February 2013 - socentlaw

REPEAL IRC § 4944 TO ENCOURAGE INVESTMENT IN SOCIAL ENTERPRISE

A while ago, I posted to this blog a short (mildly humorous???) story illustrating how certain federal income tax rules generally prohibit “risky” investments by private foundations, even when those investments have potential for tremendous social or environmental benefit. The so-called “jeopardizing investment” rules of IRC § 4944 impose a minimum 10% (with a possible 25% additional) tax on investments by private foundations that “jeopardize the carrying out of [the foundation’s] exempt purpose.”

In my prior post, I hypothesized a private foundation considering an early-stage investment in a company developing an inexpensive, solar-powered car. I further hypothesized that the private foundation’s manager reasonably and rationally believed that an investment in the car company could have substantial environmental benefits. Further, the investment was on fair terms and involved no self-dealing or other economic benefit to the private foundation’s insiders. Unless the purchase of stock in the car company qualified under the narrow program-related investment exception, however, the investing private foundation could be subject to a 10% (and possible additional 25%) penalty tax under IRC § 4944. Moreover, the investment in the solar-powered car company could be penalized even though an outright grant by the private foundation to benefit environmental causes clearly would be permissible (and even encouraged).

Thus, from a tax standpoint, a private foundation manager seeking to support environmental causes is better off investing in BP and then giving away returns to Green Peace than making a “risky” investment in a solar-powered car company—even when that investment might have a much larger and more lasting positive impact on the environment. This makes no sense.

Actually, the most compelling illustration I can provide as to why the “jeopardizing investment” rules of IRC § 4944 ultimately make no sense comes directly from the implementing Regulations. Specifically, Reg. § 53.4944-1(c) provides:

A is a foundation manager of B, a private foundation with assets of $100,000. A approves the following three investments by B after taking into account with respect to each of them B’s portfolio as a whole: (1) An investment of $5,000 in the common stock of corporation X; (2) an investment of $10,000 in the common stock of corporation Y; and (3) an investment of $8,000 in the common stock of corporation Z. Corporation X has been in business a considerable time, its record of earnings is good, and there is no reason to anticipate a diminution of its earnings. [Imagine BP.] Corporation Y has a promising product, has had earnings in some years and substantial losses in others, has never paid a dividend, and is widely reported in investment advisory services as seriously undercapitalized. Corporation Z has been in business a short period of time and manufactures a product that is new, is not sold by others, and must compete with a well-established alternative product that serves the same purpose. Z’s stock is classified as a high-risk investment by most investment advisory services with the possibility of substantial long-term appreciation but with little prospect of a current return. [Imagine Y or Z as our solar-powered car company.] A has studied the records of the three corporations and knows the foregoing facts. In each case the price per share of common stock purchased by B is favorable to B. Under the standards of [IRC § 4944], the investment of $10,000 in the common stock of Y and the investment of $8,000 in the common stock of Z may be classified as jeopardizing investments (emphasis added), while the investment of $5,000 in the common stock of X will not be so classified. B would then be liable for an initial tax of [$1,000 (i.e., 10 percent of $10,000)] for each year (or part thereof) in the taxable period for the investment in Y, and an initial tax of [$800 (i.e., 10 percent of $8,000)] for each year (or part thereof) in the taxable period for the investment in Z. Further, since A had actual knowledge that the investments in the common stock of Y and Z were jeopardizing investments, A [the foundation manager] would then be liable [personally] for the same amount of initial taxes as B.

WHAT??? So the investment in Y is “promising” and at a “favorable” price, but still subject to a penalty tax? The investment in Z has “the possibility of substantial long-term appreciation” and is at a “favorable” price, but likewise is prohibited? Er, okay, let me get out my crystal ball and discern between a “promising” or “substantial long-term” investment and a “jeopardizing” one. Suppose that in the above example X corporation represented Enron instead of BP? In hindsight, an investment in Enron would have been the ultimate jeopardizing investment, but it would have been perfectly fine under IRC § 4944. Oh, and that’s not all! Incredibly, if Y’s “promising” product (e.g., an inexpensive, solar-powered car) would benefit the environment, then even if the investing private foundation’s mission was protecting the environment it could be penalized under IRC § 4944 for buying stock in the company.

