CBH? The Museum Directors Museum Benefactors. The Prudent Man Rule.

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Lecture 2: The Prudent Man Rule

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  1. Lecture 2: The Prudent Man Rule Professor Linda Allen Foundations of Finance C15.0025.00

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

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

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

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

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