Time for a new foundation for philanthropy

Buzz Schmidt

Philanthropic institutions and accountability – two big notions whose paths seldom cross. Whose presence in the same sentence evokes sidewise looks from lawyers and financial advisers, snickers from savvy leaders of operating charities, and anxiety from foundation CEOs who thought they had achieved their dream jobs – ones without an external reporting requirement. I believe the combination will remain a near impossibility so long as philanthropic institutions operate within the current structure of philanthropic law and ‘best practice’, especially the presumption of perpetuity. This article offers interim remedies and suggests some longer-term prescriptions for fundamental change.

By philanthropic institutions (PIs) I mean the tens of thousands of private foundations, donor advised funds (DAFs), charitable trusts, endowed supporting organizations and large endowments of operating charities. PIs of these types are found and/or their formation contemplated throughout the world.

PIs are tax-privileged grantmaking institutions; they are controlled effectively by the original donors or their nominees; their policies presume an indefinite or perpetual life; they require no external source of funding or approval; they pay costly fees to investment, legal and accounting professionals; and they have no obligation to report to anyone about their operating strategies, achievements and failures or to justify their indefinite warehousing of ‘society’s capital’ in the face of acute immediate need. In virtually all cases, their leaders are rewarded in accordance with the growth of the PI’s financial assets, not with effective pursuit of its charitable purpose.

‘No external fiduciary forces – no constituents, investors, customers or regulators – care about the performance of PIs, how effectively their capital is deployed, how they interact with grantees, or the ‘wasting’ value of their warehoused capital.’

Our failure to recognize the essential identity of these different types of organization hinders attempts to promote consistent policies. Singling out one distracts attention from the obscure and unaccountable practices of others. True PI accountability will exist only if these institutions face sustained fiduciary scrutiny from external parties with real powers to reward or honour exemplars, challenge laggards and penalize transgressors. This just isn’t the case today, in the US or elsewhere. No external fiduciary forces – no constituents, investors, customers or regulators – care about the performance of PIs, how effectively their capital is deployed, how they interact with grantees, or the ‘wasting’ value of their warehoused capital.

Should 'pursuit of perpetuity' be the driving maxim?

Should ‘pursuit of perpetuity’ be the driving maxim?

 

Why greater accountability matters
On the other hand, an army of tax lawyers, accountants, financial advisers, investment managers and PI executives, all benefiting from perpetuation of the status quo, do care. They have filled the accountability vacuum with a canon of best practice that flows from one maxim: pursue a programme of professional investment management that assures each endowment’s inflation-adjusted current value perpetually. They have positioned themselves and their firms to ‘earn’ significant fees perpetually. In this and other respects, we are left without accountable or effective PIs and, as a direct consequence, with a far less than optimal social sector. Where there is no adequate external scrutiny for PIs, the social sector’s ‘institutional investor’, charities themselves are left without adequate external scrutiny.

A long-term solution will require wholesale changes in the rules, policies and government oversight of PIs. Securing such changes will not be easy. In the US, the army of professionals has already stymied simple measures to establish greater accountability, such as modestly increased annual foundation payout thresholds (currently 5 per cent of the market value of the foundation’s endowment in the US) or elimination of foundation operating expenses in the calculation of payout. Major structural changes must await a higher level of public, expert, trustee and practitioner appreciation of these issues.

What can we do in the short term?
In the meantime, I propose a list of ambitious but nonetheless doable incremental adjustments that could make a real difference to PI accountability.

Fund government oversight Active, confident regulators are essential in any interim as well as ultimate strategy for accountability. This could be funded from a tax on foundations themselves. In the US, for example, the IRS has been collecting excise taxes from foundations since 1968 for this purpose. It is time the IRS put those funds to use.

Promote an alternative canon of PI best fiscal practice for tax lawyers, accountants and financial advisers The various experts who advise anyone forming a PI invariably resort to standard forms that tend to promote (even stipulate) perpetual life, minimum charitable disbursements, tax efficiency to the extent allowable, ‘client’ privacy, and long-term professional relationships to ensure ongoing compliance with the law and best practice.

