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Bar Journal - Fall 2006

UMIFA: Preserving Equity Among Generations For The Charitable Dollar

By:

I. 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!

II. 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.

III. WHICH FUNDS AND WHICH INSTITUTIONS?

A. 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 institution itself. 

B. Which Institutions?

RSA 292-B: 1-a, I defines an “institution” as “an incorporated or unincorporated organization organized and operated exclusively for educational, religious, charitable or other eleemosynary purposes, or a governmental organization to the extent that it holds funds exclusively for any of these purposes.”  Thus, the term “institution” includes public charities, supporting organizations, private foundations, community foundations and any other eleemosynary organization. It also includes any governmental organization holding funds exclusively for charitable purposes.

UMIFA commentary cites as an example of a governmental organization holding funds for charitable purposes, a public school with an endowment fund. UMIFA, Uniform Laws Annotated, §1, Comment. However, the New Hampshire statute expressly provides that the term “institutional fund” shall not include a fund held by a town or other municipality under RSA 31:19 or a fund created by a town or other municipality under RSA 31:19a. (RSA 292-B:1-a II). These statutes authorize the establishment of trusts funds by towns for public purposes and the acceptance by towns of gifts, legacies and devises for a broad range of public purposes. The basis for this exclusion is the investment standard imposed upon municipal trustees under RSA 31:25-b, the “Prudent Man Rule” which is incompatible with the provisions of the Prudent Investor standard authorized under RSA 292-B.

IV. HOW UMIFA WORKS

RSA 292-B: 6 subjects trustees to a simple and clear standard of conduct in the investment, management and distribution of all of their institutional funds:  They must be prudent as defined in Article 9 of RSA 564-B, the Uniform Prudent Investor Act.

UMIFA gives trustees six principal tools to aid in the investment and distribution of institutional funds: It gives them broad investment authority enabling them to invest on a total return basis (RSA 292-B: 4); it permits them to delegate the management of investments to investment professionals and others (RSA 292-B: 5); it permits them to distribute some of the net appreciation of their endowment funds (RSA 292-B: 2); it permits them to accumulate endowment fund income (RSA 292-B: 3-a); and it provides simplified ways for governing boards to obtain the release of unreasonable restrictions on institutional funds (RSA 292-B: 7).

A. Investment Authority and Responsibility.

RSA 292-B: 4, I authorizes the investment of an institutional fund “in any real or personal property deemed advisable by the governing board, whether or not it produces a current return.”  This authority gives governing boards the ability to invest for the greatest total return consistent with standards of prudence, distributing some of that return currently while retaining some to maintain or increase the value of the fund, at a rate calculated to at least equal the rate of inflation.

Boards must invest their funds by taking into account the long-term and short-term needs of their institutions, anticipated returns, price levels and general economic conditions. RSA 292-B:  6. They must meet the standards for a prudent investor. RSA 292-B: 6. This means, among other things, that “reasonable care, skill and caution” be exercised in investing, not “in isolation” on an asset-by-asset basis “but in the context of the trust portfolio and as part of an overall investment strategy” (RSA 564-B) and that a portfolio be properly diversified (RSA 546-B). Leahy, Charles F., Investing for New Hampshire Non-Profits, 37 NHBJ 68 (1996).

In addition to the general investment authority and responsibility described above, UMIFA authorizes the pooling of institutional funds with other pooled and common funds, including both common funds maintained by the institutions (RSA 292-B: 4, III) and pooled funds managed by others “including shares or interests in regulated investment companies, mutual funds, common trust funds, investment partnerships, real estate investments trusts, or similar organizations in which funds are commingled and investment determinations are made by persons other than the governing board” (RSA 292-B: 4, IV).

The authorization described in RSA 292-B: 4, III and IV pooled income fund managers and trustees of charitable remainder trusts to invest in or pool with funds whose beneficiaries include both charitable and non-charitable beneficiaries. These provisions regarding pooling are the exception to the rule that UMIFA applies only to funds whose beneficiaries are limited to institutional or charitable beneficiaries.

