Philanthropy is one of the most important, but least understood, features of our market economy.  America has more than 87,000 private foundations that collectively control $798 billion in assets and make close to $55 billion in grants each year.  Foundations are the result of the grand public policy bargain that makes institutionalized philanthropy possible: wealthy donors are given significant tax incentives to create and maintain private foundations in exchange for providing a demonstrable, long-term contribution to the public good.  Part private, part public, philanthropic foundations live in a twilight world in which their desire to have impact while keeping a low profile increasingly collides with growing public expectations for transparency.  How this tension is negotiated will be crucial to the future of how private wealth contributes to the public good in America and around the world.

Foundations Matter

The assets and giving of foundations might seem relatively insignificant when compared to the hundreds of trillions of dollars flowing through global capital markets.  But philanthropic giving, in particular, has a unique advantage when it comes to executing a mission:  it is one of the last sources of capital left on earth that is not earmarked. The vast majority of foundations are endowed, and thus free from the pressures of raising money, selling products in a highly competitive marketplace, or chasing after votes to remain in office.  They have only to invest their assets and earn a reasonable return in order to pursue their missions.  This gives them an enormous degree of freedom to support controversial causes (same-sex marriage), take risks on new discoveries that have the potential to solve world problems (the Green Revolution) or stick with seemingly intractable challenges over the long-term (civil rights in America and the anti-apartheid struggle in South Africa).   Many foundations choose not to work on such risky or long-term challenges, but the important thing is that they are free to do so.

The Beginnings of Foundation Transparency

In the 1950s, two sets of McCarthy-era Congressional hearings investigated private foundations over their alleged support for “un-American activities.”  Believing that the best way to prevent such suspicion in the future was to prove they had nothing to hide, foundation executives led by John W. Gardner, then President of the Carnegie Corporation, created a remarkable institution, called quite simply “Foundation Center,” as a public information service for American philanthropy.  In 1956, when Foundation Center opened its doors, that meant some 8,000 paper documents arrayed in file cabinets for public inspection.  In 1960, Foundation Center published the first directory of American foundations, which numbered some 4,000; the buzz was all about this giant new institution that dwarfed all the others — The Ford Foundation. In 1999, Foundation Directory Online was launched — the first searchable database of American foundations, with profiles for each institution and detailed information for all of their grants. Today, Foundation Center is the leading source of information on philanthropy worldwide.

The Limits to Transparency

Historically, the primary source of the information on foundations has been their 990-PF tax returns, which they are required to file with the IRS.  When Foundation Center first gained access to those documents in the 1960s it required opening an office in Washington, DC so that staff could physically visit the IRS and hand-copy information from the forms, which at the time could not even be photographed.  Today they are available from the IRS on request, but as image (TIFF) files stored on CD-ROMs, that must be converted to searchable PDFs and optically scanned when possible, so that information from them can be keyed into databases.  Filing periods, extensions, bureaucratic delay, and the labor-intensive processing required conspire to make American philanthropy a $798 billion industry that relies on trend data that can be as much as three years old.  This is beginning to change, however, with the Government Data Act, which will phase in mandatory electronic filing of Forms 990 by all non-profits and foundations and their public release as machine readable open data by the IRS.  In the case of foundations, however, the 990-PF remains a form designed for compliance rather than data collection, and the quality of information it provides ranges from good to extremely poor, with a high volume of mistakes and omissions.

Greater Transparency Is Inevitable

When it comes to transparency, what used to be a bilateral relationship between private foundations and government has now become a triangle with the digitally literate public.  People expect to be able to get information on virtually everything — government, corporations, stores, products, celebrities, friends, enemies and themselves — instantly through their smartphones, tablets or watches.  The modern version of the old motto “trust but verify” has been updated to “trust but Google.”  There is no reason that foundations, because they are private and like to have a low profile, should imagine they are somehow exempt.  You say your mission is to: “to improve the quality of life for present and future generations”?  Great, I’m going to find how you’re doing it!  And increasingly, philanthropists who try to fly under the radar get detected:  when Sean Parker of Napster and Facebook fame came under criticism for holding a lavish wedding under the canopy of Northern California’s protected Redwoods, he tried to defend himself with all the good work his foundation was doing.  The only problem was, nobody knew he had a foundation because he hadn’t gone to the trouble of telling anyone by creating a website.

