New York State Enacts Prudent Management of Institutional Funds ActNov 08, 2010
Not-for-profit institutions1 must generally manage their donated investment assets, called institutional funds,2 consistent with their donors’ instructions. But donors usually leave flexibility for not-for-profit institutions to decide when and how to invest and spend from those funds. When the donor is silent, State laws provide guidance on how not-for-profit institutions may manage their funds. Until a few years ago, virtually every State had adopted some version of the Uniform Management of Institutional Funds Act (“UMIFA”), a model law drafted by the National Conference of Commissioners on Uniform State Laws (“NCCUSL”). In 2006, the NCCUSL approved the Uniform Prudent Management of Institutional Funds Act (“UPMIFA”), a revised model act intended to replace UMIFA, that emphasizes that investment decisions must be made prudently and in consideration of the overall resources of the institution and its charitable purposes. UPMIFA provides that investments 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,” and requires diversification of assets absent “special circumstances.”3 Most significantly, UPMIFA eliminates UMIFA’s concept of “historic dollar value,” which prohibited expending assets of an endowment fund4 where the value of such assets had depreciated below the value of the original gift. Instead, UPMIFA allows an institution to expend 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,” subject to certain guiding criteria, discussed below.5
On September 17, 2010 New York State enacted the New York Prudent Management of Institutional Funds Act (“NYPMIFA”),6 joining about 47 other States that have adopted a form of UPMIFA. However, NYPMIFA varies in significant ways from the model act, and imposes unique burdens on directors of not-for-profit institutions and fund managers. This memorandum provides an overview of NYPMIFA, including the provisions of the statute that differ from the model act.
A. Managing and Investing Institutional Funds
In addition to a general duty of loyalty, UPMIFA imposes a duty on institutional fund managers to act “in good faith and with the care an ordinarily prudent person in a like position would exercise under similar circumstances,” and to “make a reasonable effort to verify facts relevant to the management and investment of the fund.”7 Fund managers must consider several investment factors, including relevant general economic conditions, the possible effect of inflation or deflation, tax consequences, the overall investment portfolio of the fund, the expected total return from income and appreciation, the fund owner’s other resources and needs (including the need to make distributions and preserve capital), and any special relationship or value of the fund to the institution’s purposes.8 Investments must be diversified, unless the institution has prudently determined that special circumstances exist weighing against diversification.9
Diversification and Written Investment Policies
In addition to the general duties described in the model law, NYPMIFA imposes an additional obligation on the institution to review any decision not to diversify an institutional fund “as frequently as circumstances require, but at least annually[.]”10 NYPMIFA also requires institutions to adopt written investment policies guiding investment and delegating management and investment functions.11 These requirements may be modified by a donor’s specific instruction contained in a written gift instrument.12
Delegation of Management and Investment Function
The model UPMIFA includes an optional provision that allows institutions to delegate investment and/or management authority over institutional funds to external agents, or to internal committees, officers or employees.13 New York has adopted a modified version of this provision, requiring that an institution “act in good faith with the care of an ordinarily prudent person” in “selecting, continuing or terminating an agent, including assessing the agent’s independence,” “establishing the scope and terms of the delegation, including the payment of compensation,” and monitoring the agent’s performance and compliance.14 An institution that acts in compliance with these provisions will not be liable for an agent’s actions or decisions.15 A person who has “special skills or expertise, or is selected in reliance upon the person’s representation that the person has special skills or expertise,” has an affirmative obligation to “use those skills or that expertise in managing and investing institutional funds.”16
NYPMIFA also requires that contracts between an institution and its external agent delegating investment management authority must allow the institution to terminate the contract at any time, without penalty, upon not more than 60 days notice.17
Modification of Restrictions on Small, Old Funds
UPMIFA allows institutions to modify institutional fund restrictions in gift instruments after notice to a State attorney general, without approval by a court, if the institution has determined that the restriction is unlawful, impossible to achieve or wasteful, the fund is older than 20 years, the amount of the fund is smaller than a statutory figure, and the institution uses the fund assets in a manner consistent with the expressed purpose of the gift instrument.18 New York has allowed such modification for funds with total values of less than $100,000.19 In addition, notice to the New York State Attorney General must include an explanation of the institution’s determination that the fund meets the above three requirements, the proposed release or modification, a copy of the institution’s record of approving the release or modification, and a statement of the proposed use of the fund after the release or modification is approved.20 If the Attorney General does not respond within 90 days, the institution may proceed with the proposed release or modification.21
B. Expending or Accumulating Endowment Funds
