New York becomes the 47th state to adopt new uniform law for managing, investing and spending charitable endowments
On Sept. 17, 2010, New York adopted its own version of the Uniform Prudent Management of Institutional Funds Act (UPMIFA), modernizing the rules for the management investment, and expenditure of charitable endowments.
But New York charities should beware. The New York Prudent Management of Institutional Funds Act (NYPMIFA) is the most donor friendly of any state’s statute adopting UPMIFA. Among other things, it’s the only state to require charities to notify living donors of many existing endowments and provide such donors with the choice of (1) whether the charity may expend a percentage of the total endowment (including the amount contributed by the donor), or (2) whether the charity must preserve and never spend the amount contributed by the donor, (known under prior law as the “historic dollar value”).
Charitable Endowments – The Basics
Although the largest endowments tend to belong to educational institutions, most charities either have or would like to have an endowment. All charities need to be able to plan for the long-term and not be completely dependent on current revenues. Endowments, either donor restricted or board restricted, are the vehicles that allow for this long-term stability because by definition the charity may expend only a portion of the assets in an endowment fund in a particular year.
An endowment fund usually consists of many – sometimes thousands – of different funds. The vast majority of these funds are subject to restrictions on their use that donors impose and the charity is legally obligated to comply with. Endowments tend to be subject to two different sets of restrictions. All endowments, are subject to the restriction that only a portion of it may be expended annually. In addition, many donor-restricted endowments require that the expended funds be used only for a specified purpose, such as scholarships, endowment professorships or cancer research.
Most endowments are set up by individuals, corporations or foundations as charitable donations or grants. However, the charity’s board can set aside certain endowment funds. Donor-restricted endowments are subject to a large body of common and statutory law protecting the wishes of the donors from unauthorized use by the recipient charity. Board-restricted endowment funds (sometimes referred to as “quasi-endowment”), on the other hand, may typically be unrestricted by board vote at any time and aren’t subject to the large body of state law protecting donor restricted endowments from improper expenditure.
State Law Regulation
The Uniform Management of Institutional Funds Act (UMIFA) enacted in 1972 or its replacement, UPMIFA enacted in 2006, govern the regulation of charitable endowments in virtually all states.
UMIFA revolutionized charitable investing by setting new standards for both the investment of funds held by charities and the expenditure of funds donated as “endowments” to these institutions. Prior to the enactment of UMIFA, charitable endowments were governed by rigid trust law concepts. UMIFA changed these traditional standards for charitable investing by adopting more of a corporate law standard for investing and managing charitable endowments based on the following general principles: (1) that assets should be invested prudently in diversified investments that sought growth as well as income (the first statutory approval of modern portfolio theory); and (2) that appreciation of assets (that is, capital gains) could be prudently spent for the purposes of any endowment fund held by a charitable institution (a rejection of traditional trust law concepts defining what qualifies as “income” versus “principal”).
UPMIFA maintains the two guiding principles of UMIFA, but updates the statute to reflect more modern concepts of trust law due to the enactment of the Uniform Prudent Investor Act (UPIA) in 1994 and the Uniform Principal and Income Act in 1997 (1997 Act).
Scope of UPMIFA
Because UPMIFA has already been adopted in 47 states, along with the District of Columbia, our emphasis will be more on UPMIFA than UMIFA. Although UPMIFA applies to the investment of certain charitable assets not held in endowment, for purposes of this article we’ll only focus on UPMIFA’s application to donor restricted (not board-restricted) endowments.
UPMIFA applies to all donor-restricted endowments held by a nonprofit corporation and those held by a wholly charitable trust with a charitable institution as trustee. UPMIFA doesn’t apply to wholly charitable trusts in which an individual or for-profit entity (for example, a bank) is the trustee. UPMIFA also doesn’t apply to split-interest charitable trusts like charitable remainder and charitable lead trusts. Wholly charitable trusts with an individual or for-profit entity as trustee and split-interest charitable trusts are instead governed by the UPIA.
