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This is the thirty-fourth in a series of Installments on this blog that discusses issues that arose in the aftermath of the Bernard L. Madoff (“Madoff”) scandal.  Various Installments of this series  have discussed the impact of the Madoff scheme on public charities in the context of new disclosure requirements for Form 990 adopted by the Internal Revenue Service in 2008.  Installment 29 of this series featured the limited public disclosures made available by Howard Hughes Medical Institute (“HHMI”) regarding its reported investments with Madoff.

In light of the relative paucity of public information regarding the investments by HHMI with Madoff, a study of public filings of its stated investment adviser might be helpful. As reported in Installment 29 , on February 5, 2009, in the early aftermath of the arrest of Madoff in December 2008, HHMI was on a 163-page list of “victims” produced by the Madoff Bankruptcy Court and re-published by Data360.org.

According to that list, HHMI was an investor with Madoff through “RELATIVE VALUE STRATEGIES LLC C/O IVY ASSET MANAGEMENT CORP.” Just as one may learn significant information about charities from the publicly available Forms 990, one may acquire considerable information from Form ADV, the Uniform Application for Investment Adviser Registration, that is required to be filed with the Securities and Exchange Commission (“SEC”) and updated by all investment advisers registered with the SEC. The current form of a filed Form ADV may be obtained universally through the SEC Website.  Forms ADV of earlier years may be obtained by making a request to the SEC under the federal Freedom of Information Act (“FOIA”).

My search on the Internet for “Relative Value Strategies LLC” yielded only that it is a limited liability company formed in Delaware in 1997. There was no record of its being an investment adviser registered with the SEC.  Rather, “relative value strategies” may be found on the Internet primarily as a generic term for an investment strategy of hedge funds that seek profit by exploiting irregularities or discrepancies in the pricing of stocks, bonds or derivatives.  Such hedge funds, which take a position on forward interest rates, the spread between different yields and the price differences between related securities, are also called “market neutral” or “arbitrage” funds.

Therefore, it appears that Relative Value Strategies, LLC was used by Ivy Asset Management Corp., now known as Ivy Asset Management LLC (collectively, “Ivy”), primarily as a fictitious name under which it operated.  However, there is much information available about Ivy on the Internet and as a registered investment adviser on the SEC Website.  An example is an April 1, 2010 article in The Wall Street Journal, which reports Ivy’s extensive executive restructuring, staff layoffs, acquisition by BNY Mellon and investigation by the New York Attorney General.

The most recent information on Ivy of note is the disclosure in Schedule D to the Ivy Form ADV on the SEC Website (the “Current Ivy ADV”) that the New York Attorney General filed a complaint on May 11, 2010 and a summons on July 22, 2010, against Ivy and two of its officers, alleging violations of New York law by Ivy in “concealing material information concerning Bernard L. Madoff from certain clients, allegedly contributing to losses by individuals or entities for whom those clients provided investment-related services.”

What is equally interesting, however, from the perspective of one who is analyzing HHMI and its investment with Madoff is a consistent response in the Current Ivy ADV and Forms ADV filed by Ivy during early 2008 and 2009 that were obtained under a FOIA request. Item 5.C. requires an investment adviser to identify each type of client that it advises and the approximate percentage that such type of client constitutes in number. One possible response is “None” with the next higher category being “Up to 10%.”

In each of Ivy’s Form ADV filings during 2008, 2009 and 2010, for the category “(7) Charitable organizations,” Ivy responded “None.” This is clearly and totally inconsistent with the type of client that HHMI was as an investor. On HHMI’s Internet page “About HHMI,” HHMI prominently has the following excerpt from its Code of Conduct: “As a non-profit charitable organization, HHMI is committed to conducting its activities in accordance with the highest standards of integrity and ethics.”

If HHMI had examined the Form ADV filed in 2008 by Ivy, it could have seen a red flag. Ivy has consistently reported that it did not advise clients that were charitable organizations. Either Ivy failed to carry out the requirement as to HHMI of “knowing its customer,” or Ivy simply inaccurately reported its composition of clients. By referring to the Forms ADV, HHMI could have become alerted earlier as to a potential problem in utilizing the services of Ivy. Clearly by Ivy’s own disclosures to the SEC, it lacked sufficient experience to provide advice on investment strategies for an organization of the stature of HHMI in the context of HHMI’s overall charitable mission.

