By Jason Zweig | 11:54 am ET Oct. 3, 2014
Image Credit: Christophe Vorlet
In the government’s bid to crack down on risky trading, charities and other nonprofit organizations may become collateral damage. That is causing alarm in the nonprofit world and should be a concern for donors.
Under new rules, your local charity could be obligated to register with federal regulators as a commodity-pool operator—even if it doesn’t invest directly in corn or pork bellies. CPOs, as they are sometimes called on Wall Street, invest in a range of derivatives contracts, including futures, swaps and options on foreign currencies, commodities and interest rates. That is light years away from the mission of most nonprofits.
Having to register as a CPO with the Commodity Futures Trading Commission would entail higher costs and more red tape. As a result, if you are a donor or board member, you need to ask a whole new set of questions about how the institution’s money is managed.
The registration requirements are imposed by an obscure provision of the Dodd-Frank Act, the 848-page law that was enacted in 2010 to constrain giant financial firms, not charities.
The Dodd-Frank provision doesn’t apply to individual investors. But it can subject a nonprofit to CFTC regulation if the organization oversees money for more than one entity—other nonprofits, certain affiliates or individuals—and invests, even indirectly, in certain financial contracts.
In principle, that could include a local charity in Ypsilanti, say, or a multibillion-dollar endowment.
“There’s a fair amount of consternation and confusion about this,” an investment manager at one of the largest university endowments in the country recently told me. (The nonprofit officials I spoke with declined to be named, citing internal policy or concerns about drawing the attention of regulators.)
“We’re accidental commodity-pool operators,” an executive at another major nonprofit said, explaining that the organization happens to own some stock funds that may occasionally use futures contracts to invest excess cash.
The CFTC feels these concerns are overblown. “We don’t think this will affect large numbers of charities across the country,” says an agency spokesman.
In 1995, the Philanthropy Protection Act exempted nonprofits from registration with the Securities and Exchange Commission. But no such sweeping exemption exists from the CFTC’s commodity regulations. And now Dodd-Frank has tossed many new instruments, like swaps and other derivatives, into the definition of “commodity.”
So industry experts still are worried. “Nonprofits should use their resources to further their charitable objectives and should not be subject to the same costs as if they were running an investment business devoted to commodities,” says Deborah Prutzman, chief executive of the Regulatory Fundamentals Group, a New York firm that assists nonprofits in complying with investment regulation.
Becoming a commodity-pool operator would oblige a charity to comply with complex record-keeping, reporting and licensing requirements. The CFTC hasn’t yet made any charities do so under the Dodd-Frank mandate.
So nonprofits must take extra care not to commingle money management for multiple entities into a single pool and to know exactly what their investment advisers are buying. Stock, bond and other fund managers may sometimes invest in swaps or futures, potentially subjecting a charity to oversight under Dodd-Frank, lawyers say.
“It becomes very hard to know what you can invest in,” says Edwin Laurenson, a partner at the law firm of McDermott Will & Emery in New York. “I have one [nonprofit] client that simply decided to instruct any investment managers that it hires that they can’t invest in commodity interests in any form.”
That doesn’t just mean crude oil, foreign-currency contracts and the like. It could also means exchange-traded funds, since these popular portfolios that track indexes typically reserve the right to invest, at least occasionally, in futures or swaps.
All else being equal, ruling out ETFs, with their low annual costs, makes investing more expensive.
“The CFTC needs to consider whether it may inadvertently be in the process of subjecting a large part of the nonprofit community to its jurisdiction,” says Ms. Prutzman of the Regulatory Fundamentals Group. “Imposing full-scale financial-services regulation on charities will impede their ability to serve the public.”
In a letter earlier this year providing guidance to a group of churches in Texas, the staff of the CFTC said that it wouldn’t require them to register as a commodity-pool operator so long as members of the churches didn’t invest their own money (beyond donations) alongside the assets of the religious organizations and the churches weren’t soliciting new funds for the specific purpose of investing in commodities.
A senior CFTC official says the agency is working on clarifying the rules for university endowments and is open to addressing the concerns of other nonprofits down the road.
So if you sit on the board or the investment committee of a nonprofit, make sure donors aren’t permitted to invest their money for personal benefit alongside the charity’s assets.
You also should scour the prospectuses of all holdings to determine whether the managers use swaps, futures or other derivatives. Ask the nonprofit’s attorney whether that could require the charity to register with the CFTC; if he or she doesn’t know, write the agency and ask. A rash of inquiries from the public might help the CFTC clear up these questions once and for all.
Source: The Wall Street Journal