BILL ANALYSIS
SENATE JUDICIARY COMMITTEE
Senator Ellen M. Corbett, Chair
2007-2008 Regular Session
SB 1329 S
Senator Harman B
As Amended March 24, 2008
Hearing Date: April 8, 2008 1
Corporations Code & Probate Code 3
GMO:jd 2
9
SUBJECT
Charitable Institutions: Fund Management and Investment
DESCRIPTION
Existing law, the Uniform Management of Institutional Funds
Act (UMIFA), guides charities on the management and
investment of funds by charitable organizations, providing
rules on spending from endowment funds, and permits the
release of restrictions on the use and management of
charitable funds.
SB 1329 would repeal UMIFA and enact the Uniform Prudent
Management of Institutional Funds Act (UPMIFA) instead.
UPMIFA would update the prudence standard that applies to
the management and investment of charitable funds or
endowment funds and would give institutions the ability to
cope more easily with fluctuations in the value of the
endowment.
The bill would change the rules applicable to charitable
institutions so that the charity may spend the amount it
deems prudent after considering the donor's intent that the
endowment fund continue permanently, the purposes of the
fund, and relevant economic factors. It would allow the
alteration without court approval, including release to a
larger pooled fund, of a small old fund (less than $100,000
and more than 20 years old), with notice to the Attorney
General.
Finally, the bill would authorize the court, upon petition
(more)
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by the Attorney General, to order the winding up and
dissolution of a nonprofit public benefit corporation
without meeting the requirements of existing law, based on
the ground that it is impossible or impracticable to meet
some or all of those requirements.
(This analysis reflects author's amendments to be offered
in committee.)
BACKGROUND
SB 1329 would enact recommendations from the California
Commission on Uniform State Laws (CCUSL), the sponsor of
the bill.
According to the author and sponsor, the existing UMIFA
anticipated the Uniform Prudent Investor Act (UPIA)
(Probate Code 16045 et seq.) which was enacted in 1997
and modified in 2000. UPIA provides the modern guidance
for the prudent standard a fiduciary should follow in
making investment decisions. In order to carry out its
standard of total return investing, California also adopted
the Uniform Principal and Income Act in 1999 (UPAIA) (AB
846 (Ackerman), Ch. 145, Stats. 1999) and revised certain
portions relating to unitrusts in 2005 (SB 754
(Poochigian), Ch. 100, Stats. 2005). This bill, which
would enact the new Uniform Prudent Management of
Institutional Funds Act (UPMIFA), coordinates with and
borrows from both the UPIA and the UPAIA.
The UPMIFA has been enacted in 13 states and the District
of Columbia and introduced in 19 states (including
California, Illinois, Arizona, and New Mexico) in 2008.
The UPMIFA will affect only nonprofit charitable
institutions.
CHANGES TO EXISTING LAW
1. Existing law , the Uniform Management of Institutional
Funds Act (UMIFA), governs the management and use of
endowed institutional funds held by charitable
institutions. (Probate Code Sec., 18500 et seq. All
references are to the Probate Code unless otherwise
indicated.)
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This bill would repeal the UMIFA. In its place, this
bill would enact the Uniform Prudent Management of
Institutional Funds Act (UPMIFA). Various differences
between UMIFA and the proposed UPMIFA are discussed in
the Comment section.
This bill would define various terms in the act,
including "institutional fund," "gift instrument," and
"endowment fund." An "endowment fund" means an
institutional fund or part thereof that, under the terms
of a gift instrument, is not wholly expendable by the
institution on a current basis. The term would not
include assets designated by the institution as an
endowment fund for its own use.
This bill would impose on an institution managing an
institutional fund the duty to consider the charitable
purposes of the institution and the purposes of the
institutional fund when managing the fund, subject to the
donor's intent, as well as the duty to manage and invest
the fund in good faith and in compliance with the prudent
investor standard. This bill would provide rules to
follow and factors to consider for an institution
managing such funds. (See Comment 3a.)
