Legislature(2009 - 2010)BELTZ 211

03/20/2009 08:00 AM EDUCATION

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07:59:35 AM Start
07:59:47 AM SB134
08:38:58 AM Adjourn
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
Heard & Held
Bills Previously Heard/Scheduled
        SB 134-PRUDENT MANAGEMENT OF INSTITUTIONAL FUNDS                                                                    
7:59:47 AM                                                                                                                    
CHAIR DAVIS announced consideration of SB 134.                                                                                  
SENATOR PASKVAN,  sponsor of  SB 134, said  this bill  will bring                                                               
Alaska's  guidance and  requirements  for  the administration  of                                                               
endowments and  charitable funds up  to date and  consistent with                                                               
national   standards.   The   Uniform   Prudent   Management   of                                                               
Institutional Funds  Act (UPMIFA)  attempts to  bring all  of the                                                               
various  types  of   non-profit  organizations  and  governmental                                                               
entities   under  the   same  requirements   and  standards   for                                                               
administration of  endowments and  charitable funds. This  act is                                                               
default legislation  which only applies  in the absence  of other                                                               
more specific  requirements or law or  governing instruments. For                                                               
example, this  does not  apply to the  Permanent Fund  because it                                                               
has specific investment standards written into its act.                                                                         
He  said that  UPMIFA  replaces obscure  and  obsolete rules  and                                                               
concepts  for the  investment and  management  of endowments  and                                                               
charitable  funds with  current industry  best practices.  UPMIFA                                                               
provides  clear  guidance on  the  standards  of performance  and                                                               
prudent   practices  for   the  investment   and  management   of                                                               
endowments  and  charitable  funds consistent  with  the  Uniform                                                               
Prudent Investment  Act adopted  by Alaska  10 years  ago. UPMIFA                                                               
defines specific factors to be  considered in managing charitable                                                               
funds such  as the accumulation  of earnings, the  expenditure of                                                               
endowment  funds,  and  the  obligation  to  provide  for  future                                                               
beneficiaries. The  investment of funds including  the obligation                                                               
to manage to the overall objective  of the funds in the portfolio                                                               
to  consider   the  investment   horizon,  cost   of  management,                                                               
diversification, rebalancing, verification  or relevant facts and                                                               
use of  special skills  or expertise  that a  fiduciary possesses                                                               
and a prudent delegation of investment and management functions.                                                                
He explained  that UPMIFA minimizes  the exposure  of non-profits                                                               
and  volunteer trustees  to disputes  and  legal challenges  over                                                               
issues related  to obscure and outdated  administrative rules and                                                               
practices  by   clarifying  the  specific  requirements   in  the                                                               
applicable performance standards.                                                                                               
Further, he  said, UPMIFA  incorporates a  less onerous  and less                                                               
expensive  process  for  the modification  or  release  of  donor                                                               
restrictions   on   gifts   that  may   have   become   wasteful,                                                               
impractical, unlawful  or impossible  to achieve.  He said,  as a                                                               
member of an investment board, he  believes these are some of the                                                               
investment  standards  that  are   important  to  bring  Alaska's                                                               
investment standards in line with national standards.                                                                           
8:03:31 AM                                                                                                                    
SENATOR HUGGINS asked  if there are any  organizations other than                                                               
the Permanent Fund that do not come under UPMIFA.                                                                               
SENATOR PASKVAN replied that he is not aware of any.                                                                            
SENATOR  HUGGINS  asked  if  he   could  foresee  any  unintended                                                               
SENATOR  PASKVAN replied  no; and  this is  a step  in the  right                                                               
direction  to, for  example, provide  voluntary trustees  who are                                                               
making   decisions  on   these  institutional   funds  a   better                                                               
understanding of prudent investment practices.                                                                                  
8:04:58 AM                                                                                                                    
SENATOR HUGGINS asked  if this wouldn't require a  staff of three                                                               
lawyers to administer.                                                                                                          
SENATOR PASKVAN  answered no; "the point  of this is to  not have                                                               
that happen."                                                                                                                   
8:05:28 AM                                                                                                                    
JAMES  LYNCH, Associate  Vice President,  Finance, University  of                                                               
Alaska (UA),  said he has  managed their endowments for  the last                                                               
25  years  and supported  SB  134.  He  related that  UPMIFA  was                                                               
