Underwater Endowments Training in New York

I have to admit that I am a bit of a cynic when it comes to educational programs. Usually, the speakers are going over things I know already and frankly, I am part of the ADD generation with about a 3 second attention span.

So, when I got ready to attend the NYC bar's 3hr presentation on Underwater Endowments (held last week), I packed plenty of snacks and extra reading material.

I've written on the topic, organized several presentations on it. What else can I learn except: when is New York going to pass UPMIFA!?!

I was wrong. I am going to use this opportunity to list some very important facts that I picked up (please go to previous posts on UPMIFA for background). All of these points are specific to New York (especially since New York still maintains the old UMIFA) but I still recommend that non-New Yorkers look over these tidbits because they are definitely food for thought.

1. When does an organization have an affirmative duty to literally restore an underwater endowment to its historic gift value (ie..put real money into the endowment account)?

I used to think this was an accounting canard. Wrong I was - at least partially. In New York, the AG says that if a permanent endowment goes below its historic gift value due to application of the org's spending-rate policy, then it does have an affirmative duty to replenish the endowment! On the flip side, if you can attribute the drop to market depreciation, you don't have an affirmative duty.

Wait a second. This doesn't make sense. You apply your spending rate, there is nothing wrong with that when you are not underwater. Then the market tanks and the fund goes negative. When is it the fault of the spending rate and not the market? A question I should have asked. It seems that the AG takes the position that if the market appreciation generally lagged behind the spending rate, the board should have adjusted the spending rate down to prevent the fund from going underwater. In other words, it's pretty murky in New York when to blame the spending rate vs. the market decline.

Advice for all boards (in UMIFA or UPMIFA states): watch the funds, know the original funding amounts of each fund, be aware of long term goals of each fund, spend less to extend life of fund of each fund when need be.

2. Have you ever had auditors or accountants claiming that you have bring back the permanent endowments to their historical gift value on your financials (aside from the NY AG's approach mentioned about but from an accounting point of view)? To me, this was part of the accountant's canard mentioned above. It turns out that there is some truth to this (and this may or may not apply to apply to UPMIFA states, too).

The accounting principals require that on your books, any underwater permanent endowments must make up the deficit from other assets on your books (ie..unrestricted assets).

Practically, this does not mean transferring funds from unrestricted accounts to the permanent endowment accounts. It means that the books have to allocate unrestricted assets towards the negative balances, all on paper though.

So if its only on paper, what's the big deal? The big deal is that underwater endowments drag down your bottom line net assets which might violate debt covenants (agreements with lenders to ensure that the organization maintains a certain level of assets).

Two solutions to this problem are: 1. try to make sure debt covenants are drafted to exclude the negative impact of underwater endowments; and 2. your financials should show negative underwater balances as separate and explained items.

3. I know New York is peculiar but the current proposed form of UPMIFA is a real doozy. There was some excitement that NY might include a presumption that greater than 7% spending rates are presumed to be imprudent. Not such a big deal to me but charities should rather do without it (still, my advice is to take the new law regardless of this provision).

The doozy though (for the proposed NY version) is a 90 day check the box provision. What's this??? UPMIFA, if passed as currently proposed in NY, would require all charities with living permanent endowment donors to send a letter to those donors giving the donors 90 days to decide whether the donor wants his or her fund to follow UPMIFA or to stay with the old UMIFA law. Actually, the wording is really screwy and assuming the law requires charities to use the law's language in the letter, it will give donors the impression that their choice is between the charity spending their entire fund (new law) vs. maintaining their fund (old law). Yikes for New York charities.

4. Incorporating in Delaware (or wherever) may actually help avoid NY's insane laws regarding endowments. When I heard this, I made them repeat it. According to the big shot attorneys on the panel at the bar conference, for these purposes only, the state of incorporation would control. This is a good question for your general counsel but some New York charities may already be off the hook in this area if they were incorporated in other states.

5. NY's proposed law, and included in other state versions, has an escape clause for older, smaller endowments. The uniform version of UPMIFA included a provision for less than $25,000 and older than 20 years permanent funds. It permits charities upon notice to their AG (90 days to protest) to release or modify restrictions if the purposes are unlawful, impracticable, impossible or wasteful. NY's version increased this old endowment escape clause to $250,000! I know NJ included a $250,000 version of this clause, too! NY's proposed version requires notice to living donors - not sure if this applies to other state versions.

I would say that if this law gets passed in NY, and certainly the 42 other state that have passed a form of UPMIFA, it would be time to clean up all of those old, out dated endowments.

For non-New Yorkers, check your UPMIFA (if you have it).