In addition to the obligations described above with respect to the management and investment of institutional funds generally, UPMIFA adopts a similar prudence standard to be applied in determining how much an institution may expend from an endowment fund.22 Unless the donor has provided specific instructions in a written gift instrument (e.g., establishing a spending level, rate or amount), UPMIFA requires an institution to spend an amount that is “prudent” for the “uses, benefits, purposes and duration for which the endowment fund is established.”23 Institutions must consider the duration and preservation of the endowment fund, the purposes of the institution and the endowment fund, general economic conditions, inflation/deflation, the expected total return from income and appreciation of investments, the other resources of the institution, and the institution’s investment policy.24 NYPMIFA also requires that institutions consider “alternatives” to spending from an endowment fund and the effect that such alternatives could have on the institution (a consideration that is not included in the model act).25
NYPMIFA requires a “contemporaneous record” be made for each decision to appropriate assets in an endowment fund for expenditure, describing the consideration given by the governing board to each of the relevant factors prescribed by law.26
Presumption of Imprudence
The model law includes an optional provision that creates a rebuttable presumption of imprudence for an institution that expends more than 7% of the average fair market value of an endowment fund in any one year.27 (Spending less than 7% in a given year does not create a presumption of prudence.)28 NYPMIFA includes this provision, but calculates the average fair market value “over a period of not less than five years” (rather than over a period of three years, as provided in the model UPMIFA statute), and only applies to gift instruments executed on or after September 17, 2010.29
New York’s statute requires institutions to notify any “available” donors 90 days in advance of applying the new NYPMIFA endowment spending and accumulation rules described above, for gift instruments executed before September 17, 2010.30 A donor is “available” if (i) he or she is living or, if the donor is not a natural person, the entity is in existence and conducting activities, and (ii) the donor can be identified and located through reasonable efforts.31 The notice must request that the donor advise whether the institution may spend as much of the gift as the institution determines is prudent (the new UPMIFA standard), or must maintain the “historic dollar value” of the gift (the prior UMIFA standard).32 During the 90-day period, a donor may also clarify or amend a gift instrument to prohibit application of NYPMIFA’s spending and accumulation rules. If the donor does not respond during the 90-day period, the new spending and accumulation rules will automatically apply.33 However, no notice is required if the gift instrument permits appropriation without regard to the fund’s “historic dollar value” or limits the institution’s authority to spend or accumulate funds based on some other rubric, or if the gift was received in response to an institutional solicitation and the donor did not otherwise explicitly restrict the use of the funds.34
Financial Statement Disclosures
Each year, not-for-profit institutions must disclose information in their financial statements about the assets, spending policies, and related investment policies of their endowment funds, including a determination with respect to each endowment gift of the amount of the gift that must not be expended.35 For a donor-restricted endowment fund that was in existence before a version of UPMIFA is first effective, the institution must report any resulting net asset reclassification.36
2 An “institutional fund” is a fund held by an institution, but excludes program-related assets, funds held for an institution by a non-institution trustee, and funds in which a non-institution beneficiary has an interest (other than an interest arising upon violation or failure of the purposes of the fund). Id. § 551(e).
3 UPMIFA § 3(e)(2) and (4); N.Y. Not-for-Profit Corp. Law § 552(e)(2) and (4).
4 An “endowment fund” is an “institutional fund or part thereof that, under the terms of a gift instrument, is not wholly expendable by the institution on a current basis[,]” but excluding assets designated by the institution as an endowment fund for its own use, consistent with the gift instrument. N.Y. Not-for-Profit Corp. Law § 551(b).
5 UPMIFA § 4(a); N.Y. Not-for-Profit Corp. Law § 553(a).
6 Chapter 490 of the Laws of New York, 2010.
7 UPMIFA § 3(b)-(c); N.Y. Not-for-Profit Corp. Law § 552(b)-(c).
8 UPMIFA § 3(e)(1); N.Y. Not-for-Profit Corp. Law § 552(e)(1).
9 UPMIFA § 3(e)(4); N.Y. Not-for-Profit Corp. Law § 552(e)(4).
10 N.Y. Not-for-Profit Corp. Law § 552(e)(4).
11 Id. § 552(f).
12 Id. § 552(a).
13 UPMIFA § 5.
14 N.Y. Not-for-Profit Corp. Law § 554(a)(1)-(3).
15 UPMIFA § 5(c); N.Y. Not-for-Profit Corp. Law § 554(c).
16 UPMIFA § 3(e)(6); N.Y. Not-for-Profit Corp. Law § 552(e)(6).
17 N.Y. Not-for-Profit Corp. Law § 554(e).
18 UPMIFA § 6(d).
19 N.Y. Not-for-Profit Corp. Law § 555(d)(1).
20 Id. § 555(d)(2).
21 Id. § 555(d)(3).
22 UPMIFA § 4(a); N.Y. Not-for-Profit Corp. Law § 553(a). As noted above, an “endowment fund” is an institutional fund that, under the terms of the gift instrument, is “not wholly expendable by the institution on a current basis.” N.Y. Not-for-Profit Corp. Law § 551(b).
23 UPMIFA § 4(a); N.Y. Not-for-Profit Corp. Law § 553(a).
24 UPMIFA § 4(a); N.Y. Not-for-Profit Corp. Law § 553(a)(1)-(6).
25 N.Y. Not-for-Profit Corp. Law § 553(a)(7).
26 Id. § 553(a)(8).
27 UPMIFA § 4(d).
29 N.Y. Not-for-Profit Corp. Law § 553(d).
30 Id. § 553(e)(1). NYPMIFA includes model language for the form of notification. Id.
31 Id. § 551(j).
32 Id. § 553(e)(1).
34 Id. § 553(e)(2).
35 FASB ASC 958-205-45-13 through 45-35 (“Reporting Endowment Funds”).