I originally wrote this piece in 2010 as an introduction to UPMIFA (the Uniform Prudent Management of Institutional Funds Act). It’s an important act, so I thought it was worth revisiting. I’ve reframed it to reflect the current conditions.
What is UPMIFA? Where did it come from?
UPMIFA stands for the “Uniform Prudent Management of Institutional Funds Act”, a delightfully paradoxical name for a decidedly non-uniform set of rules and regulations. There are several variations on the theme, including a presumption of imprudence under a specific set of circumstances.
UPMIFA is a model state law drafted in 2006 by a group of legal experts called the National Conference of Commissioners on Uniform State Laws. Designed to replace the 1972 Uniform Management of Institutional Funds Act (UMIFA), it provides guidance on investment decisions and endowment expenditures for charitable organizations. The UPMIFA rules provide more specific guidance regarding investment and spending policies than UMIFA.
UPMIFA’s revision of the spending policy rules was designed to promote a total return approach to spending, similar to the total return approach to investing. The goals are to:
- Invest at a rate that preserves the purchasing power of the principal over the long term
- Spend at a rate that reflects the donor’s intentions over the long term
UPMIFA updates UMIFA by eliminating an historic dollar value (HDV) “floor” in favor of guidance on “prudent” behavior. UPMIFA:
- Modernizes the rules governing endowment fund expenditures, providing better guidance on spending
- Gives organizations the ability to better manage fluctuations in the value of their endowments
- Governs the release and modification of restrictions on charitable funds to permit more efficient management of these funds
The Good News
UPMIFA now allows nonprofits to spend from an “underwater” endowment if the governing board determines it is prudent to do so. (An endowment is considered underwater when its market value has fallen below the amount restricted by the donor.) Previously UMIFA required nonprofits to maintain permanent endowments at the value of the original contribution received. Rhode Island nonprofits had to maintain permanent endowments at the donated value adjusted for inflation. This was usually based on the Consumer Price Index.
UPMIFA allows a charity to spend from the principal of an endowment fund upon a good faith determination that such spending is prudent considering the use, benefit, purpose, and duration for which the fund was established.
The Bad News
There may be some requirement for asset diversification based on what could be considered a prudent course of action. Some states adopted a “presumption of imprudence” for any spending in excess of 7 percent per year.
Does UPMIFA apply to you?
- UPMIFA applies to charities organized as nonprofit corporations. The rules may also apply to certain foundations and charitable trusts. UPMIFA only applies to permanently restricted endowments, which are restricted by the donor or law.
- The difference between permanently restricted and other endowments is important since many boards create endowments using unrestricted funds (quasi-endowments). UPMIFA does not apply to quasi-endowments. UPMIFA also does not generally apply to certain non-charitable trusts or foundations as many of these amounts are not permanently restricted.
- Along with the proposed UPMIFA law, The Financial Accounting Standards Board (FASB) issued a Staff Position (FSP FAS 117-1), which requires significant new disclosures for all permanently restricted endowments, even in states [KF1] which have not adopted UPMIFA. Among other points, the FSP provides that unless stated otherwise in the gift instrument, the assets in the endowment fund are restricted until appropriated and expended. This means that all realized and unrealized gains and losses have an implied time restriction and are temporarily restricted until appropriated, usually by a spending policy, and used for the restricted purpose, if any. This FSP applies retroactively and requires all previously unappropriated and accumulated earnings to be reclassified from unrestricted to temporarily restricted. Further, in Rhode Island, earnings previously added to the permanent endowment based on the old law may now need to be reclassified to temporarily restricted. These two changes have a large impact on balance sheets and therefore debt covenants.
Why should you talk to your board about UPMIFA?
UPMIFA is designed to help you communicate with and educate your board. Like any high level changes in your nonprofit’s management and governance, an educated board is your best ally. (Often a board considers and votes on policies written and submitted by the finance team.)
UPMIFA allows nonprofits to spend from “underwater” endowments, but their boards must be certain that such action is “prudent” based on seven specific factors. In other words, boards bear the responsibility for determining what a prudent course of action is.
If boards do decide to spend from an underwater endowment, they also need to create a spending policy, putting in place guidelines and defining how far underwater they are willing to go. For example, some boards may decide that they will only spend up to 20 percent of their endowment corpus.
In addition, any board-approved spending policy must be based on the average market value of investments over the immediately preceding twelve quarters, or more. Determine if twelve quarters is enough, or if you should go back further to help smooth the fluctuations.
