"New York State Makes Significant Changes to the Laws Governing How Not-for-Profit Organizations May Manage and Spend Their Endowment Funds"

On September 17, 2010, New York State enacted the New York Prudent Management of Institutional Funds Act (NYPMIFA). This law, which is a modified version of the Uniform Prudent Management of Institutional Funds Act, makes significant changes to the rules governing how New York not-for-profit organizations may manage, invest and spend their endowment funds. The new law is designed to allow organizations to cope more easily with fluctuations in the value of their endowments and to afford them greater access to funds needed to support their programs and services in difficult financial times.¹ This should provide some relief to organizations that, due to the recent economic downturn, have found themselves with underwater endowments. It also expands the options available to organizations seeking relief from donor restrictions on funds that have become obsolete, impracticable or wasteful. NYPMIFA applies to New York not-for-profit, education and religious corporations, associations organized and operated exclusively for charitable purposes, and certain trusts.²

NYPMIFA is quite complex, and certain provisions of the law are somewhat ambiguous. The Charities Bureau of the New York State Attorney General’s Office has indicated that it will issue, as quickly as possible, guidance on the Attorney General’s interpretation of NYPMIFA and the obligations it imposes on organizations. However, because NYPMIFA took effect upon its enactment on September 17, we thought that it would be helpful to provide you with this initial analysis of the new law’s substantive provisions. We will update you as guidance is issued.

Prior Law

Prior to the adoption of NYPMIFA, New York not-for-profit, education and religious corporations were governed by the New York Management of Institutional Funds Act (NYMIFA).³ This law permitted a corporation to spend the income earned by an endowment fund, i.e., interest, dividends, rents and royalties, as well as the net appreciation (realized with respect to all assets and unrealized with respect to readily marketable assets) of such fund. However, the endowment fund’s principal, i.e., its historic dollar value, needed to be preserved. The historic dollar value of an endowment fund is the aggregate fair value of the fund at the time of the original gift plus the value of any subsequent gift when made.⁴

Changes Effected by NYP-MIFA

I. Spending From Endowment Funds (N-PCL § 553)

Historic Dollar Value Replaced by Enhanced Prudence Standard: Eight Factors to Consider

NYPMIFA eliminates the historic dollar value floor on spending. It replaces historic dollar value with a requirement for acting prudently and guidance on what that means when an organization wishes to spend endowment fund assets.⁵ Now, an organization may “appropriate,” i.e., make available, for expenditure as much of an endowment fund, including principal, as the governing board finds prudent taking into consideration the “uses, benefits, purposes and duration” for which the fund was established. In making this decision, the governing board must exercise its duty of care, i.e., act in good faith with the care that an ordinarily prudent person in a like position would exercise under similar circumstances, and must consider, if relevant, the following eight factors:

• the duration and preservation of the endowment fund;
• purposes of the organization and the fund;
• general economic conditions;
• possible effect of inflation or deflation;
• expected total return from income and appreciation of investments;
• other resources of the organization;
• the organization’s investment policy; and
• where appropriate, alternatives to spending from the endowment fund and the possible effects of those alternatives on the organization.

For each decision to appropriate funds for expenditure, the organization must keep a "contemporaneous record," e.g., minutes of the meeting of the governing board at which such decision was made, describing the nature and extent of the consideration that the governing board gave to each of these eight factors.

NYPMIFA requires that donor intent be respected when an organization makes decisions with respect to either investing or spending from its endowment funds. If a donor, in the gift instrument, has directed that appreciation not be spent, the organization must comply with that directive and consider it when making decisions regarding the management and investment of the fund. A donor may limit the application of NYPMIFA’s spending rules to his or her gift by specifically stating the limitation in the gift instrument.⁶

Rebuttable Presumption of Imprudence

NYPMIFA includes a provision intended to ensure against excessive spending from endowments. In that regard, NYPMIFA provides that the appropriation for expenditure of more than seven percent of the fair market value of an endowment fund in any one year creates a rebuttable presumption of imprudence.⁷ This provision applies only to gifts where the gift instrument was executed on or after September 17, 2010 (NYPMIFA’s effective date).

Notifying Donors of New Spending Rules

Donors of endowment funds in existence before September 17, 2010, must be given the opportunity to opt out of NYPMIFA’s new spending rules. Organizations must provide 90 days’ notice to a donor, if “available,” before applying those rules to a fund for the first time. A donor is “available” if such donor is an individual who is living, or a corporation or other entity that is in existence and conducting activities, and the donor can be identified and located with reasonable efforts. The notice must ask the donor to indicate whether the organization (i) may spend as much of his or her gift as it determines is prudent or (ii) must maintain the historic dollar value of the gift. The notice also must include an explanation of the potential impact that each choice would have on spending from the fund. Notice need not be given to donors (i) where the gift instrument already permits appropriation without regard to the fund’s historic dollar value, or (ii) if it specifically limits the organization’s authority to appropriate or accumulate funds, or (iii) where the endowment funds were received as a result of a solicitation by the organization and the donor provided the gift in response without executing a gift agreement or otherwise providing his or her own statement restricting the use of the funds. During the 90 day notice period, a donor may modify the gift instrument — with or without the consent of the organization — to prohibit application of NYPMIFA’s spending rules. If the donor does not respond within the 90 days, these new spending rules will apply to the gift. Organizations must keep records of the actions taken in compliance with these notice requirements.