RSA 292-B: 4, II authorizes trustees to “[r]etain property contributed by a donor . . . for as long as the governing board deems advisable.”  This authorization is important because it permits an institution to accept in-kind contributions of assets that trustees would not necessarily consider prudent to purchase. The institution may retain such property for as long as its trustees deem advisable. UMIFA commentary cites an example why trustees may wish to retain contributed property even though it may not be the best investment: “the hope of additional contributions” from the donor. UMIFA, ULA, § 4, Comment.

The trustees’ retention of such property is governed by the standard of prudence set forth in RSA 292-B: 6. But, in effect, the authorization permits the trustees to accept a gift, for example, stock of a closely held or “private” corporation or a large concentration of publicly traded stock or some other asset, giving the trustees considerable latitude to determine when and if the asset should be liquidated or otherwise diversified. Presumably, trustees may accept a gift of stock, for example, subject to a condition that it not be liquidated, if they conclude that acceptance is in the institution’s best interest.

B.  Delegation of Investment Management.

RSA 292-B: 5 gives trustees the power to delegate to committees, employees, officers and agents, including investment counsel, the authority to act for the trustees in investing and reinvesting institutional funds. It also permits trustees to contract with and compensate independent investment advisors, investment counsel or managers, and banks and trust companies for providing such services.

UMIFA commentary explains the reason for the inclusion of section 5 is to address concerns of some trustees about their authority to delegate investment decisions. In the past, in the absence of explicit authority to delegate, some trustees followed or tried to follow the principle of non-delegation formerly applicable to private trustees. UMIFA, ULA, § 5, Comment. As is the case under the Uniform Prudent Investment Act, the authority to delegate investment management does not relieve trustees from the responsibilities of determining prudent investment policy and for prudently selecting and supervising competent agents. RSA 292-B: 6.

Trustees managing institutional funds should document their exercise of prudence by adopting a written investment policy; by reviewing it on a regular basis; by reviewing the compliance of their investment advisors and other agents with the policy; and by monitoring the performance of their funds. Ablowich, Michael, Preparing an Investment Policy, 37 NHBJ 64 (1996).

C. Authority to Distribute Net Appreciation.

RSA 292-B: 2 authorizes trustees to distribute as much net appreciation of an endowment fund as is prudent. The purpose of this section is to give trustees authority to distribute appreciation if the gift instrument does not explicitly provide such authority, or if the terms of the gift instrument appear to restrict such distributions — for example, to traditional interpretations of “income” only. RSA 292-B: 2 and 3, read together, provide that some appreciation may be distributed even if a gift is designated as an endowment or when it directs or authorizes the institution to use “only income, interest, dividends, or rents, issues or profits or to preserve the principal intact, or a direction which contains other words of similar import.”  After UMIFA, if a donor wishes to restrict distribution of appreciation, the gift instrument must expressly indicate this.

The last sentence of RSA 292-B: 2 clarifies that the authorization to prudently distribute appreciation does not restrict trustees from distributing appreciation when they are otherwise authorized to do so, including as permitted under other law or under the terms of a gift instrument or by the charter of an institution.

D.   Limitations on the Distribution of Appreciation.

There are two limitations on the authority to distribute appreciation from an endowment fund. One relates to the “historic dollar value” of the fund. The other requirement is that appreciation be prudently distributed, and UMIFA creates a “rebuttable presumption of imprudence” as to how much appreciation may be distributed annually.

1.  The Historic Dollar Value Limitation.

Only appreciation in the fair value of assets in an endowment fund exceeding their “historic dollar value” may be distributed. RSA 292-B: 2. “Historic dollar value” is the fair market value of the fund at the time of its establishment, plus the fair market value of any subsequent donations to the fund at the time of their donation, plus the fair market value of each accumulation to the fund mandated by the gift instrument. RSA 292-B: 1-a, V.

