Nonprofit organizations should be aware of the applicable law and best
practices with respect to their endowment and investment assets. In all but a
handful of states, a charitable organization’s board of directors is subject to
statutory law governing the management of the organization’s endowment and
investment assets. These rules generally impose a statutory duty of care,
expenditure rules for endowments, and the standard of care required for
delegation of investment management. Best practices for nonprofit organizations
also suggest that organizations with significant investment assets adopt an
investment policy and a spending policy.
In managing the organization’s endowment and investment assets, boards should
ensure that they are in compliance with statutory laws, as well as best
practices. Generally, the board’s first step is determining what law applies. In
addition to the District of Columbia and the U.S. Virgin Islands, 47 states have
adopted the Uniform Prudent Management of Institutional Funds Act (UPMIFA).
Florida and Mississippi have adopted the older version, the Uniform Management
of Institutional Funds Act (UMIFA), but Pennsylvania has not adopted either of
the uniform acts. UPMIFA contains certain rules that apply to the investment and
management of an organization’s investment assets and expenditure of its
endowment funds. In addition, UPMIFA sets forth rules on the release of
restrictions on the use and management of funds.
While a board is still required to act in good faith and exercise ordinary
business care and prudence in making investment decisions, UPMIFA updates the
standard of care by directing a board to consider investment decisions in
relation to the whole investment portfolio, the economic circumstances at the
time, and the organization’s charitable purposes, as well as the charitable
purposes of the fund. UPMIFA also requires a board to exercise prudence in cost
management by allowing only appropriate and reasonable costs. The board has a
duty to investigate the information it uses to make investment decisions. In
addition, any person who has special skills or expertise is required to use such
skills or expertise in making investment decisions.
The board should also be aware of duties that exist under common law, namely,
the duty of care and the duty of loyalty. The duty of care requires directors to
actively participate in making decisions on behalf of the organization by being
reasonably informed, acting in good faith, and exercising the care of an
ordinarily prudent person in similar circumstances. The duty of loyalty requires
directors to act in the best interests of the organization, including the
disclosure of conflicts of interest, avoidance of competition with the
organization for business opportunities, maintenance of confidentiality, and
avoidance of use of the organization’s assets for personal benefit.
A third duty, the duty of obedience, may also exist. The duty of obedience
requires directors to comply with applicable federal, state, and local laws,
comply with the organization’s governing documents, and act to advance the
organization’s mission and exempt purpose.
Best practices suggest that a board adopt a written investment policy to
provide guidelines for adequate financial management. Such a policy should state
the investment goals of the organization, keeping in mind that the more specific
the objectives are, the more helpful they will be to investment managers. For
example, including a measurable return objective and time horizon for
achievement of returns will help managers track the achievement of the
organization’s goals. The policy should also state acceptable levels of risk
tolerance and turnover rate, percentages of portfolio asset allocations with
explanations of why each asset class is included and procedures for reassessing
the allocations, and procedures for evaluating performance of the portfolio and
the investment managers.
A spending policy will also help directors manage the funding of the
organization’s exempt purposes while addressing the need to maintain the
economic value or purchasing power of the organization’s assets. UPMIFA
eliminated the concept of historic dollar value incorporated in its predecessor,
UMIFA, and instead gives factors for the board to consider in setting prudent
levels or rates of spending for an endowment fund. The board must ensure that
the spending policy complies with any applicable restrictions in gift
instruments, and the policy should be reviewed as needed, but at least annually.
Directors will best serve the charitable organization by being aware of the
applicable provisions of UPMIFA regarding investment decisions and consistently
reviewing and updating the organization’s investment and spending policies.
McGuireWoods Nonprofit & Tax-Exempt Organizations Group
and tax-exempt organizations lawyers provide advice and guidance that enable
charities and other nonprofits to operate more efficiently and effectively in
today’s increasingly complicated, regulated and competitive environment.