Revisions to the Uniform Management of Institutional Funds Act Susan N. Gary, Reporter Comments Based on Draft Dated January 29, 2004 Background In the fall of 2000 the National Conference of Commissioners on Uniform State Laws ( NCCUSL ) created a Study Committee to review the Uniform Management of Institutional Funds Act ( UMIFA ) and consider whether a revision of UMIFA was needed. The Study Committee s report recommended that NCCUSL appoint a drafting committee, and the Drafting Committee began its work in the spring of 2002. UMIFA was originally promulgated in 1972. The Act provides guidance to institutional nonprofits on investment authority, permits delegation of authority to independent financial advisors, authorizes the expenditure of appreciation of investment funds, and provides rules for the release of restrictions on the use or investment of funds. As a Uniform Act, UMIFA has been highly successful. Forty-seven jurisdictions have enacted UMIFA, and although variations exist, the general principles of UMIFA have been adopted almost universally. UMIFA s approach to endowment management permitting the expenditure of unrealized appreciation has enabled fund managers to use modern investment techniques such as total return investing and unitrust-style spending. UMIFA was, in a sense, a forerunner of the Uniform Prudent Investor Act, an act that regulates the investment responsibilities and authority of trustees of trusts. Although UMIFA has been successful, the Study Committee determined that the time had come for a revision. The committee report identified as the driving concern the need to conform UMIFA with the provisions of two important uniform acts that have been promulgated more recently than the original UMIFA. The Uniform Prudent Investor Act (1994) ( UPIA ) and the Uniform Trust Code (2000) ( UTC ) both contain provisions that relate to the purposes underlying UMIFA. Consistency among its uniform laws is a goal of NCCUSL and incorporating these later changes into UMIFA became part of the Drafting Committee s charge. The Study Committee identified the following specific tasks for the Drafting Committee: Conform the investment provisions of UMIFA with UPIA. Update the rules on release of restrictions to reflect the cy pres standards in the UTC. Consider whether a settlor should be able to enforce a restriction on a gift. Clarify the scope of the terms institution and institutional fund so that the coverage of the Act will be clear. Consider whether UMIFA could ameliorate tensions between UMIFA s concept of appreciation and that of the Accounting Standards Board. Appendix 12G Revisions to UMIFA Page 1 of 6
Definitions - What Does the Act Cover? Definition of Endowment Fund. An endowment fund is a fund that is not wholly expendable on a current basis. Thus, an endowment fund may exist in perpetuity, but a fund created for a ten-year period also fits within the definition. The investment provisions of UMIFA apply to all institutional funds, but Section 4, Expenditure of Endowment Funds, applies only to endowment funds. Whether a fund is an endowment fund depends on the terms of the gift instrument used to create the fund. UMIFA defines gift instrument to mean all written documents, including electronic writings, under which property is transferred to a charity. Questions may arise about which documents are integrated as part of the gift instrument. For example, if a solicitation uses the term endowment, does that mean that any funds received in response to the solicitation are subject to the restrictions that apply to endowments? In the view of the Drafting Committee, a solicitation could become part of the writing that creates the endowment. The question would be whether the solicitation was integrated with other writings and whether a subsequent instrument superseded the language in the solicitation. Definition of Institution. The Drafting Committee decided that UMIFA should apply to all charities, regardless of their form of organization. UMIFA (1972) did not apply to trusts, but the Committee concluded that the rules for the management, investment and expenditure of charitable funds should not depend on the organizational form of the charity. Many of the provisions UMIFA adopts derive from trust law, so charitable trusts have already been subject to many of these rules. The Drafting Committee also decided to include in the definition of institution those funds held by a corporate trustee for the benefit of a charity. UMIFA (1972) had excluded those funds, which led to difficulties for funds that used a bank as a trustee. The definition of institution can also include a governmental organization, because some governmental organizations or branches of government hold funds for charitable purposes. States that have established universities by charter (Iowa is an example) may need additional language to clarify that UMIFA applies to those universities. Definition of Institutional Fund. Much of what UMIFA does relates to investment management. The rules governing investments, including a prudent investor standard of conduct, the authority to invest in a wide range of investments, and the ability to delegate investment functions, apply to all funds held by the institution for its own use or purposes. Definition of Instrument. Electronic records have been added to the definition of instrument. Appendix 12G Revisions to UMIFA Page 2 of 6