To illustrate: $500,000 is placed in an endowment fund with the requirement that it be invested until it has reached $750,000. Thereafter the donor adds another $250,000. In this example, the historic dollar value of the fund is $500,000 at the time of its establishment; it grows to $750,000 as the governing board invests and accumulates within the fund. RSA 292-B: 2 prohibits the governing board from distributing any appreciation until the accumulation has been achieved, at which time only appreciation in excess of $750,000 is eligible for distribution. With the subsequent addition of $250,000 to the fund, the historic value increases to $1,000,000. If the fair market value of the fund thereafter is reduced to less than $1,000,000, the governing board is prohibited from making any distribution of appreciation until the fund has been restored to its historic dollar value of $1,000,000. Thereafter, so long as there is appreciation in excess of historic dollar value, the trustees may distribute such appreciation in accordance with the limitations of RSA 292-B:6.

It becomes clear from the illustration that, in order to apply the historic dollar value rule, the institution must maintain records documenting such value. But, the statute is applicable, not only to funds established after the effective date of RSA 292-B, but also to older endowment funds, for which it may be a practical impossibility to document historic dollar value. For this reason, RSA 292-B: 1-a, V provides that trustees may make a good faith determination of the historic dollar value of their institutional funds. Such determination made in good faith is “conclusive.”  If the trustees were to conclude that they had insufficient information to make a good faith determination, RSA 547: 3(c) provides jurisdiction for the probate court to determine historic dollar value.

It must be noted that the “historic dollar value” rule applies only to endowment funds as defined in RSA 292-B: 1-a, III and not to other funds such as an institution’s unrestricted funds. In this respect, the statute can be confusing, because institutions frequently consider all of their funds under the broad heading of “endowment.”

Additionally, the Financial Standards Accounting Board (“FSAB”) has its own rules classifying the funds held by charitable organizations as “unrestricted”, “temporarily restricted” or “permanently restricted.”  UMIFA “endowment funds” usually fall within the FASB classification of “permanently restricted” but could, depending on the terms of the gift, be “temporarily restricted.”  See FASB, Statements of Financial Accounting Standard (“SFAS”), No. 117. SFAS 124 allocates an institution’s gains and losses depending on how its funds are classified under SFAS 117. The FASB allocation rules can significantly affect the determination of whether an endowment fund is above or below “historic dollar value.”

2. The Rebuttable Presumption of Imprudence

The second limitation on the authority to distribute appreciation is that it may not be done imprudently. RSA 292-B: 6. The distribution of appreciation in any year exceeding seven percent (7 percent) of the fair market value of a restricted endowment fund (calculated on the basis of market values determined at least quarterly and averaged over a period of three or more years) creates a “rebuttable presumption of imprudence.”  RSA 292-B: 6.

Two things must be noted about this provision. First, the percentage describes the amount of appreciation that may be distributed. Second, and of greater importance, the “rebuttable presumption of imprudence” does not create a safe harbor for a governing board. In other words, a board may not assume that it can safely distribute the income plus up to seven percent (7 percent) of a fund’s appreciation as long as there is a positive spread between current market value and historic dollar value. A spending policy based on total-return investing typically describes annual distributions as a percentage of the total fund including interest and dividends.  Most would argue that it would be a highly unusual situation when prevailing market conditions would permit a governing board to prudently make regular annual distributions from even a well-performing endowment fund at a level of seven percent (7 percent) of the total fund’s fair market value, much less seven percent (7 percent) of the permanent fund plus interest and dividends earned.

E.   Accumulation of Income in Endowment Funds.

RSA 292-B: 3-a and 3-b provide that even though the terms of a gift instrument may appear to require the distribution of all current income, absent an explicit prohibition on accumulation, trustees are not required to distribute all of the “natural” income of an endowment fund. These provisions are New Hampshire “enhancements” to the statute. Curiously, there are no comparable provisions authorizing accumulation of income in the UMIFA Model Act.

