The Uniform Prudent Management of Institutional Funds Act

What is UPMIFA?

UPMIFA stands for the Uniform Prudent Management of Institutional Funds Act. It was drafted by the National Conference of Commissioners on Uniform State Laws and has been adopted in the District of Columbia and in all states except Pennsylvania. UPMIFA is an updated version of the Uniform Management of Institutional Funds Act (UMIFA), which was created in 1972 and adopted in 47 states.

Who does it apply to?

At the organizational level, UPMIFA applies to any nonprofit organizations. It also applies to organizations characterized as trusts if the charities are trustees. (It doesn’t apply to trusts where the trustees are individuals or institutions.)

Within qualifying organizations, UPMIFA applies to assets held for investment purposes, meaning it doesn’t apply to assets used within the function of the organization. (An office building owned for investment purposes would fall under UPMIFA, but the office building where the organization operates wouldn’t.) It applies to funds where spending is restricted (meaning used for a specific purpose, not general spending) and is meant in perpetuity (meaning not meant to be spent down).

One important note is that donor instructions trump the guidelines set forth by UPMIFA. For instance, if the donor dictates specific spending and/or investment guidelines, then those guidelines are to be followed, even in the face of UPMIFA.

What does it mean to my organization?

One of UPMIFA’s most significant characteristics is that it allows endowments to spend from “underwater” endowment funds, as long as the spending is prudent. Under UMIFA, endowments weren’t allowed to spend under the historic dollar value of the original gifts, with the exceptions of interest and dividends. This meant that funds established just prior to (or during) bear markets would likely be instantly frozen, as the value would quickly drop below the historic dollar value.

The latest bear market provides a perfect example of why many endowments welcomed the change. At the beginning of 2008, the North Carolina Symphony’s endowment was worth $9.3 million, well above its historic dollar value of $7.25 million and enough to allow the organization to make a $600,000 withdrawal to cover salaries and concerts. By March 2009, the fund had dropped to $6.9 million, meaning the symphony was restricted from touching the endowment and needed to find other ways to make up the revenue. (North Carolina has since adopted UPMIFA.)

Many schools also found themselves unable to access their endowments. New York University, for example, had about $10 million of its $16 million in scholarship endowments unavailable in March 2009. (New York has also adopted UPMIFA.)

UPMIFA replaces the restriction on spending from underwater funds with a more subjective guideline of spending a prudent amount. Endowments may spend from underwater funds, but they must ensure their spending isn’t so drastic that it puts the original intent of the donation in jeopardy.

Many states include a 7 percent rule for spending, which means endowments may spend up to 7 percent of the value of the fund while still demonstrating prudent spending. (This doesn’t mean spending up to 7 percent isn’t scrutinized, but simply establishes an automatic threshold that triggers a red flag.) Anything beyond the 7 percent mark creates a rebuttable presumption of imprudence, which is a way of saying guilty until proven innocent. A withdrawal in excess of 7 percent is automatically considered imprudent, but the organization is allowed to demonstrate why the additional withdrawal should be considered acceptable.

Some states may also include a provision aimed at newer and smaller organizations. Those with limited spending experience and assets aggregated at less than $2 million must notify the state’s attorney general before engaging in spending that takes the total value of its assets below the historic dollar value. (Please note that these two provisions haven’t been adopted by all states.)

Changing donor restrictions

Another significant change involves changing the restrictions surrounding an endowment fund. Under UMIFA, impractical spending restrictions had to be addressed in court, and the only option was having the restrictions (or donor intent) completely removed. Under UPMIFA, the courts can approve modifications to the restrictions, as long as the restrictions are in line with the donor’s probable intent. In addition, organizations can also modify restrictions without court approval if the funds have less than $25,000 and are more than 20 years old. (In those cases, the state attorney must be notified, and the use of the funds must still be consistent with the donor’s original intent.)

What it means for investing

The law changes can have several impacts on the investing methodologies used by organizations. First, the removal of the historic dollar value floor means endowments can invest newly donated funds in greater accordance with to the purpose of the fund. Previously, endowments may have invested new funds conservatively, avoiding falling under the historic dollar value, but potentially harming the long-term viability of the fund’s intent. This no longer becomes a worry.

Perhaps the biggest changes involve the way boards must approach establishing and revising their investment policies. The removal of hard rules such as the spending floor allows for more flexibility, but can also lead to uncertainty about the correct way to proceed and what exactly constitutes prudence related to investing.

Institutions must show prudence in selecting investment managers. This means institutions can’t simply pick a board member’s brother because the board member says he’s a good guy. This manager can, however, be chosen after thorough due diligence of his investment methodology and fees. Institutions must also establish limitations on how the investment manager operates and must periodically review the investment manager’s work to ensure he or she is complying with the proper guidelines.

To help determine a prudent spending policy, UPMIFA noted seven factors that should be considered for determining spending rates and individual investments:

1)      Duration and preservation of the endowment fund

2)      Purposes of the institution and endowment fund

3)      General economic conditions

4)      Effects of inflation and/or deflation

5)      Expected total return

6)      The institution’s other resources

7)      The institution’s investment policy

Summary

The changes in endowment fund governance from UMIFA to UPMIFA should be welcomed by organizations, as they allow for more operating flexibility. However, that additional flexibility comes with a cost. Board members now have more responsibility to do their due diligence in selecting spending policies, investment policies and investment managers. Boards who either spend the time to get comfortable with the new guidelines or hire investment managers well versed in UPMIFA should give their organizations an additional boost in fulfilling their missions.

The opinions expressed by featured authors are their own and may not accurately reflect those of the BAM ALLIANCE. This article is for general information only and is not intended to serve as specific financial, accounting or tax advice.

© 2012, The BAM ALLIANCE

Buckingham

BUCKINGHAM was founded in 1994 to provide a disciplined, academically based investment experience tailored to address each client’s distinct willingness, ability and need to accept market risk. Offering an advisor relationship built on personal trust and company-wide integrity, we serve as a Registered Investment Advisor offering fee-based investment management to individuals, businesses, trusts, partnerships, not-for-profit organizations and retirement plans.

Foundational Materials

Buckingham prides itself on producing a wealth of non-biased financial information on a regular basis. See these articles from our blog and from our thought leaders around the nation.

Buckingham Library

Click on the covers to learn more and order the books our national thought leaders have written in recent years.

Previous Slide
Next Slide