Please note: this article was published soon after NYPMIFA’s passing. Since that time, the NY Attorney General came out with a clarification memo. If you get to this article, I strongly suggest reading more recent posts on this blog on NYPMIFA as you will likely see differing rulings. The later discussions should take precedence over the earlier ones!
On September 17, 2010, New York Governor David Paterson finally signed and enacted New York’s version of the Uniform Prudent Management of Institutional Funds Acts, referred to now as NYPMIFA (New York Prudent Management of Institutional Funds Act). New York is the 47th state to enact this legislation.
The anticipation for this law change was great since its most prominent feature is to “unfreeze” nonprofit endowment funds that have fallen below their original gift amounts, a significant problem for many nonprofits during the current recession.
Now, in the aftermath of NYPMIFA’s enactment, New York nonprofits must take a close look as this law, particularly since New York’s version has some significant differences from the standard Uniform version. To start addressing open questions regarding NYPMIFA, three prominent New York law firms (Skadden Arps, Patterson Belknap, and Simpson Thacher) published memos going into greater detail about NYPMIFA, providing action steps and answering more potential questions.
Links to these three memos can be found at the end of this article and it is strongly recommended to print, read and share those memos with nonprofit leadership, boards and legal counsel. Rather than attempt to go through every detail and nuance of NYPMIFA, this article will highlight some of the more startling changes that practically all New York institutions need understand and start implementing.
The remainder of this article will attempt to highlight some of the more important and surprising points brought out in these three memos. Please note that neither this summary of the points from the memos or the memos themselves should be considered as specific legal advice and should only be used for general informational purposes. Please also note that NYPMIFA only applies to nonprofits which were actually incorporated in New York.
Relief from Underwater Endowment Funds
The most well-known feature of NYPMIFA is that it eliminates the requirement that nonprofits maintain a permanent endowment fund’s “historic dollar value” (usually the original gift amount). NYPMIFA now allows nonprofits to apply their “spending rates” even when funds which have fallen below their original funding value. But, there are several very important caveats that nonprofits need to be aware of before moving forward with applying NYPMIFA.
- Funds created prior to 9/17/2010 – For all funds created prior to 9/17/2010, where a donor is “available” (meaning alive and able to be located with reasonable efforts), nonprofits must send a written notice offering these donors the option NOT to apply NYPMIFA to their particular funds (thus requiring the nonprofit to maintain the original funding value). A nonprofit may proceed to apply NYPMIFA to any fund 90 days after the notice is mailed if no response is received. The law requires nonprofits to provide a response device (envelope or postcard) for these donors to reply.
- Funds created from 9/17/2010 – NYPMIFA automatically applies to all endowment funds created from 9/17/2010 and moving forward, unless a donor agreement includes explicit language excluding it from the law.
- Endowment agreements and solicitation materials – The new law requires that all endowment fund solicitation materials include a statement notifying potential donors of the new invasion of principal aspects of NYPMIFA. The sample language in the statute is: “unless otherwise restricted by the gift instrument pursuant to paragraph (B) of section 553 of the not-for-profit corporation law, the institution may expend so much of an endowment fund as it deems prudent after considering the factors set forth in paragraph (A) of section 553 of the not-for-profit corporation law.” While this type of language is required specifically for endowment solicitation materials, it would follow that endowment agreements going forward should also include a similar statement. Note: the statute is clear that NYPMIFA applies to all new permanent endowment agreements established after 9/17/2010, regardless of whether this type of statement is included in the agreement. Legal counsel should be consulted on any potential changes to permanent endowment gift agreements.
Prudent Factors and the 7% Presumption of Imprudence
While there may be some nonprofits cheering over the ending of the historic gift value limitation on endowment spending, the most immediate and prominent impact on endowment fund management as a result of NYPMIFA will be the requirement to apply a series of eight prudent factors (see appendix for list of factors within a hypothetical prudent factor analysis) when making all grant decisions for permanent endowments.
