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Understanding UPMIFA: Part Two
David Wheeler Newman completes his explanation of the application of the Uniform Prudent Management of Institutional Funds Act(UPMIFA). In this second part, he discusses the selection of an agent and the monitoring and supervision of that agent.
By: David Wheeler Newman, Originally published on the MSK Blog
The Uniform Prudent Management of Institutional Funds Act (UPMIFA or the Act) was adopted in 2006 by the National Conference of Commissioners on Uniform State Laws, as the successor to the Uniform Management of Institutional Funds Act (UMIFA), and has (on 1/1/2017) been enacted in every state except Pennsylvania. UPMIFA provides guidance and authority to charitable organizations concerning the management and investment of charitable funds and for endowment spending.
A prior post focused on UPMIFA rules for endowments held by charitable organizations, including standards for determining the annual spending from those funds, while this post will address UPMIFA rules for the delegation of management and investment functions.
UPMIFA adopts a prudent standard for investment decision making, taken from the Uniform Prudent Investor Act. An organization’s governing board is directed to act as a prudent investor would, using a portfolio approach in making investment decisions. The diversification of investments that is part of the portfolio approach anticipates that the board may be required to delegate some authority over management and investment of funds for which it is responsible. Note, however, that a board may not delegate spending decisions – only management and investment functions.
Section 5 of UPMIFA provides rules for delegation by a governing board to external agents. This section is characterized in the Act as optional, because many states already provide sufficient authority to delegate authority through other statutes. The Uniform Prudent Investor Act provides delegation rules for charitable trusts, while nonprofit corporation statutes often provide comparable rules. However, even in states in which UPMIFA section 5 has not be codified, it provides useful guidance for determining when delegation of management and investment is permitted. Under these rules, a governing board is permitted to delegate these functions to external agents if the board exercises reasonable skill, care and caution in selecting the agent, defining the scope of the delegation and reviewing the performance of the agent.
Selecting an Agent
The board must be deliberate in its selection of an investment advisor, consultant, outsourced chief investment officer, or other external agent to which management or investment authority will be delegated. Reasonably cautious steps might begin with defining the type of assistance that is required. For example, will the agent be responsible for only one fund, such as the endowment fund, or will its authority extend to other funds, such as short-term funds that will be spent currently? Will the organization look to the agent for expertise with a particular asset class, such as hedge funds or private equity? Other steps might be:
- The board may want to get suggestions from other similar organizations
- The board might create a request for proposals to be sent to a list of candidates, requesting detailed information on services, fees, and references
- References should be checked
- The board, or relevant committee, should keep a record of its selection process
In making decisions concerning delegation, the governing board must consider other provisions of UPMIFA that instruct the institution to incur only reasonable costs in managing and investing an institutional fund. Fees are important.
The Scope of Delegation
The scope and terms of the delegation of certain management and investment functions to an external agent will typically be contained in an investment management agreement, which must be consistent with the purposes of the institution and the specific fund for which the function is being delegated. One way to do so is for the board to adopt an investment policy for each of the funds for which it is responsible (e.g. short-term funds that will be spent currently, endowment funds with a long-term time horizon, and other funds such as depreciation reserves or building funds). The agreement with each agent will require that agent to perform in accordance with the investment policy for the fund for which it is delegated authority. The investment management agreement with each agent will contain other business terms, such as fees to be charged by the agent, and administrative provisions, including the frequency and format of reports by the agent to the board.
UPMIFA requires the governing board to periodically review the agent’s actions in order to monitor its performance and compliance with the scope and terms of the delegation. This may be accomplished by comparing data in the periodic reports with the requirements of the investment management agreement and policy statement. For example, for a diversified portfolio, the policy may establish a range for the percentage of the portfolio that may consist of a particular asset class, and in monitoring the actions of the agent, the board will want to satisfy itself that the asset class is in fact within that range, or obtain a satisfactory explanation from the manager if it is not.
For members of a governing board to determine if they have met the required standard of care in monitoring the delegation of authority under an investment management agreement, they should feel confident that they could answer questions regarding compliance of investment activities with the investment management agreement and the investment policy statement, based on reports received from the manager.
Investing has become much more complicated, especially for large diversified endowments, as the number of asset classes has exploded. Recognizing that it is not reasonable to expect a single agent to be qualified in all areas of investment, UPMIFA specifically recognizes that the scope of delegation may include redelegation, which could, for example, be authority granted to an outsourced chief investment officer of the authority to redelegate limited authority to investment managers with expertise in particular investment areas.
UPMIFA does not address issues of internal delegation, but instead defers to state laws governing trusts and nonprofit corporations. For example, a board of directors would typically be permitted to delegate management and investment functions to its chief investment officer if it reasonably concludes that he or she is reliable and competent to perform the delegated tasks. Monitoring the performance of the officer or other employee to whom an internal delegation has been made remains the responsibility of the governing board, however.
Fiscal oversight is the most important fiduciary responsibility of any nonprofit board. Some of that duty can be performed by oversight of staff or through the audit committee. However, modern portfolio investing is beyond the expertise of most boards, which frequently must look outside the organization for the necessary investment experience and skills. UPMIFA not only allows delegation of this important function, it also provides helpful guidelines to the board to assure its members that they have performed their duty while protecting themselves from liability.
Coming Up Next
This is the second in a series of posts on UPMIFA. A future post will address the rules for release or modification of restrictions contained in gift agreements.