Case:

Lucky Lucy Lindstrom finished college and headed west. She started as a financial analyst with a large company in Seattle. After just four years, she became a Registered Investment Advisor (RIA) and began advising clients. Lucy also managed her own investments. With her keen insight into financial markets, Lucy soon began to move from traditional stocks and bonds into futures and commodities markets. Lucy was so successful in these markets that she now only manages her own large personal portfolio. Somewhat late in life, Lucy discovered the wonderful world of philanthropy. She volunteered at her favorite charity and learned that giving someone in need a helping hand is even more gratifying than making another million in the futures market.

Lucy had invested $1,000,000 in stock in a renewable energy company with the name Northern Long Shot, Inc. This company designs and manufactures energy solutions for companies across the far north. Recently, the stock rose from the $1 per share that she paid to over $5 per share. After this success, Northern Long Shot decided to "spin off" a smaller company with a portion of their energy systems. Lucy exchanged her $5 million in stock for 60% of the stock in Northern Long Shot II, Inc. After the exchange, Lucy decided to give the Northern Long Shot II stock to a private charitable foundation to help those in need.

Lucy discussed several options with her attorney. She asked her attorney about the ability of her private foundation to receive the Northern Long Shot II, Inc. stock. Her attorney noted that private foundations are subject to various rules on self-dealing, minimum distributions and excess business holdings. They also must not invest in a way that would jeopardize the charitable interest.

Question:

Lucy said, "Wow! There are a lot of rules for private foundations. Why would my private foundation have to be careful with the type of investments? After all, I am an RIA who has been very successful with investments."

Solution:

Her attorney explained that the trustee of a private foundation generally has a lot of flexibility when investing a private foundation's assets. Investments are proper so long as they are permitted by the private foundation's organizational documents and state law and do not "jeopardize the carrying out of any of its exempt purposes." Sec. 4944. An investment jeopardizes a private foundation's exempt purposes if it is overly risky. This risk determination is made on an investment-by-investment basis. Possible jeopardy investments which are closely scrutinized include trading securities on margin, trading in commodities futures, purchases of puts, calls, straddles and warrants and selling short.

If a foundation makes a jeopardy investment, the foundation is subject to an excise tax on the amount invested. In addition, a foundation manager who knowingly participates in a jeopardy investment is subject to an excise tax on the amount of the investment. If the private foundation does not subsequently remove the investment from jeopardy, an additional excise tax on the amount invested is imposed on the foundation. Any foundation manager who knowingly participated in the investment is also subject to an excise tax on the amount of the investment.

Fortunately, there is an exception for property transferred to Lucy's private foundation by gift. Since the Northern Long Shot II stock was given to her private foundation, rather than purchased by the foundation, the jeopardizing investment rules do not apply. Reg. 53.4944-1(a)(2)(ii)(a).

Lucy thought about these rules. After giving the Northern Long Shot II stock to her foundation, it sold the stock tax-free and her private foundation invested the proceeds in a diversified portfolio. Lucy now makes grants from her private foundation's income and growth. She realizes that the private foundation needs to follow prudent investor guidelines and may not have the complete freedom she enjoys with her personal investment portfolio.