- Documentation – While it is to be seen whether nonprofits will be required to apply and document the prudent factor analysis for each and every endowment fund (which would be extremely burdensome), it is clear that institutions must maintain a contemporaneous record describing the consideration given by the governing board or committee to each of the eight factors.
- Similarly situated funds – One of the law firm memos stated that it was “their belief” that nonprofit boards could apply the prudent factor analysis to a group of similarly situated (i.e. similar funds in purpose and application) in one analysis to cover a group of funds. Nonprofits will want to monitor communications from the New York attorney general on this question and advice should be sought from counsel until it is clarified.
- No safe haven – While the law creates a rebuttable presumption of imprudence for all spending rates greater than 7%, this does not mean that spending rates of 7% or less have a presumption of prudence. In other words, nonprofit governing boards need to go through the prudent factor analysis for all endowment spending decisions on funds governed by NYPMIFA, regardless of whether the spending rate is above or below 7%.
- Change required for new funds – Continuing to apply the old procedures to funds established after 9/17/2010 will not suffice to comply with NYPMIFA. Endowment programs cannot just continue with prior practices of maintaining the historical gift value for new gifts, even if the board determines that it has no plans to invade any principal of their funds. Rather, all board grant decisions regarding post-9/17/2010 gifts must go through the NYPMIFA prudent factor analysis.
- Questions regarding older funds – It is not clear from the memos whether the prudent factor analysis will be required for pre-existing funds which opt-out of NYPMIFA, even though a general standard of prudence will always be applicable. Additionally, it appears to be the case that the 7% presumption of imprudence does not apply to pre-9/17/2010 endowment funds which opt-in to NYPMIFA. Nevertheless, any nonprofit which expends in excess of 7% of a NYPMIFA governed fund’s value would have to document a full prudent factor analysis to such a decision and face challenges from auditors and/or regulators.
Modification on Smaller, Older Funds
One of the lesser publicized opportunities created by NYPMIFA is a new ability to release or modify restrictions for smaller, older funds without the need to institute costly “cy pres” legal action. While it has always been possible to release/modify an obsolete or impracticable restriction through donor consent (for living donors) or court action (where donor is deceased), NYPMIFA creates a procedure for release/modification that only requires notice to the Attorney General and to living donors. The following are the parameters for this option:
- 20 years/less than $100,000 – This special Attorney General notice provision for release/modification for old, small endowment funds only applies to funds over 20 years old and under $100,000 in balance.
- Legitimate reasons for release/modification – Additionally, the restriction that is sought to be released or modified must be either “unlawful, impracticable, impossible to achieve or wasteful.”
- Notice to Attorney General – Notice must be sent to the Attorney General explaining why this provision of NYPMIFA applies to this fund, legitimate reasons for the release/modification and the plan for the fund. The Attorney General has 90 days to respond to the notice, after which a nonprofit may proceed with the proposed release or modification.
- Notice to Living Donors – NYPMIFA does require notice to living/available donors of such proposed changes to funds but it does not require consent. Presumably, a living/available donor should be provided a similar or the same notice sent to the Attorney General and the donors would need to contact either the nonprofit or the Attorney General with objections. It is not clear if donors have any other recourse and it appears that once the 90 days lapse without Attorney General response, even if a donor is protesting, the release/modification stands.
Endowment Investment Policies
NYPMIFA adds several completely new policy and procedure requirements in regards to the investment of endowment funds. These requirements are very particular and increase the need for education and review of this function with boards and investment committees for all New York nonprofits which manage endowment funds.
- Written investment policy required – While it is generally a given that institutions which manage investments have a written investment policy, NYPMIFA now actually requires written a policy.
