California Clarifies Investment Standards for Public Benefit and Religious Corporations

By Jeffrey D. Davine

Without a lot of fanfare, the California State Legislature recently passed a bill that seeks to provide some clarity for charities as to how they are supposed to invest their assets.

Assembly Bill 792 (“AB 792”) was passed by the California State Legislature in June, 2015, signed by Governor Brown in July, 2015, and will become effective on January 1st of next year. According to its author, it will assist California nonprofit public benefit and California religious corporations in making better investment decisions by clarifying California law regarding the investment of their assets. The hope is that this, in turn, will provide these entities with improved investment returns.

AB 792 attempts to resolve an inconsistency in California law between two sets of standards that apply to investment funds that are held by two types of California nonprofit corporations- nonprofit public benefit corporations and nonprofit religious corporations. One set of investment standards is contained within the California Corporations Code (Section 5240 for public benefit corporations and Section 9250 for religious corporations). The other standard is contained within the Uniform Prudent Management of Institutional Funds Act (“UPMIFA”)- Probate Code Section 18500, et seq. Although both standards apply, the interaction between the two are imprecise and somewhat incongruent. As a result, governing boards of California public benefit and religious corporations are often advised to comply with both standards. However, trying to comply with both standards can result in an investment portfolio that is more conservative than what may be necessary. This, in turn, can result in many charities realizing lower investment returns than what they should be.

California Corporations Code Sections 5240 (which applies to public benefit corporations) instructs charities to “avoid speculation, looking instead to the permanent disposition of the funds, considering the probable income as well as the probable safety of the corporation’s capital.” Unfortunately, there isn’t a precise definition of “speculation.” Courts have emphasized that fiduciaries should avoid all risk and have reviewed investment decisions individually rather than looking at the decisions for an investment portfolio as a whole. This standard has often discouraged charities from diversifying their portfolios and resulted in what many would characterize as overly conservative investment decisions. Moreover, it is inconsistent with modern investment approaches that no longer eliminate risk but, instead, recommend calculated risk.

California Corporations Code Section 9250 (which applies to religious corporations) incorporates California Corporations Code Section 9241 by reference and instructs directors to perform their duties “in good faith, in a manner such director believes to be in the best interests of the corporation and with such care, including reasonable inquiry, as is appropriate under the circumstances.” As is true with respect to the requirements that apply to public benefit corporations, this standard is vague.

The UPMIFA standard, which also applies to California charities, differs from the requirements contained in California Corporations Code Sections 5240 and 9250 as follows:

UPMIFA provides for an “overall” approach as opposed to focusing on a specific investment; and

Instead of applying a broad requirement to “avoid speculation,” UPMIFA requires charities to take into consideration a variety of factors when managing their investments, including a consideration of the investment’s risk and the appropriateness of it with respect to the charity.

AB 792 clarifies California law by providing that compliance with the applicable guidelines set forth under UPMIFA will satisfy the investment standard under both California Corporations Code Section 5240 and California Corporations Code Section 9250.

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