DATELINE: January 30, 2009, Chicago
Earlier this week, Brandeis University announced it was closing the Rose Art Museum. The museum's renowned collection of contemporary art was to be sold, with the hope that the sale would produce hundreds of millions of funds that could be added to the university’s quasi-endowment. One legal expert declared that the university had no idea of the size of the can of worms that it had opened when it announced the closing of the Rose. The university has since backed away from the decision to sell the collection, but the university still contends that it will close the museum. The question remains: What will happen to the valuable collection, particularly given that the original proposal was percipitated by the university's financial crisis?
We alrady have received calls and e-mails about the decision from...
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the media and our readers so we thought we should discuss some of the legal issues that likely are already crawling from the can that Brandeis opened.
The Code of Ethics. Brandeis Provost, Mary Krauss, said that one reason for closing the museum is that the university cannot abide by a code of ethics applicable to museums. We assume she is referring to the American Association of Museums, which includes in its Code of Ethics the following requirement:
Thus, the museum ensures that:
…disposal of collections through sale, trade, or research activities is solely for the advancement of the museum's mission. Proceeds from the sale of nonliving collections are to be used consistent with the established standards of the museum's discipline, but in no event shall they be used for anything other than acquisition or direct care of collections.
We don’t necessarily disagree with the code's sentiment, particularly if the plan is to use the proceeds to cover operating costs. But Provost Krauss is setting up a strawman. We know of no law that requires an institution to comply with the AAM code of ethics before it can refer to itself as a museum. Membership in AAM is voluntary. There is no legal requirement that Brandeis or the Rose be AAM members--although we do acknowledge that expulsion could make it difficult for the Rose to retain or hire curators and other musuem officials.
We do observe that institutions like AAM are part of the problem. Its code of ethics is fine, but it slavishly hauls the same talismans out every time a member institution runs into financial trouble without providing meaningful solutions to what are very real financial issues that are often outside the control of the financially-troubled institution. One could make the case that the ethics code is designed to force transfers of works held in smaller museum collections to large museums, thereby concentrating works of art in large cities. Members with large endowments can afford to be pious and they may benefit from such piety. The effect of these rules may be to destroy smaller museums. Is it time for a new assocation of small museums?
Incorporating the AAM Code of Ethics into Donor Restrictions. One faithful reader wrote us to ask whether we thought donors to the Rose might look to the AAM Code of Ethics to stop the sale of works they donated to the museum by arguing that the AAM Code of Ethics had somehow been incorporated into donor gift instruments. We guess the argument would be that donors relied on AAM membership in deciding to make their gifts. We have no doubt that advocates for donors might make that argument, but the argument is both wrong and dangerous.
The rule focuses on museums with continuing operations. We would argue that a decision to close a museum does not fall within the rule because there are no continuing operations. More importantly, such a construction provides donors with too much opportunity to make mischief. Suppose the donor saw five security guards on duty just before she made her gift. Does that mean the donor can demand that five security guards must always be on duty? Or if those guards are paid 20% above minimum wage, can the donor object when museum reduces the guards' wages to 15% above minimum wage. As should be apparent, allowing donors to rely on external circumstances that exist at the time of the gift would lead to a never ending entanglement of donors in an institution’s management and affairs. We believe the law would and should not incorporate the AAM Code of Ethics into the terms of a restricted gift unless the donor specifically made continued compliance with the code an explicit restriction and spelled out that requirement in a written the deed of gift.
Donor Standing to Stop the Sale of Art Works. Some donors may file suit to stop the sale of their works. We certainly are not intimately familiar with Massachusetts law, but we suspect that the donors lack standing to file lawsuit to enforce the terms of restrictions on their gifts to the Brandeis and the Rose. Typically, the state attorneys general are the only parties with the authority to ask a court to enforce, release, or modify restrictions in a restricted gift instrument. That does not mean that donors will not consider suits or that a court will not grant them standing. The law of standing is tricky and slippery and courts have been known to grant standing to donors.
Massachusetts Attorney General’s Role. Newspaper accounts already have reported that the Massachusetts Attorney General plans to review each restricted gift to make sure that every sale of each piece of art complies with the terms of the related restrictions. In some cases, the sale may be prohibited. In others, a sale may be permitted, but only if the proceeds are used for specific purposes. In still others, if the Rose closes, Brandeis may be required to transfer the work to another institution. We suspect that there will be restrictions that thwart some sales. Certainly donors who make major gifts to universities and museums will learn from this high-profile incident, with the result that the gift instruments accompanying gifts of art will become more complex and restrictive.
Limitations on Spending Institutional Funds. In an interview with Judith H. Dobrzynski of the Daily Beast, Peter French, Brandeis’s chief operating officer, indicated that Massachusetts law prevents Brandeis from spending the principal/corpus/historic value of its endowment. In effect what French is saying is that Brandeis has to sell hard assets like paintings because Massachusetts prevents it from looking to what are referred to as institutional funds as an alternative source of funds. There are a couple of points that need to be made about French’s statement. First, endowment is often referred to as a monolith, but university endowments are often comprised of hundreds, if not thousands of individual funds. The question of what Brandeis can spend from its endowment first and foremost is determined by examining the terms of the each individual fund.