UPMIFA incorporates many of the provisions of the UPIA, providing additional guidance for the investment management of endowment funds and enumerating a more exact set of rules for investing in a prudent manner. UPMIFA requires endowments to be invested “in good faith and with the care an ordinarily prudent person in a like position would exercise under similar circumstances.” It requires prudence in incurring investment costs, authorizing “only costs that are appropriate and reasonable.”
Factors deemed relevant in managing and investing endowment funds under UPMIFA include: (1) general economic conditions; (2) the possible effect of inflation or deflation; (3) the expected tax consequences, if any, of investment decisions or strategies; (4) the role that each investment or course of action plays within the overall investment portfolio of the fund; (5) the expected total return from income and the appreciation of investments; (6) other resources of the institution; (7) the needs of the institution and the fund to make distributions and to preserve principal; and (8) an asset’s special relationship or special value, if any, to the charitable purposes of the institution.
UPMIFA emphasizes that investment decisions must be made in relation to the overall resources of the institution and its charitable purposes. No investment decision may be made in isolation, but must be made in light of the endowment fund’s entire portfolio, and as a part of an investment strategy having risk and return objectives reasonably suited to the fund and to the institution. Under UPMIFA, a charitable institution must diversify assets in its endowment unless “special circumstances” dictate otherwise. Within a reasonable time after receiving property, a charitable institution must determine whether to retain or dispose of the property to conform to the fund’s investment strategy and objective. Finally, investment experts, whether in-house or hired for the purpose, are held to a standard of care consistent with that expertise.
Expenditure of Endowment Funds
UMIFA initiated the concept of total return expenditure for endowment purposes, expressly permitting prudent expenditure of both appreciation and income and replacing the old trust law concept that only income (for example, interest and dividends) could be spent. Thus, under UMIFA, asset growth and income could be appropriated for program purposes, subject to the rule that a fund couldn’t be spent below the historic dollar value, defined under UMIFA as the amount contributed by the donor.
UPMIFA builds upon UMIFA’s rule permitting the expenditure of appreciation, but it eliminates the concept of “historic dollar value.” UPMIFA, instead, provides better guidance on what constitutes a prudent expenditure, thus alleviating the need for a rigid rule that provides a floor on spending. UPMIFA states that the institution “may appropriate for expenditure or accumulate so much of an endowment fund as the institution determines to be prudent for the uses, benefits, purposes and duration for which the endowment fund is established.” It sets forth the following seven criteria to guide the institution in its yearly expenditure decisions: (1) the duration and preservation of the endowment fund; (2) the purposes of the institution and the endowment fund; (3) general economic conditions; (4) the effect of inflation or deflation; (5) the expected total return from income and the appreciation of investments; (6) other resources of the institution; and (7) the investment policy of the institution. These standards mirror the standards that apply to investment decisionmaking, thus unifying both investment and expenditure decisions more concretely than UMIFA did.
Delegation of Functions
UPMIFA incorporates the delegation rule found in Section 9 of the UPIA, updating UMIFA’s rudimentary delegation rule. UPMIFA permits an institution’s decisionmakers to delegate management and investment functions to external agents if the decisionmakers exercise reasonable skill, care and caution in selecting the agent, defining the scope of the delegation and reviewing the performance of the agent. For example, an institution may select an investment manger to assist with investment decisions. Decisionmakers may not, however, delegate the authority to make decisions concerning expenditures. They may only delegate management and investment functions. Unlike UMIFA, UPMIFA explicitly protects decisionmakers who comply with the requirements for proper delegation from liability for action or decisions of the agents. In making decisions concerning delegation, UPMIFA directs that the institution be mindful that it should incur only reasonable costs in managing and investing the endowment fund.
