United States: Will 2015 IRS Notice Boost Foundations' Mission-Related Investing In 2016?

Foundations are effective vehicles for families who want to make a collective philanthropic impact now and for generations to come. Traditionally, foundations have achieved this impact solely through strategic grantmaking. A growing number of foundations are looking for ways to go further, however. These foundations seek strategies that will allow them to deploy their investment portfolios – in addition to grantmaking – to advance their charitable missions without hurting the value of their endowments long-term. One such strategy, using "mission-related investments" or MRIs, is trending in the press and at sector conferences, but most foundation directors and trustees have yet to jump on its bandwagon. New guidance from the IRS may change that.

MRIs can mean different things to different people.  Some use the term interchangeably with "impact investments." There is no legal definition of either. Here we mean it to refer to investments that are meant to generate a financial return while advancing the foundation's charitable mission at the same time. A double bottom line, if you will. Because generating financial return is a significant purpose of mission-related investments, they do not fit into the category defined by the tax code as "program-related investments" or PRIs. MRIs, then, can be thought of as non-PRIs. The distinction between MRIs and PRIs is important here, because the IRS guidance is directed at investments that do not qualify as PRIs.

Why haven't foundation directors and trustees been clamoring for MRIs? Two reasons, we believe. First, many foundation managers have avoided MRIs, particularly if the investments generate lower returns or carry greater risks than comparable conventional investments, for fear of inadvertently making a so-called "jeopardizing investment" and triggering excise taxes on themselves and their foundations. Second, foundation managers, faced with the headwind of the 5 percent payout requirement and rightly concerned about sustaining their endowment's value, tend to view the MRI asset class with skepticism. (Note, only PRIs count toward the 5 percent payout; MRIs do not.) In many cases, this general skepticism is enough of a barrier to keep the managers from digging deeper to identify MRIs that show promise for generating adequate financial return.

IRS Notice 2015-62, issued last September, addresses the first reason: the "jeopardizing investment" fear. The Notice begins by confirming what everyone already knew — that an investment will not be considered a "jeopardizing investment" if the foundation managers exercised ordinary business care and prudence by analyzing all relevant facts and circumstances when evaluating the investment. But it then clarifies for the first time an important point: these relevant facts and circumstances may include the relationship between a particular investment and the foundation's charitable purposes. Thus, foundations managers are not required to select only those investments that generate the highest rate of return, carry the lowest degrees of risk, or possess the greatest degree of liquidity, so long as they carefully select investments that support, and do not jeopardize, the furtherance of their foundation's charitable purposes. Indeed, prudent foundation managers may select an investment that furthers a foundation's charitable purposes, even if it has a lower rate of return than what might otherwise be obtained from a similar investment that has no relation to these charitable purposes.

Foundation managers are reminded by Notice 2015-62 of how important it can be to demonstrate the requisite standard of care on an asset-by-asset basis, especially when the relationship of an investment to the foundation's mission was a significant factor in the manager's decision making. Foundations can draw motivation from Notice 2015-62 to take steps to update their mission statements and investment policies, develop protocols for contemporaneously documenting MRI decisions in a manner commensurate with the size and risk of each investment, and implement safeguards to ensure they memorialize how each MRI aligns with their mission.

Notice 2015-62 should spark new conversations in foundation circles about MRIs as a tool to advance charitable purposes. And we believe, for careful and prudent foundation managers, it should put to rest most, if not all, of their "jeopardizing investment" worries associated with MRIs. But we see the skepticism that persists around MRIs generally as being the higher of the two hurdles. We are not alone in this view. (See the excellent article by Ben Gose in THE CHRONICLE OF PHILANTHROPY titled Foundations Are Cautious on Impact Investing, 12/1/2015.) Whether Notice 2015-62 will move the needle on that skepticism remains to be seen.

Originally published on January 20, 2016

This update is for information purposes only and should not be construed as legal advice on any specific facts or circumstances. Under the rules of the Supreme Judicial Court of Massachusetts, this material may be considered as advertising.

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