Is the Law Causing Charities to Drown Because Their Endowment Funds Are Now "under Water"?

• Publication year: 2022

43 Creighton L. Rev. 529. IS THE LAW CAUSING CHARITIES TO DROWN BECAUSE THEIR ENDOWMENT FUNDS ARE NOW "UNDER WATER"?

IS THE LAW CAUSING CHARITIES TO DROWN BECAUSE THEIR ENDOWMENT FUNDS ARE NOW "UNDER WATER"?

STEVEN J. RIEKES(fn*)

I. INTRODUCTION: THE PROBLEM

Like the rest of society, charitable institutions, from animal shelters to universities, have been suffering the effects of a major downturn in the economy not seen since the Great Depression. Unfortunately, charitable institutions may have their suffering compounded by laws or legal interpretations of them governing the management of their endowment funds.

One unfamiliar with the arcane legal aspects of this problem might think that endowment funds would be just the sort of cushion that charities would need to see them through difficult economic times. On the contrary, however, some people involved with the management of charitable endowment funds or otherwise involved with the laws or interpretation of them were of the opinion that, in many cases, permanent endowment funds cannot be used during this difficult period, because they are "under water." By this, they mean that the assets, in today's market, are valued substantially less than the value of the assets originally contributed when the endowment fund was established (also taking into consideration the value of subsequent contributions at the time or times they may have been made). Further, some people concluded that if a fund is "under water," then said fund, including any income generated by said fund, may not be used to support the intended charity until such time as the value of the fund as when contributed re-emerges from the troubled financial waters. In other words, before a fund can be used to support its intended charity, its dollar value would have to equal or exceed the dollar value of assets when contributed to it, originally and subsequently. This could mean that if endowment funds were established or received by contributions at the time when the market was at a high point, such as in 2006, it might take ten years or even longer, to return to those valuations.(fn1) In the meantime, the charity could be absolutely devastated, unable to use its own endowment fund.

II. THE ORIGINS OF THE PROBLEM: THE UNIFORM MANAGEMENT OF INSTITUTIONAL FUNDS ACT ("UMIFA")

How could such an odd situation exist? Before the 1970s, many charities used traditional trust accounting principles in regard to their endowment funds. By endowment funds, I mean funds established by a donor to a charity in which the principal or corpus of the fund is regarded as being held in perpetuity or for at least a long number of years. The fund's assets, being its principal or corpus, should generate income, either through interest or dividends, or by other means, which income would be used to support the intended charity. On the other hand, capital gains would be allocated to the principal, and could not be used for support purposes, but would increase the value of the permanent endowment fund, hopefully generating higher future income. In this era, trustees dealing with these funds tended to invest in conservative investments, such as government bonds and the like.

However, in the 1960s, a growing concern existed as inflation rose, bond values fell, and the value of equities increased. Therefore, the Ford Foundation commissioned a study of endowment funds by William Cary and Craig Bright.(fn2)

The Cary and Bright study indicated that it might be better for charities if certain corporate accounting principles were utilized to govern endowment funds rather than traditional trust accounting allocations above described. In this way, the managers of charitable endowment funds could look to the rising values in the equity markets and take advantage of the general appreciation in those markets which has, indeed, occurred from those times until 2007. Instead of being restricted to interest, dividends, and the like, capital gains, both realized and unrealized, could be utilized in calculating income for distribution purposes. Thus, in 1972, utilizing the observations of Cary and Bright, the National Conference of Commissioners on Uniform State Laws drafted the Uniform Management of Institutional Funds Act(fn3) ("UMIFA"), which was eventually adopted by forty-seven states.(fn4) Nebraska adopted UMIFA in 1996. See Neb. Rev. Stat. sections 58 601 to 58-609, which have now been repealed.(fn5) Thus, as was provided in section 3 of UMIFA, the governing board of a charitable institution "may appropriate for expenditure for the uses and purposes for which an endowment fund is established so much of the net appreciation, realized and unrealized, in the fair value of the assets of an endowment fund over the historic dollar of the fund as is prudent ..."(fn6)

Commensurate with this development was the adoption by many charities of a "total return" policy in which distribution to a particular charity from its endowment fund would encompass the rising value of equity investments as reflected in the appreciating equity markets. The concept of "total return" investing is not defined specifically in UMIFA. For purposes of this Article, a "total return" policy means generally, distributions or expenditures from an endowment fund, taking into consideration not only the income but also full appreciation of the whole investment portfolio at an appropriate risk level.(fn7)

The problem facing the charities arises from the phrase "the historic dollar value of the fund," as above quoted from section 5 of UMIFA.(fn8) That phrase is more specifically defined by section 2(5) of UMIFA(fn9) as follows:

Historic dollar value means the aggregate fair value in dollars of (a) an endowment fund at the time it became an endowment fund, (b) each subsequent donation to the fund at the time it is made, and (c) each accumulation made pursuant to a direction in the applicable gift instrument at the time the accumulation is added to the fund.(fn10)

This provision is now wreaking havoc in the charitable sphere. For example, in Massachusetts, the Audubon Society's endowment fund, although substantial, lost twenty-eight percent of its value in 2008, and thus, a significant portion of it cannot be tapped for spending. This required the Audubon Society to furlough naturalists at its sanctuaries and science centers. The Massachusetts Society for the Prevention of Cruelty to Animals had to close three of its seven animal shelters. Brandeis University threatened to close its Rose Art Museum and sell its collection because "Massachusetts law made it difficult to use much of its endowment, which recently totaled $549 million after posting a 25% decline since June."(fn11) Thus, even with severe declines in market value, the mentioned charitable...