Thursday March 28, 2024

3.1.11 Disclosure AT - SEC Exemption

Disclosure AT - SEC Exemption

Philanthropy Protection Act of 1995:   The Philanthropy Protection Act of 1995 is a fairly comprehensive statute.

Specimen AT Disclosure Statement:   While counsel for individual charities should review the exact format of any disclosure statement, it could be possible to use a disclosure statement similar to the following in appropriate circumstances.

Recommended Action Plan:   First, review the securities compliance issues for your organization.

Conclusion:   Reasonable regulation is generally positive for charities.

Philanthropy Protection Act of 1995

The Philanthropy Protection Act of 1995 is a fairly comprehensive statute. It deals specifically with securities regulation issues.

Securities laws are designed to protect consumers. A multitude of organizations and institutions in our society issue securities of many different types. These stocks, bonds, annuities, insurance products and other securities are regulated by federal and state statutes. The basic goals of these laws include a full and fair representation of the value underlying the security, and an explanation of the individuals and entities conducting the business activities represented by the securities.

As a result of the actions of charities in commingling trust assets, there has been greater movement towards securities regulation of charitable trusts and charitable pooled income funds. Commencing in the 1980s, some charities began to combine unitrust principal amounts into common investment funds. Unquestionably, the creation of the larger funds diversified risk and enabled more professional management of the joint funds. While the corpus of each charitable remainder unitrust and annuity trust is treated as a separate investment, it has been the practice of some charities to pool the investment amounts and then distribute the earnings in investments among the trusts. In this sense, the internal common funds are comparable to private mutual funds.

This practice certainly creates the kinds of risks specifically addressed by securities regulation. The common funds represent underlying securities and it is entirely fair and appropriate that there be full disclosure of the invesment risks involved and invesment management practice so that prospective donors understand the nature of the unitrust and annuity trust investments.

The purpose of the Philanthropy Protection Act provisions is to exempt the charitable common funds from the full requirements of the Investment Company Act of 1940, while requiring a level of disclosure appropriate for these common funds. Sec. 2(a) of the Philanthropy Protection Act exempts from Sec. 3(c)(10) of the Investment Company Act of 1940 the pooled income fund, a fund set aside as a reserve for charitable gift annuities, common remainder trust or lead trust funds and other irrevocable charitable trust funds. This means that the charitable funds are no longer "investment companies" for purposes of the act. However, Subsection (e) of the same statute requires that, in exchange for exemption, the funds shall provide "to each donor to such fund, at the time of the donation or within 90 days after the enactment of this sub-section, whichever is later, written information describing the material terms of the operation of such funds."

What then are the requisite "material terms?" First, it is important to understand the circumstances in which the act applies and the circumstances in which it does not apply. It appears that the act does not apply to a bank or trust company (they are subject to other more comprehensive securities regulation) and does not apply to a private trustee, but applies only to charitable trustees. Furthermore, it applies to charitable trustees only when they are pooling or commingling funds from the various trusts. The "collective investment and reinvestment" requirement seems to exclude any charitable trusts maintained by a charity as trustee in which the investments are all separate from the other trusts and funds maintained by that same charity.

In recent years, charitable remainder trusts have been more frequently commingled. If a charity is commingling unitrusts and annuity trusts for investment purposes, there must be full and fair disclosure. However, this disclosure does not need to be a 40-page prospectus.

It is important to comply with both the letter and spirit of securities law. Where the latter is not particularly specific (in this case the "material facts" disclosure is not clearly specified by the statute), then one should attempt to make a full and fair, but reasonable, disclosure. This disclosure should enable the trustor to know the names and business structure of the party or organizations that will be investing the funds, the general nature of the investments, the methods for reporting the investments to the trustors and any other information relating to who is investing and how the investments are made. This information will assist the trustor in understanding the nature, quality and risk of the various investments. While there is no specific mandated form for this information, common sense and good faith efforts to provide this information should be received favorably by the Securities and Exchange Commission.

Specimen AT Disclosure Statement

While counsel for individual charities should review the exact format of any disclosure statement, it could be possible to use a disclosure statement similar to the following in appropriate circumstances. This example of a disclosure statement is offered for educational purposes. This is an area of the law with a wide range of views by attorneys who advise charities. All organizations must have a thorough review by their own corporate counsel.

