State prudent investor laws and federal tax law impose a number of restrictions on the manner in which the assets of a private foundation can be invested. The investment of a foundation’s assets essentially must:
- provide sufficient liquidity to allow 5% of the asset value to be paid in grants each year;
- not include an interest in an active trade or business that (when combined with the ownership interests of insiders) exceeds 20%, unless a special rule applies;
- not be so risky that the investment jeopardizes the ability of the foundation to carry on its exempt purposes (investments must be “prudent”); and
- not provide significant benefit to an insider.
An investment is considered to jeopardize the carrying out of the exempt purpose of a private foundation if it is determined that the foundation managers, in making such investment, have failed to exercise ordinary business care and prudence, under the facts and circumstances prevailing at the time of making the investment, in providing for the long- and short-term financial needs of the foundation to carry out its exempt purposes. No category of investments is treated as an automatic violation, but careful scrutiny is applied to: (i) trading in securities on margin, (ii) trading in commodity futures, (iii) investing in working interests in oil and gas wells, (iv) buying puts, calls, and straddles, (v) buying warrants, and (vi) selling short.
There is a specific exclusion from the definition of “jeopardizing investment” for a program-related investment (“PRI”). Generally, a PRI is an investment for which:
- the primary purpose is to accomplish one or more charitable purposes;
- the production of income or the appreciation of property is not a significant purpose;
- and lobbying or electioneering is not a purpose.
A PRI might take the form of a loan to a charity or a loan to, or equity investment in, a business entity for a charitable purpose, such as to develop or distribute a lifesaving drug for use in developing countries that would not otherwise be commercially viable.
Until recently, there was a question as to whether private foundation managers could consider the relationship between a particular investment and the foundation’s charitable purpose in deciding whether to make the investment (referred to as a “mission-related investment” or “MRI”), even where the production of income or the appreciation of property is a significant purpose. The relevant treasury regulations provide that an investment will be considered jeopardizing if a foundation’s managers fail to exercise ordinary business care and prudence. Since MRIs may offer lower returns than non-MRI investments, some questioned whether a lower return could cause them to be treated as “imprudent,” and therefore as jeopardizing investments.
IRS Notice 2015-62 makes clear that foundation managers may consider the relationship between an investment and the foundation’s mission in making prudent, profit-driven investments. The Notice also indicates that MRIs will not be considered imprudent because they offer an expected return that is less than what could be earned on other investments. This approach is consistent with state law requirements for charitable investments under the Uniform Prudent Management of Institutional Funds Act: foundation managers may consider the relationship of a proposed investment to the foundation’s charitable purpose as part of the determination as to whether an investment is prudent