Greater Boca Raton Estate Council February 21, 2012 Florida - - PowerPoint PPT Presentation

Greater Boca Raton Estate Council

February 21, 2012

Florida Uniform Prudent Management of Institutional Funds (FUPMIFA)

June 2011

On June 17, 2011, Governor Scott signed into law the Florida Uniform Prudent Management of Institutional Funds Act (FUPMIFA) HB 599-

• 2011. In general, FUPMIFA requires Florida charities to invest prudently.

Specifically, FUPMIFA imposes investment standards on Florida

• charities. All Florida Charities should review their investments and

investment policies to insure compliance with FUPMIFA. The Challenge “Managing a portfolio is as demanding a specialty as stomach surgery

• r nuclear engineering. There is no more reason to expect the ordinary

individual serving as trustee (or director) to possess the requisite investment experience than to expect the ordinary citizen to possess experience in gastro entomology or atomic science.” John Langbein, Professor Yale University

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prudent man rule

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Prudent Man Rule – Harvard College v. Armory, 9 Pick. (26 Mass) 446 (1830) – the prudent man rule: "All that is required of a trustee to invest is, that he shall conduct himself faithfully and exercise sound discretion. He is to observe how men of prudence, discretion and intelligence manage their own affairs, not in regard to speculation, but in regard to the permanent disposition of their funds, considering the probable income, as well as the probable safety of the capital to be invested." Introduce risk to portfolio to combat inflation Each investment considered on its own merit – even though overall positive return – but legal lists are out. Restatement of the Law Trusts 2d (1957)

modern portfolio theory

Modern Portfolio Theory (MPT) – is a theory of portfolio construction that combines a classes

• f investment assets to maximize portfolio expected return for given level of portfolio risk or

minimize portfolio risk for a given level of expected portfolio return – whether MPT works is questioned but there does not seem to be an viable alternative theory Harry Markowitz created MPT — 1952 – Journal of Finance – 15 page article describes portfolio allocation under uncertainty — 1955 – Ph.D – University of Chicago – His thesis on portfolio construction that has come to be called Modern Portfolio Theory — 1990 – Nobel Prize in Economics (with William Sharpe – of the Sharpe Ratio)

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modern portfolio theory

MPT uses the expected return of an asset class, expected volatility of an asset class and expected correlation between asset classes each of which is a judgment call by a human.

Mean Variance Optimization (MVO) – This is the quantitative tool Markowitz developed to implement MPT i.e. the optimal portfolio allocation for a given risk or a given return – or the efficient Frontier.

15%

• 25%

Standard Deviation Risk 15 Return

• Small Cap
• Non US
• Lg Cap
• Corp Bonds
• Govt Bonds

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Risk Return 25%

• A. 9% total return

13% standard deviation

• B. 5% total return

8% standard deviation

Efficient Frontier A B Standard Deviation US Large Cap 20% 20% 17.0% US Small Cap 10% 10% 22.0% Non US 30% 0% 19.0% Corp Bonds 20% 35% 8.7% Govt Bonds 20% 35% 5.7%

modern portfolio theory

GLOSERY Total Portfolio Return – means appreciation, interest, dividends etc – with a total return portfolio, spending is not limited to traditional income – it is based on total return or portfolio value Correlation between Assets Classes – statistical relationship between asset classes – e.g. – the S&P/MSCI (international large cap) correlation is .80% – that means the MSCI will move .80% for each 1% MSCI move --- MPT is the combining of uncorrelated asset classes -- correlation ranges from -1 to +1 0 being no correlation. Expected Total Return best guess Expected Standard Deviation or Volatility or Risk best guess

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Uniform Management Institutional Funds Act (UMIFA)

• 1972 – National Conference of Commissioners on Uniform State Laws
• Apply MPT – eliminate individual asset test – look at entire portfolio
• Historic Dollar Value spending limit
• Permit delegation

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history

Employee Retirement Security Act of 1974 (ERISA) §404(a)

