W. Scott Simon
This month’s column continues the respite from my (so far) four-part series on non- fiduciary investment consultants. Last month, I warned you to keep your eye on the octopus that is the Uniform Prudent Investor Act because its tentacles have spread far and wide into virtually all fields of trust investment law.
One such field involves non-profits. In July, the Chicago-based National Conference of Commissioners on Uniform State Laws (the same group that brought us the Uniform Prudent Investor Act) published the Uniform Prudent Management of Institutional Funds Act.
Publication of this act now completes the trifecta of modern prudent fiduciary investing: the 1994 Uniform Prudent Investor Act, which governs the investment conduct of trustees of private family trusts, the 1997 Uniform Management Public Employee Retirement Systems Act, which governs the investment conduct of trustees of public pension plans, and the 2006 Uniform Prudent Management of Institutional Funds Act, which governs the investment conduct of trustees of non-profit money such as foundations and endowments.
The Uniform Prudent Investor Act also has an indirect bearing on the investment conduct of trustees of private pension plans subject to the Employee Retirement Income Security Act (ERISA). John H. Langbein, Reporter for the Uniform Prudent Investor Act and Chancellor Kent Professor of Law and Legal History at Yale University law school, explains: “ERISA has always been interpreted with a strong eye on the common law, and it is therefore quite clear that the Uniform Prudent Investor Act will powerfully affect the federal courts in their interpretation of ERISA.”
And let’s not forget how influential the Uniform Prudent Investor Act has been on the 1997 Uniform Principal and Income Act and the 2000 Uniform Trust Code.
The Uniform Prudent Management of Institutional Funds Act
Commentary to section 3 of the Uniform Prudent Management of Institutional Funds Act (UPMIFA) notes, in part: “This section adopts the prudence standard for investment decision making. The section directs directors or others responsible for managing and investing the funds of an institution to act as a prudent investor would, using a portfolio approach in making investments and considering the risk and return objectives of the fund.”
Those Whose Investment Conduct Is Covered by UPMIFA
Commentary to section 3 of UPMIFA notes, in part: “The duties imposed by [UPMIFA] apply to those who govern an institution, including directors and trustees, and to those to whom the directors or managers delegate responsibility for investment and management of institutional funds. The standard applies to officers and employees of an institution and to agents who invest and manage institutional funds. Volunteers who work with an institution will be subject to the duties imposed here, but state and federal statutes may provide reduced monetary liability for persons who act without compensation. UPMIFA does not affect the application of those monetary liability shield statutes.”
The Kinds of Institutions Covered by UPMIFA
Commentary to section 1 of UPMIFA notes, in part: “[UPMIFA] applies generally to institutions organized and operated exclusively for charitable purposes. These institutions [include] charitable organizations created as non-profit corporations, trusts, unincorporated associations, governmental subdivisions or agencies, or any form of entity that is organized exclusively for charitable purposes. This reflects the fact that standards for investing and managing institutional funds are and should be the same regardless of whether a charitable organization is organized as a trust, as a non-profit corporation, or in some other manner.”
Comparing the Text of the More Important Provisions of UPMIFA and UPIA
Much of the language of the Uniform Prudent Investor Act (UPIA) was copied into the text of UPMIFA as is evident from some of the following more important provisions common to UPMIFA and UPIA.
Fiduciary Standard of Care
UPMIFA Section 3(b)
“In addition to complying with the duty of loyalty imposed by law other than this [act], each person responsible for managing and investing an institutional fund shall manage and invest the fund in good faith and with the care an ordinarily prudent person in a like position would exercise under similar circumstances.”
UPMIFA adopts the prudence standard for investment decision making. Commentary to section 3 of UPMIFA notes, in part: “The language of the prudence standard adopted in UPMIFA is derived from the [Revised Model Nonprofit Corporation Act] and from the prudent investor rule of UPIA.”
The prudence standard set forth in section 3(b) of UPMIFA–“in good faith and with the care an ordinarily prudent person in a like position would exercise under similar circumstances”–is taken verbatim from Section 8.30(a)(1)-(2) of the Revised Model Nonprofit Corporation Act (“RMNCA”).
That standard “is consistent with the business judgment standard under corporate law, as applied to charitable institutions.” (Emphasis in the original.) Commentary to section 3 of UPMIFA notes further: “The standard for prudent investment set forth in Section 3 first states the duty of care as articulated in the RMNCA. The standard then provides more specific guidance for those managing and investing institutional funds by incorporating language from UPIA. The factors and rules derived from UPIA are consistent with good practice under current law applicable to nonprofit corporations.”
