Foundations, like many investors, are considering how to use their assets to both provide investment return and to promote their social and charitable causes (a strategy sometimes referred to as “social impact investing”). One approach is to engage in mission-related investments (MRIs). An MRI is a financial investment that aligns with and furthers a charitable mission, but for which the primary purpose is financial return.
An MRI is not defined by the Internal Revenue Code or Treasury Regulations, and questions arose as to whether such an investment would trigger penalties under the Section 4944 “jeopardizing investment” rule. This rule imposes an excise tax on imprudent investments made by a private foundation that may jeopardize the exempt purpose of the private foundation. Foundation managers are concerned that choosing to invest in one business over another because of the foundation’s social impact goals could violate this rule if it meant choosing an investment that offered a lower expected rate of return or higher risk. For example, the foundation may choose to not own stock in a tobacco company because of the social impact of the tobacco business; if a tobacco stock offers a better return than alternatives, there was some argument that not investing in the tobacco stock would violate the jeopardizing investment rule. Common examples of MRIs are start-up entities that have a possibility of success because of consumers’ desire to help impact society in their purchases or activities, such as Impossible Foods, Toms Shoes, and Warby Parker, which are credible financial investments, but also offer positive social returns.
Mission related and social impact investing is in a different category than “program-related investments.” The IRS has long held that “program-related investments” (PRIs) do not trigger the jeopardy investment rule because they enjoy a specific exception to that rule. But the rules for PRI qualification are much stricter--in order to qualify as a program related investment, the primary purpose of an investment must be charitable, educational, scientific, etc. and the production of income or appreciation of property cannot be the primary investment purpose. In contrast, MRIs and social impact investing include investments that are made with the primary purpose of financial return, and often times include large publicly traded companies (or just instances where foundations want to avoid certain types of socially-negative investments).
To address this issue, the IRS published Notice 2015-62. In this notice, the Service confirmed that a foundation may consider the foundation’s mission when making investment decisions without violating the jeopardizing investment rule (this covered all types of investing, even those investments that were made for the primary purpose of investment profits and gains). In other words, foundations have latitude to consider social impact investing in making investments. The IRS Notice provided that the foundation must still exercise the requisite ordinary business care and prudence in its business decisions.
Notice 2015-62 gives private foundations comfort to make investments under both a “proactive” social impact investing strategy where the investment manager actively looks for companies that will generate investment returns as well as a positive and social environmental impact or a more passive “screening approach” where an investment manager avoids certain industries or activities in investment selections.
The IRS Notice 2015-62 referenced state statutes requiring prudent investments by foundations. These will be explored in a later article.