In recent years, private foundations increasingly have sought to incorporate socially responsible investing (“SRI”) mandates. Some SRI mandates take the form of negative screens—e.g., screening out tobacco stocks. Other SRI approaches are more proactive—e.g., a foundation focusing on disease eradication might invest in companies that develop vaccines. However, there has been a view—accurate or not—that some socially responsible investments yield lower risk-adjusted financial returns than traditional investments (such investments are sometimes referred to as “concessionary”).
Accordingly, when a foundation engages in an SRI program, several legal issues arise.
Among the potential issues is IRC § 4944, which prohibits a foundation from making “jeopardizing investments.”
The penalty for making such an investment is an excise tax both on the foundation and on the managers participating in the investment decision.
A jeopardizing investment as an investment in which it is determined that the managers failed to exercise ordinary business care and prudence in providing for the foundation’s financial needs (Treas. Reg. § 53.4944-1(a)(2)(i)). The determination is made on an investment-by-investment basis, taking into account the foundation’s entire portfolio. High-risk investments may be closely scrutinized to determine whether managers have met the requisite standard of care.
Program-related investments (“PRIs”) specifically are excepted from the definition of jeopardizing investments. A PRI is an investment, the primary purpose of which is to accomplish the foundation’s charitable purposes, and no significant purpose of which is the production of income or appreciation of property. Accordingly, an investment will not run afoul of IRC § 4944 so long as its primary purpose is to accomplish the foundation’s charitable purposes and financial return is not a significant purpose.
But what of an investment which seeks both to further the foundation’s charitable purposes and generate a financial return? What if the expected return is concessionary?
IRS Notice 2015-62, released on September 16, 2015, addresses these questions. The Notice concluded that, so long as ordinary care and prudence are exercised, a foundation and its managers will not be subject to tax under IRC § 4944 if the managers make a concessionary investment that furthers the foundation’s charitable purposes. The Notice explains that foundation managers are not required to select only investments that offer the highest rates of return, the lowest risks, or the greatest liquidity, so long as ordinary care and prudence are exercised.