Commentary to section 3 of UPMIFA notes: “The Drafting Committee decided that by adopting language from both the RMNCA and UPIA, UPMIFA could clarify that the same standards of prudent investing apply to all charitable institutions. Although UPIA § (2)(a) [and the] Restatement use the phrase ‘care, skill and caution,’ the Drafting Committee decided to use the more familiar corporate formulation as found in RMNCA. The Drafting Committee does not intend any substantive change to the UPIA standard and believes that ‘reasonable care, skill, and caution’ are implicit in the term ‘care’ as used in the RMNCA. The Drafting Committee included the detailed provisions from UPIA, because the Committee believed that the greater precision of the prudence norms of the Restatement and UPIA could helpfully inform managers of charitable institutions.”
A highly influential commentator, cited in commentary to the UPIA and Reporter’s Notes to the Restatement, and in the Prefatory Note to UPMIFA explains: “The modern paradigm of prudence applies to all fiduciaries [emphasis in the Prefatory Note] who are subject to some version of [the prudent man rule], whether under ERISA, the private foundation provisions of the [Internal Revenue] Code [Section 4944], UMIFA, other state statutes, or the common law.” The Prefatory Note to UPMIFA explains further: “UPMIFA combines the approaches taken by UPIA and [the RMNCA]. UPMIFA reflects the fact that standards for managing and investing institutional funds are and should be the same regardless of whether a charitable organization is organized as a trust, as a nonprofit corporation, or as some other entity.
UPIA Section 2(a)
“A trustee shall invest and manage trust assets as a prudent investor would, by considering the purposes, terms, distribution requirements, and other circumstances of the trust. In satisfying this standard, the trustee shall exercise reasonable care, skill, and caution.”
Duty of Loyalty
UPMIFA Section 3(b)
“In addition to complying with the duty of loyalty imposed by law other than this [act]…”
Commentary to section 3 notes that the duty of loyalty applies to the investment conduct of those responsible for managing and investing institutional funds.
However, “Section 3 does not state the loyalty standard that applies.” The reason for this is that different “standards of loyalty may apply to directors of nonprofit corporations and trustees of charitable trusts.” Under the duty of loyalty set forth in section 8.30 of the RMNCA, a director of a nonprofit corporation should act “in a manner the director reasonably believes to be in the best interests of the corporation.” The trust law articulation of the duty of loyalty, however, states that a trustee of a charitable trust is under a duty to act in the sole interests rather than best interests of the beneficiary. As a result, the drafters of UPMIFA decided that incorporating the duty of loyalty was unnecessary. Under UPMIFA, then, [the] duty of loyalty under nonprofit corporation law will apply to charities organized as nonprofit corporations, and the duty of loyalty under trust law will apply to charitable trusts.”
UPIA Section 5
“A trustee shall invest and manage the trust assets solely in the interest of the beneficiaries.”
Duty to Minimize Investment Costs
UPMIFA Section 3(c)(1)
“In managing and investing an institutional fund, an institution may incur only costs that are appropriate and reasonable in relation to the assets, the purposes of the institution, and the skills available to the institution.”
Commentary to section 3 of UPMIFA notes, in part: “Subsection [3](c)(1) tracks the language of UPIA § 7 and requires an institution to minimize costs. An institution may prudently incur costs by hiring an investment advisor, but the costs incurred should be appropriate under the circumstances. The duty is consistent with the duty to act prudently under § 8.30 of the RMNCA.”
UPIA Section 7
“In investing and managing trust assets, a trustee may only incur costs that are appropriate and reasonable in relation to the assets, the purposes of the trust, and the skills of the trustee.”
Commentary to section 7 of UPIA could not be clearer about the importance modern prudent fiduciary investing places on maintaining low investment costs: “Wasting beneficiaries’ money is imprudent. In devising and implementing strategies for the investment and management of trust assets, trustees are obliged to minimize costs.”
Duty to Investigate/Verify Facts
UPMIFA Section 3(c)(2)
“[A]n institution shall make a reasonable effort to verify facts relevant to the management and investment of the fund.”
Commentary to section 3 of UPMIFA notes, in part: “The subsection [3(c)(2)] requires persons who make investment and management decisions to investigate the accuracy of the information used in making decisions.”
UPIA Section 2(d)
“A trustee shall make a reasonable effort to verify facts relevant to the investment and management of trust assets.”
Factors to Consider in Prudent Decision Making
UPMIFA Section 3(e)(1)(A)-(H)
“Except as otherwise provided by a gift instrument, the following rules apply. In managing and investing an institutional fund, the following factors, if relevant, must be considered:
- general economic conditions;
- the possible effect of inflation or deflation;
- the expected tax consequences, if any, of investment decisions or strategies;
- the role that each investment or course of action plays within the overall investment portfolio of the fund;
- the expected total return from income and the appreciation of investments;
- other resources of the institution;
- the needs of the institution and the fund to make distributions and to preserve capital; and
- an asset’s special relationship or special value, if any, to the charitable purposes of the “
Commentary to section 3 of UPMIFA notes, in part: “In making decisions about whether to acquire or retain an asset, the institution should consider the institution’s mission, its current programs, and the desire to cultivate additional donations from a donor, in addition to factors related more directly to the asset’s potential as an investment.”
