[Things That Annoy Me will be a regular feature of these blog posts because, well, there are a lot of Things That Annoy Me.]

In case you don’t know – I hope you don’t have a family foundation – the Internal Revenue Code has a provision (IRC § 4944) prohibiting so-called “jeopardizing investments.” What the IRS means by that is that in the course of making the investment the foundation “failed to exercise ordinary business care and prudence under the facts and circumstances prevailing at the time” the investment was made.

Oh, great, you’re thinking, is that damn Curtis going to argue for the right to make careless and imprudent investments? Well, not today, but don’t tempt me…

What I’m wondering is why, given the fifty state laws on fiduciary principles, the many uniform codes on the subject, and close to a thousand years of common law precedent, Congress had to weigh in with its own slightly bizarre formulation.

But the real problem with § 4944 is that it put the beancounters at the IRS in charge of investment policy for billions of dollars of private foundation assets – which was like handing a loaded .357 Magnum to a three-year-old. The IRS, after all, is heavy on accountants and lawyers(1) and very, very light on investment professionals.

If you think I’m being hard on the good folks at the IRS, here are some investments that will be carefully scrutinized (and which private foundations therefore avoid like the plague): margin trading, commodity futures, working interests in oil and gas wells, selling short, buying puts, calls, straddles or warrants. Hello? Memo to the IRS: every well-managed institutional portfolio in America includes all or most of these investments. It’s only private foundations, thanks to the beancounters, that are still investing like it was 1950 (which is when the “jeopardizing investments” provision was added to the IRC).

As though all this wasn’t annoying enough, the beancounters really got riled up after the Madoff scandal, and have now added (I’m serious) hedge funds to the list of scrutinized investments. Memo (two) to the IRS: Bernie Madoff wasn’t running a hedge fund. Investors with Madoff didn’t become limited partners, there were no lockups, no investor or fund-level gates, no profit-sharing. Madoff was a regulated broker/dealer, like all the guys at Merrill, UBS, Morgan Stanley, etc. How about we carefully scrutinize any investments made with these guys?

But since the beancounters at the IRS don’t know a hedge fund from a ticker tape, if you’re a private foundation and want to invest in hedge funds, woe to you, pal, the IRS will be all over you. Thinking of starting a new foundation? The application form asks if you plan to invest in hedge funds. Answer “No” and your approval will come back by return email. Answer “Yes” and you’ll wish you’d never been born. I know several family foundations that won’t invest in a hedge fund unless they have a written opinion from legal counsel.(2) Memo (three) to the IRS: every well-managed institutional portfolio in America includes hedge funds. Except in the private foundation world.

Many studies have shown that most private foundations are gradually liquidating themselves in real terms, having less and less money to give away (inflation-adjusted) every year. One important reason for this is § 4944 and the positively weird interpretation of it by the IRS. Private foundations are one of the great glories of the American experiment. This is no way to treat them.


(1) Full disclosure: I’m a lawyer.

(2) The regulations under § 4944 state that if a foundation relies on a written legal opinion it will generally be ok. This is known as the Full Employment for Lawyers regulation.


Next up: Things That Annoy Me, Part 2

Please note that this post is intended to provide interested persons with an insight on the capital markets and is not intended to promote any manager or firm, nor does it intend to advertise their performance. All opinions expressed are those of Gregory Curtis and do not necessarily represent the views of Greycourt & Co., Inc., the wealth management firm with which he is associated. The information in this report is not intended to address the needs of any particular investor.


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