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Even Small Foundations Have a Big Responsibility

Whether you employ hundreds or have a staff of just one, foundations must comply with similar financial guidelines.

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Anyone who runs a nonprofit organization should be heartened by the unprecedented generosity of our fellow citizens following the devastating earthquake in Haiti last month. Millions of dollars in donations poured into a multitude of worthy organizations. But with this ramp-up in charitable giving, we also saw increased scrutiny of how the recipients were managing their books. Whether the focus of a nonprofit is disaster relief, landmark preservation, or saving the planet, the careful stewardship of its financial resources is paramount to the success of its goals.

Foundations with limited staff or financial expertise can find this especially daunting. According to the Association of Small Foundations, the vast majority of its members operate with zero or one staffer. A nonprofit's tiny staff and dedicated volunteers may have the talent and resources needed to help a remote village in sub-Saharan Africa create an irrigation system but lack the bandwidth or skills to address tax reporting and investment management. Attracting active and qualified board talent with an adequate understanding of finance can be a challenge, as well. While it's easy to understand why investment management takes a backseat to feeding or clothing the hungry, small foundations are subject to the same compliance requirements as their larger cousins.

Those requirements got tougher when the Uniform Prudent Management of Institutional Funds Act of 2006 replaced the Uniform Management of Institutional Funds Act. New compliance requirements were added for all foundations. In simple terms, the 2006 act requires that an organization's policymakers invest its assets, "in good faith and with the care an ordinarily prudent person in a like position would exercise under similar circumstances." "Prudence" is the key concept here.

Highlights of the act included these tenets: Investment costs should be appropriate and reasonable, economic factors such as inflation or deflation need to be weighed during portfolio design, investment decisions must be appropriate to the institution's portfolio and resources, diversified portfolio construction is the standard unless circumstances dictate otherwise, and incoming assets should be reviewed periodically for conformity with the institution's objectives.

These requirements are easily within the reach of well-staffed organizations like the Pew Charitable Trust or Gates Foundation. However, if a foundation's paid staff is limited to one CEO and its board is not financially savvy, this can be much more difficult to manage. Thus, most small foundations delegate the investment function to a trusted advisor.

Provisions for delegating investment authority to an outside agent or advisor are spelled out clearly: "An institution shall act in good faith, with the care that an ordinarily prudent person in like position would exercise under similar circumstance," when selecting an agent, establishing the terms of that agent's authority, and periodically reviewing his or her performance.

A well-written policy statement also is essential. Such statements often include a mission or objectives, delineate a time frame for spending goals, establish periodic foundation payouts for operating expenses, describe portfolio design criteria and target investment returns, provide proxy voting guidelines if appropriate, and define oversight and monitoring requirements. Taken together, these are the rules by which a foundation's investments are managed.

Once these issues have been addressed, I recommend that foundations consider the ethical ramifications of how they manage their capital. Luther Ragin Jr., one of the pioneers of a socially conscious approach known as "mission-related investing," is said to have asked his board, "Should a private foundation be more than a private investment company that uses some of its excess cash flow for charitable purposes?" Here in the East Bay, we instinctively want to answer, "Yes!" Unfortunately, this leads us to the more complicated question: "What about fiduciary responsibility?"

It takes cold, hard cash to battle global warming or world hunger, which is why the board of a foundation is tasked with the fiduciary responsibility of maximizing investment returns within certain parameters. Foundations don't just need money to support their immediate objectives. They need enough capital to sustain the foundation for years to come. And yet, board members often feel a moral duty to "walk the walk." If a foundation's objectives include protecting the environment, investing in even a highly profitable company with a record of toxic dumping would likely present a conflict.

This debate is currently being waged in many nonprofit circles, but in my experience it doesn't make sense to separate the investment function from an organization's mission. I'm convinced it's both prudent and possible for an organization's investments to incorporate its convictions. You can help folks in Haiti rebuild their lives and construct a "responsible" portfolio with risk and return characteristics that are similar to those of a less-responsible portfolio.

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