Philanthropic Advisory Services
The U.S. Court of Appeals for the 9th Circuitissued an opinion, Warfield v. Alanniz,569 F.3d 1015 (9th Cir 2009), recentlythat classified charitable gift annuities as security instruments. Defendants in the case promised investorsthat their investment would create an annuity with a high rate of return andthat, upon their death, the remainder of their investment would go towards thecharity of their choosing. Sadly, theinvestment scheme was just that, a scheme. The early investors were paid disbursements from the investments oflater investors, the brokers skimmed off the top, and the entire structurecollapsed in on itself. Litigation beganwith the filing of a civil complaint by the SEC and ended with the 9thCircuit’s ruling and a criminal sentence for at least one of the defendants.
While the Warfieldcase dealt specifically with a Ponzi scheme, the court’s reasoning indicates that itsholding applies to legitimate charitable gift annuities and fund advisers as well. The court applied a three-part test todetermine that the gift annuities constituted investment contracts for thepurposes of the Securities Acts. Thetest for what constitutes a “security” requires “(1) an investment of money (2)in a common enterprise (3) with the expectation of profits produced by theefforts of others.” This is the testthat the Supreme Court expounded over 60 years ago in SEC v.W.J. Howey Co., 328 U.S. 293 (1946).
The focus of the 9th Circuit’s analysis falls tothe third prong of the test. Thearguments and analysis boil down to one central question: whether the investorsexpected to make a profit. The courtanswered this question based on the marketing of the ‘charitable’foundation. Specifically, thefoundation “marketed its gift annuities as investments, and not merely asvehicles for philanthropy,” promising returns equivalent to stock investmentsthat pay dividends of 19.3%. Based onthe foregoing, the 9thCircuit found that the charitable gift annuities were investmentcontracts subject to federal securities regulation. The court alsoheld that the Philanthropy Protection Act of 1995 did not apply. ThePhilanthropy Protection Act exempts charitable organizations thatcollect funds for the issuance of charitable gift annuities, from theregistration requirements of the Securities Acts. The court held thatthe fact that the sellers of the gift annuities at issue collectedcommissions on the sales of the annuities precluded the application ofthe Philanthropy Protection Act exemption.
The court’s conclusions are in line with currentcalls for tighter regulation of all investment instruments, (whetherissued by for-profit or nonprofit entities) and of those who create andbroker them
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