Navigating the New Endowment Landscape Under UPMIFA 1 and FAS 117-1: A Practical Guide and Compliance Checklist for Nonprofits

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NONPROFIT ORGANIZATIONS ARTICLE OCTOBER 2009 Navigating the New Endwment Landscape Under UPMIFA 1 and FAS 117-1: A Practical Guide and Cmpliance Checklist fr Nnprfits k By Dianne Chipps Bailey and

1 NONPROFIT ORGANIZATIONS ARTICLE OCTOBER 2009 Navigating the New Endwment Landscape Under UPMIFA 1 and FAS 117-1: A Practical Guide and Cmpliance Checklist fr Nnprfits k By Dianne Chipps Bailey and Ashley C. Hedgecck In July f 2006, the Natinal Cnference f Cmmissiners n Unifrm State Laws apprved and recmmended state enactment f the Unifrm Prudent Management f Institutinal Funds Act (UPMIFA), a unifrm law drafted t mdernize the rules gverning endwment fund spending and management. Since that time, 42 states and the District f Clumbia have enacted UPMIFA 2 r sme variatin theref t replace prir law based n the 1972 mdel act, the Unifrm Management f Institutinal Funds Act. The newly-enacted UPMIFA effects three primary changes t prir law. First, UPMIFA updates spending rules t address market vlatility and fluctuatins in asset balances, in sme instances prviding institutins greater flexibility in trubled ecnmic times. Secnd, the law prvides guidance related t the management f endwment assets and the delegatin f such management. Finally, UPMIFA makes it easier fr nnprfits t release r mdify restrictins that a dnr has impsed n lder, smaller endwment funds. UPMIFA pses a number f immediate challenges fr rganizatins that hld endwment funds. Fr example, nnprfits need t assess existing grant agreements t determine dnr intent, review investment and spending plicies t ensure they satisfy UPMIFA s requirements, and review and ptentially mdify the manner in which they accunt fr endwment funds t ensure cmpliance with accunting rules. This memrandum prvides backgrund n the new legal and accunting landscape fr endwments under UPMIFA and ffers a checklist fr the steps an institutin shuld cnsider when navigating the new rules. Scpe f UPMIFA An endwment fund is a fund that, under the terms f a gift instrument, is nt whlly expendable by the nnprfit n a current basis. UPMIFA nly applies t funds with dnr-impsed, rather than bard-designated, restrictins 3. 1

2 Spending Prudently Under UPMIFA Befre UPMIFA, prir law authrized charities t spend earnings and appreciatin frm an endwment fund ver the fund s histric dllar value the aggregate value f all cntributins t an endwment fund at the time they were made but the rganizatin culd nt spend frm underwater funds that had fallen belw histric dllar value. UPMIFA eliminates the cncept f histric dllar value and ffers gverning bards mre flexibility by allwing rganizatins t expend amunts frm an endwment based n what is prudent, acting in gd faith with the care an rdinarily prudent persn in a like psitin wuld exercise under similar circumstances. Subject t the specific intent f the dnr expressed in a gift instrument, an rganizatin in an UPMIFA jurisdictin may expend r accumulate as much f an endwment fund as the institutin determines is prudent fr the uses, benefits, purpses, and duratin fr which the endwment fund is established. In determining what is prudent, the rganizatin must cnsider: The duratin and preservatin f the endwment fund The purpses f the institutin and the endwment fund General ecnmic cnditins The pssible effect f inflatin r deflatin The expected ttal return frm incme and the appreciatin f investments Other resurces f the institutin The investment plicy f the institutin T be clear, UPMIFA des nt permit a gverning bard t cnvert an endwment fund int a ttally expendable fund the duratin and preservatin f the fund always must be a pririty. Hwever, UPMIFA des permit the institutin t preserve the purchasing pwer f the current value f the fund while being respnsive t the needs f the rganizatin during shrt-term value fluctuatins. UPMIFA als has an ptinal prvisin that creates a rebuttable presumptin f imprudence if an institutin expends greater than 7 percent f a fund s fair market value, averaged ver a three year perid. Sme states have enacted this ptinal prvisin r sme variatin theref in rder t prvide a bright-line test and safeguard against excessive expenditure. 4 Other states have eliminated the ptinal prvisin altgether, instead pting t grant gverning bards maximum discretin within the limits set by the prudence standard. In bth types f jurisdictins, gverning bards shuld be prepared t thrughly analyze and weigh each f the abve factrs pursuant t a bard adpted spending plicy and dcument their decisin-making prcess in the meeting minutes. Investing Prudently Under UPMIFA UPMIFA requires nnprfits t apply mdern prtfli thery and invest n a diversified basis. The standard f care fr making such investment decisins is the same prudence standard that applies t spending decisins the gverning bard must manage and invest the fund in gd faith and with the care an rdinarily prudent persn in a like psitin wuld exercise under similar circumstances. In making investment and management decisins, the rganizatin must cnsider: General ecnmic cnditins Effects f inflatin r deflatin Tax cnsequences Hw an investment fits within the ttal prtfli Prtfli s expected ttal return Other resurces available t the institutin Institutinal needs and the relatinship between distributins and capital preservatin An asset s special relatinship r value, if any, t the charitable purpses f the institutin 2