• Prudent Man standard of care
• MPT
• Delegation

Uniform Prudent Investor Act – 1994 (UPIA)

• American Law Institute 3d Restatement of Trusts – Prudent Investor

Act-1992

• §518.10-14 Fla. Statutes – 1993 FUPIA
• MPT
• Applies to a fiduciary managing money – a charitable trust

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history

history

Fiduciary Accounting Income – Total Return enacted Florida 2003

• Treasury Reg. §1.643(b)-1 IRS recognizes MPT in states that adopt the

UPIA

• §738.104 (Power to Adjust) & §738.1041 (Total Return Unitrust) -

distribution.

• Fiduciary Accounting rules apply to charitable trusts.

Uniform Prudent Management of Institutional Funds Act (UPMIFA) 2006

• Uniform Law Commission fka National Conference of Commissioners on

Uniform Laws.

• Continues MPT
• Eliminate Historic Dollar Value – Address endowment spending

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history

Florida Uniform Prudent Management of Institutional Funds Act (FUPMIFA)

• July 1, 2012 – effective date
• Fla. Stat. §617.2104, HB 599 (2011)
• 98% ± UPMIFA
• Fla. Stat. § 1010.10 –repealed - This is history

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what does fupmifa require?

In a very general sense, FUPMIFA requires each subject institution to prudently manage its funds. FUPMIFA sets out a standard of conduct that must be

• followed. The investment requirements apply to all funds, not only endowments.

FUPMIFA also provides guidelines for distributions from endowments. The investment and distribution guidelines are very similar conceptually to UMIFA, ERISA, UPIA, §1010.10 Fla. Stat., total return concepts of investments (aka modern portfolio theory or MPT) and everything Markowitz, Sharpe et al. teach. Prior to FUPMIFA there was no statutory investment guidance for a Florida charity that was not subject to FUPIA or Fla. Stat. § 1010.10.

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to whom does FUPMIFA apply?

FUPMIFA applies to an individual, corporation business trust, estate, trust, partnership, limited liability company, association, joint venture, public corporation, government or government subdivision, agency or instrumentality or any other legal or commercial entity operated exclusively for charitable purposes – generally referred to as institution. Charitable purpose means the relief of poverty, advancement of education or religion, the promotion of health, the promotion of a government purpose or any

• ther purpose which benefits the community.

FUPMIFA does not apply to an individual or a trust subject to § 518.11 or when donor mandates FUPMIFA does not apply. The gift instrument, if any controls – FUPMIFA is a default provision FUPMIFA applies to all investments not just endowments e.g. bank accounts, escrows, etc. § 617.2104(2)(d).

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penalty – failure to apply FUPMIFA? ?? Florida AG Donor Media

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FUPMIFA standard of conduct

Following are statutorily mandated investment standards that "institutions" must follow:

• Subject to the gift agreement consider the charitable purpose of the institution and the

institutional fund [not only an endowment] §617.2104(3)(a)

• Manage in good faith and with the care of an ordinary prudent person §617.2104(3)(b)
• Incur only reasonable costs and verify facts §617.2104(3)(c)
• Pooling of investment assets is permitted §617.2104(3)(d)
• Decisions are made NOT in isolation but rather in the context of the entire portfolio and

as part of an overall investment strategy with risk/return objectives §617.2104(3)(e)2

• May invest in any kind of property (no legal list) but still have UBI concerns like

investing on margin §617.2104(3)(e)3

• Diversify investments unless the institution "reasonably and prudently" determines the

purpose of the Fund is better served without diversification. §617.2104(3)(e)4  Evaluate whether to keep in-kind contributions – Gift Review Policy §617.2104(3)(e)5

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FUPMIFA standard of conduct?