Investment and Management Decisions Section 3 The Prudence Standard. Section 3 of UMIFA directs each institution to make decisions in investing and managing assets of the institution as a prudent investor would. Section 3 derives its approach, and for the most part its language, from UPIA. The Act sets forth factors the institution should consider in making investment decisions. Some factors focus on the nature of the charity and the particular fund. These factors include directions from the donor in the gift instrument, the purposes of the charity and of the fund, the needs of the institution to make distributions and to preserve capital, and other resources of the institution. Other factors look to general economic conditions and to investment strategies that analyze the portfolio as a whole, including total-return investing and sensitivity to the risk and return curve of the entire portfolio. UMIFA, like UPIA, requires diversification absent special circumstances and requires the institution to minimize costs associated with investment. The only provision from UPIA not included in UMIFA is a provision that imposes a duty on trustees who have special skills or expertise to use those skills as trustees. The Drafting Committee concluded that imposing a higher standard on some members of a charity s governing board exceeded the scope of UMIFA. Program-related Assets. The Drafting Committee decided not to exclude programrelated assets from UMIFA. Instead, the Act requires an institution to consider the programrelated use to which an asset will be put in making decisions about whether to acquire or retain the asset. Program-related assets are not held to the same risk and return analysis that applies to an institutional fund held purely for investment purposes. The degree to which the charity will use the asset for programmatic purposes will serve as a factor in the charity s decision making with regard to the asset. Expenditure of Endowment Funds When Can a Charity Distribute Appreciation? Historic Dollar Value. One of the reasons behind the first UMIFA was a need to permit investment strategies that did not depend on the characterization of an institution s assets as income or principal for accounting purposes. If an institution could spend only income from an endowment fund, then investments in assets with appreciation potential could affect the institution s ability to use its endowment. UMIFA (1972) created the concept of historic dollar value and then permitted the expenditure of appreciation in excess of historic dollar value if the institution determined that expenditure of the funds was prudent. Historic dollar value was determined based on contributions to the endowment fund. Income, appreciation and depreciation of assets did not affect historic dollar value. In recent years, the concept of historic dollar value has created substantial difficulties for some institutions. For example, an institution established five years ago with a substantial gift of dot.com stock could find the historic dollar value of its endowment at a level much higher than the current value of those assets. The institution might have to wait years before its endowment again reaches the historic dollar value. A rule that permits distributions from the endowment only if the asset value exceeds the value at the time the contributions were made could prevent the institution from distributing anything for many years. Appendix 12G Revisions to UMIFA Page 3 of 6
For other organizations, the historic dollar value floor has little meaning. An institution established in 1930 with a gift at stock would have an historic dollar value substantially below the value of the initial gift if adjusted to reflect inflation. New Approach - UMIFA Section 4. The Drafting Committee revised UMIFA to provide more flexibility to the persons at the institution making decisions about expending funds. The intent is not to allow a governing board to convert an endowment fund into a nonendowment fund, but rather to encourage the board to preserve the purchasing power of the current value of an endowment fund. The institution should be able to establish a spending approach that will be responsive to short-term fluctuations in the value of the fund. The Drafting Committee replaced the historic dollar value approach with a standard of prudence that applies to the decision-making process of the governing board. The articulation of the standard derives from UPIA and thus already applies to trusts, at least in states that have adopted UPIA. Under the prudence standard, the board must exercise reasonable care, skill, and caution, and must consider a number of factors in deciding how much to distribute from an endowment fund. These factors include the purposes of the institution, the intent of donors to the endowment fund, the needs of the institution, the availability of other resources, and general economic conditions. Restriction Limiting Expenditures. If a donor wants to limit expenditures from an endowment gift to accounting income and does not want the institution to be able to expend principal under the provisions of Section 4, then the donor must say so very explicitly in the instrument making the gift. Merely designating the gift as an endowment or authorizing the institution to use only income will not be sufficient. Presumption of Imprudence. If expenditures in one year exceed seven percent