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 or 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 1 22828811.PPT
prudent man rule 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) 2 22828811.PPT
modern portfolio theory Modern Portfolio Theory (MPT) – is a theory of portfolio construction that combines a classes of 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) 3 22828811.PPT
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. 15 • Small Cap • Non US • Lg Cap Return • Corp Bonds • Govt Bonds 0 Standard Deviation Risk 25% 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% Efficient Frontier A B Standard Deviation • US Large Cap 20% 20% 17.0% Return A. 9% total return US Small Cap 10% 10% 22.0% 13% standard deviation • • Non US 30% 0% 19.0% B. 5% total return Corp Bonds 20% 35% 8.7% 8% standard deviation Govt Bonds 20% 35% 5.7% Risk 0 25% 4 22828811.PPT
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 5 22828811.PPT
history 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 6 22828811.PPT
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 7 22828811.PPT
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 8 22828811.PPT
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 9 22828811.PPT
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. 10 22828811.PPT
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 other 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). 11 22828811.PPT
penalty – failure to apply FUPMIFA? ?? Florida AG Donor Media 12 22828811.PPT
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 13 22828811.PPT
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 14 22828811.PPT
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