In any event, a message is clear. Every investor, whether or not a charitable organization, should consider obtaining current and past Forms ADV filed by their investment advisers with the SEC as part of due diligence to consider whether the stated purposes, classes of clients and scope of operations are compatible with the needs of such investor.

[To be continued in Installment 35]
 

(With appreciation to Michael J. Kline, Esq., the author of this entry and author of an on-going analysis of the concerns of Madoff stakeholders. Mr. Kline is a partner with Fox Rothschild LLP, based in our Princeton, NJ office, and is a past Chair of the firm's Corporate Department. He concentrates his practice in the areas of corporate, securities, and health law, and frequently writes and speaks on topics such as corporate compliance, governance and business and nonprofit law and ethics)

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In a series of insider trading cases, the Second Circuit has appeared to hike the government’s burden of proof in showing the “willfulness” of conduct needed for conviction by requiring evidence that a defendant acted with the knowledge that he was violating the securities laws. This additional layer of proof, common to prosecutions of many regulatory offenses, helpfully requires a jury to find more than the usual mens rea standard of “knowing and intentional” conduct. Recently, a defendant sought to have the enhanced level of proof applied in a conventional securities fraud case, but the court declined to do so.

Mark Kaiser was a corporate officer of U.S. Food Service, a distributor of food products to restaurants, and he supervised the company’s purchasing department. He had received bonuses based on the amount of promotional allowances paid to USF by its vendors; those allowances increased as USF’s purchases from the vendors increased. Apparently not content with the ordinary course amount of the payments, Kaiser, according to the government, inflated the amount of payments USF appeared to receive, and his resulting bonuses, by having vendors pre-pay large bonuses based on purchasing targets not yet achieved. Kaiser then allegedly hid the scheme by causing false bookkeeping entries and by personally lying to outside auditors about the nature of various payments received by his company. He was convicted in the Southern District of New York of securities fraud and causing false filings to be made to the SEC.

Kaiser appealed on several grounds, including the claim that the jury instruction on the “willfulness” element under 15 U.S.C. § 78ff(a) (penalizing "[a]ny person who willfully violates any provision of this chapter ....") was erroneous because the trial judge failed to instruct that a defendant could only act “willfully” if he had knowledge that his actions were illegal. He succeeded in vacating his conviction and winning a new trial, but on other issues, including a flawed “conscious avoidance” charge; the Second Circuit flatly rejected his argument that “willfulness” in this context requires knowledge of illegality. United States v. Kaiser, 609 F.3d 556 (2nd Cir. 2010).

While noting recent its own precedent that endorsed a higher standard for willfulness in insider trading cases, the appeals court distinguished insider trading, which does not necessarily involve deception and, therefore, where an insider may be unaware that his conduct was illegal and therefore wrongful. The court explained that the same cannot be said of one who deliberately misleads investors about a security.

Although the appeals court held the district court erred in instructing the jury on “conscious avoidance”, the court upheld the district court’s instruction on willfulness. The Second Circuit disagreed with Kaiser’s argument that “willfulness” requires knowledge of illegality and held that Section 32(a) of the Exchange Act does not require proof that the defendant knew he was violating the law, only that which was charged in this case: knowingly false statements made with an intent to deceive, with an absence of good faith on the defendant’s part. Those requirements, the court noted, necessarily suffice to prove that Kaiser knew he was committing a wrongful act.
 

(With appreciation to Christine Soares, Esq., for contributing this entry)

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This is the thirty-third in a series of Installments on this blog that discusses issues that arose in the aftermath of the Bernard L. Madoff (“Madoff”) scandal.  Against the backdrop of the Madoff scandal, various Installments of this series have analyzed new disclosure requirements for public charities adopted by the Internal Revenue Service (“IRS”) in 2008 with its new Form 990. In particular, Installment 31 of this series provided analysis of the Form 990 for 2008 (the “2008 Form 990”) of American Jewish Congress, Inc. (“AJCongress”), which, like other Forms 990, is universally available on Guidestar.

