2006 Fall, Pg. 18. UMIFA: Preserving Equity Among Generations For The Charitable Dollar.

AuthorBy Attorney Mary Susan Leahy and Terry M. Knowles

New Hampshire Bar Journal

2006.

2006 Fall, Pg. 18.

UMIFA: Preserving Equity Among Generations For The Charitable Dollar

New Hampshire Bar Journal Fall 2006, Volume 47, No. 3Taxes, Trusts, Judicial Review, and more. . .UMIFA: Preserving Equity Among Generations For The Charitable DollarBy Attorney Mary Susan Leahy and Terry M. KnowlesI. INTRODUCTION

In the words of James Tobin, 1981 Nobel laureate: "The trustees of an endowment institution are the guardians of the future against the claims of the present. Their task is to preserve equity among generations." The Uniform Management of Institutional Funds Act, ("UMIFA"), RSA 292-B, enacted in 1973, makes it possible for charitable trustees to accomplish this task in New Hampshire.

UMIFA, as presently enacted in New Hampshire, modernizes the management of institutional funds by setting standards of conduct which encourage trustees to adopt and implement long term investment and spending policies. Simply stated, UMIFA authorizes charitable trustees to do two things: Invest an endowment fund on a "total return basis" and adopt a spending policy for annual distributions from the fund based on a percentage of the fund's fair market value. The ability to adopt such a spending policy means trustees can make annual distributions using both the fund's "natural income", i.e., earned interest and dividends, in combination with realized and unrealized appreciation in the value of the fund's underlying assets.

Equally important, UMIFA permits the adoption and implementation of an enhanced spending policy for funds whose donors specify that "income only" be spent. In order for donor restricted "income only" funds to make an annual distribution of anything other than the fund's natural income, UMIFA requires that there be appreciation in the fund over and above the fund's "historic dollar value." Second, the amount of appreciation distributed must be prudent. The statute creates a rebuttable presumption of imprudence if the appreciation that is distributed exceeds the fund's value in any one year by seven percent.

The "historic dollar value" limitation was hardly noticed when UMIFA was first enacted and yet this limitation proved to be an unexpected problem for some institutions. A number of charitable institutions in New Hampshire received a significant infusion of donor-restricted funds (in some cases, larger than their existing endowments) immediately before the significant stock market decline which began in 2000. How these institutions must have wished, in retrospect, that those stocks and bonds had been donated a few months later than they were, giving them the benefit of a lower historic dollar value!

  1. THE RATIONALE FOR UMIFA

    UMIFA's primary aim is to provide charitable trustees greater flexibility and discretion in the adoption and implementation of investment policies and asset allocation models within the general standards of prudent investment.

    By the latter half of the twentieth century, the ability to invest endowment funds and distribute on a total return basis had become vital to charitable institutions because dividends on stocks, as a percentage of market value had declined. Many fast-growing companies paid no dividends on their stock. These trends made it difficult if not impossible for trustees to invest to produce sufficient natural income for current needs while at the same maintaining the purchasing power of their portfolios. Additionally, the language in many gift instruments limiting distributions from an endowment fund to "income only" led governing boards to favor fixed-income investments to maintain the current distributions on which their institutions depended for their current operations. Yet, favoring fixed-income investments restricted governing boards from optimally investing endowment funds to grow over time.

    Too often the desperate need of some institutions for funds to meet current operating expenses has led their managers, contrary to their best long-term judgment, to forego investments with favorable growth prospects if they have a low current yield. It would be far wiser to take capital gains as well as dividends and interest into account in investing for the highest overall return consistent with the safety and preservation of the funds invested. If the current return is insufficient for the institution's needs, the difference between that return and what it would have been under a more restrictive policy can be made up by the use of a prudent portion of capital gains.

    William L. Cary and Craig B. Bright, The Law and Lore of Endowment Funds, Ford Foundation, (1969) at 5-6.

    Prior to UMIFA, there was little statutory or case law governing investing by charitable institutions. The Cary and Bright Ford Foundation study commissioned in the 1960's documented concerns colleges and universities had about potential legal limitations on total-return investing to achieve growth and maintain purchasing power. Although the study concluded the concerns of institutional trustees about the ability to invest on a total-return basis were "more legendary than real," institutions wanted statutory law confirming their ability to employ a total-return investment strategy.

    This desire for clarity in the law was the impetus for the development of the UMIFA Model Act. It was approved by the National Conference of Commissioners on Uniform State Laws ("NCCUSL") in 1972. In their Prefatory Note and Comments at their 1972 annual conference meeting, the Commissioners noted:

    Over the past several years the governing boards of eleemosynary institutions, particularly colleges and universities, have sought to make more effective use of endowment and other investment funds. They and their counsel have wrestled with questions as to permissible investments, delegation of investment authority, and use of the total return concept in investing endowment funds. Studies of the legal authority and responsibility for the management of the funds of an institution have pointed up the uncertain state of the law in most jurisdictions. There is virtually no statutory law regarding trustees or governing boards of eleemosynary institutions, and case law is sparse. There is, however, substantial concern about the potential liability of the managers of the institutional funds even though cases of actual liability are virtually nil. As deliberations of the Special Committee, the Advisory Committee and the Reporters responsible for the preparation of this Act have progressed, it became clear that the problems were not unique to educational institutions but were faced by any charitable, religious or any other eleemosynary institution which owned a fund to be invested.

    UMIFA frees institutions from past real or imagined investment constraints by defining a new standard for prudent investing. It "encourages" governing boards to adopt and implement investment policies with the objective of producing the greatest total return of appreciation and income consistent with the standard of prudent investing. RSA 292-B: . In fact, the statute does more than "encourage." RSA 292-B: 6 provides that governing boards "shall" adhere to standards of prudent investment.

    To overcome the perceived limitation on distributing appreciation, UMIFA provided that unless a gift instrument explicitly prohibits the distribution of net appreciation, restrictions in gift instruments that may appear to limit or prohibit distributions of an endowment fund's appreciation, such as a direction to use only "income," "interest," "dividends," "rents, issues or profits," or "to preserve the principal intact" may be ignored, thereby permitting the distribution of a prudent portion of appreciation. RSA 292-B: 2 and 3. At the same time, UMIFA clarified the rules regarding accumulation of income, permitting governing boards to accumulate some of a portfolio's net income in situations where gift instruments purported to mandate distribution of all of a fund's income. RSA 292-B: 3-a and 3-b.

  2. WHICH FUNDS AND WHICH INSTITUTIONS?

    1. Which Funds?

      Originally, UMIFA did not apply to a fund held by an independent trustee for an institution. It applied only to a fund "held by an institution for its exclusive use, benefit, or purposes", provided that a non-charitable beneficiary might have rights to the fund upon violation or failure of the purposes of the fund without disqualifying the fund that otherwise had only institutional or other charitable beneficiaries. RSA 292-B: 1-a, II.

      An amendment adopted in 2000 expanded the definition of "institutional fund" to include funds held in trust for one or more charitable institutions in which no beneficiary that is not a charitable beneficiary has an interest. RSA 292-B: 1-a, II. Consistent with the broadened applicability of UMIFA in New Hampshire to trusts held for charitable institutions by independent trustees, New Hampshire has broadened the term "governing board" to include the trustee or trustees of those trusts. RSA 292-B: 1-1, III. New Hampshire is the only jurisdiction of the 46 that have adopted UMIFA that has broadened the applicability of the statute to include institutional funds held by a fiduciary other than the...

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