You might suppose that an IRS that was death on so-called “jeopardizing investments” (see my post of 3/20/13) would work itself into a positive frenzy over a foundation that invested all its assets in one security. Talk about jeopardy!

But, no! Not at all! You could spend a thoroughly unpleasant couple of years reading through all 16,845 pages of the Internal Revenue Code and its regulations without finding anything directly on point.

The closest you could come is the provision on “excess business holdings” (§ 4943). But this provision refers to concentrated holdings not at the foundation level but at the corporate level. Confusing? Here are two (admittedly extreme) examples:

Example 1. Foundation A invests 3% of its assets in Corporation B, but that 3% represents 21% of B’s voting stock. Result? The foundation has violated the excess business holdings rule and can be fined very large sums of money.

Example 2. Foundation C invests 100% of its assets in Corporation D, but the 100% represents only 19% of D’s voting stock. Result? The IRS is happy as a clam! All’s well with the universe!

There are lots of perfectly sensible reasons why a private family might want to hold a concentrated stock position, even though they know it’s dangerous as hell. But once capital has been permanently committed to charity via a private foundation, the sensible reasons go away and the there’s nothing left but the danger. We actually have an almost laboratory-quality example of this in the histories of the Hewlett and Packard Foundations.

“Bill and Dave” (as they were known for years at HP) both established foundations and both funded the foundations entirely with HP stock. The Hewlett Foundation sold the stock and built a diversified portfolio, while the Packard Foundation didn’t. Why not?

There were two reasons. The first was that David Packard had expressed a preference for keeping the stock. But if Packard had wanted to keep the stock, he should have kept it – and not given it to a foundation and taken a huge tax write-off. If you or your family has built a great company and you want to take a chance that the stock might blow up in your face, so be it, you’ve earned the privilege. But when the stock blows up in a foundation’s hands, it’s not the family who suffers, it’s the grantees, the foundation staff and the broader community. (See below.)

The second reason for not diversifying away from HP was that “the stock has performed extremely well for many years” (as the Packard Foundation’s president put it). In the investment business, this is known as driving-by-looking-in-the-rearview-mirror (and therefore not noticing the bridge abutment you’re about to do a header into).

In the case of the Packard Foundation, the bridge abutment came along at the peak of the Tech Bubble in early 2000. At that point the Packard Foundation was the second largest foundation in America, with $18 billion in assets. By the end of 2002, Packard had just $5 billion in assets. Grants were cut by nearly 40%, devastating unsuspecting nonprofit organizations all over the country. Half the staff was fired.(1)

Maybe you’re thinking this was just a blip in the price of HP stock, and that it would soon recover. Ha! You’ve obviously forgotten how that once-great company has lurched from trouble to crisis to fiasco several times since the Tech Bust. HP stock peaked at $78 (split-adjusted) in April of 2000 before plunging to $11.45 in September of 2002. From its peak in 2000 through the end of 2012, HP returned a cumulative -72% while the S&P had one of its worst decades ever, returning “only” 20%.(2)

But did the Packard Foundation’s actions “jeopardize” its charitable mission? If you think so, you probably don’t work for the IRS.


(1) The story is told by Adam Lashinsky in the March 2003 issue of Fortune magazine.

(2) The Packard Foundation finally began diversifying away from HP in 2003, after riding the stock all the way to the bottom.

Next up: Separated at Birth

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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