3 In additin, UPMIFA expressly permits nnprfits t delegate the management and investment f an endwment fund as lng as the bard acts prudently and in gd faith in selecting the agent, establishing the scpe and terms f the delegatin, and mnitring the agent s perfrmance and cmpliance with the terms f the delegatin. Releasing r Mdifying Dnr Restrictins Under UPMIFA UPMIFA als updates the methd fr releasing r mdifying dnr restrictins n the use f certain endwment funds. The traditinal methds f release r mdificatin still apply but lder, smaller funds can nw be released r mdified withut making a request t the curt r the dnr as lng as the prperty is used in a manner cnsistent with the dnr s intent. If the fund is less than $25,000 and mre than 20 years ld 5, a nnprfit may mdify r release the fund s restrictins by giving ntice t the Attrney General. As a practical matter, f curse, it may be in the best interest f nnprfits t cmmunicate with dnrs when pssible befre unilaterally releasing r mdifying fund restrictins, ntwithstanding this change in the law. The mdificatin r release takes effect autmatically 60 days after ntice t the Attrney General. Accunting fr UPMIFA In respnse t the adptin f UPMIFA by many states and UPMIFA s eliminatin f the histric dllar value cncept, the Financial Accunting Standards Bard ( FASB ) issued FASB Staff Psitin FAS N t prvide new financial reprting guidelines fr dnr-restricted endwment funds in states that have enacted UPMIFA. FAS directs nnprfit rganizatins in classifying certain assets and requires certain disclsures fr all rganizatins that hld endwment funds, whether dnr-restricted r bard-designated. The fllwing rules apply t endwment funds under FAS This mem discusses the new rules gverning endwments under the mdel act. There are differences between the prvisins in the mdel act and each state s enacted versin f UPMIFA. 2. UPMIFA is currently being cnsidered fr enactment in 5 ther states. 3. In additin, UPMIFA nly applies t 501(c)(3) charitable rganizatins. It des nt apply t trusts managed by nncharitable entities r individuals, r t 501(c)(7) fraternal rganizatins. 4. Nte, hwever, that spending less than this predetermined percent presumptin des nt create a presumptin f prudence. 5. Many states have mdified the size and age requirements suggested in the mdel act. Rbinsn, Bradshaw & Hinsn, P.A. is a crprate and cmmercial law firm with mre than 125 attrneys. The firm has ffices in Charltte and Chapel Hill, Nrth Carlina, and Rck Hill, Suth Carlina. Fr ver frty years, the firm has cnsistently prvided innvative slutins t its clients business needs frm bth a legal and practical perspective. The firm serves as cunsel t public and clsely held crpratins perating in dmestic and freign markets; limited liability cmpanies; limited and general partnerships; individuals; municipal, cunty and state agencies; public utilities; health care institutins; financial institutins and tax-exempt rganizatins. Fr mre infrmatin n Rbinsn, Bradshaw & Hinsn, please visit ur Web site at

