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- New Rules for Funds Held by New York Public Charities, Private Foundations and Other Not-For-Profit Organizations
New Rules for Funds Held by New York Public Charities, Private Foundations and Other Not-For-Profit Organizations
- It modifies and expands the investment guidelines for all “institutional funds” and requires institutions to adopt a written investment management policy.
- It relieves public charities and other institutions of the strict prohibition under prior law against spending down an “endowment fund” below its original amount.
- It provides public charities and other institutions with greater ability to modify or release outdated or other inappropriate donor-imposed restrictions on the use of their funds.
The new law applies primarily to “institutional funds.” An institutional fund is a fund held by an “institution,” which is generally a charitable organization (including educational and religious corporations), a charitable trust where the trustee is a charitable organization and any not-for-profit corporation formed under the New York Not-For-Profit Corporation Law (including political, social and professional or trade organizations). Both public charities and private foundations are covered by the new law. Although the term is not specifically defined in the new law, a “fund” is property held for investment, as opposed to (1) property held for use in the organization’s exempt activities (such as works of art owned by a museum) and (2) cash from contributions held pending expenditure.
New Investment Standards
The new law modifies New York’s standard of prudence that is applicable to an institution’s management of its investments by adopting specific factors which must be considered when making investment decisions. These factors include: (1) general economic conditions; (2) the effects of inflation and deflation; (3) tax consequences; (4) the role of each investment within the overall investment portfolio of the institutional fund; (5) the expected total return from income and appreciation of investments; (6) the other resources of the institution; (7) the needs of the institution and the fund to make distributions and to preserve capital; and (8) an asset’s special value or relationship to the institution’s purposes. An institution must also diversify its investments unless, because of special circumstances, it determines that the purposes of the institutional fund are better served without diversification. Any failure to diversify must be reviewed at least annually. An institution’s expenses related to investment management must be reasonable.
As under prior law, an institution may delegate investment responsibility to an independent investment manager. However, the institution must now: (1) act in good faith and with prudent care when selecting, continuing or terminating its investment agent; (2) establish the scope and terms of the delegation; and (3) monitor the agent’s performance. The prior requirement that an investment manager’s contract must be terminable on not more than 60 days notice without penalty has been retained. Given the increased investment management considerations that now must be made, governing boards of institutions without investment committees or outside investment managers may wish to reconsider their desirability.
An institution must adopt a written investment policy that reflects the prudent investor requirements of the new law. The policy should be tailored to meet the individual needs and goals of each institution. This requirement applies to all entities holding institutional funds, including private foundations.
Use of Endowment Funds
Special rules apply to “endowment funds,” defined as “an institutional fund that, under the terms of a gift instrument, is not wholly expendable on a current basis.” Because there must be a specific spending limitation in a fund’s gift instrument for it to be deemed an endowment fund, the investment assets of most private foundations will not be subject to the new endowment fund rules.
Previously, endowment funds were generally subject to the original or historic dollar value concept, which prevented an institution from accessing an endowment fund whose value had dropped below the fund’s dollar value at the time of its contribution by the donor. With the severe market downturn in the past three years, many institutions have found themselves hamstrung by this restriction. The new rules provide institutions with greater access to their endowment funds, including funds that become “underwater.”
The new law provides that a gift instrument executed on or after September 17, 2010 that designates a donation as an endowment, or contains a direction to use only the income of the fund or “to preserve the principal intact,” will be subject to the new rules for endowment funds. Under the new rules, institutions are allowed to appropriate as much of an endowment fund as the institution determines is prudent for the uses, benefits, purposes and duration for which the fund was established. The new law provides eight factors for an institution to consider when making expenditure decisions: (1) the duration and preservation of the endowment fund; (2) the purposes of the institution and the endowment fund; (3) general economic conditions; (4) effects of inflation and deflation; (5) expected total return from income and appreciation of investments; (6) other resources of the institution; (7) alternatives to expenditure of the endowment fund; and (8) the institution’s investment policy. Institutions must keep contemporaneous records describing their consideration of all eight factors.
The new law also applies a presumption of imprudence for expenditures greater than 7% of an endowment fund’s fair market value (unless such expenditures are authorized in the gift instrument). This presumption can be rebutted if circumstances make such expenditures prudent, and such circumstances must be contemporaneously recorded.
If a donor wishes to further limit an institution’s authority to expend an endowment fund, he or she must do so specifically and explicitly in the gift instrument. The new law also provides that solicitations for an endowment fund must notify would-be donors of the new endowment rules.
For gift instruments executed before September 17, 2010, the new law allows institutions to appropriate money below an endowment fund’s original or historic dollar value provided that the donor is given 90 days advance notice, during which he or she may approve the application of the new appropriation standards to the fund or affirm the continued application of the original or historic dollar value limitation. If the donor does not respond within 90 days, the institution may proceed under the new standards. Donor notice is not required where (1) the gift instrument allows an institution to spend as much of the endowment as is prudent, (2) the gift instrument specifies a spending rate or (3) the gift was made in response to an institutional solicitation (such as a request to contribute to a capital campaign) and the donor does not include a separate statement expressing a restriction on the use of funds.
Increased Ability to Modify or Release Fund Restrictions
Under prior law, an institution could ask a donor to modify or release fund restrictions on management, investment or purpose contained in a gift instrument. If the donor was unavailable, the institution could seek court modification or release of the restrictions with notice to the New York Attorney General, provided the restrictions were obsolete, inappropriate or impracticable.
Under the new law, an institution can seek court modification (with notice to the donor and the New York Attorney General) of a restriction in a gift instrument concerning management or investment if the restriction is impracticable or wasteful, impairs management or investment or if (because of circumstances not anticipated by the donor) modification would further the purposes of the institutional fund.
Similar to prior law, court relief can also be sought (with notice to the donor and the New York Attorney General) where a particular purpose or restriction in a gift instrument becomes unlawful, impractical, impossible to achieve or wasteful. For smaller funds (less than $100,000) that have existed for more than 20 years, an institution can modify or release a gift restriction on management, investment or purpose that is unlawful, impracticable, impossible to achieve or wasteful without court approval with 90 days advance notice to the donor and the New York Attorney General.
These provisions of the new law apply to both pre-existing and future funds. They also do not limit the use of the traditional legal doctrine of cy pres to reform gift instruments whose purposes have become frustrated.
Questions regarding this advisory should be addressed to Howard J. Barnet (212-238-8606, firstname.lastname@example.org), Austin D. Keyes (212-238-8641, email@example.com), Jerome J. Caulfield (212-238-8809, firstname.lastname@example.org) or Jinsoo J. Ro (212-238-8833, email@example.com).
Carter Ledyard & Milburn LLP uses Client Advisories to inform clients and other interested parties of noteworthy issues, decisions and legislation which may affect them or their businesses. A Client Advisory does not constitute legal advice or an opinion. This document was not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.
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