Thursday April 25, 2024

7.3.2 Investment Responsibilities (UPMIFA)

Investment Responsibilities (UPMIFA)

I. Definition - Endowment:  An endowment is a fund, established by a donor or by the charity's governing board, consisting of charitable gifts that are not wholly expendable by the institution on a current basis.

II. UMIFA vs. UPMIFA:  The Uniform Prudent Management of Institutional Funds Act ("UPMIFA", "the Act") replaces the Uniform Management of Institutional Funds Act ("UMIFA").

III. Duties and Responsibilities of Fiduciaries:  Sections 1 and 2 of UPMIFA simply give the Act its name and define certain terms to be used throughout the various provisions.

IV. Investment Managers and the Investment Policy Statement:  In general, the Act allows an organization's Board of Directors to delegate the management and investment of an endowment fund to a professional investment manager.

VI. Expenditures:  Section 4 of UPMIFA relates one of the primary changes from prior law. This section deals with endowment spending

V. Investing an Endowment:  The identification of excess benefit transactions and application of intermediate sanctions does not supersede or replace the traditional private inurement prohibition.

VI. Expenditures:  Section 4 of UPMIFA relates one of the primary changes from prior law. This section deals with endowment spending.

VII. Removing Restrictions:  Section 6 of UPMIFA states the conditions under which a charity may modify or remove restrictions on an endowment fund.

Many non-profit organizations have endowment funds established either by a donor or by the charity's governing board. It is important that these funds are invested wisely so that the charity can benefit from income provided by the well-invested fund.

This raises a number of questions. How should the fund be invested? What are the responsibilities of the investment manager and the board of directors? UPMIFA and common practice provide some guidance to a charity with these sorts of questions.

I. Definition - Endowment


An endowment is a fund, established by a donor or by the charity's governing board, consisting of charitable gifts that are not wholly expendable by the institution on a current basis. Instead, the gift instrument provides that the gift principal must be maintained and reinvested in order to create a source of income for the organization.

There are generally three types of endowment funds: permanent endowment funds, term endowment funds and quasi-endowment funds. A donor contributing to a permanent endowment fund includes a restriction that the principal must be retained and invested in perpetuity. On the other hand, a donor contributing to a term endowment fund specifies that at some point in time the principal will become available for the general or a specific purpose of the organization. Finally, a quasi-endowment fund is set up by the non-profit's governing board to be retained and invested for a specific purpose.

II. UMIFA vs. UPMIFA


The Uniform Prudent Management of Institutional Funds Act ("UPMIFA", "the Act") replaces the Uniform Management of Institutional Funds Act ("UMIFA"). UMIFA was approved by the National Conference of Commissioners on Uniform States Laws ("NCCUSL") in 1972 and was enacted by 47 states. However, the management and investments standards of UMIFA became out of date with modern portfolio theory. In addition, after the "dotcom" bubble burst, many endowments went underwater exposing a glaring flaw in UMIFA's spending provision.

Under UMIFA, a charity could only spend income generated by the fund until the fund balance dropped to "historic value." However, if the fund dropped below historic value UMIFA did not provide any guidance on spending. Other criticisms of the "historic value" spending provision were that historic value was fixed at an arbitrary moment in time and after a number of years often became meaningless. Therefore, UPMIFA was approved by the NCCUSL in 2006 to update the investment, management and spending standards of UMIFA. As of November 2013, it has been adopted in all states except Pennsylvania.

The main purpose of the Act is to govern the management, investment and spending of charitable endowments. However, it also includes provisions on delegating authority, gift instrument construction and releasing or modifying restrictions on charitable funds.

The Act applies to public charities and private foundations organized as nonprofit corporations. It does not apply to trusts managed by corporate or individual trustees, but it does apply to trusts managed by charities.

III. Duties and Responsibilities of Fiduciaries


Sections 1 and 2 of UPMIFA simply give the Act its name and define certain terms to be used throughout the various provisions. However, Section 3 covers the standards governing management and investment of endowment funds.

In order to understand the standard governing directors, officers and investment managers when it comes to investing endowment funds, it is important to understand the concept of a fiduciary. A fiduciary is an individual (or organization) given the authority to act on behalf of another. A fiduciary is subject to certain legal duties to ensure that they act in the best interest of the person they represent.

Non-profits hold and invest donors' funds for the public benefit. As a result, the leaders of a charitable organization are subject to fiduciary duties in holding and investing those funds on behalf of the public. If you are on the board of directors, are a corporate officer or another employee with financial responsibilities then you are likely required to comply with fiduciary duties.

UPMIFA describes the fiduciary duties that apply to the officers, directors and fund managers of a non-profit organization when it comes to managing and investing endowment funds. They must comply with the duty of loyalty, the duty of care and the duty of obedience. They also have a duty to minimize costs, investigate factual accuracy and diversify investments.

  1. Duty of Loyalty The Act does not specifically state the duty of loyalty, but simply incorporates "the duty of loyalty imposed by law other than this Act." The drafters were concerned that different standards of loyalty might apply to non-profit directors and trustees of charitable trusts. As a result, the Act simply incorporates both standards by using the above quoted language.

