Derivatives and the Prudent Investor Rule

Robert J. Aalberts (Ernst Lied Professor of Legal Studies, University of Nevada – Las Vegas) and Percy S. Poon (Associate Professor of Finance, University of Nevada – Las Vegas) have recently published their article Derivatives and the Modern Prudent Investor Rule: Too Risky or Too Necessary?, 67 Ohio St. L.J. 525 (2006).
   

Here is the abstract of their article:
 

This Article first discusses the general provisions of the Modern Uniform Prudent Investor Act and the Restatement (Third) of Trusts § 227, both of which were promulgated in the early 1990s in an effort to reform trust investment practices. Their success has been undeniable. By 2005, forty-five American jurisdictions had adopted the acts’ provisions in some form. Next we discuss and analyze the acts’ model statutory language and commentary, as well as analogous case law and legal commentary which expressly and impliedly embrace the prudent use of derivatives. Following this, there is a general discussion of what derivatives are, and how and when they are commonly used, with a focus on the risks of speculation as well as the benefits of hedging when managing an investment portfolio within the parameters of the model acts. We conclude with hypothetical scenarios and an in-depth analysis to illustrate further how fiduciaries might find derivatives to be highly beneficial, as well as a possible “safe harbor” for shielding their trusts from a world of unpredictable economic conditions.