This bill would authorize an institution, subject to a
donor's intent expressed in the gift instrument, to
appropriate for expenditure or accumulate so much of an
endowment as the institution deems prudent for the uses
or purposes and duration of the endowment. This bill
would provide that unless stated otherwise in a gift
instrument, the assets in an endowment fund are
donor-restricted assets until appropriated for
expenditure by the institution. This bill would provide
factors for the institution to consider when making a
determination to appropriate or accumulate so much of an
endowment fund. (See Comments 3b and 3c.)
This bill would allow the institution to delegate to an
external agent the management and investment of an
institutional fund to the extent the institution could
prudently delegate under the circumstances, and would
delineate the areas over which the institution must
exercise prudence. (See Comment 5.)
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This bill would authorize, if the donor consents in
writing, the institution to release or modify, in whole
or in part, a restriction contained in a gift instrument
on the management, investment, or purpose of an
institutional fund. This bill would however, prohibit a
release or modification to allow the fund to be used for
purposes other than a charitable purpose of the
institution. (See Comment 6.)
The bill would, using the doctrine of cy pres, allow a
court, upon application of an institution, to modify a
restriction contained in a gift instrument regarding the
management or investment of a fund if the restriction has
become impracticable or wasteful, if it impairs the
management or investment of the fund, or if, because of
circumstances not anticipated by the donor, a
modification of a restriction will further the purposes
of the fund. (See Comment 6.)
The bill would, if an institution determines that a
restriction contained in a gift instrument on the
management, investment, or purpose of an institutional
fund is unlawful, impossible to achieve, or wasteful,
authorize the institution, after 60 days' notice to the
Attorney General, to release or modify the restriction in
whole or in part, if the following apply: (1) the fund
subject to the restriction has a total value of less than
$100,000; (2) 20 or more years have elapsed since the
fund was established; and (3) the institution uses the
property in a manner consistent with the charitable
purposes expressed in the gift instrument. (See Comment
6.)
This bill would apply to institutional funds existing on
or established after January 1, 2009. As applied to
institutional funds existing on January 1, 2009, this
bill would affect only those decisions made or actions
taken on or after January 1, 2009.
2. Existing law establishes the requirements for the
winding up and involuntary dissolution of a nonprofit
public benefit corporation, which include the final
settlement of accounts and the filing of a final
franchise tax return, among others.
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This bill would authorize a court, upon petition by the
Attorney General, to order the winding up and dissolution
of a nonprofit public benefit corporation without meeting
the requirements of existing law, based on the ground
that it is impossible or impracticable to meet some or
all of those requirements. (See Comment 7.)
COMMENT
1. Author's amendments
The author has offered amendments to the committee to
address a concern relating to donor-restricted funds that
would be eligible, under this bill, for release when the
funds are at least 20 years old and consist of no more
than $100,000. The amendment would allow an institution,
after releasing or modifying a restriction, to use the
donated property in accordance with the restriction
notwithstanding its release or modification, and that use
would be deemed to satisfy the consistency requirement of
the provision.
2. Need for the bill
The sponsor of SB 1329 states that the current rules
under UMIFA have prevented endowments from using assets
that have plunged in value (such as contributions of
Silicon Valley investments) for the charitable purpose
the endowment intended and institutions from merging
various small institutional funds that have been reduced
in value over the years. This bill would repeal UMIFA,
including the use of the Historic Dollar Value (HDV) for
endowment expenditures, which is the amount the charity
has historically deemed prudent to spend from the
endowment fund, as the floor for expenditures from the
endowment, thereby freeing up the charity to spend from
the fund assets what it deems prudent after consideration
of the donor's intent that the endowment fund continue
permanently, the purposes of the fund, and relevant
economic factors.
The author and sponsor state that in enacting UPMIFA,
this bill would update the rules to give institutions the
ability to cope more easily with fluctuations in the
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value of the endowment and would permit more efficient
management of these funds.
3. Rules of management and investment
a. Good faith and prudent investor standard to be used
Proposed Sec. 18503 would require the institution
(defined as a person or entity organized exclusively
for charitable purposes or a governmental entity that
holds funds exclusively for a charitable purpose, or a
trust that had both charitable and noncharitable
interests, after all noncharitable interests have
terminated) to consider both the purposes of the
charity and the purpose of the institutional fund in
managing and investing the fund, subject only to the
intent of a donor expressed in the gift instrument.