approved by the Uniform Law  Commission in 2006 and in subsequent                                                               
years  has  been  adopted  by  26  states  and  the  District  of                                                               
Columbia. In 2009 it was adopted  by three more states, and bills                                                               
were introduced  to implement  these UPMIFA  in 14  other states.                                                               
There are two reasons for that:  one is that for most states this                                                               
is an  update of prior  uniform regulation  that came out  in the                                                               
1970s, and most states have  operated under similar standards for                                                               
the last 30-40  years. Alaska never adopted  the original Uniform                                                               
Management Act.  The other reason  is that  it provides a  lot of                                                               
flexibility  for managers  during economic  turmoil and  economic                                                               
downturn.  This update  was developed  because of  confusion that                                                               
arose in  the last market  decline and  the bursting of  the tech                                                               
bubble in 2001/2.                                                                                                               
8:08:32 AM                                                                                                                    
MR.  LYNCH  explained that  the  Act  is  a compilation  of  best                                                               
practices for charitable foundations  and endowments; it protects                                                               
donors by making  their intent paramount in  determining what can                                                               
and  should happen  to donations  and  endowments. It  authorizes                                                               
such things  as the total  return concept, which  allows managers                                                               
of   endowments  to   use  current   investment  techniques   and                                                               
strategies.  Otherwise they  end up  with a  lot of  fixed income                                                               
investments, and  there's almost no  way that investing  in fixed                                                               
income  can   inflation-proof  a  fund.  It   also  provides  the                                                               
charitable organizations with the  flexibility they need in these                                                               
economic times to deal with market conditions.                                                                                  
He explained  that when you  manage an endowment, you  have three                                                               
objectives. The first one is to  maximize the returns, next is to                                                               
inflation-proof to be  able to retain the  purchasing power. When                                                               
these  endowments are  used at  the University  for supporting  a                                                               
faculty  member's salary  or a  scholarship, for  instance, those                                                               
costs go up  annually. The endowment has  to be inflation-proofed                                                               
so that spending can increase  as needed. Third, management tries                                                               
to stabilize distributions. It's not  much value to find out that                                                               
the investment  market is down  this year, but the  student still                                                               
has  to pay  tuition. The  same is  true for  a faculty  member's                                                               
8:11:13 AM                                                                                                                    
Stabilization is  probably the  most important  of the  three, he                                                               
emphasized.  The Act  protects the  non-profit community  and its                                                               
many  volunteers. It  protects them  from the  failure to  follow                                                               
what are really outdated rules  and obscure practices on managing                                                               
these funds.                                                                                                                    
He explained  that it does  a couple  of other small  things that                                                               
are important  for administration  of funds. Two  sections relate                                                               
exclusively to the University; one  makes sure that this Act does                                                               
apply to  the University. Second,  it's to correct  an unintended                                                               
consequence that occurred during  establishment of the Retirement                                                               
Management  Board. The  authority  for the  Board  of Regents  to                                                               
manage its  endowments and  the land  grant trust  fund basically                                                               
came from  a statutory reference  to the Alaska Pension  Board in                                                               
AS 14.25.180 that dealt with some  of the fiduciary duties of the                                                               
Pension  Board  and applied  those  to  the University.  It  also                                                               
indicated   that   AS   37.10.071,   which   is   the   fiduciary                                                               
responsibilities  toward state  funds,  applies to  the Board  of                                                               
Regents.  When  the  reference  was  changed  to  the  Retirement                                                               
Management Board, provisions were  inserted for managing pensions                                                               
that don't apply to endowments at all,  and it is not clear as to                                                               
whether  other state  statutes on  fiduciary responsibilities  do                                                               
apply. This corrects that situation.                                                                                            
8:14:02 AM                                                                                                                    
ERIC   WOHLFORTH,   Chair,   University   Investment   Committee,                                                               
University of Alaska, said this bill  would apply in a case where                                                               
the  trust instrument  is  silent  with regard  to  the terms  of                                                               
management  and  the provisions  for  payouts.  He explained  the                                                               