Second, donors often make general gifts, which provide that capital is to be preserved, but income can be spent to fund operations. In that case, French’s statement is correct. Secion 2 of Chapter 180A of the Massachusetts statutes provides:
The governing board may appropriate for expenditure for the uses and purposes for which an endowment fund is established so much of the net appreciation, realized and unrealized, in the fair value of the assets of the endowment fund over the historic dollar value of the fund as is prudent under the standard established by section eight; provided, however, the appropriation of net appreciation for expenditure in any year in an amount greater than seven per cent of the fair market value of the institution’s endowment funds, calculated on the basis of market values determined at least quarterly and averaged over a period of three or more years, shall create a rebuttable presumption of imprudence on the part of the governing board. This section does not limit the authority of the governing board to expend funds as permitted under other law, the terms of the applicable gift instrument, or the charter of the institution.
This language is a variation on the language found in the Uniform Management of Institutional Funds Act (UMIFA) that first saw the light of day in 1972. The states are currently replacing it with the updated Uniform Prudent Management of Institutional Funds Act (UPMIFA), which has been adopted by 26 states (and the District of Columbia) in just two years—that is a very rapid rate of adoption. Massachusetts has yet to adopt UPMIFA. Under UPMIFA, which is retroactive, Brandeis would not be limited by the historic dollar value of the fund (essentially the value at the time of the gift). Brandeis would have far greater flexibility and might be able to respond to the predicament that it now faces by increasing its spending rate, something which UPMIFA both contemplates and facilitates.
Despite the limitations imposed by the Massachusetts version of UPMIFA, Brandeis does have several options under UMIFA available to it that would permit it to tap a larger share of its endowment. First, it could go back to large donors and ask them to release restrictions on otherwise restricted funds. This is permitted by Section 9 of the Massachusetts version of UMIFA, which provides:
With the written consent of the donor, the governing board may release, in whole or in part, a restriction imposed by the applicable gift instrument on the use or investment of an institutional fund.
In some cases, the donor will be dead. In that case, the statute provides for what is in effect a procedure rooted in the doctrine of cy pres (as near as). Section 9 provides:
If written consent of the donor cannot be obtained by reason of his death, disability, unavailability, or impossibility of identification, the governing board may apply in the name of the institution to a court of competent jurisdiction for release of a restriction imposed by the applicable gift instrument on the use or investment of an institutional fund. The Attorney General shall be notified of the application and shall be given an opportunity to be heard. If the court finds that the restriction is obsolete, inappropriate, or impracticable, it may by order release the restriction in whole or in part. A release under this subsection may not change an endowment fund to a fund that is not an endowment fund.
A release under this section may not allow a fund to be used for purposes other than the educational, religious, charitable, or other eleemosynary purposes of the institution affected.
As should be apparent, Brandeis would need to notify the Massachusetts Attorney General if it decided to ask a court to release what it would claim to be obsolete, inappropriate, or impracticable restrictions. The attorney general would then have the opportunity to participate in the court proceedings. This process is certainly an option, but it would not be an simple one. What one person views as an obsolete or impracticable restriction, another often views as a viable one. Brandeis’s predicament illustrates this well. The university might argue that restrictions on the endowment make continued operation of the university impractical and therefore should be released. The attorney general or the court might well counter that Brandeis has other alternatives to save itself other than tapping the endowment. Those alternatives might include curbing new construction plans, cutting faculty, or even shuttering the Rose and selling its collection.
Before moving on to the third option available to Brandeis, we should note that Section 9 explicitly states that it does not limit the application of the doctrine of cy pres. We are not sure what purpose this language serves. As to institutional funds, Section 9 seems to incorporate the doctrine of cy pres or something closely akin to it.
A third option available to Rose would be obtain an agreement from the Massachusetts Attorney General that temporarily spending above 8% under the circumstances would not be deemed to be imprudent. Remember that Section 2 relies on a presumption, not a rule. Brandeis’s situation nicely illustrates why statutes should not try to impose hard and fast spending rules.
Due of Care By Brandeis Trustees. The picture painted by the Daily Beast is of an institution in financial meltdown. The university is projecting an operating deficit of $79 million over the next six years, its reserve fund is expected to depleted within the next 18 months, and it has large construction projects underway. French told the Daily Beast that the university’s alternatives include closing 40% of its buildings, reducing staff by 30%, or firing 200 of its 360 faculty members. Tuition increases always are a possibility, but tuition has already been increased.
Once again, we have to ask: Where was the board of trustees? Maybe the board and the administration have been struggling with these issues for the last several years, but the publicity surrounding the Rose announcement certainly gives the appearance that nobody saw the crisis coming. We believe that what appear to be sudden revelations at least require an examination of whether the trustees were diligent. The one bit of good news is that Brandeis’s endowment is only down $170 million from a $700 million base. That is only a 24% decline, which reflects a much better result than other endowed institutions have achieved. Maybe the board was attentive and Brandeis is the just the victim of a confluence of circumstances. One of the those clearly is Bernie Madoff. Although Brandeis apparently did not invest any portion of its endowment with Madoff, some of its potential benefactors apparenlty did. Brandeis' mistake may have been counting on estate plans that have yet to ripen.
One thing is for sure, our lawyer friend was correct. Brandeis’s announcement has opened up a gigantic can of worms.
Thanks to Felix Salmon of Conde Nest Portfolio for bringing the Daily Beast interview to our attention. Mr. Salmon writes the Market Movers blog and writes for Conde Nest Portfolio.
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