    The duty of loyalty under non-profit corporation law applies to charities organized as non-profits and the duty of loyalty under trust law applies to charitable trusts. The difference between the two standards is slight. The duty of loyalty under non-profit corporation law says that a director or officer must act in a manner that he or she reasonably believes to be in the best interests of the organization. Trust law states that the trustee of a charitable trust must act in a manner that he or she reasonably believes to be in the sole interests of the trust beneficiaries. The basic idea is that the manager must consider the organization's or the trust beneficiary's interests as his or her own and invest the funds in a way that protects those interests.

  2. Duty of Care The duty of care requires officers, directors and fund managers to manage and invest the endowment fund "in good faith and with the care an ordinarily prudent person in a like position would exercise in similar circumstances." In other words, the non-profit manager must invest the endowment as a prudent non-profit investment manager would invest the funds. Complying with the duty of care while managing investments requires the fund manager to consider eight factors in making investment decisions: (1) general economic conditions; (2) the possible effect of inflation/deflation; (3) the expected tax consequences of investment decisions/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) the other resources of the institution; (7) the needs of the institution and the fund to make distributions and to preserve capital; and (8) an asset's special relationship or special value to the charitable purposes of the institution. Investment managers must consider these factors in making investment decisions in order to comply with the duty of care.

  3. Duty of Obedience The duty of obedience shows the Act's deference to the intent of the donor. Section 3 begins, "Subject to the intent of a donor expressed in the gift instrument..." and proceeds to require the investment manager to consider the charitable purposes of the fund and the organization in making investment decisions. However, everything is subject to the intent of the donor in the gift instrument. So, fund managers have an overarching duty to comply with the donor's intent as expressed in the gift instrument. This is why organizations should pay particular attention to how a gift instrument is worded.

  4. Duty to Manage Costs The Act also imposes a duty to manage costs. It states that in managing and investing institutional funds, the charity may incur only costs that are appropriate and reasonable in relation to the organization's assets, the purposes of the organization and the skills available to the organization. This is essentially a duty to minimize costs. The organization may incur costs in hiring an investment manager (as discussed below), but these costs must be appropriate under the circumstances. In order to comply with the duty to manage costs, directors and officers should review costs associated with investments to make sure that they are appropriate.
  5. Duty to Investigate Directors, officers and fund managers also have a duty to investigate the factual accuracy of information. The Act provides that in managing and investing funds, the charity must make a reasonable effort to verify facts relevant to the management and investment of the fund. So, those that make investment and management decisions must investigate the accuracy of the information they rely upon to make those decisions.

  6. Duty to Diversify The duty to diversify investments is consistent with modern portfolio theory. The goal of modern portfolio theory is to maximize expected total return for a given level of risk. The Act requires a non-profit to diversify the investments of its institutional fund unless it reasonably determines that, because of special circumstances, the purposes of the fund are better served without diversification. This standard requires a non-profit to diversify unless a special determination is made. The determination that a special circumstance exists is made based on the needs of the charity and not solely for the benefit of a donor.

In addition to the above duties, Section 3 also includes two other provisions governing how management decisions are made. First, the institution must make decisions about retaining or disposing of contributed property within a reasonable time after receiving the property. Second, if a manager has special skills or expertise (or represents that they do) then the manager has a duty to use those skills or expertise in managing and investing institutional funds

IV. Investment Managers and the Investment Policy Statement


In general, the Act allows an organization's Board of Directors to delegate the management and investment of an endowment fund to a professional investment manager. UPMIFA states that "an institution may delegate to an external agent the management and investment of an institutional fund." The directors must exercise the duty of care in (1) selecting an agent; (2) establishing the scope and terms of the delegation; and (3) periodically reviewing the agent's actions. In investing and managing the funds, the professional manager owes a duty to the charity to exercise reasonable care to comply with the scope and terms of the authority delegated to him or her. If the Board of Directors would rather delegate management of the fund to a Board committee, an officer or an employee then they may do so.

  1. Selecting a Manager In selecting a professional investment manager a charity should take special care. This is a decision that affects the future success of the organization and can take some time. The Board of Directors can select the manager or the Board can hire an outside consulting agency to select the manager for them based on stated criteria. If they choose to select the manager themselves then this is usually done by putting together a Request for Proposal. The request should list the required qualifications and expected costs for services. Outside consulting firms are also available to select managers, negotiate the scope of the arrangement and manage the progress of the investment manager on a continual basis. Remember that if an outside consulting firm is chosen, the Board members are still responsible to fulfill their fiduciary duties.

  2. Scope and Terms of Authority It is important for the organization to establish the scope and terms of the investment manager's authority. One way the organization can guide the decisions of the investment manager is by writing a coherent investment policy statement. This should define investment objectives and state basic investment guidelines.

