Charitable nonprofits organizations (“charities”) are subject to state prudent investment laws as we have previously written about here. The most important of these laws is the Uniform Prudent Management of Institutional Funds Act (UPMIFA) applicable in 49 states (all except Pennsylvania) and DC.

UPMIFA and Management and Investment Factors

UPMIFA describes eight factors that must be considered in managing and investing an institutional fund (including endowment funds and generally, reserve funds and investment funds):

1. General economic conditions.
2. The possible effect of inflation or deflation.
3. The expected tax consequences, if any, of investment decisions or strategies.
4. The role that each investment or course of 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.
8. An asset’s special relationship or special value, if any, to the charitable purposes of the institution.

Asset’s Special Relationship or Special Value to the Mission

UPMIFA does not specify what weight to give each of the eight factors, but they must all be considered. While investment advisors familiar with charity and foundation investment requirements may consider factors 1-7 relatively simple and something they would always consider, factor 8 seems to be largely overlooked. An outside investment advisor may have no way of knowing this information without a deeper conversation with the organization’s leadership. Moreover, use of the qualifying term “if any” means that the investment assets are not required to have a special relationship or special value to the charitable purposes of the charity.

This does not, however, necessarily absolve the fiduciaries of the organization from failing to consider the organization’s charitable purposes when selecting investments. For example, board members of a charity whose mission is to promote health and prevent lung disease should not allow for passive investments in tobacco companies.

The issue gets more complicated if the charitable organization incorporates within its charitable purpose certain statements of its values that also must be advanced. As an example, Charity A has adopted the purpose in its governing documents: to promote health and prevent lung disease through activities, disbursements, and investments that further the community’s health. The reference to community health may have been intended to guide the organization away from placing all of its focus on individual care at the expense of public health.

With such a purpose statement, it seems noncontroversial to maintain a negative investment screen on tobacco companies. However, it may arguably mean that there should also be a negative screen on fossil fuel companies if the fiduciaries believe that such companies are exacerbating the harms caused by climate change on community health. At first look, this might seem unlikely to create significant legal risk for fiduciaries who do not require the investment policy to have the fossil fuel negative screen. But then we saw the legal complaints against higher education fiduciaries regarding their failure to divest from fossil fuel investments. See just two of the examples below:

Excerpt from the Complaint by Divest Princeton

Under the New Jersey Uniform Prudent Management of Institutional Funds Act, the Board of Trustees has a fiduciary duty to invest with consideration for the University’s charitable purposes — a duty that distinguishes non-profit institutions from other investors. It may be problematic, then, that the Board of Trustees has invested a portion of the University’s 37.7 billion dollar endowment in the fossil fuel industry — damaging the world’s natural systems, disproportionately harming youth, low-income people, and communities of color, and imperiling the University’s financial and physical condition. In the midst of the climate crisis, powerful institutions must take responsibility for their contributions to global warming. As concerned students, faculty, alumni, political leaders, civic groups, and community members, we ask that you investigate this conduct and use your enforcement powers to bring the Board’s investment practices into compliance with its fiduciary obligations.

https://www.divestprinceton.com/_files/ugd/113c45_9214473fe3c94312aafdc5360b6f87db.pdf

Excerpt from the Complaint by Fossil Fuel Divest Harvard

The Harvard Corporation, as fiduciary of a non-profit educational institution, is bound by the laws of the Commonwealth to promote the well-being of Harvard’s students and community and to further the university’s commitment to “the advancement and education of youth.” Under the Massachusetts Uniform Prudential Management of Institutional Funds Act, the Harvard Corporation has a fiduciary duty to invest with consideration for the University’s “charitable purposes” – a duty that distinguishes non-profit institutions from other investors. Instead, the Corporation has invested a portion of Harvard’s $41.9 billion endowment in the fossil fuel industry — damaging the world’s natural systems, disproportionately harming youth, poor people, and communities of color, and imperiling the university’s financial and physical condition. In the midst of the climate crisis, powerful institutions must take responsibility for their contributions to global warming. As concerned students, faculty, alumni, political leaders, civic groups, and community members, we ask that you investigate this conduct and that you use your enforcement powers to order the Harvard Corporation to cease its investments in fossil fuels. …

Climate change is an existential threat to humanity and our environment. In addition to sea level rise, extreme weather events, and species die-off, climate change causes injuries to all members of society, and particularly to the most vulnerable. Pollution from the combustion of fossil fuels results in an estimated 10,000 premature deaths daily. Communities of color disproportionately suffer pollution and health detriments from fossil fuel extraction and combustion. Poor people bear the brunt of climate-based economic disruption, as illustrated by the plight of climate migrants and refugees already forced from their homes by drought, flooding, and social conflict. Indigenous communities are regularly invaded and harmed by the spread of fossil fuel infrastructure. As a result of the economic precarity and increased burden of care work that results from climate disruptions, women suffer more serious injuries from unabated climate change.

