by Kristen G. Juras Assistant Professor University of Montana School of Law

Transcription

1 Uniform Prudent Management of Institutional Funds Act by Kristen G. Juras Assistant Professor University of Montana School of Law A. UMIFA Becomes UPMIFA. In 1973, Montana adopted the Uniform Management of Institutional Funds Act (UMIFA) promulgated in 1972 by the National Conference of Commissioners on Uniform State Laws (NCCUSL). It was codified at MCA et seq. 1. UMIFA was intended to provide standards to govern the investment and expenditure of funds of charitable institutions. UMIFA modified the common law rules in two important regards. a. First, it departed from the prudent investor standard applicable to trustees and incorporated a less restrictive ordinary business care standard. For example, trustees could invest in property which did not generate current income if appropriate to carry out the purposes of the charity. b. Second, it allowed a charity in appropriate situations to expend the appreciation of principal (rather than limiting expenditures to traditional concepts of income, such as interest and dividends). 2. In the meantime, common law and statutory rules governing investments and expenditures by trustees have evolved to embrace total portfolio return and unitrust concepts, as evidenced by the adoption of the Uniform Prudent Investor Act in Montana and numerous other states. See MCA et seq. 3. In 2006, NCCUSL adopted the Uniform Prudent Management of Institutional Funds Act (UPMIFA). UPMIFA s purposes include: a. updating the investment standards applicable to charitable institutions to reflect the trends in prudent investment standards; b. updating the rules governing expenditures from endowment UPMIFA Page 1

2 funds, including abandonment of the historic dollar value concept; c. clarifying the rules governing the release and modification of donor restrictions on charitable funds; and d. affirming the importance of following and protecting donor intent with respect to expenditures from endowments. For an in-depth article comparing UMIFA with UPMIFA, see Susan A. Gary, Charities, Endowments and Donor Intent: The Uniform Prudent Management of Institutional Funds Act, 41 Ga. L. Rev (2007). B. Institutions Governed by UPMIFA. UPMIFA applies to institutions, defined at MCA (4) to include: 1. An institution organized and operated exclusively for charitable purposes; 2. a government or governmental subdivision, agency, or instrumentality, to the extent that it holds funds exclusively for a charitable purpose; and 3. a charitable trust, after all non-charitable interests have terminated. However, when read in context with the definition of institutional funds, a charitable trust will be subject to UPMIFA only if a charity acts as trustee. It does not apply to funds held in a charitable trust for which an individual or a non-charitable organization acts as trustee. For example, if a trust company acts as the trustee of a charitable trust established for the benefit of the University of Montana Foundation, the trust company is not subject to UPMIFA. Instead, the trust company is governed by the rules applicable to trustees. On the other hand, if the University of Montana Foundation serves as a trustee of a charitable trust for the benefit of the Foundation after all non-charitable interests have terminated, it is governed by UPMIFA in managing the trust. C. Funds Governed by UPMIFA. UPMIFA applies to a fund held by an institution exclusively for charitable purposes. However, assets held by an institution primarily for program-related purposes rather than exclusively for investment are not subject to UPMIFA. MCA (5). For example, in deciding whether to use its funds to purchase a new building in which to operate, a charitable organization does not have to apply UPMIFA standards. UPMIFA Page 2

3 D. UPMIFA Fundamentals. MCA (1) sets forth two fundamental duties of the institution in making investment and management decisions: 1. An institution must comply with donor intent as expressed in the terms of the gift instrument; and 2. An institution must consider the institution s charitable purposes in making investment decisions. E. UPMIFA Investment Standards. MCA (5) specifies the factors a charity must consider in making investment decisions, incorporating many of the factors set forth in the Uniform Prudent Investor Act (see MCA ). Except as otherwise provided by a gift instrument, the following rules apply: 1. Management and investment decisions about an individual asset must be made not in isolation but rather in the context of the institutional fund s portfolio of investments as a whole and as a part of an overall investment strategy having risk and return objectives reasonably suited to the fund and to the institution. MCA (5)(b). 2. An institution is required to diversify the investments of an institutional fund unless the institution reasonably determines that, because of special circumstances, the purposes of the fund are better served without diversification. MCA (5)(d). 3. Within a reasonable time after receiving property, an institution must decide whether to retain or dispose of the property or to re-balance a portfolio, consistent with the institutions purposes, donor intent and UPMIFA. MCA (5)(e). 4. In managing and investing an institutional fund, the following factors, if relevant, must be considered under MCA (5)(a): (A) general economic conditions; (B) the possible effect of inflation or deflation; (C) the expected tax consequences, if any, of investment decisions or strategies; (D) the role that each investment or course of action plays within the UPMIFA Page 3