The federal income tax rules thus support a bizarre paradox for private foundations: a foundation can give its money away to an organization supporting the foundation’s mission, but if it makes a risky but “promising” investment in support of its mission, the foundation faces the threat of penalty taxes.

If a private foundation is not engaged in self-dealing or otherwise benefitting its managers and other insiders, why do we care how its money is invested? The rules presume that a “risky” investment is a waste. But for whom is a “risky” investment a waste? Where does the “risky” money go? Does it just vaporize into thin air? No, it goes to pay third-parties for services, or products, or ideas, or research, or whatever. From my perspective, nothing would be better than the Gates Foundation spending its billions on risky, unproven, but promising investments potentially benefitting the environment, education, and healthcare. Can you imagine the jobs that would be created? Can you imagine the innovations that might result? At worst, the money spent goes to work in the broader economy rather than being stockpiled. Who says such risky expenditures are “jeopardizing investments”? The only real jeopardy is to social enterprise companies that could use the money to take reasonable and rationale risks for the benefit of us all.

We need to fix this.  Let’s repeal IRC § 4944.

MORE ON INTEREST CONVERGENCE: CONSERVATIVE & LIBERAL SUPPORT OF SOCIAL ENTERPRISE

I am continuing my research on interest convergence as a reason why the social enterprise movement has been successful (or at least recently gained momentum). This time I am looking at interest convergence from an ideological standpoint. Another brilliant aspect of social enterprise is that its goals do not fall neatly into conservative or liberal ideology. Consider, for example, (i) that the benefit corporation statutes adopted in twelve states and the District of Columbia generally have been passed with overwhelmingly bipartisan support, (2) social enterprises have been founded by conservative and liberal entrepreneurs alike, and (3) social enterprise missions are often couched in both conservative and liberal language (e.g., typically-conservative anti-government, anti-poverty language of “self-sufficiency” but also typically-liberal language of “doing good” and “giving back”.) Although the benefit corporation is not synonymous with social enterprise, it can be taken as a proxy—and the benefit corporation concept has widespread bipartisan appeal. The ends are attractive to liberals; conservatives like the means. Generically, liberals want the problems to be solved; conservatives want the problems solved without government and with some modicum of self-sufficiency and sustainability.

This leads me to ponder if social and environmental impact measurements also incorporate the normative values of both conservatives and liberals. Certainly, some of the typical slogans are similar. Is “Made in America” (which often makes me wary) the same as “Buy Local” (which sounds so much more pleasant and quaint)? When we talk about sustainability, what definitions of community are being employed? Is it the local community, national community, or global community? Are we talking about “us vs. them” (where “them” typically denotes Chinese laborers who are “stealing” American jobs)? Similarly, on an academic panel on social enterprise last fall, I asked a representative from an organization that sets social and environmental impact measurement standards whether or not Chick-fil-A, the infamous, privately-held fast food restaurant which claims to pay competitive wages, provides employee health and retirement benefits, prizes its environmental stewardship (which includes recycling, energy and water conservation, a sustainable supply chain, and a LEED-certified “test” restaurant) but contributes a portion of its profits to a family foundation that funds anti-same-sex marriage initiatives, can be considered a social enterprise. The response was “no.”

I have never been one to defend a company like Chick-fil-a (ever). And I am in no way defending Chick-fil-a right now (really, please take me at my word). But I am still puzzling about the distinguishing feature of social enterprise – what is the core of social enterprise? In my most recent article, I present various business models of social enterprise, including a philanthropy-based business model through which companies donate profits to foundations to do good (like TOMS Shoes or any other Buy-One-Give-One business, which I generally am not a fan of). What Chick-fil-a donates to its conservative, anti-gay family foundation may fit into this philanthropy-based business model. Perhaps what a company does with its profits (i.e., revenue minus cost) is just philanthropy, comparative to a shareholder who has received dividends off the profits of a company and then goes and donates to Goodwill. But the things that Chick-fil-a does with its core business—the employee benefits, the environmental stewardship, etc.—maybe that is a truer measure or defining characteristic of a social enterprise.

