ERISA’s prudent-man test legally incentivized trustees to follow modern portfolio theory

Evidence

The pension fund and endowment trustees who employed investment managers also had to worry whether, with efficient-market theory becoming academic orthodoxy and beginning to influence regulators, they might be held to have behaved imprudently if they allowed stock portfolios to diverge too much from coverage of the overall market. A particular spur in this respect was the 1974 Employee Retirement Income Security Act (Whitley 1986a, p. 169). Section 404 of the act laid down the “prudent man” test: `A fiduciary shall … discharge his duties with the care, skill, prudence and diligence … that a prudent man … would use in the conduct of an enterprise of like character.” (quoted by Brown 1977, p. 37) Following modern portfolio theory could be a defense against the charge of imprudence, while diverging too radically from its precepts might even leave one open to such a charge. — Donald MacKenzie, An Engine, Not a Camera, 382

Categorization

• DEFINE: Establishes the ‘prudent man’ test and how it pushed trustees toward portfolio theory as legal cover.
• XREF: Directly serves the book’s performativity thesis: law made financial theory consequential for market behavior. Connects to the general literature on how regulation diffuses academic models.