of the value of an endowment fund, UMIFA treats the decision to spend that amount as presumptively imprudent. An institution can rebut the presumption by showing that in a given year expenditures in excess of seven percent were prudent, after considering all the circumstances affecting the institution and the fund. The Drafting Committee added the presumption to allay fears that without the historic dollar value floor an institution would spend endowment assets too rapidly. The presumption should serve as a reminder that prudence controls decision making and that each governing board must make decisions on expenditures based on the circumstances of the institution. The presumption does not mean that expenditures below seven percent are presumptively prudent. Indeed, spending at rates of five or six percent annually will be too high for many, if not most, endowments. The Drafting Committee declined to provide a safe harbor for spending because of the impossibility of creating a spending rule by statute that could consider the many factors that go into prudent decision making for an individual institution. Thus, a governing board must exercise its discretion in making prudent decisions for the institution. Appendix 12G Revisions to UMIFA Page 4 of 6
Delegation of Investment Management Section 5 UMIFA (1972) contains a provision permitting delegation of investment authority, so the power to delegate investment management is not new. Revised UMIFA updates the delegation provision by incorporating the rule on delegation from UPIA. Release or Modification of Restrictions Section 6 With Donor Consent. The donor can consent, in writing, to release a restriction on the use or investment of an institutional fund. The power to release a restriction provided under the Act does not create a power with tax consequences for the donor. The initial gift will be a completed gift because the power to release the restriction does not include a power to divert the property from the charitable beneficiary. Cy pres. UMIFA adopts the cy pres approach provided for charitable trusts in UTC 413. The governing board must seek court approval for the release and must give notice to the state attorney general. The court may release or modi1~ the restriction if the restriction is unlawful, impracticable, impossible to achieve, or wasteful. Any release or modification must be consistent with the purposes for the fund expressed in the gift instrument. Although UMIFA does not require the charity to notify donors to a fund subject to cy pres, good practice will be to notify all donors who can reasonably be located. Small Value, Old Fund. If a fund has a total value of less than $25,000 and if the fund has existed at least 20 years, the governing board can apply cy pres itself, without court approval, if the other requirements of cy pres are met. The charity must notify the attorney general of the proposed modification and must use the fund in a manner consistent with the purposes stated in the gift instrument. The Drafting Committee determined that for some small funds that have existed for a long time, a restriction may no longer make sense but the cost of a judicial cy pres proceeding will be prohibitive. The fund may have many donors or because of the age of the fund the donor may be deceased or impossible to find. Either way, obtaining donor consent may not be feasible, so judicial cy pres will be the only option. The Committee wanted to allow a charity to modify the restriction without the cost of going to court. Before proceeding with a modification under this section the charity must notify the attorney general. The attorney general can intercede if the restriction is not unlawful, impracticable, impossible to achieve, or wasteful, or if the proposed modification is inconsistent with the purposes stated in the gift instrument for the fund. Appendix 12G Revisions to UMIFA Page 5 of 6
Enforcement of Restricted Gifts Donor Standing The Study Committee charged the Drafting Committee with considering whether a donor should have standing to enforce a restriction on the donor s gift. In general, only a state attorney general has standing to sue a charity. The attorney general represents the public interest in the assets that have been committed to the public good. In some limited circumstances, courts have expanded standing, but when a donor makes a gift to an institution, the donor may be without recourse to enforce the terms of the gift unless the donor specifically reserved the right to enforce those terms in a gift instrument. After much discussion and consideration of proposals in initial drafts of revised UMIFA, the Drafting Committee concluded that donor standing fell outside the scope of UMIFA and should not be addressed in the Act. Accounting Standards The Drafting Committee also concluded that issues involved in accounting treatment of restricted funds were beyond the scope of UMIFA. Looking Ahead NCCUSL will vote on UMIFA at its annual meeting in August 2004. The current draft, as well as all prior drafts, can be found by going to www.nccusl.org. On the NCCUSL homepage, go to Select a Committee and select UMIFA. After selecting UMIFA, click on Search and you will reach a page with all prior drafts, memos to the Drafting Committee, and a list of the Committee members. Comments and questions can be sent to sgary@law.uoregon.edu. Appendix 12G Revisions to UMIFA Page 6 of 6