Philanthropic Advisory Services

The U.S. Court of Appeals for the 9^th Circuit issued an opinion, Warfield v. Alanniz, 569 F.3d 1015 (9th Cir 2009),  recently that classified charitable gift annuities as security instruments.  Defendants in the case promised investors that their investment would create an annuity with a high rate of return and that, upon their death, the remainder of their investment would go towards the charity of their choosing.  Sadly, the investment scheme was just that, a scheme.  The early investors were paid disbursements from the investments of later investors, the brokers skimmed off the top, and the entire structure collapsed in on itself.  Litigation began with the filing of a civil complaint by the SEC and ended with the 9^th Circuit’s ruling and a criminal sentence for at least one of the defendants.

While the Warfield case dealt specifically with a Ponzi scheme, the court's reasoning indicates that its holding applies to legitimate charitable gift annuities and fund advisers as well.  The court applied a three-part test to determine that the gift annuities constituted investment contracts for the purposes of the Securities Acts.  The test for what constitutes a “security” requires “(1) an investment of money (2) in a common enterprise (3) with the expectation of profits produced by the efforts of others.”  This is the test that the Supreme Court expounded over 60 years ago in SEC v. W.J. Howey Co., 328 U.S. 293 (1946).

The focus of the 9^th Circuit’s analysis falls to the third prong of the test.  The arguments and analysis boil down to one central question: whether the investors expected to make a profit.  The court answered this question based on the marketing of the ‘charitable’ foundation.   Specifically, the foundation “marketed its gift annuities as investments, and not merely as vehicles for philanthropy,” promising returns equivalent to stock investments that pay dividends of 19.3%.  Based on the foregoing, the 9^th Circuit found that the charitable gift annuities were investment contracts subject to federal securities regulation.  The court also held that the Philanthropy Protection Act of 1995 did not apply.  The Philanthropy Protection Act exempts charitable organizations that collect funds for the issuance of charitable gift annuities, from the registration requirements of the Securities Acts.  The court held that the fact that the sellers of the gift annuities at issue collected commissions on the sales of the annuities precluded the application of the Philanthropy Protection Act exemption.

The court's conclusions are in line with current calls for tighter regulation of all investment instruments, (whether issued by for-profit or nonprofit entities) and of those who create and broker them

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