Senator Liz Krueger and Assemblyman Jonathan L. Bing have introduced in the State Legislature S4778 and A7907, respectively, the so-called Uniform Prudent Management of Institutional Funds Act (UPMIFA) as a new article of the Not-for-Profit Corporation Law (NPCL). These bills continue an unfortunate trend that must be stopped if we are to avoid future Madoff scandals in the philanthropic world. 1 That trend further would shield charitable fiduciaries from legal responsibility for their investment decisions.
This bill also impairs donors’ rights to enforce their endowments and other restricted gifts contrary to the Appellate Division, First Department’s landmark ruling in Smithers v. St. Luke’s-Roosevelt Hospital Center 2 and other current donors’ rights developments. 3
Nicholas Kristoff, a columnist for The New York Times, listed 147 private foundations whose Madoff investments were more than material, in fact, 100 percent in far too many cases. 4 Yet, under proposed NPCL §554, “Delegation of management and investment functions,” the investment agents are not fiduciaries to the delegating institutions. Under §554(b) investment agents only owe delegating institutions “a duty . . . to exercise reasonable care.”
Worse, under §554(c):
Section 2 of the bill would, among other things, repeal the “historic dollar value” limitation on endowment invasion in NPCL §513(c). While anomalously leaving the definition thereof in §102(a)(16), the bill would thus reward the profligate institution with authority to wipe out entirely an endowment, even below its basis in the donor’s hands. For those institutions whose endowments are under water but need cash, the solution is, with the consent of available donors and on notice to the state attorney general, to ask a court for permission to borrow from the endowment on reasonable terms for a reasonable time.
Proposed §553 authorizes an institution to “appropriate for expenditure . . . so much of its endowment fund,” subject “to the intent of the donor expressed in the gift instrument.” But this only pays lip service to donor intent, because §553(c)(2) says, “Terms in a gift instrument designating a gift as an endowment . . . do not otherwise limit the authority to appropriate for expenditures under paragraph (a) of this section,” a trap for the unwary or ill-advised donor.
Moreover, under proposed §§555(b), (c) and (d), donors are excluded from notice of an institution’s application to a court for modification of restrictions.
Indeed, unlike the Uniform Management of Institutional Funds Act (UMIFA),5 UPMIFA does not clearly preserve resort to cy pres or deviation proceedings. Existing NPCL §522(d) which provides, “This section does not limit the application of the doctrine of cy pres” should be added to proposed §555 as a new subsection (f).
Such proceedings should require notice to donors or their representatives.6 The UPMIFA drafters’ comment says disingenuously:
The learned drafters must be held to the knowledge that only 10 or 11 of the states do any significant charity enforcement, and within each of those that do there is great variance from time to time.7
Appellate Division, First Department Justice Betty Weinberg Ellerin was well aware of this when she wrote in Smithers:
The donor of a charitable gift is in a better position than the Attorney General to be vigilant and, if he or she is so inclined, to enforce his or her own intent . . . .
Moreover, the circumstances of this case demonstrate the need for co-existent standing for the Attorney General and the donor . . . . We conclude that the distinct but related interests of the donor and the Attorney General are best served by continuing to accord standing to donors to enforce the terms of their own gifts concurrent with the Attorney General’s standing to enforce such gifts on behalf of the beneficiaries thereof. 8 (Emphasis added).
Inexplicably, Northern District Judge Gary L. Sharpe, who is constitutionally bound to apply New York law in a diversity case, in January denied standing in Rettek v. Ellis Hospital to a donor’s relative who alleged that the Ellis Hospital Foundation had not spent any of a restricted legacy for its purpose of improving nursing school facilities, had failed to invest it properly and had “borrowed” from it for other purposes without seeking court approval on notice to the attorney general.9
Judge Sharpe distinguished Smithers, because Ms. Smithers had been a court-appointed special administrator of her donor husband’s estate. But as the above quotation shows, Justice Ellerin’s holding is not so limited. Moreover, Ms. Smithers’s husband had died only recently, and she was of the same generation. So, it was not that difficult for a surrogate to appoint her her husband’s legal representative. Ms. Rettek was two generations removed from her donors and a collateral. Obviously, to require her to be appointed a special administratrix would vitiate the substantive public policy of underlying Justice Ellerin’s decision.
The federal court cited two New York cases, one subsequent to Smithers. Board of Education of Mamaroneck v. Attorney General10 reports two cases. One was a declaratory judgment action in which the attorney general “concurred with the Board that the proposed use . . . respected the intent of the donors . . . .” 811 NYS2d at 686-87. The attorney general did not appear in the second action brought by the donor’s grandson, and in neither case did the court cite or discuss Smithers. Nor was Smithers cited or discussed in Matter of Alaimo,11 a one paragraph memorandum filed the same year Smithers was decided.
Hopefully, Governor David A. Paterson, Attorney General Andrew Cuomo and the chairs and members of the Senate and Assembly committees on Corporations Authorities and Commissions will modify these bills to protect donor intent, reinforce the fiduciary responsibilities of charity trustees, directors and officers and not reward those charities that failed to establish reserves or otherwise save during the fat years against the inevitability of the lean years.
William Josephson is a retired partner of Fried Frank Harris Shriver & Jacobson. He headed Attorney General Eliot Spitzer’s Charities Bureau from 1999 to 2004.
1. For a discussion of Internal Revenue Code issues raised by the Madoff scandal, see William Josephson, “Former Head of Charities Bureau Says Tax on Jeopardizing Investments Should Apply to Charities,” 63 Exempt Organization Tax Rev. 514 (May, 2009).
2. Smithers v. St. Luke’s-Roosevelt Hosp., Ctr., 281 A.D.2d 127, 723 N.Y.S.2d. 426 (1st Dep’t 2001).
3. See William Josephson, “Donor Intent and Donor Standing,” 59 Exempt Organization Tax Rev. 307 (2008); John Hechinger, “New Unrest on Campus as Donors Rebel,” Wall St.J., April 23, 2009, at http://online.wsj.com/article/SB12404339479415007.html.
4. See Nicholas Kristoff, “Madoff and America’s (Poorer) Foundations,” http://kristof.blogs.nytimes.com/2009/01/29/madoff-and-americas-poorer-foundations/pag.
5. Section 7(d) enacted as NPCL section 522 which the bills unwisely would repeal in its entirety.
6. E.g., N.Y. Estates, Powers & Trusts Law §8-1.1(c) (McKinney 2004); George Gleason Bogart & Ronald Chester, “Trust and Trustees” §441 & nn.26, 27 & 28.
7. See Marion R. Fremont-Smith, “Governing Nonprofit Organizations” c.6 (2001); Barbara Duffy, “Oversight or Out of Sight? The Role of the Wisconsin Attorney General in Charity Regulation,” 63 Exempt Organization Tax Rev. 471 (May, 2009).
8. Smithers, 723 N.Y.S.2d at 434 36.
9. Rettek v. Ellis Hospital, 2009 U.S. Dist. LEXIS 1007 (N.D.N.Y. Jan. 12, 2009).
10. 25 A.D.3d 637, 811 N.Y.S. 685 (2d Dep’t 2006).
11. 288 A.D.2d 916, 732 N.Y.S.2d 819 (4th Dep’t 2001).