typical gift  to the University  establishing a  scholarship fund                                                               
is  silent on  such things  as  what the  payout can  be for  the                                                               
scholarship. Trust law in Alaska now  says you can't go below the                                                               
original cost  of the fund,  so a lot of  University scholarships                                                               
this year  won't have a  payout. This  bill applies in  all cases                                                               
where the  original gift  instrument is silent  and says  you can                                                               
have a  percent of  market value  payout. However  documents with                                                               
other stated  payout provisions in  them would prevail  over this                                                               
This bill  also gives portfolio  managers freedom in the  kind of                                                               
assets that  can be invested  in the portfolio according  to very                                                               
elaborate  rules relating  to prudence.  It does  not attempt  to                                                               
specify  what  sorts of  investments  are  legally required.  The                                                               
default nature of  this bill is important as well  as the broader                                                               
authority for investing that previously existed.                                                                                
8:17:03 AM                                                                                                                    
SENATOR HUGGINS asked about his  use of the terms "endowment" and                                                               
"principle." He  asked if this legislation  allows his investment                                                               
organization to dip  into the principal when it  was silent where                                                               
without this legislation that couldn't be done.                                                                                 
MR.  WOHLFORTH  said  that  is   correct.  The  original  Uniform                                                               
Management  of Institutional  Funds Act  of 1970  said you  could                                                               
distribute current  yield and  capital appreciation.  The updated                                                               
UPMIFA says you can distribute any  money in the endowment and if                                                               
it drops below  the original gift value you can  continue to make                                                               
distributions,  but  you have  to  inflation-proof  the fund.  It                                                               
allows you to basically borrow  against future earnings. However,                                                               
there are  a lot of requirements  imposed. You have to  take into                                                               
consideration   general  economic   conditions,  the   effect  of                                                               
inflations,   expected  tax   consequences,  the   roll  of   the                                                               
investment  itself  within  the  portfolio,  the  expected  total                                                               
return  and the  other resources  of the  institution. It  allows                                                               
flexibility, but it is all governed by what is prudent.                                                                         
SENATOR  HUGGINS  said  his  concern  is  the  present  financial                                                               
debacle where  the economic  paradigm most  people have  lived by                                                               
has  been  thrown  out  the  window.  He  mentioned  the  current                                                               
arguments  for  and  against  the Permanent  Fund  paying  out  a                                                               
dividend this  year because the  principle has dropped  below the                                                               
original deposits.                                                                                                              
MR. WOHLFORTH agreed  that this is an  unprecedented period where                                                               
a whole new  paradigm of investment is slowly  emerging, but this                                                               
legislation in  general does not  tie them to any  particular era                                                               
or time with regard to what  is an appropriate payout rule. Until                                                               
1970, endowments could only invest  in bonds and pay out interest                                                               
-  period. That  was replaced  by the  total return  concept that                                                               
allows  investments  in common  stocks  as  well as  bonds.  That                                                               
notion became  part of the  accepted investment tool and  is part                                                               
of this  legislation. What has  happened in  the last year  and a                                                               
half has  thrown almost every  calculation out of kilter,  but he                                                               
didn't  think  it had  thrown  the  total  return notion  out  of                                                               
kilter. He thinks that flexibility is  necessary so that as a new                                                               
paradigm  develops,  people  can  get   a  better  idea  of  what                                                               
investment philosophy ought to be going forward.                                                                                
8:23:07 AM                                                                                                                    
SENATOR  HUGGINS continued;  it appears  to him  at the  national                                                               
level the  prevailing thought is decreasing  flexibility in favor                                                               
of more regulation and asked him to comment on that.                                                                            
MR. WOHLFORTH  responded that is  true, but  those considerations                                                               
of decreasing  flexibility to deal with  "the bizarre instruments                                                               
that  have developed"  do  not  seem to  apply  at the  endowment                                                               
level.  This  legislation  doesn't  tie endowments  to  a  return                                                               
environment,  which is  based on  100-percent  fixed income,  but                                                               
rather it  provides for operating  in different  environments but                                                               
with prudent investment guidelines.                                                                                             