RSA 292-B: 3-a gives trustees the right to prudently accumulate income, either to add to principal or to hold in a reserve for future expenditure. Indeed, economic conditions may arise requiring a prudent investor to accumulate income in order to prudently manage an endowment fund. Many will recall the double-digit interest rates in the not too distant past. In such an economic climate, trustees must consider whether it is imprudent not to accumulate some of the income of their institutional funds.

RSA 292-B: 3-a  is the counterpart rule of construction to that set forth in RSA 292-B: 3-b regarding the distribution of appreciation. RSA 292-B: 3-b provides that a restriction against accumulation or addition to principal may not be implied from designation of the fund as an endowment fund or from the “direction or authorization” in the gift instrument to distribute “income,” “interest,” dividends,” “currently expendable income,” “rent, issues or profits” or similar provisions.

F.  Obtaining a Release of Restrictions on the Use of Funds.

RSA 292-B: 7, I simplifies the process for obtaining the release of a use restriction or an investment restriction imposed by provisions in a gift instrument that make it difficult to administer or invest an institutional fund. If the donor is available and willing, trustees may simply obtain the donor’s consent to lifting the restrictions. Although the donor no longer has a property interest in the fund, if both the donor and the trustees agree that the restrictions no longer apply, the restriction disappears. The granting of a release is not anticipated to cause federal tax issues for the donor because the donor has no right to enforce the restriction, no interest in the fund and no power to change the beneficiary. The statute gives the donor “only the right to acquiesce in a lessening of a restriction already in effect” at the request of the institution. UMIFA, ULA, § 7, Comment.

If the written consent of the donor cannot be obtained because of death, disability, unavailability or impossibility of identification, the trustees may apply to the probate court for release of the restriction, with notice to the attorney general and opportunity to be heard. The court may order the release of the restriction if it is found to be obsolete, inappropriate, or impracticable. RSA 292-B: 7, II.

The probate court does not have the power to convert an endowment fund to something other than an endowment fund, i.e., it cannot convert a fund “that is not wholly expendable . . . on a current basis” to one that is. RSA 292-B: 7, II; RSA 292-B: 1-a, III. Further, RSA 292-B: 7, III provides that a release cannot result in use of a fund for purposes other than the charitable purposes of the institution in question.

V.   THE DEVIL IS IN THE DETAILS; QUESTIONS AND ANSWERS

Q.  What is the difference between an “institutional fund,” and an “endowment fund?”

A.   All funds held by governing boards of charitable institutions or by private trustees exclusively for charitable purposes are “institutional funds.”  RSA 292-B: 1-a, II. An “endowment fund” is an “institutional fund” that “is not wholly expendable to or by an institution on a current basis” such as a fund that is restricted to distribution of “income” only. RSA 292-B: 1-a, III.

Q. May institutions aggregate their endowment funds to determine whether endowment principal is above historic dollar value?

A.   Yes, provided that endowment funds restricted to a particular use be aggregated separately from endowment funds restricted to another use or uses. For example, if one group of library funds were restricted to purchasing science books and another group of funds were restricted to purchasing art books, the historic dollar value of each group of funds would have to be separately maintained. Endowment funds that are not restricted to particular uses or that are for the same use may be aggregated for purposes of determining historic dollar value.

Q.  Does the seven percent (7 percent) “spending rate” specified in RSA 292-B: 6 serve as a safe harbor for governing boards? In other words, is an institution safe as long as it has a spending policy that does not spend more than seven percent (7 percent) of net appreciation annually?