Installment 31 stated that, on July 22, 2010, AJCongress President Richard Gordon reported on the AJCongress Website (the “Gordon Statement”) that the organization was suspending operations after, among other things, “Bernie Madoff stole approximately $21 million from our organization. . . .”

Installment 31 reported incorrectly that the only reference to Madoff and the AJCongress losses on the AJCongress website is the Gordon Statement.  Another reference to the Madoff losses for AJCongress may be found in the 2009 Annual Report of AJCongress (the “2009 Annual Report”), which may be reached directly from the AJCongress Homepage by clicking on the link “Click here to view Annual Report of Accomplishments- 2009.”

Unfortunately, in stark contradiction to the Gordon Statement, the first two paragraphs of the 2009 Annual Report read as follows:

As a difficult year—our 91st—draws to a close, it is appropriate to bring our friends and supporters up to date on our accomplishments. These are considerable, although the year began so inauspiciously with the looting of AJCongress endowment funds by Bernard Madoff.

We acted promptly to contain the damage, but the price the Madoff fraud exacted was high—we were forced to let go many valued and long-time AJCongress employees; we reduced spending to a minimum; and we relocated to smaller quarters. We have completed these actions, stabilized our finances and have begun to look forward to expanding the agency so that it may continue its historic role as attorney general of the American Jewish community.

The 2009 Annual Report concludes as follows:

The past year [2009] was a time for consolidating and reorganizing. This coming year [2010] must be a time of vigorous growth for AJCongress. But that can happen only if you contribute generously as this year comes to a close. We are counting on you.

The 2009 Annual Report paragraphs are seriously outdated, create a mistaken impression and belie the Gordon Statement. Even more concerning is the fact that the link to the 2009 Annual Report on the Homepage is placed directly below an active “Donation” link.  The Gordon Statement is not on the AJCongress Homepage or the pages seeking donations or memberships. Nor is there any cross-reference on those pages to the Gordon Statement, as there is to the 2009 Annual Report and its contradictory information.

As reported in Installment 31, AJCongress appears to be continuing business as usual on its Website in soliciting donations and memberships. As a personal matter, on August 5, 2010, I became an individual member in AJCongress online with a credit card payment. An unknowing visitor to the AJCongress Website could easily do that without seeing any information about the organization’s current distressed status. These disclosure matters should be addressed and rectified by AJCongress promptly.

As a final point, Charity Navigator,,a website that rates charities based on their Form 990 filings with the IRS, has made AJCongress number one on its list of “10 Charities Drowning in Administrative Costs.” Charity Navigator states that each of the 10 named charities

directs more than 44% of its budget towards administrative costs. That means most of your money goes toward such expenses as liability insurance, accounting and legal services, administrative salaries, and investment expenses, not the programs you aim to support.

Out of fairness to AJCongress and its venerable charitable history, it should be observed that the 2008 Form 990, upon which the organization’s Charity Navigator rating was based, included the results of the financial devastation that emanated from the Madoff revelations.

Nevertheless, AJCongress should consider correcting the disclosure deficiencies on its Website cited above by appropriately highlighting the curtailment of its charitable activities.

[To be continued in Installment 34]
 

(With appreciation to Michael J. Kline, Esq., the author of this entry and author of an on-going analysis of the concerns of Madoff stakeholders. Mr. Kline is a partner with Fox Rothschild LLP, based in our Princeton, NJ office, and is a past Chair of the firm's Corporate Department. He concentrates his practice in the areas of corporate, securities, and health law, and frequently writes and speaks on topics such as corporate compliance, governance and business and nonprofit law and ethics)

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This is the thirty-second in a series of installments on this blog  that have focused substantially on issues of charities arising in the aftermath of the long global Ponzi scheme of Bernard L. Madoff (“Madoff”) and others. All potential stakeholders should consult professional advisors to have their positions evaluated.

Installments 14 and 16 of this series, among others, discussed Hadassah and its relationships with Madoff, as well as to how the organization has chosen to disclose publicly its involvement and investments with Madoff.  Defined terms and links not otherwise contained herein are included in such Installments.  Readers are encouraged to consult the earlier blog posts as a background for this Installment.

