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Tight Leash

March 3, 2009

Just when they need money most, some colleges and universities are incapable of tapping their rainy day funds.

Currently, 21 states are still governed by decades-old laws that restrict endowment spending, according to the Uniform Law Commission. With revenues drying up for many colleges, these regulations are likely to result in fewer scholarships being awarded next year at some institutions, according to fund raisers and legal analysts.

At issue is a provision in the uniformly adopted law, which states that universities and other nonprofit groups can’t withdraw money from endowments that fall below their “historic dollar value.” The provision would kick in, for example, if a donor gave $1 million a year ago and the value of that fund has fallen below $1 million because of poor market returns. In the midst of an economic crisis, such scenarios are increasingly common, and the spending restrictions are causing heartburn for foundation officials.

The law was designed to protect donors' endowed contributions in perpetuity, although some argue that goal can be attained through prudent investment even in the absence of legal restrictions tied to the gift's initial value.

In North Carolina, where the state university system has seen the market value of endowments drop 16 percent in the last six months, legal restrictions are already making it difficult to fulfill scholarship obligations, according to Cathy Hanby-Sikora, the system’s associate vice president for advancement.

“It’s crucial for us," she said. "At a time when state sources of funding are severely restrained we would like to be able to depend on endowment earnings to make a difference, but we can’t because the endowments are down very significantly.”

The challenges are particularly pressing for North Carolina’s younger institutions, which are more likely to have large percentages of endowment funds tied to relatively recent gifts. Those gifts have had little time to appreciate, so any blow to their market value will make them untouchable.

The North Carolina system is still in the process of a calculating how much money is inaccessible because of the law. The National Council of Nonprofits and the Council on Foundations also have no data on the number of endowments that are now underwater, according to the Associated Press, which reported on the restrictions Monday.

Given the number of universities that have reported steep losses in the market value of their endowments, however, it’s fair to assume that dozens if not hundreds are affected in some way by spending restrictions tied to historic market values.

Endowed professorships and chairs are potentially affected by restrictions on endowment spending, but most experts expect that those positions will continue to be funded through other monies because of contractual obligations. Scholarships that have yet to be awarded, on the other hand, may not be so secure.

Push for Reform

In recent years, there has been a major push for states to adopt new laws that erase the “historic market value” provision, replacing it with more emphasis on endowment managers to act with “prudence” when spending endowed funds. The more flexible law allows colleges to dip into the principal of an endowed fund in times of emergency -- like now.

Harvey P. Dale, director of the National Center on Philanthropy Law at New York University, said changing the law is long overdue in his home state and elsewhere. The updated law, known as the Uniform Prudent Management of Institutional Funds Act (UPMIFA), has been adopted by the District of Columbia and 26 states, including Arkansas last month. The more restrictive law is known as the Uniform Management of Institutional Funds Act, or UMIFA.

“There are a lot of more recent funds that have gone underwater because of the current financial tsunami,” Dale said. “So what do you do? If you’re in a state that still has UMIFA, you’re screwed.”

There are some, however, who prefer the “bright line” of regulation drawn by laws that restrict endowment spending based on market values. Other arguments against the change suggest that lifting restrictions retroactively undoes the intent of donors who gave gifts with the understanding that the restrictions would apply.

Back to Donors

In higher education circles, many argue that donors intend to have their money help institutions and students during the most trying times -- and restrictions on spending make that impossible. That said, endowment managers still have a responsibility to preserve their funds, which are designed to last in perpetuity: only the money earned through investments is intended to be spent.

Martin Dorph, senior vice president for finance and budget at New York University, said changing state law would not prompt universities to start spending recklessly “willy-nilly.”

“We don’t just say, ‘Oh great, the handcuffs are off, let’s start spending off the endowment,’ ” he said.

The law already allows organizations to spend into the principal of a gift if a donor gives the green light, and that means some universities may ask donors to lift restrictions. More likely, however, may be the possibility of fund raisers asking donors to give one-time funds that can be used to maintain scholarships or programs while the endowment recovers.

At the University of Mississippi, where the endowment has fallen by $72 million -- to $400 million -- in the last eight months, development officers are actively courting existing donors to keep their scholarships active while the endowment is underwater. To that end, the university has started a scholarship fund named for the outgoing chancellor, Robert Khayat.

“That’s one phase of beginning to attack the problem,” said Wendell Weakley, president of the University of Mississippi Foundation.

Brandeis Case Brought Issue to Light

Discussions about restrictions on spending grew more public recently when Brandeis University announced plans to sell off its art collection, citing financial difficulties. While Brandeis discarded the plan amid criticism and legal concerns, the episode brought to the forefront a debate about spending restrictions.

The Brandeis story is just one more instance in which the global economic crisis seems to be teaching Americans about issues they never concerned themselves with before. (Remember when you’d never heard of a credit default swap? Those were the days.)

Jack Siegel, a Chicago tax lawyer who blogged about the Brandeis case on charitygovernance.com, said he was stunned to see the acronym “UPMIFA” make it into a local newspaper. The real-world implications of obscure state regulations, however, are now becoming apparent to students and their families, he said.

“It was very interesting when this article broke to see this technical issue,” said Siegel, author of A Desktop Guide for Nonprofit Directors, Officers and Advisors. “You talk [about] UPMIFA and you’re talking a closed group of maybe [a few hundred] people in this country who even know the statute exists. … You start talking about what we’re talking about, you are on the esoteric of the esoteric.”

States with No Restrictions on Historic Dollar Value (UPMIFA)

  • Arizona, Arkansas, California, Colorado, Connecticut, Delaware, DC, Georgia, Idaho, Indiana, Iowa, Kansas, Minnesota, Montana, Nebraska, Nevada, New Hampshire, Ohio, Oklahoma, Oregon, South Carolina, South Dakota, Tennessee, Texas, Utah, Virginia, West Virginia.

States with Restrictions on Historic Dollar Value (UMIFA)

  • Florida, Hawaii, Illinois, Kentucky, Louisiana, Maine, Maryland, Massachusetts, Michigan, Mississippi, Missouri, New Jersey, New Mexico, New York, North Carolina, North Dakota, Rhode Island, Vermont, Washington, Wisconsin, Wyoming.

SOURCE: Uniform Law Commission

 

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