A.   The statute only provides that distribution of appreciation from endowment funds greater than seven percent (7 percent) is presumed to be imprudent. A governing board may make annual distributions of all of the net income of an endowment fund, provided that it is prudent to do so. In addition, to the extent that the fair market value of the endowment fund exceeds historic value, the governing board may distribute annually up to seven percent (7 percent) of the fair market value of the fund calculated on a trailing 12-quarter (or longer) rolling average without being presumed imprudent. That said, all distributions from all endowment funds must always be prudent. There is no “safe harbor”. As noted in Part IV, D,2, many prudent investors do not believe that economic conditions are likely ever to favor routine annual distribution of all of the net income plus seven percent (7 percent) of the value of an appreciated endowment fund.

Q.  Is a governing board safe distributing all of the net income of an endowment fund?

A.   Not necessarily. For example, in a period of double-digit interest rates, a governing board would have to consider whether circumstances justify the distribution of all of the net income of an endowment fund. Achieving the highest total portfolio return might suggest a large commitment to fixed income; but if there is significant inflation at the same time, distribution of all income could result in a loss of purchasing power for the portfolio.

Q.  UMIFA does not talk about permissible “spending” or “distributing” from an institutional fund. Rather, it describes what a governing board may “appropriate for expenditure”.  What does this mean?

A.   RSA 292-B: 2 provides that a governing board “may appropriate for expenditure . . . so much of the net appreciation, realized and unrealized, in the fair value of the assets . . . over the historic dollar value of the fund as is prudent . . . .”  “Appropriate for expenditure” is not defined.

UMIFA commentary says:  “This section authorizes a governing board to expend for the purposes of the fund the increase in value of an endowment fund over the fund’s historic dollar value, within the limitations of Section 6 . . . .”

Then, what does “expend” mean?  Does it mean removing money from the endowment fund?  Does it mean encumbering money in the fund?  Are funds expended when the boards budget them for expenditure, or when they are encumbered, or when they are actually removed from the fund? 

In the public sector, the legislative body typically “appropriates” funds for some purpose by passing a budget bill, but the “expenditure” of public funds is typically not automatic. Instead, the executive branch must take further action to authorize the expenditure of the appropriated funds. This pervasive practice followed by public governing bodies leads to the question whether UMIFA contemplates a similar bifurcated process. Such a process might suggest that the test of an “increase in the value of the fund” would be applied twice, once at the time a governing board adopts a budget and again at the time the expenditure is made or otherwise committed. The UMIFA Comment quoted above indicates that “appropriate” is synonymous with “expend” and does not refer to “appropriate” in the bifurcated process typical of governmental bodies.

Though the annotation does not elaborate further, “expend” presumably is used in its ordinary sense, which would include removing money from the fund and placing it, for example, in the board’s quasi-endowment or with its board-designated funds; or making a binding commitment to a third party to pay (such as, signing a contract for a purchase, making a grant, writing a check or the like). Where there is uncertainty as to whether a particular action constitutes an “appropriation for expenditure”, the simplest solution is to remove the appreciation from the endowment fund.  What is important is that at the time of each appropriation, the institution must verify there is indeed available appreciation and that the money appropriated is applied to the charitable purposes of the institution.

Q.  May a governing board charge the principal of a fund with its share of expenses even if the fund has no net appreciation?

A.   UMIFA does not alter the rules requiring a fiduciary to allocate expenses between principal and income. RSA 564-A: 3, III (u) (repealed with the adoption of RSA 564-B, but anticipated to be reinstated in connection with RSA 564-B revisions); RSA 564: 21-a.

Q.  In determining whether there is net appreciation which may be distributed from an endowment fund, should a governing board compare the historic dollar value of a fund with its fair market value on the date of expenditure or with its fair market value determined on a trailing 12- quarter (or longer) rolling average immediately preceding the expenditure?

A.   At the time of each appropriation of appreciation, i.e., when the funds are withdrawn or binding commitments are made to third parties to pay appreciation, the institution must determine that the fair market value of the fund as of that date exceeds the historic value of the fund.

