A pooled income fund is similar in many respects to a mutual fund. Several donors contribute funds and receive units of participation. The funds are all jointly invested and donors receive their pro-rata share of income.
Since the pooled income fund functions in a manner similar to a mutual fund, it is potentially subject to regulation by the Securities and Exchange Commission.
SEC "No Action" Letter
Before 1980, it was possible for counsel to charities to obtain a "no action" letter from the SEC. In 1980, the SEC determined that it would be preferable to issue a "pooled income funds release" No. 33-6175. This ruling from the SEC exempted pooled income funds from securities regulation. However, the pooled fund was required to be in compliance with Sec. 642(c)(5) and must disclose fully the fund's operation to donors. In addition, the individuals promoting the fund must be employees of the charity and must not be receiving percentage or commission compensation.
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 that are designed to protect the consumer. 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 investment funds. 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, but to require a level of disclosure that is appropriate for these common funds. Sec. 2(a) of the Philanthropy Protection Act exempts 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 from Sec. 3(c)(10) of the Investment Company Act of 1940. 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 fund 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), 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 the charitable trust maintained by a charity as trustee in which the investments are all separate from the other trusts and funds maintained by that same charity.
Pooled income funds are already subject to disclosure requirements. It would seem that the Philanthropy Protection Act does not significantly expand the previously existing disclosure requirements for pooled income funds.
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.
PIF Specimen Disclosure Statement
While the exact format of any disclosure statement should be reviewed by counsel for individual charities, 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 pooled income fund 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 Ms. Jones:
Thank you for creating a pooled income fund. We appreciate your generous contribution to our charity.
Your fund will be added to the pooled income funds of other donors and the total amount will be invested. Each person will receive a proportionate part of fund earnings each year. The fund earnings will change, based on the total return of the pooled fund. 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 the fund.
The investment goal for this fund is income (or growth and income, if applicable). The fund is managed by __________________, under the supervision of our Board of Trustees (or directors). Each year, the fund produces an annual report with the names and backgrounds of the trustees (directors) who are responsible for the management of the fund.
Each donor is assigned a number of "units of participation" in the fund. Our fund is valued four times per year on the first day of January, April, July and October. The payouts are made on a pro rata basis to each person based on their number of units of participation. When funds are contributed to the fund, the distribution for the first year is prorated, based upon the number of days in that year. Your payouts may vary according to trust return, and will be made on the last day of each calendar quarter. At the end of your life (or two lives), the units of participation in your account will then be transferred to our charity as a deferred gift.
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).
As is common with most pooled funds, 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).
The contact person here at our charity is Alice Administrator. Alice will send you periodic reports on the investments and earnings of the fund (described the frequency and nature of these reports). She is also willing to answer any additional questions you may have.
When you make a transfer to the fund, you will be entitled to a charitable income tax deduction for part of your gift. If you transfer appreciated securities to the fund, you will avoid or bypass the gain on those securities. With a one-life pooled income fund, there is no current gift tax, and when you pass away, the value of your fund qualifies for an estate tax deduction. (With a two-life pooled income fund with a successor recipient who is not a spouse of the donor, you may retain a testamentary right to revoke the income stream of the successor recipient. There will be no current gift to that person, but the value of his or her interest when you pass away will be taxable in your estate).
This pooled fund is governed by federal law and the laws of the state of ___________________. We retain the right to amend the pooled income fund agreement only for the purpose of making certain that it qualifies under federal law IRC Sec. 642(c)(5) and the regulations under that section. 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 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 is the person that 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 have been 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. When the decisions are made on the securities and liability issues, it is essential that your director of marketing has input in that process.
Conclusion
Reasonable regulation is generally positive for charities. These 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.