Before dipping into your endowment, every nonprofit should understand the unique requirements of your state. For example, a recommended provision providing a rebuttable presumption of imprudence for a spending level above 7 percent was not adopted by all states.
What do boards need to know about spending policies?
UPMIFA also changed how boards should manage spending policies for their endowment funds. The UMIFA rules were straightforward. If the organization did not invade the “historic dollar value,” any spending rate was fine (in most states). UMIFA’s premise was that the sum of all contributions to a fund would delineate the amount that could never be spent: the historic dollar-value floor.
In some ways, UPMIFA provides considerably more flexibility. Within the boundaries of the donor’s intent (as expressed in the gift instrument), and the 7 percent rule, an institution may spend or accumulate as much as the board determines is prudent for the uses, benefits, purposes, and duration for which the endowment fund is established.
Note: If the gift instrument states a particular spending rate or formula, that rate or formula applies, and the board has no discretion in determining the spending policy with respect to that fund. UPMIFA does not alter the donor’s instructions.
Information on time frames for determining spending policies
UPMIFA requires the organization to look back three years in applying their spending policy, but organizations should consider if they need to adopt a longer smoothing period.
The statute does not articulate how often the board can revisit this decision, but clearly if the current spending rate exceeds the ceiling in the presumption, the well-advised board may want to change its spending rate. Whatever policy is used, it is now required to be disclosed in the footnotes to the financial statements and therefore be more transparent to donors.
7 things board members must consider when deciding whether spending is “prudent”
In making a determination to appropriate or accumulate assets in an endowment fund, the board members, acting in good faith, are to apply the prudent person standard, and consider:
- The duration and preservation of the endowment fund.
- The purposes of the organization and the endowment fund.
- General economic conditions.
- The possible effect of inflation or deflation.
- The expected total return from income and the appreciation of investments.
- Other resources of the organization.
- The investment policy of the organization.
What do boards need to know about managing and investing?
Today’s market realities have produced a dramatic shift in priorities among those responsible for managing and investing funds. There is an explicit standard of conduct in UPMIFA. Many organizations follow these standards, however, they did not explicitly address them in policies. The primary focus was on maximizing returns.
Today’s boards need to expand their consideration of investments to include:
- The intent of the donor
- The possible effects of inflation or deflation and the economy
- The purposes of the organization and the purposes of the fund
They need to invest the fund in good faith and with the care an ordinarily prudent person in a like position would exercise under similar circumstances. They need to consider what would be reasonable and appropriate costs in relation to the assets available, the expected tax consequences, the role that each investment or course of action plays within the overall investment portfolio, and the needs of the institution and the fund to make distributions and to preserve capital.
There are explicit standards addressing oversight and management of a third-party investor. Meanwhile, delegation of management and investment functions is also a consideration. The board needs to choose an agent in good faith and establish the scope and terms of the delegation. This needs to be consistent with the purpose of the organization. The board must also establish policies and processes for reviewing and monitoring the agent’s actions to monitor performance and policy compliance.
Though organizations employ many of these concepts , they don’t address them specifically in the investment policies and procedures. Like the disclosures regarding the spending policies, organizations are now required to disclose policies regarding return objectives and risk parameters, how those objectives relate to the organization’s spending policy, and the strategies employed for achieving those objectives in the footnotes to the audited financial statements.
Next Steps for Nonprofits
FuturED Finance recommends that nonprofits consider the following actions in light of UPMIFA, consulting legal counsel as needed:
- Develop or revisit your gift acceptance policy.
- Train your board and Finance/Investment Committee on the standards of prudence.
- Include UPMIFA’s seven standards of prudence in policies and procedures.
- Update spending policy and calculations, including the amount of spending from underwater endowments. Determine whether this requires changes to your asset allocation policy.
- Update your investment policies regarding portfolio performance, monitoring, and fiduciary duties.
- Calculate the amount of accumulated earnings to be reclassified based on your interpretation of the law. Create or update unitization schedules to properly reflect the required changes, and train staff regarding these changes.
- Discuss the impact of these changes with your board, management, lenders, accreditation or other agencies and other interested parties.
- Obtain amendments to debt covenants where necessary.
- Discuss all proposed changes and calculations with your auditors before the audit starts.
- Prepare new required footnote disclosures and discuss those disclosures with your board.
I hope this helps explain UPMIFA and its purposes. As always, if you have questions about how UPMIFA affects your institution or any other aspect of institutional finance, please contact me at Rebeka@FuturEDFinance.com.
Photo by Philip Strong on Unsplash