The need to refrain from promoting such outcomes is obvious for any institution that calls itself a charity. Yet the Corporation has repeatedly refused to apply Harvard’s values to its investment activity. This conduct is especially galling for managers of an institution of higher education. Fossil fuel companies have long engaged in a well-documented campaign to undermine climate science and distort public debate about how to deal with the climate crisis — including through efforts targeting Harvard scientists and researchers. The industry’s spread of scientific misinformation undermines the work of Harvard faculty and students who are researching and designing solutions for a sustainable future. Likewise, the flow of fossil fuel money to politicians and think tanks has diverted or delayed serious government action to address the climate crisis, placing a special burden on young people whose futures will be most impacted by these investments. Even as it recognizes “a special role and a special responsibility in confronting the challenges of climate change and sustainability,” the Corporation channels funds to an industry dedicated to winning short-term profits at the expense of the public good. …

The Corporation is bound by an additional legal duty: the requirement to manage Harvard’s assets with prudence. Prudent investment practice simply cannot be squared with the ownership of fossil fuel assets. Investment in the oil, gas, and coal sectors has become excessively risky thanks to increased government regulation and the fossil fuel industry’s own failure to diversify its operations and to avoid capital-intensive extraction. Fossil fuel stocks have performed significantly worse than market averages in recent years. In the last several months, the oil industry has begun to crumble, with the COVID-19 pandemic adding to already historic losses. The domestic coal sector has nearly collapsed, and natural gas likewise stands to lose much of its value as cheaper, more sustainable energy sources become more readily available. For any prudent investor, these signs clearly indicate that continued investment in fossil fuels is a losing proposition. …

The Corporation cannot plead ignorance of its duty to divest. For years, Harvard students and faculty have pushed for investment practices that align with the university’s mission. This pressure was instrumental in the Corporation’s decision in 1986 to withdraw investments from companies doing business in apartheid South Africa, its 1990 divestment from the tobacco industry, and its 2006 divestment from certain companies doing business in Darfur: acknowledgments that its investment activity must comport with Harvard’s missions and values. In recent years, various student and faculty bodies have voted for fossil fuel divestment, a position consistently endorsed by majorities in student referenda. Repeated rallies, reports, and requests for negotiation have alerted the Corporation to its fiduciary responsibility. Nonetheless, the Corporation has spurned all efforts at persuasion. Such behavior cannot be squared with the duty to manage the university’s assets in good faith.

https://climatedefenseproject.org/wp-content/uploads/2021/03/Harvard-Fossil-Fuel-Investment-Complaint.pdf

ESG

ESG in the context of investments refers to environmental, social, and governance factors. Investment firms may score and rank different companies based on the firm’s ESG criteria and market higher ranking companies as part of an ESG investment strategy.

ESG is not viewed as a negative screen. Instead, it promotes investing in high scoring companies and thereby encourages companies to act in a socially responsible manner. Generally, ESG investing appears to be sold as financially competitive with traditional (non-ESG) investing.

Whether factor 8 can allow for investment strategies and policies that place an investment’s special relationship to mission above the economic factors is not definitively known, though I believe most attorneys and financial advisors to charities would say it cannot. From a practical perspective, this might be the most prudent way to consider this issue. However, I think it’s worthy of greater consideration and recognition of the nuances.

For example, if potential financial and social returns could be accurately measured, it would be one thing to invest in a company that offered substantially less than market rate financial return for a minute social return, and a completely different thing to invest in a company that offered a marginally lower than market rate financial return for a very substantial social return.

So, if a highly desirable ESG portfolio from a mission-related perspective was desired, and it was projected to provide financial returns at a rate 1% less than other investment portfolios that would be considered financially prudent, it may be consistent with UPMIFA largely because of factor 8.

More Resources (updated 9/8/24)

Private Foundation: New Rules Recognizing Mission-Related Investments

How to File a Legal Complaint for fossil Fuel Divestment: A Guide for Divestment Activists

‘Social Profit Orientation’ Can Help Companies and Nonprofits Alike Do More Good in the World (Leonard L. Berry, Lerzan Aksoy, and Tracey Danaher, Chronicle of Philanthropy)