Further, each person responsible for managing and
investing would be bound not only with the duty of
loyalty imposed by general law on trusts, but also
with the duty to manage and invest the fund in good
faith and with the care an ordinarily prudent person
in a like position would exercise under the
circumstances, i.e., the prudent investor standard
imbedded in the Uniform Prudent Investor Act.
Finally, SB 1329 would require a person with
special skills or expertise, or who was selected upon
that person's representation that he or she has
special skills or expertise, has a duty to use those
skills or expertise in managing and investing
institutional funds.
It is not clear what additional protection this
provision would give to a donor or to the institution.
One provision (proposed Section 18503(b)) already
would require "each person responsible for managing
and investing an institutional fund" to manage and
invest such funds in good faith and with prudent care.
Such a person (presumably a trustee of the
institutional fund or a board member of the
institution) may delegate the management and
investment responsibilities to an expert (perhaps an
investment manager, in house or from outside, who
presumably would be a regulated professional).
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Regardless of who the responsibility is delegated to,
the ultimate duty lies with the trustees (or board
members). By including this provision in the statute,
it would appear that trustees or board members may
find it useful to be able to shift responsibility for
any action relating to management and investments that
have untoward results unto the "experts" they hire.
This provision is not in the current UMIFA, and the
sponsor has not provided any information that would
justify the inclusion of this provision in UPMIFA.
SHOULD THIS PROVISION BE STRICKEN FROM THE BILL?
b. Cost management obligations; due diligence to verify
facts
SB 1329 would allow the institution to incur only
costs that are appropriate and reasonable, in relation
to the assets, the purposes of the institution, and
the skill available to the institution. It also would
be required to exert a reasonable effort to verify
facts relevant to the management and investment of the
fund. For purposes of management and investment, the
institution would be allowed to pool two or more
institutional funds.
c. Factors to consider in management and investing an
institutional fund
SB 1329 would require the institution to consider the
following factors in managing and investing an
institutional fund: (1) general economic conditions;
(2) the possible effect of inflation or deflation; (3)
the expected tax consequence of investment decisions
or strategies; (4) the role that each investment or
action plays within the overall investment portfolio
of the fund; (5) the expected total return from income
and the appreciation of investments; (6) other
resources of the institution; (7) the needs of the
institution and the fund to make distributions and to
preserve capital; and (8) an asset's special
relationship or special value, if any, to the
charitable purposes of the institution.
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As a rule, an institution would be required to
consider its overall portfolio and overall investment
strategy (which includes risk and return objectives
reasonably suited to the fund and to the institution)
when making decisions about an individual asset. Thus,
an institution would be required to invest in any type
of property consistent with its purpose, and diversify
its investments, unless diversification would
frustrate the purpose of the fund or the purpose would
be better served without diversification. Finally, an
institution would be required, upon receiving a gift
of property, to promptly make adjustments to the
portfolio or dispose of or retain the property in
order to bring the institutional fund into compliance.
In response to the Attorney General's suggestion that
any ambiguity be cleared with regard to the
prohibition against speculative investments embodied
in Corporations Code Sec. 5240 and the concomitant
liability of directors for such speculative investment
decisions, the author has offered an amendment
expressly stating that nothing in the section
pertaining to management and investment decisions
alters the duties and responsibilities of a director
of a nonprofit public benefit corporation under
Corporations Code Sec. 5240.
4. Appropriations and expenditures from an endowment fund
Under UMIFA, a charity can spend from an endowment fund
the amount of appreciation above the historical dollar
value (HDV) the charity deems prudent, but it can never
spend below the HDV. (Sec. 18502.) This rule has created
problems for institutions managing funds with assets that
have depreciated in value over time, such that there is
not enough appreciation in the fund to even distribute
the HDV.
For example, for a $500,000 endowment, the institution
prudently distributes 5% annually for ten years to
designated scholarships ($25,000 or more, based on the
return on investment). This year, due to a severe
downturn in the economy and fluctuations in investment
earnings, the endowment suffers a loss and is reduced to
$400,000. In this case, the endowment will still have to
distribute at least $25,000, the minimum historical
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dollar value of the expenditure from this endowment, even
though 5% would amount only to $20,000. This rule would
operate to deplete the endowment, which would be a
violation of the general purpose of keeping the endowment
funded permanently.