• FUPMIFA specifically requires persons selected to manage funds who possess special

investment skills, apply those skills. Board members, advisory boards, and others who are managing funds or advising should read FUPMIFA. §617.2104(3)(e)6

• FUPMIFA requires the person investing assets do so prudently and (unless a gift

agreement provides otherwise) requires the following factors be considered when investing all funds (not just endowments): §617.2104(3)(e)1 — general economic conditions — inflation / deflation — tax consequences, e.g. unrelated business income — the role of each investment in the overall portfolio — expected total return — other resources of the charity — needs of the charity, both and long term — an asset's special relationship to the charity — the role of diversification

• General Rule – Manage Risks

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endowment expenditures

• An endowment is a fund that the donor (not the charity) specifies is not wholly expendable by the
• charity. For example, a gift where the donor says here is $1,000, but you may only spend the

income is a fund that is not wholly expendable by the charity. Typically this is called an endowment. Notwithstanding what the donor said about spending only income, FUPMIFA allows the charity to spend a portion of such a fund (for example an income only fund or an endowment) based on factors that it must take into consideration when appropriating funds for expenditure unless the donor specifically limits expenditures. The factors are: — the duration of the endowment — the purpose of the endowment — general economic conditions — inflation / deflation — expected [total return] (income and appreciation) — other resources of the institution — the charity's investment policy — The donor can limit the authority to appropriate only by specifically so stating in the gift agreement. — NOT purchasing power §617.2104(4)

• Written Spending Policy – what does it say (not where is it)?

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delegation of investment functions

An institution may "prudently delegate" an investment function to an external agent, such as an investment manager. § 617.2104(5) —good faith selection of agent —review periodically agent's actions —set scope and terms of delegation

• Gift agreement may prohibit delegation
• The external agent is subject to Florida law
• The institution that complies with prudent delegation not liable for the acts of

the external agent if delegation in accordance with FUPMIFA

• May delegate investment functions to committees, officers and employees
• f the institution
• Written agreement with external agent – recite statute and prudence

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donor imposed restrictions on uses or investments of contributions?

• Yes. FUPMIFA permits donor restrictions to be modified in certain circumstances.

FUPMIFA does not deal with standing to enforce gifts (i.e., does a donor have standing to enforce a gift agreement). § 617.2104(6) Modification is permitted as follows:

• Donor Consent – permitted but can't change purpose of gift (gift tax -

completed gift concern)

• No Donor Consent

—Gift $0-$100,000 – restriction has become "impractical or wasteful, impairs the management, investment, or use of the fund or because of circumstances not anticipated by the donor or modification of a restriction will further the purpose of the fund" —$100,000-$250,000 – restriction is "unlawful, impractical or impossible to achieve or wasteful" the institution may modify if:

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donor imposed restrictions on uses or investments of contributions

– the attorney general is notified – more than 20 years have elapsed since the Fund was established – the fund is used for a charitable purpose consistent with the gift instrument —any size – Circuit Court in which institution is located if restriction has become "impractical, wasteful, if it impairs the management

• n investment of the Fund or if because of circumstances not

anticipated by the donor or modification of the restriction will further the purposes of the Fund. Notify Attorney General. —any size – Circuit Court in which institution is located if restriction is "unlawful, impracticable, impossible to achieve or wasteful." Notify the Attorney General. See §736.04113 and §736.0412

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audited statements

See FAS 117-1 as codified by ASC 958-205 Beginning 2008 audited statements of charities subject to an UPMIFA statute must expand disclosures about investments and investment process. For example the following are disclosures a charity board may decide to include in its Footnotes:

• A description of its endowment spending policies

—return objectives —risk parameters —relation of return, spending and risk policies —strategy to achieve objectives

• Details about endowment investment policy

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what to do now?

Each Florida Not-for-Profit §501(c)(3) should read FUPMIFA and then revise its investment policy statement accordingly. This assumes there is a written investment policy statement — which should be the case. A paper trail, showing a full investment management system is a lifesaver if the fiduciary (director or trustee) is called upon to defend (donors, media, AG, IRS, etc.) an investment loss or lack of performance.

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