In particular, Installment 16, posted in September 2009, discussed the fact that it is alleged that Hadassah had received $40 million more in distributions from Madoff than it had invested with him.  Additionally, an article by Diana B. Henriques in The New York Times was quoted in Installment 16 as having said, “[t]here is the widespread fear among some — unfounded, Mr. [Irving] Picard [the trustee in the Madoff bankruptcy proceeding] says — that he will sue struggling charities or people of limited means for money they withdrew in the past but no longer have.”

On July 26, 2010, Michael Rothfeld reported in The Wall Street Journal that Mr. Picard is preparing new lawsuits against approximately 1,000 individuals to claw back funds from investors with Madoff who received more in principal distributions than they had invested with him. According to the article, Mr. Picard is trying to commence such lawsuits in advance of the expiration of the two-year statute of limitations in December 2010.

Mr. Rothfeld states in his article that Mr. Picard is suing several types of Madoff investors, including “15 civil suits seeking more than $15 billion on a combined basis from Mr. Madoff's brother and sons, investment funds that fed money to the [Madoff] firm, wealthy investors close to Mr. Madoff who redeemed large amounts of cash, and other defendants.”

No mention is made in the article as to whether the “wealthy investors close to Mr. Madoff who redeemed large amounts of cash and other defendants” may or will include Hadassah or other charities that have been alleged to have received more in distributions from Madoff than the dollars they had invested with him.  Again, as observed in Installment 16, the criteria that Mr. Picard will use to separate those from whom he will seek clawback and those “struggling” charities and “people of limited means” from whom he will not raise fundamental questions of fairness, size and relative value that will likely lead to much more controversy and potential litigation.

[Continued in Installment 33]
 

(With appreciation to Michael J. Kline, Esq., the author of this entry and author of an on-going analysis of the concerns of Madoff stakeholders. Mr. Kline is a partner with Fox Rothschild LLP, based in our Princeton, NJ office, and is a past Chair of the firm's Corporate Department. He concentrates his practice in the areas of corporate, securities, and health law, and frequently writes and speaks on topics such as corporate compliance, governance and business and nonprofit law and ethics)

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Defending a securities fraud prosecution brought under 15 U.S.C. § 78j and Rule 10b-5 on the theory of undisclosed material information can be enormously challenging because the standard for judging whether particular information would have been material to a reasonable investor is so elastic and unpredictable. Just how immaterial the supposedly “material” information may be was underscored recently by the Ninth Circuit.

The case of United States v. Laurienti, 2010 WL 2266986 (9th Cir., June 8, 2010), concerned the securities fraud prosecution of the owners, senior managers and brokers of a defunct broker-dealer called Hampton Porter. The indictment alleged that Hampton Porter made a practice of selling blocks of stock provided to it by issuers through a “pump and dump” scheme. Its brokers were incentivized to sell these house stocks through greatly enhanced commissions, and only retained those commissions if they could discourage clients from selling out of their positions in the house stocks. By stoking buying activity in these stocks, the shares’ prices rose artificially and dramatically, and then the broker-dealer and others would dump their shares of those stocks to realize the gains. Clients of the firm were not informed, of course, about the brokers’ increased commissions on the house stocks, as compared to their commissions on all other stocks. Naturally, former clients testified at trial that if they had known of the house stocks’ commission rates, they would not have purchased those stocks. There was also evidence at trial of high-pressure sales tactics and unauthorized transactions in certain accounts, but no evidence of any misrepresentations or undisclosed information about the issuing companies, their performance, or the intrinsic value of the stocks.

The owners and managers pled guilty, leaving several brokers to go to trial; they were convicted. On appeal, the brokers maintained that there was no legal obligation to disclose their commissions, so they could not have committed securities fraud by failing to make the disclosure, and there was no other evidence of fraudulent statements or omissions.

Initially, the court of appeals opinion suggested, with an almost imperceptible wistfulness, that if the government had proceeded solely on a conspiracy to commit securities fraud theory, then the appeal would have been more easily resolved in its favor. In that scenario, the evidence of undisclosed commissions, “even if not independently criminal conduct,” would have amounted to circumstantial evidence of the brokers’ agreement to join the conspiracy of the owners and managers, and the conspiracy proof would have been complete against the brokers with no evidence at all of their committing actual acts of fraud. However, the opinion notes almost ruefully, the government did offer the failure to disclose bonuses not just on the conspiracy charge “but also as an independent violation of Rule 10b-5,” leaving the court no alternative but to decide the precise question: is it illegal to fail to disclose increased commission rates?