Voluntary Transparency Is Growing

Foundations are beginning to realize that you can’t make a difference in the world without being more transparent. Having an impact requires fully understanding the problem you are trying to solve, learning what other foundations already know, and identifying foundations with similar interests with whom you can partner to work at scale.  None of this is possible unless foundations openly share information about their work, their grants, and lessons learned.  More and more foundations are experimenting with social media, open data, open licensing of research, blogging and other forms of transparency, realizing that the knowledge they and their colleagues possess may be as valuable as the money they have to give away.  So prevalent is this trend that Foundation Center has devoted a special website to document and share innovations in foundation transparency entitled Glasspockets.  Its name comes straight from the testimony of Russell Leffingwell, a Republican Banker and Foundation Trustee, who boldly told his Congressional inquisitors during those McCarthy era hearings mentioned earlier:  “We think that the foundation should have glass pockets.”

Two Cheers for LLCs and Impact Investing

The two biggest trends in American philanthropy are the rise of Silicon Valley philanthropists and the concept of impact investing.  The Facebook billionaires and other tech entrepreneurs are amassing very large fortunes far earlier in their lives than previous generations of philanthropists and are bringing their confidence, innovation and spirit of disruption with them as they decide just how to go about their charitable giving.  Many are determined to do it differently than the big, historical foundations like Ford, Rockefeller, or even the much newer mega-foundation, Gates.  In fact, much of this cohort questions the very notion of setting up a formal foundation, because they see it as slow, bureaucratic and limited primarily to the making of grants.   Mark Zuckerberg and Priscilla Chan made a big splash when they recently announced that they would use 99% of their Facebook shares to create an LLC “… to advance human potential and promote equality for all children in the next generation.”   Though critics immediately pounced on them for using an LLC rather than a traditional foundation for its potential tax advantages, the Zuckerbergs claimed that the real reason was to give them full flexibility to make equity investments, loans and grants to further their vision.

This notion of using equity investments is commonly called impact investing.  The appeal is immense:  imagine if the $798 billion in foundation endowments and some portion of those trillions in the capital markets could be put to use to save the world while making a profit for investors.   This is the classic “win-win” that we all desire and there is clearly something to it.  If your charitable mission is to reduce global warming, why not make market-rate, equity investments in alternative energy instead of fossil fuels?   It is less clear how impact investing can be applied to some areas of philanthropic focus such as racial discrimination, human rights or bullying, but clearly impact investing is here to stay and an industry is fast developing around it.

For all their promise, there is one important caution when it comes to these new forms of philanthropy and impact investing, and that is their lack of transparency.  Traditional foundations are required by government to disclose each and every grant they make to fulfill the requirement to spend the equivalent of 5% of their assets for their charitable purpose each year; LLCs are not.  This means that whatever we know about Mark Zuckerberg’s philanthropy going forward will be precisely what he chooses to tell us.  The same is true of impact investing, for which the only data trail is we have today relies on voluntary disclosure by the investors themselves.  The irony is that Silicon Valley entrepreneurs, who have amassed enormous fortunes by harvesting data from hundreds of millions of users, and impact investors, who rely on open access to reliable information to make their decisions, should show such little concern when it comes to the transparency of their own efforts to make the world a better place.

If markets functioned perfectly, there would be no poverty, pollution and injustice.  But they don’t and never will, which is why we need to be compassionate, idealistic, pragmatic, and flexible in using all the tools at our disposal to meet the challenges of our time. That so much poverty persists alongside such massive accumulation of wealth is unacceptable and dangerous for the long-term prospects of our increasingly global society. While philanthropy, made possible by accumulated wealth, is a product of those contradictions, it also has the means and a responsibility to do something about them.   Whether it be through traditional foundations, experimentation with LLCs, or impact investing, philanthropy is vital to the future of our market-driven world.  And like it has with markets, transparency and the open access to information it provides can only make philanthropy stronger.

Bradford K. Smith is President of Foundation Center, the leading source of information about philanthropy worldwide.  Mr. Smith has devoted his entire career to the philanthropic and nonprofit sectors.