What It Means to Use Endowment Money Wisely

To the Editor:

The article in your September 17 issue “New State Laws Give Charities More Wiggle Room on Endowment Spending” explains some of the changes the Uniform Prudent Management of Institutional Funds Act brings to the law governing endowment spending, but contains a few statements that may be misleading.

The article made the first two of the following statements directly and implied the third. These three statements require further discussion

• A charity cannot spend from an endowment fund that is “under water” (i.e., with a value below the value of the original gift).
• The Uniform Management of Institutional Funds Act, the law that preceded UPMIFA, was created to protect money in endowment funds; UPMIFA allows charities to spend whatever they want.
• UPMIFA changes donor intent.

At the outset, it is useful to remember that UMIFA and UPMIFA both provide interpretations of donor intent concerning spending from endowment funds. The statutes apply only when a charity and donor have not reached some other agreement about the “rules” that will govern endowment spending.

In the 1960s, most people assumed that “income” for an endowment meant trust accounting income. The trust accounting rules defined income as interest, dividends, rents, and royalties and assigned all capital gains to principal. An endowment that could only distribute “income” might be tempted to invest primarily in bonds to generate interest. A decision not to invest in stocks meant more income in the short term, but also meant that the value of the fund eroded over time.

UMIFA created a concept called historic dollar value, to represent the dollars contributed to an endowment. The historic dollar value did not represent “principal” and UMIFA did not suggest that a fund should spend everything above the historic dollar value. The concept simply provided a way to say that a charity could spend appreciation, whether realized or unrealized. An endowment fund is said to be “under water” when the value of the fund falls below its historic dollar value.

A fund cannot spend appreciation while it is under water. UMIFA said nothing about when a charity could spend interest and dividend income, and the right to spend that income appears to continue under other law, even when a fund is under water. Thus even under UMIFA, a fund could continue to spend when the amount in the endowment dropped below the original amount contributed, as long as investments generated ordinary income.

When a donor says, “pay only the income,” the donor has not clearly indicated what that means. Before UMIFA, charities interpreted it to mean “pay only interest and dividend income.” UMIFA then changed the interpretation and interpreted it as “spend the amount of appreciation above the historic dollar value that the university determines to be prudent.”

UPMIFA changes the interpretation again and interprets the donor to mean “spend some amount each year but hold enough back to preserve the long-term viability of the fund.” Both UMIFA and UPMIFA require the charity to act prudently in deciding how much to spend, but UPMIFA provides more and better guidance for making that determination.

UMIFA actually increased the ability of a charity to spend from an endowment fund by authorizing the spending of capital gains. UPMIFA provides a list of factors for a charity to consider in making a prudent decision. The duration of the fund is key among those factors and reminds the charity not to spend too much or too quickly. UPMIFA permits spending when a fund’s value falls below the historic dollar value, but only if spending under those circumstances is prudent, keeping in mind the long-term nature of an endowment fund.

Neither UMIFA nor UPMIFA changes donor intent, although both change the interpretation of what an endowment means.

UPMIFA allows a charity to spend appreciation when a fund goes under water, and for that reason interest in UPMIFA has grown.

Under UPMIFA a charity will not need to change its investment strategy to generate interest and dividend income in order to continue spending, and a charity can use its endowment sensibly during these difficult economic times. But UPMIFA will not solve a charity’s economic woes and still leaves the charity with hard decisions.

UPMIFA improves the law, both by providing flexibility to charities to allow them to make good decisions and by providing better guidance about what it means to be “prudent.”

Susan N. Gary
Orlando J. and Marian H. Hollis Professor of Law
University of Oregon
Eugene

Professor Gary served as reporter to the drafting committee to revise the Uniform Management of Institutional Funds Act.