Reaching first the existence of a duty to disclose, the court held that in the presence of a relationship of trust and confidence between broker and client, Rule 10b-5 imposes on the broker an obligation to disclose all facts material to the relationship, citing Chiarella v. United States, 445 U.S. 222 (1980) (which concerned subsections (a) and (c) of Rule 10b-5, involving respectively, employing a device or scheme to defraud and engaging in a practice which operates to defraud, and which required disclosure of material facts if there was a relationship of trust). In dictum, the Laurienti court extended the obligation to disclose to subsection (b) of Rule 10b-5 (omitting material facts necessary to render other statements not misleading), even when there is not a relationship of trust. Although the jury instructions here were errant in failing to require the essential element of a trust relationship, the Ninth Circuit held that the broker defendants had waived their objections to the error.

Turning to the issue of the materiality of the commissions, the appeals court rejected the argument that the enhanced commission rates were immaterial as a matter of law, since, it held, a reasonable investor would consider them important. However, the court hastened to add, not all compensation arrangements are material and de minimis variations among different commission rates would indeed be immaterial.

Finally, the brokers argued that even if enhanced commissions are now to be deemed material, they had no way of anticipating that holding and so had no warning of the bounds of the criminal law. The court had two curt responses: (a) its holding was not unforeseeable in light of Chiarella; and (b) the failure to disclose is not illegal unless accompanied by an intent to defraud. A perfectly appropriate defense counsel response to the second point would be to firmly grasp one’s head with both hands and shake slowly from side to side, since the court’s guidance hardly illuminates the path between criminal and non-criminal conduct and leaves that demarcation entirely to the government’s charging decisions.
 

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This is the thirty-first in a series of Installments on this blog that discusses issues that arose in the aftermath of the Bernard L. Madoff (“Madoff”) scandal.  Various Installments of this series
have analyzed new disclosure requirements for public charities adopted by the Internal Revenue Service (“IRS”) in 2008 for its new Form 990 against the backdrop of the Madoff scandal.  The Forms 990, including the Form 990 (the “2008 Form 990”) of American Jewish Congress, Inc. (“AJCongress”) for the calendar year 2008 discussed below are universally available on the Internet on Guidestar and other sites.

AJCongress was founded 91 years ago to fight anti-Semitism and protect civil rights. The organization was one of the charities that was identified early as a major victim of Madoff when the scandal became public in December 2008, at which time AJCongress said it would not close. 

On July 22, 2010, AJCongress President Richard Gordon reported on the AJCongress Website that the organization was suspending operations after, among other things, “Bernie Madoff stole approximately $21 million from our organization. . . .”

A review of the current AJCongress Website reveals that the statement of Mr. Gordon is the only reference to Madoff and the AJCongress losses.  Further, in spite of the suspension of activities by AJCongress and some reports that it is seeking to merge with at least one other charity, AJCongress appears to be continuing business on its Website as usual in soliciting donations and memberships, including life memberships that cost $1,000.  The statement by Mr. Gordon is only contained under the AJCongress tab for “Press Statements,” not on its Homepage or the pages seeking AJCongress donations or memberships.  A visitor to the Website would have to visit that tab specifically in order to learn about the dire financial straits of AJCongress.

Clearly “best practices” in transparency would mandate that the statement by Mr. Gordon as to suspension of AJCongress activities be placed on the AJCongress Homepage and/or the fund solicitation pages, or at least prominently cross-referenced on those pages.

Probing deeper into the AJCongress disclosure process, a review of the 2008 Form 990 filed with the IRS on November 23, 2009 reveals that AJCongress properly answered “Yes” to the following question on Line 5 under the heading “Government, Management, and Disclosure”: “Did the organization become aware during the year of a material diversion of the organization’s assets?”

On Schedule O to the 2008 Form 990, AJCongress gave the following explanation for the foregoing “Yes” answer:

Approximately $2.2 million of investitures with Bernard Madoff Securities were stolen by Mr. Madoff. Additionally, some $16 million in trust funds were administered by AJCongress officers and employees (in one case, the Trusts’ [sic] were for the benefit of AJCongress) were also taken by Mr. Madoff.

