What Is the Uniform Prudent Investor Act (UPIA)?
The Uniform Prudent Investor Act (UPIA) is a standard that sets out guidelines for trustees to follow when investing trust assets on behalf of a trustor. It also applies to financial professionals who make recommendations or place trades on behalf of clients. It is an update to the former "Prudent Man" standard intended to reflect the changes that have occurred in investment practice since the late 1960s.
Specifically, the Uniform Prudent Investor Act adopts a modern portfolio theory (MPT) and total return approach to the exercise of fiduciary investment and discretion.
- The Uniform Prudent Investor Act (UPIA) is a statute that sets out guidelines for trustees to follow when making investments on behalf of others, an update to the Prudent Man Rule.
- The Prudent Man Rule stated that a trust fiduciary was required to invest trust assets as a “prudent man” would invest his own assets.
- The UPIA requires trustees to take into account a diversified portfolio approach that follows modern portfolio theory and a total return approach.
Understanding the Uniform Prudent Investor Act (UPIA)
The Uniform Prudent Investor Act was adopted in 1992 by the American Law Institute’s Third Restatement of the Law of Trusts. It was an update to the previously accepted Prudent Man Rule.
By taking the total portfolio approach and eliminating category restrictions on different types of investments, the Uniform Prudent Investor Act fostered a greater degree of diversification in investment portfolios. It also made it possible for trustees to include in their portfolios investments such as derivatives, commodities, and futures. While these investments individually have a relatively higher degree of risk, they could theoretically reduce overall portfolio risk and boost returns when considered in a total portfolio context.
The Prudent Man Rule
The Prudent Man Rule was based on Massachusetts common law written in 1830 and revised in 1959. It stated that a trust fiduciary was required to invest trust assets as a “prudent man” would invest his own assets, with the following in mind:
- The needs of beneficiaries
- The need to preserve the estate
- The need for income
A prudent investment will not always turn out to be a highly profitable investment; in addition, no one can predict with certainty what will happen with any investment decision.
More recently, the prudent man rule has been renamed the prudent person rule. This set of guidelines can also be applied outside of trustee domains, where it is referred to as the prudent investor rule.
The Uniform Prudent Investor Act’s Updates to the Rule
The Uniform Prudent Investor Act made four main changes to the previous Prudent Man Rule standard:
- A trust account's entire investment portfolio is considered when determining the prudence of an individual investment. Under the Uniform Prudent Investor Act standard, a fiduciary would not be held liable for individual investment losses so long as the investment was consistent with the overall portfolio or investment objectives.
- Diversification is explicitly required as a duty for prudent fiduciary investing.
- No category or type of investment is deemed inherently imprudent. Instead, suitability to the portfolio's needs is considered. As a result, investment junior lien loans, investments in limited partnerships, derivatives, futures, and similar investment vehicles are now possible. However, speculation and outright risk-taking are not sanctioned by the rule and remain subject to possible liability.
- A fiduciary is permitted to delegate investment management and other functions to qualified third parties.
The Uniform Prudent Investor Act’s most important change was that the standard of prudence would henceforth be applied to any investment in the context of the total portfolio, rather than to individual investments.