4 overall investment portfolio of the fund; (E) the expected total return from income and the appreciation of investments; (F) other resources of the institution; (G) the needs of the institution and the fund to make distributions and to preserve capital; and (H) an asset s special relationship or special value, if any, to the charitable purposes of the institution. F. Additional Duties. In making investment and management decisions, the institution must also abide by the following duties: 1. The decision makers must exercise a duty of loyalty, as defined by fiduciary standards (MCA (2)); 2. The decision makers must act in good faith and exercise a duty of care, described as the care an ordinarily prudent person in a like position would exercise under similar circumstances (MCA (2)); 3. The institution must incur only those investment costs that are appropriate and reasonable in relation to the assets, the purposes of the institution, and the skills available to the institution (MCA (3)); 4. The institution must stay informed and investigate the accuracy of the information used in making investment decisions (MCA (3)); and 5. A person managing or investing institutional funds must use any particular skills or expertise she has in carrying out the management or investment duties. MCA (5)(f). G. Delegation. Subject to any restrictions in the gift instrument or other UPMIFA Page 4

5 applicable laws, MCA allows the institution to delegate to an external agent the management and investment of an institutional fund to the extent that an institution could prudently delegate under the circumstances. In making the decision to delegate, an institution must act in good faith and with the care that an ordinarily prudent person in a like position would exercise under similar circumstances in: (1) selecting an agent; (2) establishing the scope and terms of the delegation, consistent with the purposes of the institution and the institutional fund; and (3) periodically reviewing the agent s actions in order to monitor the agent s performance and compliance with the scope and terms of the delegation. H. Endowment Funds. MCA provides special rules governing expenditures from endowment funds. An endowment fund is defined as those funds donated to a charity with the intent that the funds not be wholly expendable by the institution on a current basis. MCA (2). The term does not include unrestricted assets that an institution itself designates as an endowment fund for its own use. MCA (2)(b). 1. Whether a fund is an endowment fund depends on the terms of the "gift instrument" used to create the fund. If the gift instrument indicates an intent that the gift is not to be currently expended, the funds are endowment funds. For example, a donor s direction to a charity to hold the fund as an endowment or retain principal and spend income would be sufficient to establish an endowment fund. 2. A gift instrument is defined to include all records, including an institutional solicitation, under which property is granted to, transferred to, or held by an institution as an institutional fund. MCA (3). A record means information that is inscribed on a tangible medium or that is stored in an electronic or other medium and is retrievable in perceivable form. MCA (8) UPMIFA Page 5

6 a. As explained in the official comments: A record is an expansive concept and means a writing in any form, including electronic. The term includes a will, deed, grant, conveyance, agreement, or memorandum, and also includes writings that do not have a donative purpose. For example, under some circumstances the bylaws of the institution, minutes of the board of directors, or canceled checks could be a gift instrument or be one of several records constituting a gift instrument. I. UMIFA Historic Dollar Concept. Under UMIFA, an institution could spend not only the traditional income earned by an endowment fund, such as dividends and investments, but was also allowed, if prudent, to expend the appreciation in a fund s historic dollar value. The Commissioners questioned whether the use of historic dollar value may mislead charities into a decision to expend all appreciation above a fund s historic dollar value, rather than preserving some appreciation. The Commissioners also noted that UMIFA provided insufficient guidance as to rules governing expenditures if the fund s value fell below its historic dollar value. 1. UPMIFA has abandoned the concept of historic dollar value. The historic dollar value of a fund is not relevant in making a decision under UPMIFA as to expenditures from that fund. J. General UPMIFA Spending Rules for Endowment Funds. UPMIFA applies a prudence standard to the process of making decisions about expenditures from an endowment fund. MCA allows an institution to spend or accumulate so much of an endowment fund as the institution determines is prudent for the uses, benefits, purposes, and duration for which the endowment fund is established. Expenditures are not limited to historic concepts of income, but can also be made from appreciation. Under MCA (1), in making expenditure and accumulation decisions, the institution must act in good faith and with the care that an ordinarily prudent person in a like position would exercise under similar circumstances, considering, if relevant, the following factors: (1) the duration and preservation of the endowment fund; (2) the purposes of the institution and the endowment fund; UPMIFA Page 6

7 (3) general economic conditions; (4) the possible 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. K. Donor Intent; Rules of Construction. The foregoing expenditure rules apply only to the extent that a donor and an institution have not reached some other agreement about spending from an endowment. 1. Under MCA (2), in order to limit the expenditure rules noted above, a gift instrument must specifically state the limitation. For example, a donor might require that a charity spend five percent of an endowed gift each year, regardless of investment performance or other factors. Or a donor may specifically restrict expenditures of a fund to income, and may further define income to exclude appreciation. 2. MCA (3) provides that general language in a gift instrument to use only "income", "interest", "dividends", or "rents, issues, or profits" or "to preserve the principal intact" is insufficient to limit the authority to appropriate for expenditure or accumulate under the expenditure rules of subsection (1). a. For example, if a donor makes a gift of $100,000 to the University of Montana Foundation to spend the income to provide scholarships for students attending the UM Law School, the UM Foundation is not limited to spending only interest and dividends. It may apply the above spending guidelines to reach a conclusion that expenditure of capital appreciation would be prudent. 3. If a donor clearly expresses an intent that would not allow the spending rules set forth in UPMIFA to apply (for example, an instruction to spend 5% of the value of the fund), then as a practical matter the institution should UPMIFA Page 7

