National Conference of Commissioners on Uniform State Laws

211 E. Ontario St., Suite 1300, Chicago, IL 60611
tel 312-915-0195, fax 312-915-0187

For Immediate Release

Uniform Prudent Investor Act (UPIA) and Revised Uniform Principal and Income Act:
States Nationwide Need to Adopt Both Acts to Bring Trust Law
Into Line with Modern Portfolio Theory

January 2000 - More than half the states have enacted some version of the prudent investor rule, a major revision in the law of investment portfolio management for trustees that is working its way through the state legislatures.

Many people put family assets into trusts to avoid the courts and delays of probate and to minimize taxes. But until the prudent investor rule, these advantages of trusts have been offset by the limitations on investments imposed on trustees by prior law. Under the older prudent man rule, each investment was considered separately in determining whether the trustee had acted prudently. Trustees who lost money in any one investment could be sued, even if their overall handling of trust assets had turned a handsome profit.

The new rule was first stated in the model common law rule adopted by the American Law Institute (ALI) in 1992. Like the ALI rule, the Uniform Prudent Investor Act -- approved by the Uniform Law Commissioners (ULC) in 1994, and now the law in 32 states and the District of Columbia -- implements an interconnected set of reforms driven by modern portfolio theory. The Uniform Act makes fundamental alterations in the way trustees must invest, giving them much broader choices in making investments without lessening the standard of care required of them for protecting trust assets.

Uniform Prudent Investor Act

The Uniform Prudent Investor Act follows the practice of money managers who look at the portfolio as a whole, diversifying investments among several types of assets with different risk and reward characteristics. The tradeoff between risk and return is identified as the trustees' central consideration.

There are several other significant changes. Under the old rule, broad categories of investments were considered imprudent, per se. Now the trustee can invest in anything that plays an appropriate role in achieving the risk/return objectives of the trust and that meets the other requirements of prudent investing. Just as important, the former rule of trust law that forbids the trustee to delegate investment and management functions has been reversed. Trustees, for example an adult child appointed by an aging parent, are now encouraged to delegate investment responsibilities to professionals.

"The bottom line is that we are going to get better investment returns for trust beneficiaries under the new law than we had under the old," says John H. Langbein, a Uniform Law Commissioner who served as Reporter for the drafting committee.

Uniform Principal and Income Act

But even as states have modernized their laws of trust investments, and others are getting on the prudent investor bandwagon, states must now update their traditional principal and income allocation rules so that they can work with the doctrine of modern portfolio investment theory.

Recognizing this discrepancy, in 1997 the Uniform Law Commissioners approved a revision of the 1931 and 1962 Uniform Principal and Income Acts, the law in 41 states. The new act has been adopted in Arkansas, California, Connecticut, Iowa, North Dakota, Oklahoma, and Virginia.

Like its predecessor, this revision distinguishes between property that is principal, which will be distributed to persons entitled to receive principal when an income interest ends, and property that is income, distributed to income beneficiaries.
But it provides a means for implementing the transition to an investment regime based on principles embodied in the Uniform Prudent Investor Act, especially the principle of investing for total return rather than a certain level of "income" as traditionally perceived in terms of interest, dividends, and rents.

The revised act, for example, helps the trustee who has made a prudent, modern portfolio-based investment decision that has the initial effect of skewing return from all the assets, viewed as a portfolio, as between income and principal beneficiaries. The Act gives that trustee a power to reallocate the portfolio return suitably. To leave a trustee constrained by the traditional system would inhibit the trustee's ability to fully implement modern portfolio theory.

The Revised Uniform Principal and Income Act provides answers to long-standing problems in reconciling modern portfolio management with traditional rules of income allocation. It also provides for investment modalities that were not in existence in 1962 -- such as derivatives, options, deferred payment obligations, and synthetic financial assets. It is important that every state adopt this act as soon as possible.

The ULC, officially known as the National Conference of Commissioners on Uniform State Laws, is now in its 109th year. The organization comprises more than 300 lawyers, judges, and law professors, appointed by the states as well as the District of Columbia, Puerto Rico, and the U.S. Virgin Islands, to draft proposals for uniform and model laws and work toward their enactment in their legislatures. Since its inception in 1892, the group has promulgated more than 200 acts, among them such bulwarks of state statutory law as the Uniform Commercial Code, the Uniform Probate Code, and the Uniform Partnership Act.

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