Release or Modifications of Donor Restrictions
UPMIFA expands the rules for releasing or modifying donor restrictions that are found in UMIFA. Sometimes a donor restriction becomes impractical or wasteful or may impair the management of the fund. UPMIFA provides that the donor may consent to release the restriction without court approval, if the donor is still alive and able to do so. If the donor isn’t available or the institution doesn’t want to seek the donor’s approval, UPMIFA clarifies UMIFA to make it clear that the trust law doctrines of cy pres (modifying a purpose restriction) and deviation (modifying an administrative provision) apply to charitable funds held by a non-profit corporation. A charitable corporation may therefore petition a state court to release or modify a donor restriction in a manner that a court determines to be in accordance with the donor’s probable intention. If the charity asks for court approval of a modification, the charity must notify that state’s chief charitable regulator (usually the Attorney General) and the regulator has the right, but not the obligation, to participate in the proceeding.
UPMIFA adds a new provision that allows a charity to modify a restriction on a small (less that $25,000) and old (over 20 years old) fund without going to court. If a restriction has become impractical or wasteful, the charity may notify that state charitable regulator, wait 60 days, and then, unless the regulator objects, modify the restriction on the small fund in a manner consistent with the charitable purposes expressed in any documents that were part of the original gift.
NYPMIFA has a number of unique provisions, which are not in UPMIFA. Several of these provisions require specific action by charities to be in compliance with the new law.
1. Opt–in / Opt–out notice. Section 553(e) requires that donors to endowment funds established prior to Sept. 17, 2010 be given the chance to opt-in or opt-out of NYMIFA’s new endowment expenditure rules. Specifically, New York charities must provide 90 days notice to available donors, before applying the new expenditure rules of NYPMIFA for the first time. The notice must give the donor the choice to either permit the charity to spend as much of the gift as may be prudent or to prohibit the charity from spending below the historic dollar value of the gift. In addition, the notice must provide the donor with the consequences of each choice. If the donor doesn’t respond within 90 days from the date notice was given, the charity is free to spend as much of the endowment each year as is prudent, as provided by NYPMIFA.
Notice to the donor isn’t required if (1) the gift instrument permits expenditure from the endowment without regard for the fund’s historic dollar value; (2) the gift instrument specifically limits the charity’s authority to expand the endowment fund; or (3) the endowment gift consists of funds received as a result of a solicitation by the charity without a separate statement by the donor expressing a restriction on the use of funds.
2. Expenditure documentation. NYPMIFA Section 553(a) requires that for each determination to appropriate an endowment fund for expenditure, the charity must keep a contemporaneous written record describing the consideration that was given by the charity’s governing board to each of the eight prudent expenditure factors required by UPMIFA.
3. Rebuttable presumption of imprudence. Although not unique to NYPMIFA, since it’s an alternative provision in UPMIFA and has been adopted by a few other states, NYPMIFA Section 553(d) provides that a rebuttable presumption of imprudence shall apply to gift instruments executed on or after Sept. 17, 2010, if the charity expends more than 7 percent of an endowment fund in any year, calculated using a five-year rolling average. It’s important to note that the statute provides than an expenditure of 7 percent or less in any given year doesn’t by itself create a presumption of prudence.
4. Investment policy statement. NYPMIFA Section 552(f) requires each charity to adopt a written investment policy statement setting forth the guidelines on investments and delegation of management and investment functions in accordance with the requirements of the statute.
5. Solicitation of endowment funds. NYPMIFA also amends existing New York law to require that any solicitations by a charity for contributions to an endowment fund include a statement that, unless otherwise restricted by the gift instrument, the charity may expend so much of the endowment fund as it deems prudent after considering the factors governing endowment expenditure under NYPMIFA.
6. Releasing restrictions on small, old endowment funds. NYPMIFA Section 555(d) increases the $25,000 maximum for an expedited procedure for releasing donor restrictions on small, 20 plus year-old endowments to $100,000.
Charitable endowments are an increasingly important component of successful medium and large charities. Endowments allow these charities to plan for the long term to maximize the impact of their charitable programs. Unfortunately, the various regulatory rules applying to charitable endowments aren’t as well understood as they should be. Advisors to charities would do well to bone up on these rules, particularly in New York, to keep charities on the straight and narrow.