Bill would alter spending from endowments | Rochester Business Journal New York business news and information

Local colleges and non-profit organizations are gearing for a change in how they can spend from endowment funds, giving them more flexibility during difficult financial periods.

The legislation, known as the Uniform Prudent Management of Institutional Funds Act or UPMIFA, would allow a non-profit organization to spend from its endowment even if the value fell below that of the original investment.

It has not yet been adopted in New York but has become the standard in 43 states, Washington, D.C., and the Virgin Islands.

For organizations locally, it would mean more control over their spending but also a requirement to tailor a specific spending policy to account for the change.

While it would remove the constraints from spending during a market downturn, when such spending might be needed more, opponents argue that it could be a slippery slope allowing less scrupulous organizations to endanger the long-term viability of their endowments.

The existing law states that once an endowment fund falls below the original investment value, an organization is not permitted to spend until it rises back above that level. Under UPMIFA, it would be up to an individual organization's board of trustees to come up with a prudent spending policy and decide whether to continue spending after the endowment value falls below that point.

This provision would benefit smaller organizations or those with newer endowments, said Barry Hawkins, a Connecticut lawyer and a uniform law commissioner who chaired the committee that drafted UPMIFA. He pointed to the example of organizations funded with gifts of stock from Internet companies during the online boom of the late 1990s.

"One problem that came from the tech bubble bursting in the late '90s is that many of the newer, cutting-edge foundations by dot-com millionaires saw the value of investments decline before their eyes," Hawkins said. "If an organization was funded with $100 million of AOL stock that had its value decline to $98 million, nothing could be spent even though the long-term prospect of AOL was good."

Larger and older organizations with more established endowments would be less likely to see effects of the change, Hawkins noted.

But even colleges with longtime endowments saw the value of some scholarship funds drop during the recent market downturn, said Margaret Cass Ferber, vice president of finance at Nazareth College of Rochester.

"You could have a recent endowment by a donor, and you don't want to tell them we can't award the scholarship this year," said Ferber, a former board member of the National Association of College and University Business Officers.

"The college may have a fund with a $50,000 contributed value that is now worth $45,000, but we have faith in the long-term growth of the endowment and we're going to continue to award $2,000 a year with every expectation it will climb back over the $50,000 level and then some."

Restricted funds
UPMIFA also would allow institutions to more easily transfer restricted funds of less than $25,000 by notifying the state attorney general. Under current law, organizations are required to go to court to reappropriate gifts given with a restricted purpose, and for smaller amounts it has not been worth the cost of legal fees, Hawkins said.

"If you had a fund that was given to a university hospital for $20,000 for polio research and it's now worth $24,000, you haven't been able to tap into that because there is no need for that kind of research now," Hawkins said. "A university would love to have that available for AIDS research, but in probate court it might cost $20,000 in legal fees to redirect it."

The attorney general would have the option of requesting more information if the transfer does not seem legitimate, Hawkins said. But Ferber said this kind of impropriety is unlikely.

Donors would become wary of giving if they knew their money could be easily transferred away from its intended purpose, she said. Colleges would be careful not to break their trust, given the importance of good donor relations for future giving.

"As a donor and one who individually would never be able to do something larger (than the $25,000 cutoff), this does make me a little squeamish, but it is putting more faith in the institutions as a whole," Ferber said. "I would be surprised if any university does this capriciously."

Hawkins said he is confident thatUPMIFA will be enacted in New York, but given the turmoil of the Legislature, he is unsure when. The proposal has the support of both the state and New York City bar associations and was moving along at a steady rate last year before the state Senate shutdown, he noted.

Laura Anglin, president of the Commission on Independent Colleges and Universities, said her organization is pushing hard for passage this year and is confident it can be done.

The legislation was pushed along in other states by the financial turmoil of the last 18 months, though it was not intended as a reaction to any specific events, Ferber said. But the effect of the law could be strongest during market downturns, experts on UPMIFA contend.

"In a time of deflation or when portfolios are hit as they were, there are some charities that cannot make distributions," said Justin Vigdor, a uniform law commissioner in New York and partner in Boylan, Brown, Code, Vigdor & Wilson LLP. "This law provides judgment factors, the ability to consider the results of economic condition, inflation and deflation, and things like how long the fund is supposed to last. It gives both major and minor charities the ability to deal prudently without being handcuffed and bound by rules already obsolete."

Effect on organizations
For Nazareth and other local organizations, the change would mean their boards of trustees working with administrators to craft spending policies addressing what to do if endowment funds drop below original value.

This extra level of control, whether or not schools spend endowments that lose value, is an important power for schools to have, Ferber said.

"It creates a degree of flexibility and puts the responsibility and privilege of decision-making in the hands of the board of trustees and the administration," she said.

One effect of UPMIFA will come through a provision intended to change bookkeeping practices, Ferber said. Current law classifies gains on an endowment as unrestricted assets, but under UPMIFA they would be treated as temporarily restricted. When UPMIFA goes into effect, this will cause a onetime shift that could affect debt covenants, Ferber said.

Banks will see a drop in an institution's unrestricted equity and could be less willing to lend money to it, Ferber said. The effect would be short-term, she added, and once banks and lenders understand the reason behind the shift, lending likely would rise again.

But in the interim it could mean some extra outreach on the part of colleges.

"We sat down with JPMorgan Chase about this issue about six or eight months ago, and they didn't know anything about it yet," she said. "There will be a lot of work necessary to educate credit providers and perhaps renegotiate debt covenants."

Not all positives
Local support for UPMIFA is not universal. Jennifer Leonard, president and executive director of the Rochester Area Community Foundation, said the law could be a slippery slope in endowment management. Organizations less focused on endowment building could invade what was meant to be a permanent fund producing permanent income.

"We're worried that the preservation of endowments will become a less honored tradition," Leonard said. "From the donor's point of view the protection of donor intent extends in our opinion to the principle of the gift they've given. And our concern is that if the principle is not sacrosanct, then the concept of endowment becomes less concrete and possibly could start evaporating."

Leonard also said there have been organizations that, through lack of oversight or sloppy bookkeeping, have spent entire endowment funds. UPMIFA would provide another excuse for such spending, she said.

For colleges, the temptation to continue spending well below an endowment's original value likely would be outweighed by a careful board policy, Ferber said. In the end, the issue comes down to having faith in that oversight.

"The potential vulnerability of this is institutions in periods of great financial struggle might be tempted to continue spending when it is not prudent," Ferber said. "We're relying on both the administration to make responsible recommendations for spending and the board of trustees to be knowledgeable enough on the risk of overspending."