The trailing 12 (or more) quarter rolling average fair market value of the fund described in RSA 292-B: 6 is a computation that is used exclusively for determining whether there is a rebuttable presumption of imprudence on the part of the governing board with respect to the aggregate of its distributions of net appreciation over the course of an entire year. This computation can be made at the beginning of each year. An institution can decide early in the year the maximum aggregate withdrawals that it will be able to make during that year. However, whether there is net appreciation available for a particular distribution must be determined at the time of the withdrawal.

Q.  What if there is net appreciation on the date of an expenditure but the trailing twelve (or more) quarter rolling average value of the fund as of the expenditure date is less than the fund’s historic dollar value?

A.   In that situation, there can be a distribution of net appreciation; however, if there are total distributions of appreciation that year in excess of seven percent  of the value of the fund calculated based on the trailing twelve (or more) quarter rolling average, there is a rebuttable presumption that the governing board has acted imprudently.

It must be kept in mind that the value of a fund calculated based upon trailing twelve (or more) quarter rolling averages has nothing to do with the determination of whether or not there is net appreciation in excess of the fund’s historic value available for any particular expenditure. It is merely used to establish the size of the aggregate annual distributions of net appreciation, which may be made without creating a rebuttable presumption of imprudence.

Q.  What if there is no net appreciation on the date of an expenditure but the trailing twelve (or more) quarter rolling average value of the fund as of the expenditure date is higher than the endowment fund’s historic value?

A.   This could occur in a falling market. If there is no net appreciation on the date of a desired expenditure from an endowment fund, the expenditure may not be made. There is no net appreciation to expend!  It does not matter that the trailing quarter rolling average value of the fund exceeds the fund’s historic value.

Q.  What if a governing board prudently determines that an expenditure of some of the principal in an endowment fund is in the best interest of the institution, but there is no net appreciation?

A.   The institution can apply to the probate court to allow a deviation from the terms of the trust with notice to and an opportunity for the attorney general to be heard.

Q.  When there is no net appreciation in an endowment fund or its historic dollar value is impaired, may the governing board nevertheless expend the fund’s net income?

A.   Yes, if it is otherwise prudent to do so. The restriction on spending when historic dollar value is impaired applies only to the distribution of appreciation.

Q.  If a governing board has never appropriated appreciation from its endowment fund and has sufficient available net appreciation, could it in one year distribute seven percent of the value of the fund based on the trailing twelve quarter rolling average values for each of the last ten years?

A.   It could not do so without creating a rebuttable presumption of imprudence. If the governing board concludes that such a distribution is otherwise prudent, e.g., a one-time distribution for an important capital project, it might consider applying to the probate court for deviation with notice to the attorney general.

Q.  Assume a private foundation has the right to distribute income. Assume further that the foundation must meet the annual minimum five percent (5 percent) spending requirement to avoid liability for the IRC §4942(a) tax. If it has net distributable income equal to only three percent (3 percent) of the value of its assets, may the foundation invade principal to meet its remaining two percent (2 percent) spending requirement if the historic dollar value of its assets is impaired?

A.   RSA 292:2-a provides that every private foundation established under RSA 292 is subject to a number of “saving” provisions whether or not they are set forth in the organization’s articles of agreement. One such provision, RSA 292: 2-a, II, provides that every private foundation must distribute for the purposes set forth in its articles of organization amounts at least sufficient to avoid liability for the IRC §4942(a) tax. This statutory provision, in effect, amends the articles of agreement of the foundation.

A private foundation is not restricted from distributing principal to avoid the IRC §4942(a) tax liability. Because the foundation is not restricted from distributing principal for that purpose, the provisions of RSA 292-B regarding not impairing historic value are not applicable. Thus, the foundation is not restricted from distributing principal for purposes of avoiding the IRC §4942(a) tax even though it does not have any net appreciation.

Q.  Assuming the same facts as in the preceding question, may this private foundation adopt a six percent (6 percent) spending policy?