- Prudence standard expanded – NYPMIFA requires in addition to a general prudence standard within a written investment policy, that the following factors be included in a written investment policy and considered in managing and investing institutional funds:
- general economic conditions;
- the possible effect of inflation or deflation;
- the expected tax consequences, if any, of investment decisions or strategies;
- the role that each investment or course of action plays within the overall investment portfolio of the fund;
- the expected total return from income and the appreciation of investments;
- other resources of the institution;
- the needs of the institution and the fund to make distributions and to preserve capital; and
- an asset’s special relationship or special value, if any, to a charitable purpose of the institution.
- Diversification – NYPMIFA requires nonprofits to review at least annually any decision not to diversify the assets of an institutional fund.
- Delegating Investment Function – NYPMIFA establishes an affirmative duty to assess the independence of external agents selected to manage and invest institutional funds, including any conflicts of interest of the agent.
The most immediate concern arising out of the enactment of NYPMIFA is the education of governing boards of the new requirements and the implementation of NYPMIFA’s requirements. Boards will likely need to drastically change their procedures for reviewing spending rates, redraft investment policies, and take on a full review of other policies, documents and procedures that may be in need of adjustment in light of the new law.
Lastly, finance/accounting offices will need to also make adjustments in the accounting of permanent endowments, which will be subject of a follow-up article as we get more clarity regarding NYPMIFA.
The memos referenced in this article may be downloaded via the following links:
Patterson Belknap: http://www.pbwt.com/resources/publications/new-york-version-of-upmifa/
Appendix A – (from Simpson Thacher memo)
Hypothetical Excerpt of Minutes of a Meeting of the Board of Directors
Regarding Appropriation from an Endowment Fund
Hypothetical Example: A charity’s determination to appropriate for expenditure from an individual endowment fund established by a single donor prior to the enactment of NYPMIFA a total of $500,000.
[INSERT NAME OF ORGANIZATION]
Minutes from a Meeting of the Board of Directors
A meeting of the Board of Directors (the “Board”) of [INSERT NAME OF ORGANIZATION] (the “Charity”) was held on [INSERT DATE] at [INSERT LOCATION]. The following directors were present, constituting a quorum: [LIST ATTENDING DIRECTORS].
[INSERT OTHER BUSINESS ADDRESSED AT THE MEETING]
Appropriation from Donor A’s Endowment Fund
The Treasurer of the Charity, [INSERT NAME OF INDIVIDUAL], presented to the Board the recommendation that the Board approve an appropriation for expenditure from the Donor A Scholarship Endowment Fund in the amount of $500,000, by application of a spending rate of 6% to the Donor A Scholarship Endowment Fund.
First, the Treasurer explained the need of the Charity for the funds. The Treasurer reported that the funds were needed to fulfill the Charity’s commitment to providing scholarships to qualified students. The Treasurer indicated there had been a decrease in the value of the Donor A Scholarship Endowment Fund. However, the Charity’s scholarship commitments had not decreased. The Treasurer informed the Board that the restriction contained in the written gift instrument applicable to the Donor A Scholarship Endowment Fund stated that the fund could
be used only for scholarship purposes, but did not include a specific spending rate. The Treasurer told the Board that the original donor of the Donor A Scholarship Endowment Fund died a number of years ago and is therefore not available to receive notice of this proposed first time appropriation from the Donor A Scholarship Endowment Fund. The donor did not designate a person in the gift instrument to act in the place of the donor.
September 20, 2010
The Board then discussed the Treasurer’s request for the appropriation. The Board considered the following eight factors in making its decision to appropriate from the endowment fund:
1. The duration and preservation of the endowment fund: The Board noted that the Donor A Scholarship Endowment Fund is of perpetual duration and that the current need to support students who have been awarded scholarships must be balanced against the need for scholarship funds in the future.
2. The purposes of the Charity and the endowment fund: The Board noted the educational purposes of the Charity, and its commitment to providing education to qualified students regardless of need. The Board noted that the applicable gift instrument limited Donor A Scholarship Endowment Fund’s use to scholarships.
3. General economic conditions: The Board discussed the economic conditions that led to the recommendation that the funds be appropriated from the Donor A Scholarship Endowment Fund. The Board discussed the current market volatility and the fact that a market upswing in the near future is unlikely.