For a charitable trust the letter should be reasonably extensive, and perhaps would be accompanied by appropriate schedules illustrating investment objectives and types of investments. While the exact form again must necessarily be subject to local determination by counsel, a letter similar to the following could be used:

Dear Miss Jones,

Thank you for creating a charitable trust. We appreciate your generous contribution to our charity.

Your trust will be invested together with other trusts and endowment funds. While our charitable investment fund is exempt from registration under federal securities laws, we do want to share with you the material terms of operation of this fund.

A portion of your trust will be invested in our common fund. We also may place some of our fund with ABC and DEF mutual funds [describe the type of internal and external funds]. The contact person here at our charity is Alice Administrator.

Alice will send you periodic reports on the investments and earnings of the fund [describe the frequency and nature of these reports]. She also is willing to give you additional information on the companies that invest our funds and some of the specific portfolios in those investments.

As is common with most trusts, there will be fees payable for the investment services. Our normal fee structure for a trust is [describe your fee structure]. These fees are withdrawn (from income, principal or partially from both). A portion of the fees covers accounting and management costs within our organization, and the balance is used to compensate our investment advisors [name the advisors].

Attached is a list of the types of securities that are typically held in the portfolio. This list could change as investment conditions dictate, but the goal of our investment advisors is to maintain approximately a similar level of diversification, risk, income and growth to that displayed in this portfolio [describe your investment strategy].

This trust is governed by federal law and the laws of the State of ___________. The trust investment funds are exempt from federal securities laws under the Philanthropy Protection Act of 1995. This explanation of your fund is consistent with the disclosure required by that law. Our actions are designed to secure for you the benefits of this agreement.

You are welcome to take this explanation to your qualified professional advisor. He or she can give you counsel regarding the risks, taxation and distributions from this trust. We offer this information solely for educational purposes and emphasize that we are not giving tax, legal or other professional counsel. For such information, you should contact your qualified professional advisor.

It has been a pleasure to be of service to you. Please feel free to contact us if we can be of any further assistance.

Cordially yours,

Jane Gift Planner

Some counsel of charities will deem letters similar to the above sufficient; some will insist on far more detailed disclosures. The decision as to the nature of this disclosure should reflect consideration of SEC, liability and marketing considerations. While this is uncharted water, it appears probable that reasonable efforts to comply with disclosure requirements will not cause adverse response from the SEC. Most likely, the primary reason for more extensive disclosure will be for liability protection reasons. In coming to an acceptable conclusion between gift planners who typically favor marketing solutions and counsel who desire ironclad liability protection, there should at least be a reasoned understanding of all issues involved.

Recommended Action Plan

First, review the securities compliance issues for your organization. If your charity invests trusts in common investment funds, take appropriate action to modify and expand the above language as deemed appropriate by your legal counsel. This should not be particularly difficult. Some gift planners have been making similar disclosures to donors prior to PPA and it seems highly probable that reasonable, fair and open disclosure by a charity will suffice in the view of the enforcement authorities of the Securities and Exchange Commission.

Second, review the liability issues with counsel. These risks should be carefully evaluated. This federal law gives plaintiffs ammunition that can be used against charities. Liability issues may cause charities to make a more complete disclosure than would otherwise be necessary under the securities laws.

Third, most success in planned giving is a result of marketing. It is essential that your director of marketing has input in making decisions on the securities and liability issues.

Conclusion

Reasonable regulation is generally positive for charities. Disclosure rules have been created for valid reasons. All participants in the field of philanthropy can adjust to these statutes and proceed to serve organizations and donors successfully.

Private Letter Rulings

PLR 200423029 CRTs May Pool Assets in Newly Created LLC for Investment Purposes:   The Humperdink family has ten charitable remainder trusts (CRTs). The Humperdink Family Foundation (Foundation) serves as trustee of each of the CRTs and wants to form a limited liability company (LLC) to coordinate the investments of all the CRTs. Formation of an LLC will allow the CRTs to diversify their portfolios, pool assets to obtain economies of scale, and obtain access to investments with higher minimums. Foundation requests rulings that formation of the LLC, contribution of CRT assets to the LLC and use of the LLC to manage the CRTs assets will not constitute self-dealing.


      Quiz-Basic



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