A.   Relying on RSA 292-B: 2 and if it is otherwise prudent to do so and can be done without impairing historic dollar value, the governing board of a private foundation may establish a six percent (6 percent) spending policy and distribute appreciation to meet that requirement, even if the amount of appreciation distributed exceeds that required to avoid the IRC §4942(a) tax as authorized by RSA 292: 2-a. Note, though, that many prudent investors question the prudence of a routine six percent (6 percent) spending policy.

VIII.  THE FUTURE OF UMIFA

The National Conference of Commissioners on Uniform State Laws adopted the draft of a new version of UMIFA, now called the Uniform Prudent Management of Institutional Funds Act (“UPMIFA”), at its meeting in July, 2006. One of the most significant and most controversial elements of the draft is its abandonment of the concept of historic dollar value.

The historic dollar value limitation imposed by UMIFA has been problematic for institutions administering extremely large endowments who view it as an artificial constraint on investment strategy. A number of these institutions urged NCCUSL to re-examine its 1972 position on historic dollar value and its applicability to modern portfolio theory. NCCUSL’s UMIFA Drafting Committee researched the positive and negative effects of this 30 year policy and stated in its 2003 draft:

"Institutions have operated effectively under UMIFA (1972), and the experience has been that institutions have operated more conservatively than [the] historic dollar value [limitation] would have permitted. Institutions have no incentive to spend everything the law permits them to spend, and good practice has been to provide for modest expenditures while maintaining the purchasing power of a fund.

The new approach abandons the use of historic dollar value as a floor for expenditures and provides more flexibility to the governing board in making decisions about whether to expend any part of an endowment fund."

While repealing the 1972 historic dollar value limitation is a potential benefit to institutions like Harvard and Yale, whose endowments are valued in the billions of dollars, a number of attorneys general, including New Hampshire Attorney General Kelly Ayotte, were concerned that less sophisticated institutions holding small endowment funds might misinterpret the legal significance of the change and be tempted to “spend everything the law permits them to spend.” In response to the numerous letters received from Attorneys General and state charity officials, NCCUSL invited further debate on the issue. While the new version of UPMIFA adopted by the Commission in July, 2006 does abandon the concept of historic dollar value it also contains several safeguards designed to prevent any institution from exhausting its endowment. The most significant of these safeguards is an annual 7 percent limitation on expenditure based on the total value of the endowment fund.

The 2006 version of UPMIFA has not yet been adopted by any state and the effect of this change will be subject to analysis and comment in future years.

IX. CONCLUSION

UMIFA has been welcomed by charitable trustees in New Hampshire and throughout the country as providing the opportunity for trustees to invest institutional funds to invest on a total return and to adopt and implement prudent spending policies. This was a giant step forward. But the law of unintended consequence is never absent, even from the best thought-out plans. The receipt of large endowments by some New Hampshire charitable institutions in 2000, followed by successive, significant drops in stock values in 2000 and 2001 reduced the value of some important endowments below “historic dollar value,” causing the unwelcome cessation or near cessation of spending for a period of time. This painful experience highlighted a potential effect of UMIFA for which many were unprepared and which may be better anticipated in the future.


Authors

Mary Susan Leahy Attorney Mary Susan Leahy is a trusts and estates attorney at McLane, Graf, Raulerson & Middleton, P. A. She has served as a trustee and member of the investment committee of a number of prominent charitable organizations. She is a fellow of the American College of Trusts and Estates Counsel and is admitted to practice law in New Hampshire and Maine.”
Terry Knowles Terry Knowles is the Assistant Director of Charitable Trusts in the Dept. of the Attorney General. She is the immediate past president of the National Association of State Charity Officials and a member of the board of the National Council of Nonprofit Organizations. She is an adjunct professor of political science at the University of New Hampshire teaching negotiation skills and nonprofit management in the graduate program.

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