The 2008 Form 990 shows that the net assets of AJCongress declined from $16,925,097 to December 31, 2007 to $3,764,412 as of December 31, 2008.

Therefore, while, the 2008 Form 990 appropriately called attention to the financial debacle that the organization had suffered during 2008, as discussed earlier, no attention was called to this fact on the AJCongress Website until the statement of suspension of activities by Mr. Gordon was posted.

Further, the 2008 Form 990 is unusually incomplete, with omissions in several areas.  For example, there were two pages attached at the end of the Form 990 of AJCongress for 2007 that named almost 100 volunteers who were on its Executive Committee and Governing Committee.  However, no volunteers were named in the 2008 Form 990 in response to Part VII, Section A, which called for a list of all current officers, directors, trustees (whether individuals or organizations), regardless of compensation.  The response in the table in Part A was cut off after the word “See -” in the 2008 Form 990 but appears that it would have directed the reader to other pages for a list of the volunteers, which have not been included.

Even more significantly, AJCongress answered “Yes” to the following question on Line 4 under the heading “Government, Management, and Disclosure” in the 2008 Form 990: “Did the organization make any significant changes to its organizational documents since the prior Form 990 was filed?”

On Schedule O to the 2008 Form 990, AJCongress gave the following explanation for the foregoing “Yes” answer: “See attached amendment to the Constitution of the American Jewish Congress.”

Again, as in the case of the members of the Executive Committee and the Governing Committee, no amendment to the Constitution was attached to the 2008 Form 990.

The omission of the amendment to the AJCongress Constitution is perplexing, as it has been reported by JTA that “the group [AJCongress] has money in the bank but cannot access it now due to the constraints of its constitution.” Had the constitutional amendments been included with the 2008 Form 990, it would have been possible for readers to analyze more meaningfully the status of AJCongress.

One final observation regarding the preparation of the 2008 Form 990 relates to the following question on Line 10 under the heading “Government, Management, and Disclosure”: “Was a copy of the Form 990 provided to the organization’s governing body before it was filed?  All organizations must describe in Schedule O the process, if any, the organization uses to review the Form 990.”

Not only did AJCongress answer the question on Line 10 “No,” there was no description in Schedule O of the process that the organization used to review the 2008 Form 990.  Perhaps if the AJCongress Executive Committee and Governing Committee had had the opportunity to see the  2008 Form 990 prior to its filing with the IRS, the omissions of the list of governing board members and the amendment to the AJCongress Constitution discussed above could have been discovered.

Although AJCongress has made disclosures of its financial status and direction since the Madoff scandal surfaced, the organization could have improved their timeliness, quality, consistency and completeness. It is not too late to improve the transparency, however, perhaps by placing a complete 2008 Form 990 on the AJCongress Website Homepage.

[This Installment has been amended from its original posting to reflect a change to "AJCongress" in the defined term for American Jewish Congress, Inc., in order to avoid potential confusion with any other organization.  We apologize for any misunderstanding that may have taken place.]

[To be continued in Installment 32]
 

(With appreciation to Michael J. Kline, Esq., the author of this entry and author of an on-going analysis of the concerns of Madoff stakeholders. Mr. Kline is a partner with Fox Rothschild LLP, based in our Princeton, NJ office, and is a past Chair of the firm's Corporate Department. He concentrates his practice in the areas of corporate, securities, and health law, and frequently writes and speaks on topics such as corporate compliance, governance and business and nonprofit law and ethics)

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This is the thirtieth in a series of Installments on this blog that discusses issues that arose for charities in the aftermath of the Bernard L. Madoff (“Madoff”) scandal.  For example, Installment 29 analyzed new disclosure requirements for public charities adopted by the Internal Revenue Service (“IRS”) in 2008 for its new Form 990 (the “New Form 990”) against the backdrop of the Madoff scandal and its relationship to Howard Hughes Medical Institute (“HHMI”).  Forms 990 that are filed with the IRS, including the New Form 990 of HHMI and those discussed in this Installment, are universally available on the Internet on Guidestar and other sites.