UPMIFA would permit an institution, subject to the intent
of a donor as expressed in the gift instrument, to
appropriate or accumulate so much of an endowment fund as
the institution finds prudent, for the uses, purposes,
and duration for which the endowment is established.
Assets in an endowment fund would be considered
donor-restricted until appropriated for expenditure. As
in all cases, the institution would be expected to act in
good faith, with the care that an ordinarily prudent
person in a like position would exercise under similar
circumstances, and to consider factors such as: the
duration and preservation of the endowment fund; the
purposes of the institution and the endowment fund;
expected total return from income and appreciation of
investments; general conditions; and the investment
policy of the institution.
The Attorney General (AG) has indicated a preference for
an alternate UPMIFA provision on the expenditure of
endowment funds. The AG has suggested that California
adopt the UPMIFA alternate language capping the
expenditure of endowment funds to no more than seven
percent (7%) of the market values determined at least
quarterly and averaged over a period not less than three
years preceding the appropriation for the expenditure.
An expenditure greater than 7% would create a rebuttable
presumption of imprudence. The Attorney General contends
that a level of spending that would significantly reduce
the purchasing power of an endowment fund over time would
generally be "antithetical to the rationale of endowment
funds, which?provide a perpetual, stable source of
financial support for the institution." The AG cites the
Uniform State Laws Commission report stating six states
have adopted this language (Montana, Nevada, Oregon,
Tennessee, Texas, and Utah), and that Texas includes only
endowment funds valued at $1 million or more in its
version of UPMIFA.
Proponents of SB 1329 reject this proposal from the
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Attorney General, stating that gifted assets do fluctuate
in value, and the ability to spend more for the purpose
of the institution and according to the intent of the
donor as expressed in the gift instrument during the
high-return years should be permitted, as long as the
expenditures are prudent. And in low-return years, they
state, spending when the fund balance has dipped below
the historical dollar value, even in accordance with the
donor's intent as expressed in a gift instrument, is not
permitted under UMIFA. Thus, they argue that this change
of rule is necessary so that institutions may discharge
their obligation to honor both the donor's intent and the
endowment's purpose.
5. Delegation of duties to external agent
SB 1329 would permit the institution to delegate to an
external agent the management and investment of the
institutional fund, as long as the delegation of
responsibility is prudent and the selection of the agent,
the delineation of scope of responsibility, and the
periodic review of performance are conducted in a prudent
manner. In this, UPMIFA would impose on the institution
the same responsibilities regarding delegation of duties
to an external agent as are imposed on trustees of any
trust under the Uniform Prudent Investor Act (UPIA) and
the Uniform Principal and Income Act (UPAIA). This
reconciling provision is not in the current UMIFA.
UMIFA currently allows delegation of the management and
investment responsibilities to the institution's
committees, officers, or employees and so would UPMIFA.
General trust law under the UPIA and UPAIA would govern
any liability arising from the delegation of management
and investment duties to committees, officers, or
employees of the institution under both UMIFA and UPMIFA.
As to agents, UMIFA is silent (so that general trust law
would govern), but UPMIFA is not.
SB 1329, which would enact UPMIFA, contains express
provisions: (1) imposing on the delegated external agent
a duty of care in the performance of the agent's duties
and scope of the delegation; (2) relieving the
institution of any liability for decisions or actions of
the external agent to which the function was delegated;
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and (3) requiring the external agent to submit to the
jurisdiction of the state courts in all proceedings
related to the delegation or the performance of the
delegated function.
SHOULD AN INSTITUTION BE RELIEVED OF RESPONSIBILITY FOR
MANAGEMENT AND INVESTMENT FUNCTIONS SIMPLY BY DELEGATING
THE RESPONSIBILITY TO AN EXTERNAL AGENT?
