October 31, 2010

Opinion: Immortality for Foundations Can Pose Big Challenges in Shifting Times

Henry Ford

The names Ford, MacArthur, Mellon, and Pew—as well as many others—are all well known because these are the names of benefactors of some of America’s largest private foundations. Such philanthropic foundations seem to offer that elusive immortality that human life lacks. It is no wonder that so many wealthy people are drawn to the idea of creating foundations that will give money away forever.

However comforting and inspirational this idea of establishing perpetual beacons of a donor’s charitable vision might be, it is also false. Because regardless of what donors and others believe about the permanence of charitable creations, it turns out that the charitable world is just like the larger world. And that means that the only constant is change.

Just looking at the short history of private foundations in the United States, at least three types of change have occurred:

Alterations in the legal treatment of charitable entities. Foundations are so ubiquitous that it is hard to believe that for most of the 19th century in many states, individuals were not allowed to establish them. If someone wanted to make a charitable gift, he was limited to making an outright transfer of property to a recognized charitable organization. Courts were generally suspicious of allowing, in the words of one opinion, “every private citizen the right to create a perpetuity for such purposes as to him seem good.”

In one notorious case, a New York court set aside a $4-million bequest by Samuel Tilden to establish a trust to finance public libraries and instead gave the money to Mr. Tilden’s heirs.

Today—a little more than a century later—the pendulum has swung the other way, and charitable trusts are not only allowed for a wide variety of purposes but are also favored by the tax code—thereby subsidizing each person’s ability to create a perpetuity for whatever purpose seems good. While some might have been disappointed by Leona Helmsley’s decision to direct her billions of dollars to the care of dogs, nobody challenged whether it was her right to do so or suggested that taxes should have been paid on the money she left her foundation.

Although today the law favors perpetual charitable entities, that could easily change. Already some public-policy experts have proposed requiring foundations to give more away annually. In addition, as federal, state, and local governments face budget challenges, it seems more likely that charitable entities will receive less generous tax benefits.

Shifting notions of what the word “charitable” means. In 1865 the Massachusetts Supreme Court ruled that a bequest to trustees (two of whom were Susan B. Anthony and Lucy Stone) to secure women the right to vote was not a charitable trust because its purpose could not be accomplished without changing laws. Just about 100 years later, another court ruled that a trust to help further passage of the proposed Equal Rights Amendment did have a charitable purpose.

Sometimes these changes have radically altered the way we think about a donor. When Sen. Augustus Bacon wrote his will in 1911, he gave a large tract of land to the city of Macon, Ga., to establish a park to be named Baconsfield in memory of his sons for “the sole, perpetual and unending use, benefit and enjoyment of white women, white girls, white boys, and white children.”

At the time, a racially segregated park in Macon, Ga., was hardly worth notice. However, less than 50 years later, public values had changed drastically, and what had seemed unremarkable in Senator Bacon’s time became socially and legally unacceptable.

The case was considered by the highest state and federal courts, which ultimately decided that Senator Bacon was more interested in his bigotry than he was in his charitable bequest, and as a result the park was given to his heirs who sold it to developers. Today, Baconsfield is an office park, and millions of law students remember Senator Bacon not as a philanthropist but as a racist.

Changes brought about by circumstances. All charitable plans are necessarily products of the mores of their times, and as times change, the charities often have to change with them.

The trust set up by the father of the American chocolate bar, Milton Hershey and his wife, Catherine, to create an orphanage for poor white male orphans is a good example of just how quickly these changes can occur.

Shortly after the Hershey Trust was established, problems began to arise. First, orphanages were no longer the preferred way to deal with the problem of parentless children, and racial and gender restrictions were no longer socially acceptable.

Those issues could be solved by a tradition called cy pres—the doctrine that allows small modifications to charitable trusts to fulfill the donor’s larger charitable intent. In the Hershey case, the purpose of the trust was changed from an orphanage to a residential school and the race and gender restrictions abolished.

However, another problem could not be so easily solved. The trust was originally financed with Hershey stock valued at $60-million—already a large amount. But by 2008 this trust had grown to more than $8-billion.

The school has had a hard time spending all of the trust income on a residential institution for a limited number of students. By 1999 the trust had built up a reserve of more than $850-million.

The Hershey Trust made a request to the court to devote $75-million to create an institute to train teachers to educate needy children. However, alumni of the school objected, and the court rejected the petition and said, “Our discretion is not unfettered and if exercised must be within the limits approximating the dominant intent of Hershey.”

While the trust assets today are still worth more than $7-billion, the school has no plans to grow larger than 2,000 students.

It is hard to imagine that if Milton Hershey—from all accounts, a smart businessman who was interested in using his wealth to help poor children—could have seen the future that he would have been happy to see the limited way in which his vast wealth was being used.

While it is tempting to think that the Hershey Trust case is anomalous, in fact, the problems of perpetual private charitable trusts over time have been fairly common.

For trusts that are too small to have their own boards, there is the problem of orphan trusts. Those are charitable trusts in which the donor and family members are no longer involved and a financial institution is the sole trustee. In 2007 The New York Times published an exposé of how these trustees often use the assets in these orphan trusts to fulfill their own charitable goals rather than those of the donor.

Charitable trusts that are very large are subject to another set of potential problems. The Bishop Trust in Hawaii is just one of several examples in which large charitable trusts have been subject to fraud and corruption. Trustees were paying themselves annual salaries of nearly $1-million each, and the situation got so bad that the Internal Revenue Service threatened to revoke their tax-exempt status if they didn’t replace all the trustees. More recently, the trustees of the Hershey Trust have been subject to investigation for using trust assets to purchase a golf club at three times its assessed value, which happened to benefit at least one of the trustees.

Even where there is no clear malfeasance, valuable resources naturally attract attention.

Although Albert Barnes did all he could to keep his vision for his art to remain at his home in Merion, Pa., it is not surprising that the value of the art—both financially and historically—resulted in the assets eventually being transferred to a downtown Philadelphia location.

There is also the issue of mission drift. Over time, many charitable organizations move from the original vision of their founders.

Even poor Leona Helmsley has ultimately not had her wish fulfilled as the trustees of her trust have bowed to public pressure and rather than giving money to dogs, have devoted the majority of her foundation’s grants to causes arguably covered by the more general language in her trust.

Is it any wonder that some of our most experienced businesspeople have made conscious efforts to limit the terms of their charitable endeavors?

Warren Buffett, Charles Feeney, Bill Gates, and John Olin have all moved away from charitable giving in perpetuity infavor of models that are designed to produce greater good today.

As a society, we need to rethink whether we want to perpetuate this myth of eternity.

Perhaps it is time that we abandon the idea that foundations can live forever and require them to spend all their assets within a certain time after their founder’s death.

In the meantime, donors and their estate planners should think seriously before adopting perpetual life. If 50 years after death is good enough for Warren Buffett and Bill Gates, perhaps it can work for the rest of us as well.

Ray D. Madoff is a professor at Boston College Law School and author of Immortality and the Law: The Rising Power of the American Dead.