Few Legal Barriers Prevent Mission-Related Investments, Study Finds

By Nicole Wallace

Foundations have considerable freedom under the law to make investments that further their charitable missions, even if those investments carry greater risk or offer lower returns than more conventional investments, according to a new study.

FSG Social Impact Advisors, a nonprofit consulting and research group in Boston, analyzed federal tax law, state laws regarding the fiduciary duty of foundation trustees, and private-letter rulings issued by the Internal Revenue Service to try to clarify the legality of so-called mission investing.

The study was commissioned by the David and Lucile Packard Foundation, in Los Altos, Calif., and the Meyer Memorial Trust, in Portland, Ore.

“Trustees are often confused — and, frankly, the state of the law is kind of confusing — about what they’re allowed to do and what they’re not allowed to do,” says Mark R. Kramer, managing director of FSG Social Impact Advisors and co-author of the report.

State Laws

The study found that state laws on fiduciary responsibility do not require foundation trustees to maximize the financial return of the foundation’s investments, but that those laws do require trustees to maintain the original value of the gift made to endow the foundation, unless the donor left specific instructions to distribute all of the philanthropy’s endowment.

“There is in many states now a legal expectation that a foundation should exist in perpetuity, and that the trustees have an obligation to keep up with inflation,” says Mr. Kramer. “But that doesn’t mean that they have an obligation to maximize the financial return without taking into account the mission objectives of the foundation.”

In addition to looking at state and federal law and IRS rulings, the report’s authors also looked for legal cases in which states took foundations to court because of their decision to make mission-related investments, says Anne Stetson, the report’s other co-author and a senior adviser to FSG.

But, she notes, the researchers found few examples.

“We did not find a lot of case history to help guide us,” she says. “Attorneys general are just not all that concerned with investment activity of foundations unless there’s fraud or self-dealing involved.”

The report’s authors argue that it would be easier for foundations to navigate the complexities of mission investing if more donors stated in the documents that establish their foundations that trustees have the option of considering the foundation’s charitable mission as they manage the fund’s investments.

“There’s a real need to revisit the standard language that attorneys use to set up foundations, to cut through all of this stuff by making it clear as an option,” says Mr. Kramer.

“If donors want to permit this,”he says, “they should put in explicit language.”

Weighing Benefits

Another thorny legal issue that the study looked at was the requirements that apply to program-related investments.

For a transaction to qualify as a program-related investment, the “overriding concern” in the foundation’s decision to invest has to be its potential charitable benefit, says Ms. Stetson.

“Generating a financial return can’t be a substantial component of the decision to invest,” she says.

Most foundations have interpreted that to mean that the investments must earn a very low rate of return, often 2 percent or lower, says Mr. Kramer.

But, he says, a review of the private-letter rulings that the IRS has issued on the subject shows that foundations have much more latitude than they believe.

“Program-related investments can be at market rates,” he says. “They can be equity investments. They can actually be much, much more flexible than is typically thought of and still qualify as a PRI.”

Both a 16-page summary of the study, written for foundation executives, trustees, and other lay people, and a longer legal research memo are available on FSG’s Web site.