8 invest those funds separately rather than pooling the investments of that fund with other investments of other endowment funds that are subject to UPMIFA expenditure standards. L. Presumption of Imprudence. UPMIFA includes an optional provision that provides a rebuttable presumption of imprudence if an institution, in applying the above standards, spends more than seven percent of the fair market value of the endowment fund (determined by reference to an average of the quarterly values of the fund in the three immediately preceding years). This provision was debated extensively by the Commissioners, who have set forth in the comments the advantages and disadvantages for states to consider in determining whether to adopt this optional provision. Montana did adopt the 7% mechanical guideline at MCA (4). 1. The advantages of providing a mechanical guideline include: a. curbing a charity s temptation to spend endowment assets too rapidly; b. providing the attorney general a benchmark in any enforcement proceedings against a charity. 2. The disadvantages of the adoption of the optional 7% guideline include: a. a fixed percentage in the statute might be perceived as a safe harbor that could lead institutions to spend more than is prudent; b. the difficulty of picking a number that will be appropriate in view of the range of institutions and charitable purposes and the fact that economic conditions will change over time. 3. The presumption of imprudence does not create an automatic safe harbor. MCA (4)(b) specifically states that the 7% rule does not create a presumption of prudence for an appropriation for expenditure of an amount less than or equal to 7% of the fair market value of the UPMIFA Page 8

9 endowment fund. A charity would be misled to believe that expenditures of six percent automatically satisfy the UPMIFA spending standards. Expenditures of six percent may be imprudent in certain situations. M. Release or Modification of Donor Restrictions. UPMIFA allows donor restrictions to be released or modified, in whole or in part, in the following situations: 1. A donor may consent in a record to release or modify a restriction. However, the donor may not allow a fund to be used for a purpose other than a charitable purpose of the institution. A record is information that is inscribed on a tangible medium or that is stored in an electronic or other medium and is retrievable in perceivable form. MCA (1). 2. Upon application of the institution, a court may modify a restriction contained in a gift instrument regarding the management or investment of an institutional fund if the restriction has become impracticable or wasteful, if it impairs the management or investment of the fund, or if, because of circumstances not anticipated by the donor, a modification of a restriction will further the purposes of the fund. MCA (2). For example, under this section a charity could seek approval to remove a restriction requiring the charity to invest only in bonds, or prohibiting the sale of certain assets contributed to the fund. This doctrine of equitable deviation, derived from trust law, does not alter the purpose of the gift but rather modifies the means in order to carry out the purpose. 3. UPMIFA incorporates the doctrine of cy pres. If a particular charitable purpose or a restriction contained in a gift instrument on the use of an institutional fund becomes unlawful, impracticable, impossible to achieve, or wasteful, the court, upon application of an institution, may modify the purpose of the fund or the restriction on the use of the fund in a manner consistent with the charitable purposes expressed in the gift instrument. MCA (3). The official comments note that the term modify encompasses the release of a restriction as well as an alteration of a restriction and also permits a court to order that the fund be paid to another UPMIFA Page 9

10 institution. 4. For both equitable deviation and cy pres matters, the institution must notify the attorney general who may choose to participate in the court proceeding. MCA (2), (3). 5. Finally, an institution may modify a release or restriction without court approval if an endowment fund is $25,000 or less and has been in existence for more than 20 years, and the institution determines that a restriction contained in a gift instrument on the management, investment, or purpose of an institutional fund is unlawful, impracticable, impossible to achieve, or wasteful, the institution. The institution must give notice of the modification to the attorney general, and must wait 60 days after notice before proceeding. The attorney general may take action if the proposed modification appears inappropriate. 6. UPMIFA does not require an institution to notify donors of a judicial action seeking modification under either the equitable deviation or cy pres procedures, nor for the non-judicial modification for small and older funds. N. Effective Date. UPMIFA applies to institutional funds existing on October 1, 2007 or established thereafter. As applied to institutional funds existing on October 1, 2007, UPMIFA governs only decisions made or actions taken on or after that date. UPMIFA has already been adopted in 13 states since its promulgation in 2006, and is currently under consideration by legislatures in six additional states. O. Accounting Standards. Under UMIFA, an endowment fund restricted as an endowment but not restricted as to purpose is reported for accounting purposes as restricted in the amount of the historic dollar value of that account and unrestricted as to all amounts above historic dollar value. Fin. Statements of Not-for-Profit Orgs., Statement of Fin. Accounting Standards No Because UPMIFA eliminates the concept of historic dollar value, no part of an endowment fund that is unrestricted as to purpose will be considered permanently restricted under current accounting rules. UPMIFA raises significant accounting questions that will need to be addressed under FASB. UPMIFA Page 10

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