Stay with me here. Let’s forget that Chick-fil-A funds a conservative, anti-gay family foundation. Some might say that such donations are not the core of Chick-fil-A’s chicken-selling business. Instead, let’s think about Chick-fil-A’s closure on Sundays. That is, it is Chick-fil-A’s corporate policy to close on Sunday and this is for religious reasons. According to the owners, Sunday is supposed to be a day of rest. This policy can probably go in the category of “conservative values.” Nonetheless, the policy may align with liberal sympathies for employees—employees shouldn’t be overworked and should be given time off to spend with their families. For example, there is always liberal outcry against Walmart and other big box stores that stay open on Thanksgiving or Christmas day. My question is—is Chick-fil-A’s policy of closing on Sundays a “plus” on the social and environmental measurements scale? Does it matter that the policy is in place for religious reasons? What are the normative values incorporated into social and environmental measurements? Do they have room for conservative values? Or do they have room for conservative values only to the extent that the end result of those values converge with liberal sympathies?

(Note: I have to thank Haskell Murray for initiating some of this conversation over at The Conglomerate blog in August: http://www.theconglomerate.org/2012/08/chick-fil-a-as-a-social-enterprise.html).

 

MIT OFFERS FREE ECONOMICS COURSE ON THE CHALLENGES OF GLOBAL POVERTY

Massachusetts Institute of Technology (“MIT”) and edX are offering a free online economic course focused on the challenges of global poverty.  The course starts this week and those who complete the course, which ends May 24, 2013, will receive a certificate.  The course is available here: https://www.edx.org/courses/MITx/14.73x/2013_Spring/about

The course description is:

“This is a course for those who are interested in the challenge posed by massive and persistent world poverty, and are hopeful that economists might have something useful to say about this challenge. The questions we will take up include: Is extreme poverty a thing of the past? What is economic life like when living under a dollar per day? Are the poor always hungry? How do we make schools work for poor citizens? How do we deal with the disease burden? Is microfinance invaluable or overrated? Without property rights, is life destined to be “nasty, brutish and short”? Should we leave economic development to the market? Should we leave economic development to non-governmental organizations (NGOs)? Does foreign aid help or hinder? Where is the best place to intervene? And many others. At the end of this course, you should have a good sense of the key questions asked by scholars interested in poverty today, and hopefully a few answers as well.”

The course is taught by MIT economics professors Abhijit Vinayak Banerjee and Esther Duflo.

I am about halfway through the first week’s material and am enjoying it.

 

REPRESENTING SOCIAL ENTERPRISE IN A LAW SCHOOL CLINIC

I have been working on a new article about the pedagogical value to law students of representing social enterprise clients through experiential law courses. Although the primary audience for the article is academics, including corporate and clinical law professors, I hope that the article will be helpful to other lawyers as well. In that respect, the article includes a robust 10-page(!) description of various models of social enterprise as well as a discussion of the corporate legal theories that either facilitate or reject the shareholder wealth maximization norm.

Here’s the abstract and link:

Careful consideration and selection of clients facilitate the pedagogical objectives of a clinical law program or other experiential learning course. This article explores the selection of social enterprises—i.e., nonprofit and for-profit organizations whose managers strategically and purposefully work to create social, environmental, and economic value or achieve a social good through the use of business techniques—as clients of two experiential learning courses at Georgetown University Law Center. Representation of social enterprises helps create a dynamic curriculum through which law students learn to merge legal theory and practice. Through service to social enterprises, law students (i) learn about sustainable business models and mechanisms at a time when the corporate sector has increased its response to sustainability challenges; (ii) examine corporate legal theory that undermines social enterprise initiatives with an eye towards advocating for more favorable law and policy; and (iii) assist in advancing the social enterprise sector through knowledge creation and information facilitation. Legal issues unique to social enterprises compel students to learn about and reflect on corporate law in a novel manner not typically present in the non-experiential classroom.  [Article available here: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2214954]

 

NYU LAW FELLOWSHIP IN ENTREPRENEURSHIP, SOCIAL ENTREPRENEURSHIP, AND INNOVATION

NYU Law is seeking a research fellow in entrepreneurship, social entrepreneurship, and innovation. Having gotten to know the last two fellows, I highly recommend this program. Application deadline is February 28, 2013. Info here: http://www.law.nyu.edu/leadershipprogram/socialenterprise/index.htm.