UPIA Section 2(c)(1)-(8)
“Among circumstances that a trustee shall consider in investing and managing trust assets are such of the following as are relevant to the trust or its beneficiaries:
- general economic conditions;
- the possible effect of inflation or deflation;
- the expected tax consequences of investment decisions or strategies;
- the role that each investment or course of action plays within the overall trust portfolio, which may include financial assets, interests in closely held enterprises, tangible and intangible personal property, and real property;
- the expected total return from income and the appreciation of capital;
- other resources of the beneficiaries;
- needs for liquidity, regularity of income, and preservation or appreciation of capital; and
- an asset’s special relationship or special value, if any, to the purposes of the trust or to one or more of the “
Portfolio Context/Overall Investment Strategy/Risk and Return
UPMIFA Section 3(e)(2)
“Management and investment decisions about an individual asset must be made not in isolation but rather in the context of the institutional fund’s portfolio of investments as a whole and as a part of an overall investment strategy having risk and return objectives reasonably suited to the fund and to the institution.”
Commentary to Section 3 of UPMIFA notes, in part: “This subsection reflects the use of portfolio theory in modern investment practice. The language comes from UPIA § 2(b), which follows the articulation of the prudent investor standard in [the] Restatement.”
UPIA Section 2(b)
“A trustee’s investment and management decisions respecting individual assets must be evaluated not in isolation but in the context of the trust portfolio as a whole and as a part of an overall investment strategy having risk and return objectives reasonably suited to the trust.”
Broad Trustee Authority to Invest in Any Asset
UPMIFA Section 3(e)(3)
“Except as otherwise provided by law other than this [act], an institution may invest in any kind of property or type of investment consistent with the standards of this section.”
Commentary to section 3 of UPMIFA notes, in part: “Consistent with the portfolio theory of investment, this subsection [derived from UPIA § 2(e)] permits a broad range of investments.”
UPIA Section 2(e)
“A trustee may invest in any kind of property or type of investment consistent with the standards of this [Act].”
Diversification
UPMIFA Section 3(e)(4)
“An institution shall diversify the investments of an institutional fund unless the institution reasonably determines that, because of special circumstances, the purposes of the fund are better served without diversification.”
Commentary to section 3 of UPMIFA notes, in part: “A decision to retain property due to ‘special circumstances’ must be made based on the needs of the charity and not solely for the benefit of a donor. A decision to retain property in the hope of obtaining additional contributions from the same donor may be considered made for the benefit of the charity, but the appropriateness of that decision will depend on the circumstances.”
UPIA Section 3
“A trustee shall diversify the investments of the trust unless the trustee reasonably determines that, because of special circumstances, the purposes of the trust are better served without diversifying.”
Special Skills or Expertise
UPMIFA Section 3(e)(6)
“A person who has special skills or expertise, or is selected in reliance upon the person’s representation that the person has special skills or expertise, has a duty to use those special skills or that expertise in managing and investing institutional funds.”
Commentary to section 3 of UPMIFA notes, in part: “The intent of [section 3(e)(6)] is that a person managing or investing institutional funds must use the person’s own judgment and experience, including any particular skills or expertise, in carrying out the management or investment duties. For example, if a charity names a person as a director in part because the person is a lawyer, the lawyer’s background may allow the lawyer to recognize legal issues in connection with funds held by the charity. The lawyer should identify the issues for the board, but the lawyer is not expected to provide legal advice.” Commentary “to RMNCA § 8.30 describes the existence of a similar rule under the law of nonprofit corporations.” The comment cites the example of directors chosen for their ability to raise money and notes that “[n]o special skill or expertise should be expected from such directors unless their background or knowledge evidences some special ability.”
UPIA Section 2(f)
“A trustee who has special skills or expertise, or is named trustee in reliance upon the trustee’s representation that the trustee has special skills or expertise, has a duty to use those special skills or expertise.”
I will cover the rest of the important provisions common to UPMIFA and UPIA in next month’s column.
W. Scott Simon is an expert on the Uniform Prudent Investor Act, Restatement (Third) of Trusts and Title I of ERISA. He provides services as a consultant and expert witness on fiduciary investment issues in depositions, arbitrations and trials as well as in written opinions. Simon is the author of two books including The Prudent Investor Act: A Guide to Understanding. He is a member of the State Bar of California, a Certified Financial Planner® and an Accredited Investment Fiduciary Analyst™. The author’s views expressed in this article do not necessarily reflect the views of Morningstar.