6. Release or modification of a restriction; cy pres
proceedings
Under existing law, the UMIFA allows the governing board
of an institution, with the written consent of the donor,
to release, in whole or in part, a restriction imposed by
the applicable gift instrument on the use or investment
of an institutional fund. If the donor's written consent
cannot be obtained (by death, disability, unavailability,
or impossibility of identification), the governing board
may apply to the court for an order releasing a
restriction. The Attorney General must be a party to
this proceeding. And, if the court finds that the
restriction is obsolete or impracticable, it may order
the restriction released in whole or in part, but the
court may not change the endowment fund to a fund that is
not an endowment fund. A release of restriction under
this provision does not allow use of the fund for other
than the educational, religious, or other charitable
purposes of the institution. Further, this provision
does not affect the application of the cy pres doctrine
to this restricted fund. (Sec. 18507.)
The doctrine of cy pres is a rule for the construction of
instruments in equity, by which the intention of the
party is carried out as near as may be, when it would be
impossible or illegal to give it literal effect. Cy pres
is the equitable power by which a court thus makes it
possible to carry out a donor's expressed charitable
intent but for some reason the donor's purpose cannot be
accomplished in the manner expressed in the gift
instrument.
SB 1329 would incorporate the general concept of cy pres
and the release or modification of a donor's restriction
on donated property and make some changes. Proposed Secs.
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18506(a), (b), and (c) are substantially similar to
existing Sec. 18507. However, proposed Sec. 18506(d) is
new, and is intended to address the problem of what to do
with an institutional fund when the balance is too low
and the costs of management becomes disproportionately
high, but the cy pres doctrine would not work to solve
the dilemma because of the costs of going to court.
Thus, under SB 1329, if an institution determines that a
restriction contained in a gift instrument on the
management, investment, or purpose of an institutional
fund is unlawful, impracticable, impossible to achieve,
or wasteful, the institution may release or modify the
restriction in whole or in part, without a court order
and without the written consent of the donor, if all of
the following apply:
a. the institutional fund has a total value of less
than $100,000;
b. the institutional fund is at least 20 years old;
and
c. the institution uses the property in a manner
consistent with the charitable purposes expressed in
the gift instrument.
The institution would be required to notify the Attorney
General of the intent to release or modify the
restriction 60 days prior to the release or modification
of the restriction.
In addition, an author's amendment to proposed Sec.
18506(d)(3) would provide that after the restriction had
been released or modified, if appropriate circumstances
arise thereafter, the institution may use the property in
accordance with the restriction notwithstanding its
release or modification, and that use would be deemed to
satisfy the consistency requirement of the paragraph.
Applied to an endowment fund, for example, where the
donor endowed the institution $500,000 to provide
scholarships to needy college students of a particular
ethnic background, this bill would allow the institution,
when the endowment is at least 20 years old and the
balance is below $100,000, to release the funds to a
general pooled institutional fund dedicated to providing
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scholarships to needy college students, but would still
allow the use of the balance transferred to provide
scholarships to qualified students of the particular
ethnic background who apply for the scholarship after the
restriction had been released and the fund pooled with
other funds.
The flexibility gained by the institution is therefore
still somewhat constrained by the restriction of the
donor's original intent, but the pooling of small
institutional funds for the same charitable purposes
results in cost-efficiencies of management and investing.
The Attorney General has suggested that the $100,000
figure for releasing or modifying a 20-year old endowment
fund's restriction is too high, and suggests $25,000 as
the proper number to use. The $25,000 asset value would
be more in line with the Probate Code sections that allow
trustees to terminate trusts unilaterally, without court
approval ($20,000 value of real estate, Sec. 13200) or
that allow a public administrator to administer an estate
without court supervision and approval ($30,000 value of
estate, Sec. 7660). However, proponents of SB 1329
contend that the $100,000 figure would be consistent with
a value of $25,000 20 years ago, which if adjusted would
be a little over $100,000. So that, if this bill is
enacted, these 20-year old funds of less than $100,000
may be pooled by the institution and used for the
charitable purpose intended.
