The Massachusetts data security breach law and proposed regulations have triggered extensive discussions and debate over the past year.  The issues and concerns raised resulted in extension of the compliance dates for the law.  However, although significant modifications have recently been made under the leadership of the new Undersecretary for Consumer Affairs, Barbara Anthony, substantial compliance with the law will soon be required (March 1, 2010) – and required by many organizations that are not aware that the new requirements apply to them, particularly nonprofit organizations and smaller businesses.

We thought it would be helpful to offer a summary of key provisions and guidance on ensuring compliance with what has been called the “toughest-in-the-nation” data protection law and corresponding regulations.

In general, nonprofit organizations, wherever located, that employ or serve Massachusetts residents are subject to the new and far-reaching Massachusetts data security regulations.  The regulations set forth standards that must be met by any non-governmental entity that owns or licenses personal information about a resident of the Commonwealth.  While the proposed regulations were recently revised to include a “risk-based” approach – a shift indicating that Undersecretary Anthony has listened to widespread criticism of the regulations, particularly from small business leaders, and understands their impact – compliance will still present significant challenges that entities of all sizes will have to consider.

The IRS has reported that user fees will increase for all applications for exemption (Forms 1023, 1024, and 1028) postmarked after January 3, 2010:

  • $400 for organizations whose gross receipts are $10,000 or less annually over a 4-year period (Currently $300)
  • $850 for organizations whose gross receipts

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With the plethora of news articles about charitable endowment losses as a result of investments with Bernie Madoff, it is incumbent on fiduciaries to review some fundamental laws on endowment.  These laws differ in each state.  This article will briefly review the rules applicable to endowments in New York.

An endowment fund is created when a person or entity donates money to a charity with the condition that the corporation cannot spend the money freely (commonly known as “permanently restricted”). The original donation is called the historic dollar value, that is, the aggregate fair value in dollars of (i) an endowment fund at the time it became an endowment fund; (ii) each subsequent donation to the fund at the time it is made, and (iii) each accumulation made pursuant to a direction in the applicable gift instrument at the time the accumulation is added to the fund. In New York, the governing board of an endowment fund operates under standards and guidelines from The New York Not for Profit Corporation Law (“NPC”), the New York Attorney General (“Attorney General”) and because New York has adopted it, principles of the Uniform Management of Institutional Funds Act (“UMIFA”).

Rules Governing Endowment Funds

New York law requires a governing board of a non-profit corporation to use all assets received for the purposes specified by the donor, including payment of reasonable and proper expenses. The board must also account for the endowment fund separate from other accounts. Further, the treasurer of the non-profit corporation must provide members of the board with annual reports of the fund’s assets and income, unless the donor states otherwise.

The Prudence Standard

Directors and officers of a non-profit corporation must discharge the duties of their positions in good faith and with the degree of diligence, care and skill which ordinarily prudent men would exercise under similar circumstances, according to the NPC and UMIFA. Before deciding whether to appropriate appreciation from endowment funds, the board must consider factors, such as the long and short term needs of the corporation in carrying out its purposes, its present and anticipated financial needs, expected return on total investments, price level trends and general economic conditions.

People have been whispering among themselves about the L3C, an emerging low-profit limited liability company structure that aspires to link business methods with charitable purposes and give socially oriented businesses greater access to investor capital.  The structure was created by Robert M. Lang, Jr., CEO of the Mary Elizabeth & Gordon B. Mannweiler Foundation.  Conceptually, the L3C is a hybrid not-for-profit/for-profit entity: like a not-for-profit, it has a primary purpose of charity, but like an LLC, it can have equity holders that have a right to distribution of profits.  Notably, although profit is allowed in an L3C, it cannot be a significant purpose of the organization.  Vermont passed the nation’s first L3C statute in April, 2008, effectively making the form legal in every state since a Vermont L3C can technically do business nationally (even internationally).  Illinois, Michigan, the Crow Indian Nation in Montana, Utah, and Wyoming have followed suit, and similar bills are currently pending in Arkansas, Missouri, North Carolina, Oregon, and Tennessee.

The L3C is taxed like any other for-profit entity and is not eligible for tax exemption under Section 501(c)(3) of the Internal Revenue Code.  L3Cs hope to encourage an influx of new capital into charitable causes that are too risky for for-profit ventures and that nonprofit dollars alone cannot sustain.  The L3C effectively creates a market for investment in companies that offer low rates of return, but contribute to the community, unlike the non-profit, which offers no rate (and sometimes a negative rate) of return on investment.  Therefore, if an entity has a charitable mission, but does not believe it can be profitable, or has a social mission, but probably could not secure program-related investments (“PRIs”)from private foundations, it would be better off forming as a not-for-profit or for-profit entity, respectively.

L3Cs envision a tiered investment structure. The first tier relies on PRIs to cover the areas of highest risk.  Under current law, private foundations are required to spend at least 5% of their net asset value annually.  PRIs essentially function as loans that will be, at least theoretically, repaid.  Even with no interest, the PRIs will still count as qualifying distributions towards the 5% requirement.  The L3C creators believe that private foundations will make PRIs with L3Cs because the PRI requirements are incorporated directly into the L3C structure itself, eliminating the need for private foundations to apply for private letter rulingsfrom the Internal Revenue Service (“IRS”), which can take up to 18 months to process and cost $50,000 or more in legal fees, plus a substantial fee to the IRS.