In other words, they give advice that satisfies the tax law in whatever jurisdiction they operate and the long-term financial interests of the advisers and their firms, but which runs counter to the public interest. We need an alternative canon that promotes operating effectiveness, efficient administration, maximization of the societal value of each PI’s capital over time, and faithful accountability regardless of the PI’s expected life.

Convince the chroniclers of philanthropy to stop conflating gifts to PIs and gifts to charity in their annual lists of the most generous donors Gifts to PIs that continue under the control of donors and their families indefinitely are not the same as gifts to operating charities. Only gifts to operating charitable entities should be considered as gifts to charity.

Require annual reporting for each donor advised fund (DAF) DAFs allow the merely well-off to engage in institutional philanthropy akin to that of the truly wealthy. This is not a bad thing, and while still a largely American phenomenon, DAFs’ popular appeal makes it likely they will emerge increasingly in Europe and elsewhere. In order to make them as ‘accountable’ as private foundations, we should require public reporting by each DAF.

One of the efficiencies of the DAF form is that hundreds, even thousands, of them can be managed simultaneously within a community foundation or specialized ‘charity’ established for that purpose. Currently, these management entities are required to report on DAFs only in the aggregate. As a consequence, the policies of the individual DAFs are impenetrable, despite variations in the size of DAF corpuses from less than $10,000 to more than $1 billion and in their percentage annual payouts from 0 to 100 per cent. Individual reporting will make the practices of this rapidly growing form of PI better known and reveal implications for policy.

It would also be tempting to establish a minimum percentage annual grants payout for each DAF at the same level as that for private foundations. However, I fear doing so would reinforce a perverse potential downside whereby a minimum payout could become the ‘target’ payout, or an effective maximum, as it has for private foundations, all the while giving reformers the false sense of satisfaction that their accountability job was done. A long-term strategy that would establish limited lives for new PIs is proposed below.  This would eliminate reliance on perversely unproductive annual payout requirements for those PIs.

Educate donors and trustees Given the difficulties of establishing new mandatory rules for reporting and performance, strategies to improve the quality of oversight by donors and trustees will necessarily form a critical piece of the interim puzzle. New off-site services to train trustees away from the eye of foundation professionals and traditional ‘best practitioners’ could prove invaluable.

Require and evaluate annual trustee reports One relatively simple but potentially significant strategy would be to require each PI to submit an annual trustee report, akin to that required by the Charity Commission of England and Wales. These would report the PI’s accomplishments, operating efficiencies, risks, and progress towards meeting long-term objectives and be endorsed formally by each trustee. An independent private body might assess trustee reports for quality and completeness, perhaps honouring the best and ‘calling out’ those that are deficient. 

‘To begin with, we should remove “pursuit of perpetuity” as the driving maxim, substituting: pursue policies, grantmaking and investments that maximize the value of each PI’s capital for society.’

And in the long term?
Alongside these interim strategies, we must begin the larger conversation about the structures, practices and reporting needed from institutional philanthropy in 21st century society. To begin with, we should remove ‘pursuit of perpetuity’ as the driving maxim, substituting: pursue policies, grantmaking and investments that maximize the value of each PI’s capital for society.
So armed, we might expect a wholesale revision of the structure of philanthropy to:

  • Recognize the identity of function of different types of PI with a single set of operating and reporting rules
  • Require a stipulation of PI operating lifespan and statement of grantmaking objectives to accompany any initial application for tax exemption.
  • Establish new maximum size thresholds for public charity endowments, related to operating budget and possibly subject area. New gifts to endowments that exceed such thresholds would therefore not be deductible.
  • Add to annual trustee reports a statement of progress in deploying funds against the PI’s stipulated operating lifespan. This would help to ensure that funds are deployed quickly enough to achieve spend-out within the stipulated time.

