4. Guard against jeopardizing investments. The Madoff scandal’s devastating effect on many leading private foundations offers a clear example of imprudent investment practices that the IRS might consider “jeopardizing investments,” says Briskin. “It’s the fiduciary responsibility of a foundation’s board to scrutinize the facts behind reported results, particularly when all assets are being managed by a single advisor,” he notes. “Boards should be measuring an advisor against tightly defined investment policies and asset allocation processes geared toward generating specific total return targets (such as the CPI plus 5 percent) at targeted risk levels.”

Note, however, that the IRS’ definition of jeopardizing investments – investments that show a lack of reasonable business care and prudence in providing for the long- and short-term financial needs of the foundation – is vague and open to interpretation. For example, although the agency views a foundation manager trading on margin or short-selling as problematic, it does not address whether the same standards apply to outside investment advisors or asset managers hired by private foundations to execute these strategies.

“If a foundation suffers losses due to jeopardy investments, both the foundation and its asset manager may have to pay a 10 percent tax on the cost basis (original purchase price) of the jeopardy investments and a penalty up to $10,000 on individual asset managers,” Briskin explains. “An additional 25 percent penalty on the cost basis of the jeopardy investments and up to $20,000 per manager may be levied if the foundation fails to liquidate the jeopardy investments.”