Madoff, however, was not the only person to have operated an alleged Ponzi scheme that materially and adversely affected charities.  The Philadelphia Inquirer published an article by Harold Brubaker on July 7, 2010, entitled “A Workout in Court over Ponzi-scheme Gift.”  The Brubaker article reported that Malvern Preparatory School (“Malvern” or the “school”), among other charities, is claiming that it is a victim of a Ponzi-scheme run by its former Trustee Joseph S. Forte (“Forte”), even though the school had received hundreds of thousands of dollars in donations from him.  Malvern is a venerable 167-year old independent Catholic middle and high school for boys in Malvern PA.  Forte is reported to be serving a 15-year prison term for investment fraud, having pleaded guilty on June 5, 2009.

Mr. Brubaker stated that, unlike other Forte charities that have chosen to negotiate with the receiver for Forte’s estate on donated monies that the receiver is endeavoring to “clawback,” Malvern is suing to retain the money donated by Forte.  The Brubaker article explains that the basis of the Malvern claim for victim status is complicated:

The school, known for its sports programs, went into debt constructing a strength-and-conditioning center at Forte's urging and after he pledged $1 million to pay for it. But Forte only paid $500,000 of his pledge, according to the school, leaving Malvern Prep in debt for the rest. The school's June 30 [2010 lawsuit] filing asserted a counterclaim for $630,000, which includes $565,000 for a portion of a term loan needed to pay for the center plus $65,000 in fees and interest.

The facts in the Malvern case are unusual because Malvern was not just a charitable beneficiary of Forte as was the Archdiocese of Philadelphia, which was mentioned in the Brubaker article.  Nor was the school simply a direct or indirect investor with Forte as, for example, Hadassah and Yeshiva University were with Madoff, as reported in Installments 22 and 23 of this series.

The discovery of the Forte scandal, his guilty plea and conviction, the Securities and Exchange Commission actions, and the appointment of Marion A. Hecht, CPA, CFE, CIRA, CFF, and MBA, Managing Director of the forensic litigation and valuation division of Goodman & Company, LLP, as receiver for Forte’s assets, all occurred during Malvern’s fiscal year ended June 30, 2009 (“Fiscal 2009”). A review of the balance sheet in the New Form 990 dated February 9, 2010, filed by Malvern for Fiscal 2009 with the IRS (the “Malvern 2009 Form 990”) reveals a decline in the category of “Pledges Receivable” during Fiscal 2009 of approximately $1.2 million from $2,003,004 to $785,992.  Because there is no note or explanation by Malvern in the Malvern 2009 Form 990 regarding the category, it is impossible to tell whether all or any portion of the $500,000 Forte pledge was written off by the school during the Fiscal 2009.

Malvern’s financial association with Forte was a complex “hybrid” case in that Malvern not only received direct donations from Forte that were presumably proceeds from his investment scheme; in effect, Malvern also was a type of investor with him. Malvern dedicated the proceeds of Forte’s bounty for the purpose of the strength-and-conditioning center that the school was reluctant to build in the first place and, in doing so, incurred its own new debt in reliance upon the anticipated payment of the remainder of the Forte pledge. Therefore, Malvern has suffered a real investment loss from the failure of Forte to satisfy his $500,000 pledge to pay for the indebtedness incurred by the school to build the project that Forte had induced it to undertake.

It is somewhat perplexing that the Malvern 2009 Form 990 makes no mention of Forte or the fate of his personal pledge, although the Forms 990 filed by the school for the immediately prior two fiscal years clearly listed him among its Trustees.

The matter is further complicated by the fact that, as discussed in Installment 29 of this series, Part VI of New Form 990 entitled “Government, Management and Disclosure” has the following question on Line 5 for an answer of “Yes” or “No” by the organization: “Did the organization become aware during the year of a material diversion of the organization’s assets?”

In the Malvern 2009 Form 990, Line 5 was answered “No.”

The instructions for completing the New Form 990 (the “Form 990 Instructions”) provides the following, in part, as to Line 5:

Answer “Yes” if the organization became aware during the organization’s tax year of a material diversion of its assets, whether or not the diversion occurred during the year. If “Yes,” explain the nature of the diversion, amounts or property involved, corrective actions taken to address the matter, and pertinent circumstances in Schedule O, though the person or persons who diverted the assets should not be identified by name.