4 FAS Accunting Requirements fr dnrrestricted endwments gverned by UPMIFA Organizatins must classify a prtin f a dnr-restricted endwment fund f perpetual duratin as permanently restricted net assets. The permanently restricted amunt is: (a) the amunt that must be permanently retained accrding t the dnr s restrictin, r (b) in the absence f such restrictins, the amunt the rganizatin s gverning bard determines must be permanently maintained in accrdance with relevant law. The prtin f an endwment fund that is nt classified as permanently restricted nw must be classified as temprarily restricted until apprpriated fr expenditure. Cnsistent with FAS 124, Accunting fr Certain Investments Held by Nt-fr-Prfit Crpratins, fr financial statement purpses, the prtin f a dnr-restricted endwment fund that is classified as permanently restricted net assets generally is nt reduced by investment lsses r an rganizatin s apprpriatin frm a fund. Rather, lsses and apprpriatins frm the permanently restricted prtin f a dnr-restricted endwment fund are charged first t temprarily restricted net assets and then t unrestricted net assets unless ne f the fllwing limited exceptins applies: The dnr cntrls the investment; Fr perpetual trusts; r The dnr grants permissin t charge lsses t the fund Organizatins must identify the prtin f an endwment fund that is nt permanently restricted and that has nt been previusly apprpriated fr expenditure (e.g., unapprpriated appreciatin n the fund). Any such amunts that were previusly classified as unrestricted net assets must be reclassified as temprarily restricted until they have been apprpriated fr expenditure. FAS Disclsure Requirements fr all dnrrestricted and bard-designated endwments All rganizatins, whether r nt subject t UPMIFA, must make new disclsures abut the management f their endwment funds n their financial statements, including: A descriptin f the gverning bard s interpretatin f the laws underlying the rganizatin s net asset classificatin f dnr-restricted endwment funds. A descriptin f the rganizatin s endwment spending plicy. A descriptin f the rganizatin s investment plicy, including: Return bjectives, Risk parameters, The relatinship f return bjectives and risk parameters t spending plicies, and Strategies emplyed t achieve such bjectives. The cmpsitin f the rganizatin s net asset class at the end f the perid, in ttal and by type f endwment fund, shwing dnr-restricted funds separately frm barddesignated funds, and A recnciliatin f beginning and ending balances f the endwment in ttal and by net asset class including: Investment incme, Net appreciatin r depreciatin, Cntributins, and Amunts alltted fr expenditure changes and reclassificatins. The FASB has prvided examples f these disclsures in an appendix attached t FAS See The prvisins f FAS are effective fr fiscal years ending after December 15, Questins? Please d nt hesitate t cntact Dianne Bailey at (704) r dbailey@rbh.cm r Ashley Hedgecck at (704) r ahedgecck@rbh.cm. 4

5 Next Steps fr Nnprfits Hlding Endwment Funds in UPMIFA Jurisdictins In light f the new rules under UPMIFA and FAS 117-1, nnprfits with endwment funds in UPMIFA jurisdictins shuld cnsider taking the fllwing actins: Train yur gverning bard and finance/investment cmmittee n the new legal and accunting rules. Making a list f questins r issues t reslve with yur legal cunsel r accuntant. Review all institutinal endwment funds and determine whether they are dnr-restricted r bardrestricted. Recall that nly dnr-restricted funds are subject t UPMIFA, but all endwment funds are subject t the disclsure rules under FAS Review existing gift instruments fr dnr-restricted funds t determine whether they impse specific dnr restrictins regarding expenditures. If a gift instrument cntains a specific prvisin fr expenditures, the gift instrument trumps UPMIFA. Review the rganizatin s spending plicy t determine whether it cmplies with UPMIFA s prudence standards. Cnsider revising the plicy t track the language f the prudence factrs listed in yur state s statute. Review the rganizatin s investment plicy and the terms f any delegatin f investment authrity t determine whether they satisfy UPMIFA. Cnsider revising the plicy t shw cnsideratin f the prudence factrs listed in yur state s statute. Dcument the gverning bard s decisins with respect t the spending and investment plicies and terms f delegatin in the bard meeting minutes. Be sure the gverning bard discusses and analyzes all f the applicable prudence factrs when making decisins abut the rganizatin s spending and investment plicies, and when delegating management and investment functins t third parties. Organizatins that have standard endwment agreements fr use with ptential dnrs shuld review the agreements t make sure they apprpriately reference r incrprate the rganizatin s new expenditure plicy and allw fr future changes. Cnsider whether t avid the requirements f UPMIFA by giving the gverning bard discretin. Determine what prtin f each dnr-restricted fund s assets shuld be classified as permanently restricted. Recall that the permanently restricted amunt is: (a) the amunt that must be permanently retained accrding t the dnr s restrictin, r (b) in the absence f such restrictins, the amunt the rganizatin s gverning bard determines must be permanently maintained in accrdance with relevant law (i.e., yur state s UPMIFA statute). Classify the prtin f each fund that is nt classified as permanently restricted until apprpriated fr expenditure. Reclassify any assets previusly classified as unrestricted t temprarily restricted if they have nt been apprpriated fr expenditure. Identify any debt cvenants issues with lending institutins and btain amendments t debt cvenants where necessary. The reclassificatin f assets frm unrestricted t temprarily r permanently restricted may cause the rganizatin t vilate its debt cvenants in certain credit agreements, s the rganizatin will want t address these issues with its lenders. Draft disclsure ftntes fr financial statements, including a descriptin f the bard s interpretatin f the laws that underlie the rganizatin s net asset classificatin f dnr-restricted endwment funds, a descriptin f the rganizatin s endwment spending plicy and investment plicy, and the cmpsitin f the rganizatin s endwment by net asset class. 5

Designated Fund Contribution Form

Designated Fund Contribution Form 1 Designated Fund Cntributin Frm Name(s) Address Street City State Zip Alternate Address: Business Seasnal Street City State Zip Telephne Wrk Hme Cell Email: Alternate email: Hw did yu hear abut the Cmmunity