II. Management and Investment Standards (N-PCL § 552)

NYPMIFA provides detailed guidance for investment management and articulates a stronger set of rules for investing prudently as described below. It requires an organization’s governing board, in managing and investing the organization’s “institutional funds,” to incur only appropriate and reasonable costs and to make reasonable efforts to verify the accuracy of information used in making decisions regarding the management and investment of the funds.

An organization’s “institutional funds” include not only its endowment funds but also all assets held by the organization primarily for investment purposes.⁸ NYPMIFA also requires organizations to adopt a written investment policy setting forth guidelines on investments and the delegation of investment functions in accordance with NYPMIFA’s standards.

Prudence Standard for Managing and Investing: Eight Factors to Consider

Under NYPMIFA, the organization’s governing board must consider the purposes of both the organization and the fund in managing and investing an institutional fund. Each person responsible for managing and investing a fund must do so in good faith and with the care an ordinarily prudent person in a like position would exercise under similar circumstances. NYPMIFA lists eight factors that must be considered, if relevant, several of which also are factors that must be considered when making decisions to appropriate endowment funds for expenditure. The eight factors are:

• general economic conditions;
• possible effect of inflation or deflation;
• 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;
• expected total return from the income and appreciation of investments;
• other resources of the organization;
• the needs of the organization and the fund to make distributions and preserve capital; and
• an asset’s special relationship or special value, if any, to the organization’s purposes.

Diversification Requirement

Organizations may continue to invest in any kind of property or type of investment and to pool two or more funds for investment purposes. The new law requires that a fund’s investments be diversified unless the organization’s governing board determines that, due to special circumstances, the purposes of the fund are better served without diversification. A decision not to diversify must be reviewed at least annually.

Overall Investment Strategy

Management and investment decisions about a specific asset must be made in the context of the fund’s portfolio of investments as a whole and as part of an overall investment strategy in light of return objectives “reasonably suited” to the charity and the fund. Organizations also are required, within a reasonable time after receiving a gift of securities or other investment assets of a fund, to make and carry out decisions regarding retaining or disposing of the property, or rebalancing the portfolio in order to bring the fund into compliance with the organization’s “purposes, terms and distribution requirements” and NYP-MIFA.

III. Delegation of Investment Authority and Selection of Investment Managers (N-PCL § 554)

An organization’s governing board may delegate to committees, officers or employees the authority to act in place of the board in investing and reinvesting institutional funds. In so delegating, the board must exercise its duty of care taking into consideration the eight factors listed above that must be considered when making investment decisions.

Delegation to External Agents

Investment management authority also may continue to be delegated to external agents, i.e., an independent investment advisor, investment counsel or manager, bank or trust company. Here again, the governing board must exercise its duty of care in selecting, continuing or terminating an external agent, including assessing the agent’s independence (including any conflicts of interest), establishing the scope of the delegation, setting the agent’s compensation and monitoring the agent’s performance.

An agent to whom an investment management function has been delegated owes a duty to the organization to exercise reasonable care, skill and caution to comply with the scope and terms of the delegation. NYPMIFA also requires, as did the prior law, that contracts between an organization and external agent to whom investment management authority is delegated must provide that the organization may terminate the contract at any time, without penalty, upon no more than 60 days notice. A governing board that delegates investment authority to an external agent in accordance with these standards and procedures will not be liable for the agent’s decisions or actions.

IV. Release or Modification of Gift Restrictions (N-PCL § 555)

The new law expands the options available to an organization to obtain relief from donor restrictions that have become obsolete, wasteful or impracticable or impossible to effect. Under prior law, an organization’s governing board could release a restriction if the donor’s written, acknowledged consent was obtained. If the donor was deceased or could not be located or identified, the organization could release the restriction by petitioning the supreme court in the jurisdiction where the organization’s office was located or, if the gift instrument was a will, the surrogate’s court where the will was probated, on notice to the New York State Attorney General. The court could release the restriction if it found that the restriction was obsolete, inappropriate or impracticable. The prior law did not specifically provide for the modification of donor restrictions. Under NYPMIFA, donor restrictions on funds may be released or modified in one of the following ways:

Donor Consent

An organization may modify or release a restriction on the management, investment or purpose of a fund if the donor consents in writing to such modification or release.

Modification by a Court

An organization also may seek court approval to modify a donor restriction even if the donor is available. The organization must notify available donors and the Attorney General of its application to the court, and both of these parties must be given an opportunity to be heard. A court may modify a restriction regarding the management or investment of a fund if: (i) the restriction has become impracticable or wasteful, (ii) it impairs the management or investment of the fund or (iii) because of circumstances unanticipated by the donor, a modification of the restriction will further the fund’s purposes. Any such modification authorized by the court must be made, to the extent practicable, in accordance with the donor’s probable intent. Similarly, if a purpose of a restricted fund or a restriction on its use has become unlawful, impracticable, impossible to achieve or wasteful, a court may modify the purpose or use restriction in a manner consistent with purposes expressed in the gift instrument.