4. The possible effect of inflation and deflation: The Board discussed the possible effect of inflation and deflation on the Donor A Scholarship Endowment Fund and the purchasing power of the Donor A Scholarship Endowment Fund.
5. The expected total return from income and the appreciation of investments: The Board discussed the Treasurer’s report on the performance of the Donor A Scholarship Endowment Fund. The Board discussed the impact the appropriation would have on the purchasing power of the Donor A Scholarship Endowment Fund.
6. Other resources of the Charity: The Board discussed the possibility of using resources from other funds to cover the Charity’s current scholarship obligations, and the Treasurer reported on the limited availability of other funds.
7. Where appropriate and circumstances would otherwise warrant, alternatives to expenditure of the endowment fund, giving due consideration to the effect that such alternatives may have on the Charity: The Board discussed how costs had already been cut and determined that further cost-cutting would negatively impact programs. The Board then discussed the possibility of using a line of credit to cover the costs of the Charity’s scholarship program, and of initiating a solicitation campaign to raise new funds for the scholarship program. The Board determined that no further lines of credit were likely to be available and that the initiation of a solicitation campaign would not address current needs, although it would be advisable to consider in the future when donors may be more receptive to new solicitations.
8. The investment policy of the Charity: The Board reviewed the Charity’s investment policy, and determined that the proposed appropriation is consistent with the return goals of the investment policy.
After further discussion, upon motion duly made and seconded, the Board unanimously:
RESOLVED, that the Board of Directors hereby approves the appropriation of 6% of the average value of the Donor A Scholarship Endowment Fund, measured as of the last day of the calendar quarter for the twenty calendar quarters preceding the date hereof, to provide student scholarships in the current fiscal year.
Appendix B – (from Simpson Thacher memo)
Sample Notification Letter
[CITY], [STATE] [ZIP]
The [NAME OF CHARITY] (“Charity”) has benefited greatly from your gift of an endowment fund. Your gift has enhanced our ability to offer our services and programs. We wish to inform you that on September 17, 2010, the Governor signed into law the New York Prudent Management of Institutional Funds Act (“NYPMIFA”). NYPMIFA contains important updates and changes to the law governing use of endowed funds by charitable institutions like Charity.
Under prior law, charitable institutions were prohibited from expending certain amounts from endowment funds when the value of those funds dropped below their “historic dollar value.” The “historic dollar value” of the endowment fund was defined as the dollar value of each of the contributions made to the endowment fund by the donor.
Under NYPMIFA, the “historic dollar value” concept has been eliminated. In its place, NYPMIFA states that a charitable institution may allocate for expenditure each year so much of the endowment fund as the charitable institution determines is prudent.
Charity plans to follow the terms of NYPMIFA in making decisions as to annual allocations for expenditure from endowment fund gifts. This would allow Charity to expend amounts from its endowment funds even when market values decline below the endowment funds’ historic dollar values.
Under the terms of NYPMIFA, Charity is required to notify you of the changes occasioned by NYPMIFA and provide you with the options below. Please check the box next to your preferred option, below.
[ ] Charity may apply the terms of NYPMIFA to my gift and appropriate for expenditure so much of the gift as Charity determines is prudent.
[ ] Notwithstanding the provisions of NYPMIFA, I direct that Charity not spend below the original dollar value of my gift. I understand and agree that the terms of NYPMIFA will apply to the management and investment of my gift, and that Charity may spend the income and appreciation over the historic dollar value if it is prudent to do so.
Please return this letter to us within ninety days in the enclosed envelope. If you do not respond within ninety days, the terms of NYPMIFA will apply to your gift.
Should you have any questions about NYPMIFA, or about how the terms of NYPMIFA will apply to your endowment gift, please contact [NAME] at [PHONE NUMBER].
We thank you, again, for your support of Charity.
[INSERT NAME, TITLE]