Foundation members have a fiduciary duty to appropriately manage the foundation's investments. In general, investments that jeopardize a foundation's corpus ("jeopardy investments") are not permitted.

Board members and trustees of charitable organizations are subject to fiduciary duties imposed under state law where the charitable organization is organized and operates. In addition, the Internal Revenue Code imposes particular requirements, restrictions and penalties regarding private foundation's. One important limitation the Internal Revenue Code relates to jeopardy investments designed to prevent foundations from investing assets in risky manner. Accordingly, foundation directors and investment managers must consider specific investment choices carefully and in accordance with the foundation's short- and long-term financial and charitable goals.

IRS Rules

Although the Internal Revenue Code names several specific investments as having the potential to be jeopardy investments and those which will be closely scrutinized — including margin trading, commodity futures, oil and gas interests, buying "puts," "calls," or "straddles", buying warrants, and short-selling — these investments are not prohibited per se. These types of investments, as with all foundation investments, must be considered carefully and employed only when appropriate. Foundation board members must also be able to articulate to the IRS the reasons these investments are appropriate elements in the foundation's portfolio.

Under prudent investor rules, the IRS generally judges jeopardy investments using the "prudent investor" standard. Under this standard, jeopardizing investments are those that show a lack of business care and prudence, under the facts and circumstances prevailing at the time investment is made, in providing for the long- and short-term financial needs of the foundation to carry out its exempt purpose. In keeping with this standard, investments are evaluated on the basis of their role in the portfolio as a whole, and not in terms of the actual loss or gain from each investment. So, it may be permissible for a small portion of a foundation's portfolio to be invested in a higher-risk investment, but it would be problematic if the higher-risk investment makes up a substantial portion of the foundation's portfolio.

Jeopardy investments could result in penalties from the IRS in the form of penalty taxes levied on both the foundation and the individual responsible for the jeopardy investment. Both the foundation and the responsible individual are subject to penalty in the form of an excise tax and have to pay an initial tax at the rate of 10% of the amount of the jeopardy investment, with additional penalties if the investment is not removed from jeopardy within in a timely fashion. Foundation managers are limited to $10,000 in initial penalties on any particular investment, and a maximum of $20,000 per investment. An additional tax of 25% of the investment is imposed on the foundation if the investment is not removed from jeopardy in a timely manner.

Avoiding the Risk of Jeopardy Investments

So, how can your foundation be sure to avoid the risk of making jeopardy investments? Consider taking the following steps:

• Consider delegating management of investment assets to a professional investment manager. Unless the foundation managers or directors individually posses the expertise and time to manage an investment portfolio with care, skill and caution, they have a duty to delegate management of these funds to a professional advisor.
• Make sure everyone with a need to know — both board members and professional advisors — is aware of the investment policy. Then, be sure to monitor the implementation of the policy. Go beyond measuring growth in the portfolio, since success in that respect can sometimes mask other issues.
• Periodically evaluate your professional advisors. At least annually, consider whether your investment advisors are fully implementing your investment policy and if they are sensitive to the specific goals of your foundation.
• Document activities. Keep a record of everything you've done so that you can demonstrate your prudent fiduciary management. A carefully designed investment strategy will help your foundation to comply with IRS regulations and ensure that your foundation is on track to achieve its charitable objectives.

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