Cy Pres Relief

NYPMIFA specifies, as did the prior law, that its provisions governing the release (or modification) of restrictions do not limit the application of the cy pres doctrine, which permits a court, in certain circumstances, to release a restriction on a charitable gift if the restriction, due to changed circumstances, has become impracticable or impossible to enforce. Accordingly, organizations still may seek cypres relief to release a donor restriction on a fund.

Modification or Release of Restrictions on Small, Old Funds

NYPMIFA also permits organizations to modify or release donor restrictions on funds without obtaining either donor consent or judicial approval where the fund is small — less than $100,000 — and more than 20 years old, and the proposed use of the fund after release or modification is consistent with the purposes expressed in the gift instrument. In such cases, the organization must notify the Attorney General of its intention to modify or release the restriction. Such notice must include an explanation of the organization’s determination that the fund meets the requirements of this section, a statement of the proposed release or modification, a copy of the record, e.g., board minutes or unanimous written consent of directors, approving the release or modification, and a statement of the proposed use of the fund after the release or modification is granted. If the Attorney General does not respond within 90 days of such notice, the organization may proceed with the proposed release or modification. With limited exception, the organization also must notify the donor, if available, of the organization’s intention to release or modify the restriction. However, NYPMIFA does not provide a mechanism for the donor to object in these cases.

Solicitations for Endowment Funds

NYPMIFA also makes a change to Article 7-A of the New York Executive Law, which sets forth the registration and reporting requirements for organizations that solicit charitable contributions in New York State. Now, any solicitation that an organization makes for contributions to an endowment fund must include a statement that, unless otherwise restricted by the gift instrument, the organization may expend so much of the endowment fund as it deems prudent after considering the factors governing appropriation decisions set forth in NYPMIFA.

V. FAS 117-1

Following the adoption of UPMIFA, the Financial Accounting Standards Board (FASB) issued staff position FAS 117-1, which sets forth rules governing the net asset classification of endowment funds of organizations that are subject to an enacted version of UPMIFA. Accordingly, New York organizations subject to NYPMIFA now will need to comply with these rules.

FAS 117-1 requires organizations to classify a portion of a donor-restricted endowment fund of permanent duration as permanently restricted assets. The amount that must be classified as permanently restricted should be the amount of the fund that must be retained permanently in accordance with explicit donor stipulations or, in the absence of such stipulations, the amount that the organization’s governing board determines must be retained permanently consistent with the prudence standards of NYPMIFA outlined above. FAS 117-1 also requires organizations to classify a portion of the endowment fund that is not classified as permanently restricted net assets as temporarily restricted net assets (time restricted) until such assets are appropriated for expenditure.

This means that organizations now will need to classify the income and appreciation from a donor-restricted endowment fund as temporarily restricted, rather than unrestricted (as prior FASB rules permitted), until those funds are appropriated for expenditure by the organization’s board.

FAS 117-1 also requires organizations holding endowment funds to include in their financial statements a number of additional disclosures intended to enable readers to better understand the net asset classifications set forth in the financial statements.

1 NYPMIFA is codified primarily in the new Article 5-A of the New York Not-for-Profit Corporation Law (N-PCL), §§ 550 through 558.

2 NYPMIFA is applicable to trusts having both charitable and non-charitable interests at the point when all non-charitable interests have terminated. As was the case under prior law, NYPMIFA’s provisions are applicable to corporations formed under the New York Education Law and, with only a few exceptions, corporations formed under the New York Religious Corporations Law.

3 In passing NYPMIFA, New York State becomes the 47th state, in addition to the District of Columbia, to adopt a version of the Uniform Prudent Management of Institutional Funds Act.

4 If the gift instrument creating the endowment fund directed that some or all appreciation be accumulated rather than spent, such appreciation also would have been included in the fund’s historic dollar value.

5 Under NYPMIFA, an endowment fund is a fund or part thereof that, under the terms of a gift instrument, is not wholly expendable by the organization on a current basis.

6 A "gift instrument" can be any written record, including a solicitation by an organization, under which property is granted or transferred to or held by an organization.

7 The fair market value of a fund for this purpose must be calculated based on market values determined at least quarterly and averaged over the five immediately preceding years. For funds that have been in existence less than five years, the fund’s fair market value will be calculated for the period of the fund’s existence.

8 An “institutional fund” is defined broadly in NYPMIFA as "a fund held by an institution." Excluded from the definition are program-related assets, a fund held for an institution by a trustee that is not an institution and a fund in which a beneficiary that is not an institution has an interest other than an interest that could arise upon violation or failure of the purposes of the fund. A program-related asset is an asset that an organization uses directly in carrying out its charitable activities and would include, for example, buildings owned by a university and used for classrooms and/or dormitories for its students.