    An investment objective is stated in terms of total return, risk tolerance, liquidity and other factors such as legal or regulatory issues. Usually the overall objective is to maximize total return while minimizing risk. An investment guideline states the types of investments that may be made in order to meet an investment objective. Will your organization invest in securities, currency, commodities, cash holdings and/or other asset classes? Once you have determined that you will invest in particular asset classes, decide the percentage of each of those asset classes within your overall investment portfolio. This is called your "asset allocation." For example, an organization might require that 75% of its equity investments be in stocks. Decisions about what assets you will invest in are tied to your organization's risk tolerance. You may want to tie your investment policy to the ratings of a particular rating agency (e.g. Standard & Poor's or Moody's). This will ensure that the investment manager does not invest in assets below a certain quality rating.

  3. Reviewing the Manger's Progress Finally, the Board must review the investment manager's progress. This should be done more frequently than annually. A quarterly or a semi-annual review is certainly appropriate. This review is usually conducted by an Investment Committee made up of members of the Board of Directors. In general, this review should determine how well the investment manager is fulfilling his or her responsibilities. The investment manager's main responsibility is to invest endowment funds under the direction of the Investment Policy Statement in order to achieve the stated objectives. Actions the manager will take in furtherance of this responsibility include buying and selling assets and voting proxies. The investment manager is also responsible to comply with UPMIFA and hold liability insurance. If non-compliance exists, the manager should notify the Board within a reasonable period of time. Also, the manager should communicate at the review any significant changes in the organization's portfolio.

V. Investing an Endowment


Section 3 of UPMIFA states that in managing and investing an institutional fund, the following factors should be considered: (1) general economic conditions; (2) the possible effect of inflation/deflation; (3) the expected tax consequences of investment decisions/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) the other resources of the institution; (7) the needs of the institution and the fund to make distributions and to preserve capital; and (8) an asset's special relationship or special value to the charitable purposes of the institution. In other words, in deciding whether the organization should sell or retain assets the investment manager should consider the above eight factors in light of the organization's investment objectives and guidelines.

General economic conditions and the possible effect of inflation or deflation require the manager to look at trends in the economy as a whole. Also, the investment manager must consider UBIT and other tax consequences when deciding whether the investment will help accomplish the organization's investment objectives.

Section 3(e)(2) provides that the decision to buy or sell an asset is not made in a vacuum but by looking at that decision in the context of the charity's entire portfolio and investment strategy. This view is in line with modern portfolio theory, which focuses on maximizing total return instead of maximizing yield. Yield refers to the income return of an investment, including interest or dividends received from a security. Total return not only includes income (interest and dividends), but also appreciation in the asset's value over time (capital gain).

Finally, Section 3(e)(3) gives an organization broad investment authority. It states that an institution may invest in any kind of property or type of investment consistent with UPMIFA. However, it also provides that this broad authority may be limited by laws other than UPMIFA or the gift instrument.

VI. Expenditures


Section 4 of UPMIFA relates one of the primary changes from prior law. This section deals with endowment spending. UMIFA permitted expenditure of appreciation of an endowment fund only to the extent the fund had appreciated value above the fund's historical dollar value. The historical dollar value was the value of all contributions to the fund at the time the contribution was made. The idea behind this rule was to make sure that the fund was maintaining a certain balance. However, it was determined that this rule was too arbitrary and that the lack of guidance when a fund went beneath the historical market value caused uncertainty about how to handle those situations.

As a result, UPMIFA permits expenditures from an endowment fund to the extent the charity determines that the expenditures are prudent after considering seven factors: (1) the duration and preservation of the endowment fund; (2) the purposes of the institution; (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.

The Act contains a presumption of imprudence if the charity spends more than 7% of the fair market value of the endowment fund. The fair market value is determined by taking the average quarterly value of the fund over at least three years. This provision is optional and so simply because a state has adopted UPMIFA does not mean they have adopted the presumption of imprudence.

Section 4 also includes a provision related to construction. The gift instrument may limit the spending authority of an organization in relation to a particular fund. However, the gift instrument must specifically define the limitation. Also, direction in a gift instrument (1) to use only "income," "interest," "dividends" or "rents issues or profits"; (2) or to "preserve the principal intact"; (3) or similar words will create a permanent endowment fund unless the gift instrument states otherwise.

VII. Removing Restrictions


Section 6 of UPMIFA states the conditions under which a charity may modify or remove restrictions on an endowment fund.

First, if a donor agrees in writing that a restriction may be removed or modified then the organization may modify or remove the restriction.

Second, a charity may petition the court to modify or remove a restriction. The court will do so if the restriction is impracticable, wasteful, impairs the management or investment of the fund or if because of unanticipated circumstances the modification or release will further the purposes of the fund. The court will modify the restriction in a manner consistent with the charitable purposes expressed in the gift instrument.

Third, UPMIFA gives organizations the power to modify or release restrictions on old funds holding small amounts under certain circumstances. Specifically, if an organization determines that a restriction becomes unlawful, impracticable, impossible to achieve or wasteful they must notify the Attorney General. Sixty days after notifying the Attorney General they may modify or remove the restriction if: (1) the institutional fund has a total value less than $25,000; (2) the fund has been in existence for more than 20 years; and (3) the charity uses the funds in a manner consistent with the charitable purposes expressed in the gift instrument.


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