Article: AI AND THE PRUDENT INVESTOR RULE

Technology tends to move at a rapid pace. This seems particularly true in the realm of artificial intelligence (AI). It seems that every day, there is some new task that can be accomplished with little to no human action apart from the inputting of parameters for that specific task. This hasn’t always turned out well for professions, as stories regularly appear detailing the ways in which legal professionals have relied on AI to the detriment of their clients or to the justice system.

Nonetheless, the use of AI continues to expand, with proponents extolling its virtues and opponents viewing it as the bete noir of contemporary society. One key area where AI is changing the game is in the world of investing. Because AI can analyze data, summarize reports, and create models, many investment companies have incorporated it. At the same time, AI faces challenges in the world of investing because markets are non-stationary, have limited financial data, and have a low signal-to-noise ratio.

Some financial advisors have a fiduciary duty to their clients and must act in those clients “best interests.” Legal literature has already begun exploring *773 the relationship between these advisors’ fiduciary duty and the use of AI in making investment decisions. Support for AI’s use exists among investment professionals, though there have been concerns raised about its use.

Like those financial advisors, trustees also have a fiduciary duty to the beneficiaries of the trust. In particular, this means the trustee must act in the beneficiary’s best interests. Unlike financial advisors, trustees are further constrained by the “prudent investor” rule, which governs the means by which a trustee may invest the trust’s principal. At the same time, the modern Prudent Investor Rule provides a degree of discretion previously unavailable to trustees. The question, then, is whether the use of AI in investment management is consistent with the Prudent Investor Rule.

This Article explores the relationship between AI-backed investment strategies and the Prudent Investor Rule. In doing so, it takes as a given the reality that AI will play a role in how trustees design and implement investment strategies on behalf of the trust’s beneficiaries. The goal is to produce a workable system for analyzing whether a trustee’s use of AI in implementing an investment strategy is consistent with the Prudent Investor Rule, or whether it violates the fiduciary duty to act in the beneficiaries’ best interests.

Part II discusses the trustee’s fiduciary duty and the Prudent Investor Rule. It begins with the early law involving legal lists and the development of the Prudent Man Rule. It then discusses the Prudent Man Rule under the Restatement (Second) of Trusts. Finally, it considers the introduction of Modern Portfolio Theory and its impact on the Prudent Investor Rule as derived from the Restatement (Third) and the Uniform Prudent Investor *774 Act. Part III examines the role AI plays in the investment industry. First, reviews the use of AI as an investment tool, then discusses how scholars have considered the use of AI in relation to the fiduciary duty imposed on financial advisors. Part IV discusses a system for AI investing best practices that are consistent with the Prudent Investor Rule. It begins by arguing that, given AI’s limitations, awareness of an agent’s AI usage is a necessary part of reasonable exercise. Finally, it discusses the use of AI within the scope and terms of the delegation of authority, as well as a trustee’s review of AI practices during the periodic review of the agent’s performance.