This is the thirty-eighth 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 and private foundations.
On October 21, 2010 Andrew M. Harris reported on Bloomberg.com that the U.S. Department of Labor has sued four investment firms for allegedly failing to examine Madoff’s business practices before entrusting him with hundreds of millions of dollars in pension funds. According to the Harris article, the action was brought under ERISA to restore to the plans all losses suffered as a result of alleged fiduciary breaches by the defendants related to Madoff investments.
One of the defendants in the Department of Labor action is Ivy Asset Management LLC, a unit of Bank of New York Mellon Corp. (“Ivy”), which was discussed in Installment 34 of this series, insofar as Ivy was involved in the reported investment with Madoff of Howard Hughes Medical Institute. The Harris article and Installment 34 also noted that, in May 2010, the New York Attorney General sued Ivy and two former officers for allegedly misleading clients about Madoff-related investments. These two officers have also been named as defendants in the Department of Labor suit.
It is interesting to consider whether private foundations and their fiduciaries could become similar targets of the Internal Revenue Service (“IRS”) for having invested with Madoff. If a private foundation makes any investments that would financially jeopardize the carrying out of its exempt purposes, both the foundation and the individual foundation managers may become liable for excise taxes under Section 4944 of the Internal Revenue Code.
"Jeopardizing investments" generally are investments that show a lack of reasonable business care and prudence in providing for the long- and short-term financial needs of the foundation for it to carry out its exempt function. No single factor determines a jeopardizing investment. Excise taxes of up to 35% percent of the amount involved (the jeopardizing investment) can be imposed on the foundation for each tax year, or part of a year that the jeopardy exists.
Additionally, an excise tax of up to 20% percent of the jeopardizing investment involved is also imposed on any foundation manager who knowingly, willfully and without reasonable cause participated in making and maintaining the jeopardizing investment.
These heavy excise taxes on private foundations and their fiduciaries are designed to discourage investments that endanger the charitable mission. The IRS should be considering imposing them in appropriate cases where fiduciaries of private foundations invested with Madoff, just as the Department of Labor is doing with pension funds. Otherwise the jeopardizing investment excise tax provisions have little teeth and are not useful in deterring such speculation.
[To be continued in Installment 39]
(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)