The Plaintiff as Victim and Investor: Prudent Investing and the Calculation of Economic Damages
Journal of Legal Economics
In recent years, 45 states have adopted laws regulating the actions of those with fiduciary responsibilities over invested funds of their principals. Under these new laws, trustees are required to behave as would a “prudent investor” in light of modern portfolio theory and are freed from depression-era statutes prohibiting all but low-yielding government securities as investment vehicles. Prudent investing recognizes the risk/return trade-off, the role of diversification and financial intermediaries in eliminating default risk, and the importance of aligning investment decisions with specific circumstances of individuals. This paper explores the implications for forensic economists of these legal changes and the changes in background financial institutions and practices that they mirror. In cases of longer-term pecuniary loss where modern investment practices are likely to be followed by the victim with median attitudes toward risk, the discount rate used by forensic economists should reflect the returns that can reasonably be expected from an at least partially diversified investment. If tort damages are calculated based exclusively on risk-free discount rates, a typically diversified investment approach for the lump sum will result in a significant positive balance at the end of the loss period.