A diversion of assets includes any unauthorized conversion or use of the organization’s assets other than for the organization’s authorized purposes, including but not limited to an embezzlement or theft. . . .

For this purpose, a diversion is considered material if the gross
dollar amount (not taking into account restitution, insurance, or similar recoveries) exceeds the lesser of (1) $250,000 or (2) 5 percent of the lesser of the organization’s gross receipts for its tax year or total assets as of the end of its tax year.

If the decline in the Pledges Receivable in the Malvern 2009 Form 990 was attributable in part to a write-off of at least $250,000 of the outstanding $500,000 Forte pledge because of the repudiation of the Forte pledge by the receiver, the school should have considered making an explanation on Schedule O. If such a write-off of the Forte pledge did actually occur during Fiscal 2009, Malvern and its professional advisers apparently employed a narrow interpretation of the definition of “diversion of assets.”

While such a narrow interpretation may be supportable, I believe that the desirability of Malvern’s having taken a broader view of the term “diversion of assets” was heightened by the fact that Forte had been a Trustee of the school. As a matter of fact the Form 990 Instructions make a specific point that the category Pledges Receivable should include pledges of trustees, after any amounts estimated to be uncollectible:

Line 3. Pledges and grants receivable, Net. Enter the total
of (a) all pledges receivable, less any amounts estimated to be
uncollectible, including pledges made by officers, directors,
trustees, key employees, and highest compensated
employees and (b) all grants receivable.

As a final note, even if no write-off of all or a portion of the Forte receivable occurred during Fiscal 2009, in my view, Malvern should have considered making an explanation in the Malvern 2009 Form 990 as to why it was continuing to carry the Forte pledge in Pledges Receivable at full value.

In summation, the New Form 990 questions and Form 990 Instructions may need some refinement by the IRS to enhance the clarity and consistency of definitions and promote greater transparency by charities, as has been recommended in this and earlier Installments of this series.

[To be continued in Installment 31]
 

(With appreciation to Michael J. Kline, Esq., the author of this entry and author of an on-going analysis of the concerns of Madoff stakeholders. Mr. Kline is a partner with Fox Rothschild LLP, based in our Princeton, NJ office, and is a past Chair of the firm's Corporate Department. He concentrates his practice in the areas of corporate, securities, and health law, and frequently writes and speaks on topics such as corporate compliance, governance and business and nonprofit law and ethics)

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On May 19, 2010, Attorney General Eric J. Holder, Jr. issued a memorandum addressing "Department Policy on Charging and Sentencing." The memorandum recognizes the advisory nature of the United States Sentencing Guidelines ("Guidelines"), emphasizes that charging and sentencing decisions must be made individually "on the merits of each case" rather than beginning and ending with the Guidelines, and extends to individual prosecutors greater discretion to make charging and sentencing decisions.

The Holder memorandum supersedes the prior DOJ position that prosecutors "charge and pursue the most serious readily provable offenses," i.e., the charges that would generate the most substantial sentence, in all cases. The prior policy also required Department prosecutors oppose any sentence below the Guidelines range.

Under the new guidance, charging, plea bargaining, and sentencing decisions “must also follow from an individualized assessment of the facts and circumstances of each particular case," and are not necessarily tethered to the Guidelines. As a result of this new approach, Department prosecutors should be more open to defense advocacy in seeking charge avoidance or reduced sentences in appropriate cases.

A more detailed description of this recent guidance may be found on the Fox Rothschild website.

(With appreciation to Eric E. Reed, Esq., for contributing this entry)

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Prompted by a critical report from the United States Government Accountability Office ("GAO"), on May 25, 2010, the Department of Justice ("DOJ") issued additional guidance on the use of corporate monitors in deferred prosecution agreements ("DPAs") and non-prosecution agreements ("NPAs") with business organizations under criminal investigation. Building on past guidance, the recent release calls for DPAs or NPAs to specify DOJ’s ongoing role in resolving disputes between the business organization and the monitor over the monitor’s compensation (which is paid by the business organization) and the monitor’s compliance recommendations (which the business organization may find unreasonable).

A more detailed description of this recent guidance may be found on the Fox Rothschild website.

(With appreciation to Eric E. Reed, Esq., for contributing this entry)

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