8:25:14 AM                                                                                                                    
MR. LYNCH added  that one of the reasons UPMIFA  was developed is                                                               
due  to the  market downturn  in 2001/2  - because  at that  time                                                               
boards and institutions made a  number of erratic decisions. Some                                                               
of  them  looked  at  their   whole  pool  of  endowments  -  the                                                               
University, for instance,  has over 600 endowments,  250 of which                                                               
are  currently   "under  water."   Those  won't  have   any  more                                                               
scholarship  distributions.   Others  decided  to   make  payouts                                                               
anyhow. What  this bill  does is  offer a  happy medium  based on                                                               
good  judgment,  which  can't  be legislated.  You  can  lay  out                                                               
standards  and principles  and then  trust the  trustees to  make                                                               
prudent  decisions. You  can borrow  against  principal, but  not                                                               
spend  it.  Your  borrowing  has   to  be  judged  based  on  the                                                               
circumstances surrounding it.                                                                                                   
8:28:22 AM                                                                                                                    
LYNN LEVENGOOD,  Uniform Law Commissioner, State  of Alaska, said                                                               
the commission provided  the legislation to the  national body to                                                               
make sure it would still qualify  as a uniform law, because minor                                                               
changes  were  made that  were  unique  to Alaska.  The  national                                                               
governing body found  the changes were not  substantial, and that                                                               
the legislation still qualified as a uniform state law.                                                                         
However, they thought  one issue needed to be  corrected and that                                                               
is  the  title, which  says  that  this  is "a  uniform,  prudent                                                               
management  of  institutional  funds  act."  The  key  words  are                                                               
"institutional   funds",  which   is   broader   than  the   term                                                               
"endowment". Under AS 13.70.090  definitions, "endowment fund" is                                                               
defined as  "an institutional  fund or  part of  an institutional                                                               
fund,"  so  the  term  "endowment"  is  narrower  than  the  term                                                               
"institutional fund". The glitch is  in the bill's last paragraph                                                               
on "applicability"  where they think  "endowment fund"  should be                                                               
changed to "institutional fund" because  that is broader in scope                                                               
and is consistent  with the title and focus of  the bill which is                                                               
to govern the management of institutional funds.                                                                                
8:32:11 AM                                                                                                                    
KEN  CASTNER  said he  serves  as  a  fiduciary  on a  couple  of                                                               
community  foundation   boards  and   is  active   in  investment                                                               
committees of both of those boards;  he supported SB 134. He said                                                               
this  bill  simply  gives  the  attorney  general  very  specific                                                               
authority to  act, which  was absent now.  Without this,  a donor                                                               
may bequest to a University for  a specific purpose, and then the                                                               
gift  might not  get used  for that  intent. The  donor would  be                                                               
completely frustrated  from asserting the intent  of the original                                                               
gift. This gives the attorney  general the authority to intercede                                                               
to make sure the donor's wishes are followed.                                                                                   
All  the other  things Senator  Huggins was  concerned about  are                                                               
already being acted  on under other national  standards, he said,                                                               
with various  federal regulations.  What was  prudent in  2005 is                                                               
different  than  what  is  prudent  today;  an  endowment  is  in                                                               
perpetuity so  you don't want to  have a sinking fund.  This bill                                                               
provides for  a balance between  prudence and  maintaining public                                                               
8:35:25 AM                                                                                                                    
CHAIR DAVIS closed public testimony.                                                                                            
SENATOR  PASKVAN agreed  to write  up an  amendment based  on Mr.                                                               
Levengood's suggestions.                                                                                                        
8:37:26 AM                                                                                                                    
SENATOR  HUGGINS asked  why "and  relating to  the University  of                                                               
Alaska" is in the title.                                                                                                        
SENATOR PASKVAN responded  that as Mr. Lynch  testified that they                                                               
are amending  the statutes to  make sure the principles  apply to                                                               
the Board of  Regents management of the  University endowments on                                                               
page 7.  This language  makes it  very clear  that the  Board can                                                               
make distributions from the principal if it is prudent.                                                                         
VICE CHAIR DAVIS held SB 134 in committee.                                                                                      

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