The public has the right and obligation to require that PIs report regularly about their policies, strategies, grantmaking performance and investments. After all, we grant tax privileges to these institutions. They are the social sector’s institutional investors and must perform well for the health of society. Existing structures and practices have combined to curtail PI accountability. Sadly, the donors and trustees of PIs themselves are unconscious abettors of this casual attitude, deferring to best practice promoted by the experts who create perpetual, unaccountable institutions, and seldom contemplating how and over what period of time they might most effectively deploy their capital. 

‘The public has the right and obligation to require that PIs report regularly about their policies, strategies, grantmaking performance and investments.’

There is no time to waste in pursuing a programme for change. With increasing numbers of great fortunes finding their way across generations, a large population of new donors is making decisions that could result in thousands more permanent and unaccountable PIs. If we wait, we will miss an immense opportunity to create the sort of institutional philanthropy that suits our needs both now and in future.

1 Public charity endowments differ from other PIs only in making gifts exclusively to a pre-named charity. Supporting organizations range from entities that operate as independent charities to grantmaking entities that use the broad charitable purposes of host community foundations to function as de facto private foundations. For the purposes of this article, I also consider the latter variety to be PIs.

Buzz Schmidt is chair of the F B Heron Foundation. Email buzzschmidt@gmail.com

Comment

Rob Reich
Lacking electoral and marketplace accountability, and lacking transparency about their operation, philanthropic institutions (PIs) are free to follow donors’ preferences, potentially in perpetuity, largely shielded from public scrutiny. Buzz Schmidt offers a passionate call to create new forms of accountability for the thousands of PIs that possess, collectively, more than $1 trillion in assets and play a consequential role in the lives of nearly all citizens in the US and Europe.

54 Rob Reich

Rob Reich

He is absolutely right that PIs lack any meaningful form of accountability, and I’m especially agreed that perpetual existence for PIs is bad policy. So count me overall as a champion for his proposals. I think his proposed accountability measures would be improved, however, with a more accurate understanding of just how PIs are unaccountable and of what kinds of virtues might flow from relative unaccountability.

I’m in favour of every short-term recommendation Schmidt makes. But these are relatively weak measures. Even if they were adopted wholesale, PIs would still be far less accountable than public agencies or commercial firms.

Schmidt’s long-term recommendations are the most interesting and contentious. Schmidt aims to develop accountability measures that will maximize the value of each PI’s capital for society. I’m dubious about the language of maximization.  I believe there are multiple potential values at stake in the deployment of philanthropic assets, so at best we should talk about optimization. That aside, I don’t agree that shorter rather than longer PI lifespans are better, nor that a cap on size is necessarily a good thing. What makes PIs valuable to society is what I have called elsewhere their potential to serve as a ‘discovery mechanism’ for social policy innovations.[1] PIs have a structural advantage, as a result of their relative lack of accountability, over market and state institutions in undertaking such work: a longer time horizon. Foundations can ‘go long’, invest in uncertain experiments, and present the most successful of them to democratic publics for approval and take-up into the state sector. If PIs are to do such work, we need to limit the gargantuan number of small rather than large PIs, and to give these PIs a time horizon for funding that is long, though not perpetual.

Schmidt has initiated an important conversation about PI reform, and I stand behind his call for greater accountability. When we focus not on maximizing the value of PIs to society  but on how they can best contribute to democratic flourishing, we gain a better understanding, I believe, of what kind of accountability mechanisms are most important. As is true with lifetime tenure for judges and professors, relative unaccountability is not always a bad thing. In advancing new accountability measures for PIs, we must be sensitive to the benefits that can potentially flow from low accountability. What we need most is to improve the performance of PIs in their distinctive contribution to democratic life.

Rob Reich is professor of political science, faculty co-director, Stanford Center on Philanthropy and Civil Society. Email reich@stanford.edu


Footnotes

  1. ^ Rob Reich (2013) ‘What are Foundations For?’ Boston Review.

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