7. Attorney General may bring action to dissolve
nonprofit public benefit corporation without meeting
winding-up requirements
Every corporation, whether for profit or not for profit,
for public benefit or private benefit, is required to
meet certain requirements in the process of voluntarily
winding up and dissolving the corporation. A petition for
involuntary dissolution of a nonprofit public benefit
corporation may be filed by an authorized person or
entity on various grounds, such as the corporation
abandoning its activities for more than one year,
internal dissention among the members such that two or
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more factions are deadlocked and business could not be
conducted properly, or those in control of the
corporation have been guilty or have knowingly
countenanced pervasive fraud, mismanagement, or abuse of
authority. The Attorney General may also petition the
court to dissolve such a corporation on the grounds of
the corporation's serious violations of the statutes
governing corporations or charitable organizations; or
the corporation has fraudulently abused or usurped
corporate privileges or powers; or there are grounds for
the forfeiture of corporate existence; or the corporation
has failed to pay to the Franchise Tax Board for a period
of five years any tax imposed on it by the state.
At the end of the process of winding up and dissolving,
and all accounts having been settled, the court may make
an order declaring the corporation duly wound up and
dissolved, and declaring that (1) a final tax return had
been filed, (2) all debts and liabilities paid or
provided for as described in the order, (3) known assets
have been distributed or that there are no known assets,
and (4) that the accounts of directors or such other
persons have been settled and they are discharged from
their duties and liabilities.
SB 1329 would provide that in an action brought by the
Attorney General to wind up and dissolve a nonprofit
public benefit corporation, the court may make an order
declaring a corporation to be wound up and dissolved
without meeting the requirements stated above (e.g.,
filing a final tax return, paying all debts &
liabilities, etc.), upon the court finding that it is
impossible or impracticable to meet some or all of those
requirements.
The Attorney General requested this change in the
nonprofit public benefit corporation law in order to fill
a gap that may prevent courts from issuing an order of
corporate dissolution in some instances, for example,
when no final tax return has been filed with the
Franchise Tax Board (FTB) because the corporate officers
have ceased to conduct business. Apparently, when a
nonprofit public benefit corporation has not been
dissolved in an orderly fashion (as has recently happened
with the San Francisco Neighbors Resource Center case,
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now pending in San Francisco), the Secretary of State has
given notice that unless the FTB filing has been made,
the Secretary will refuse to file the dissolution order.
The Attorney General seeks this change in the law so that
the dissolution may be filed and the public may get
notice that the charitable corporation has been
dissolved.
8. Miscellaneous provisions related to UPMIFA
SB 1329 contains several clarifying and/or conforming
provisions of note:
a. It would provide that compliance with UPMIFA is to
be determined in light of the facts and circumstances
existing at the time a decision is made or action
taken, not by hindsight.
b. It would apply these new rules under UPMIFA to
institutional funds existing on or established after
January 1, 2009. As applied to institutional funds
existing on January 1, 2009, UPMIFA would apply only to
decisions made on or after that date.
c. It would supersede relevant provisions in the E-SIGN
Commerce Act, except as provided.
d. It would require that in applying and construing
UPMIFA, consideration must be given to the need to
promote uniformity of the law with respect to its
subject matter.
9. Support from qualifying institutions
Large educational institutions with substantial endowment
funds, as well as the smaller educational institutions
support SB 1329. The University of California, for
example, writes, "[i]n some respects, the changes that
will be brought about by SB 1329 might be viewed as
relatively modest amendments to current law. However,
these modifications are critically important to UC, and
to other charitable institutions, as we seek to better
manage our investments, prudently and efficiently control
expenditures, and maximize the charitable funds that are
available for programmatic purposes. These are essential
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goals to the UC today, and our ability to effectively
manage our endowments will become even more vital in
years to come." (Letter dated March 24, 2008.)
Similarly, the California State University (CSU) states
that the CSU has an endowment portfolio with a market
value in excess of $800 million that distributes over $30
million per year in support of the CSU and its students.
"SB 1329 will ensure that the best investment practices
govern the investment of institutional funds. The
prudence standards in UMIFA have provided useful
guidance, but prudence norms evolve over time. The new
Act (UPMIFA) provides modern articulations of the
prudence standards for the management and investment of
charitable funds and for endowment spending, and will
encourage growth of institutional funds while reducing
investment risks." (Letter dated March 21, 2008.)
Support: University of California; California State
University; the Association of Independent
California Colleges and Universities
Opposition: None Known
HISTORY
Source: California Commission on Uniform State Laws;
Attorney General
Related Pending Legislation: None Known
Prior Legislation: None Known
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