The Picard/Wilpons Settlement: What Issues Surface for the Involved Charitable Private Foundations and Their Respective Fiduciaries? - Part 1 - Installment 75
Michael Kline writes:
This Installment addresses some of the effects on, and implications for, certain charitable private foundations (collectively, the “Involved Foundations”) and their respective officers, directors, trustees and foundation managers (collectively, the “Fiduciaries”) under the proposed settlement agreement dated April 13, 2012 (the “Settlement Agreement”), between Madoff Trustee Irving Picard and the numerous defendants, constituting the Wilpon-Katz-Mets individual, business, family trust and charitable interests (collectively, the “Wilpons”). Installment 74 and prior postings in this blog series discussed certain aspects of the Settlement Agreement.
The Settlement Agreement, which would terminate all existing litigation between the Trustee and the Wilpons (the “Litigation”), is subject to the approval of Federal District Judge Jed S. Rakoff at a hearing scheduled for 4 PM on May 15, 2012. Further information, including Forms 990-PF filed with the Internal Revenue Service (the “IRS”), respecting each of the Involved Foundations and their Fiduciaries may be found on the GuideStar Web site.
A recurring theme in this blog series has been the relatively inconsistent and sometimes perplexing manner in which the Trustee has dealt with charities that invested with Madoff. Installment 60 and prior Installments discussed some of the differences in the way Picard was dealing with the Judy & Fred Wilpon Family Foundation (the “Wilpon Family Foundation”) and the Iris & Saul Katz Family Foundation (the “Katz Family Foundation” and collectively with the Wilpon Family Foundation, the “Defendant Foundations”), as contrasted to other public charities and charitable private grant-making foundations.
The Defendant Foundations are listed on Schedule 2 to the Settlement Agreement, which is the “Summary of Six-Year Transfers from BLMIS [Madoff] to Defendants in Excess of Principal,” respecting persons subject to “clawback” efforts by the Trustee of “fictitious profits” and principal. A number of the Fiduciaries of each of the Defendant Foundations also are defendants listed on Schedule 2 for whom the Trustee was seeking clawback. The Defendant Foundations will be discussed more fully in a future Installment in this blog series.
The remaining Involved Foundations (the “Schedule 1 Foundations”) appear on Schedule 1 to the Settlement Agreement, which is the “Summary of Allowed Net Equity Claims Against the BLMIS Estate.” Therefore, the Schedule 1 Foundations are not defendants in the Litigation; nor are they signatories to the Settlement Agreement. They are claimants that have been recognized to be entitled to share in the funds recovered by the Trustee in the Madoff bankruptcy.
The Schedule 1 Foundations include, among others, The Dayle H & Michael Katz Foundation Inc. (the “Michael Katz Foundation"). Notably, each of the Schedule 1 Foundations has one or more Fiduciaries who, in one capacity and/or another, is (i) a defendant in the Litigation, (ii) listed on Schedule 2 to the Settlement Agreement and (iii) a signatory to the Settlement Agreement. The Foundation Fiduciaries of each of the Schedule 1 Foundations have an aggregate larger amount of clawback exposure on Schedule 2 than the allowed net equity claim of the related Schedule 1 Foundation (a “Schedule 1 Foundation Claim”). Except for the Michael Katz Foundation, the amount of the Schedule 1 Foundation Claim of each Schedule 1 Foundation is relatively small, less than $100,000. In the case of the Michael Katz Foundation, however, the Schedule 1 Foundation Claim is $617,000, while the maximum aggregate exposure reflected on Schedule 2 for clawback against the Michael Katz Foundation Fiduciaries exceeds that amount.
In the Settlement Agreement, each Schedule 1 Foundation Claim falls within the definition of a “Defendant Net Equity Claim” under Section 1(c) of the Settlement Agreement. Each of the Fiduciaries who is also a signatory to the Settlement Agreement (a “Fiduciary Defendant”) is defined as a “Defendant” in the Settlement Agreement, who, under Section 2(a) of the Settlement Agreement, has agreed, among other things, to assign all Defendant Net Equity Claims (which would include a Schedule 1 Foundation Claim) to the Trustee. In addition, each Fiduciary Defendant has represented and warranted under Section 6(b) of the Settlement Agreement that he or she has full power, authority and legal right to assign his or her respective Defendant Net Equity Claim (which would include a Schedule 1 Foundation Claim).
The foregoing acts by the Fiduciary Defendants may be problematic. In effect, each of the Schedule 1 Foundation Claims, which would otherwise be a future unencumbered expectancy to be paid to the respective Schedule 1 Foundation by the Trustee, is being assigned under the Settlement Agreement to the Trustee to fund a portion of the monetary clawback exposure of its respective Fiduciary Defendants. As stated earlier, the Schedule 1 Foundations are not defendants in the Litigation; nor are they directly signatories to the Settlement Agreement.
This dichotomy between the interests of Schedule 1 Foundations and their respective Fiduciary Defendants sets up a classic divergence of interests that calls for consideration of compliance requirements flowing from the duty of loyalty of fiduciaries and the potential for conflicts of interest. Moreover, the question of potential prohibited “private benefit and inurement” respecting the Schedule 1 Foundations under IRS rules can be raised as indicated in an IRS Compliance Guide:
A private foundation is prohibited from allowing more than an insubstantial accrual of benefits, including non-monetary benefits, to individuals or organizations. The intent is to ensure that a tax-exempt organization serves a public interest, not a private one. If a private benefit is substantial, it could jeopardize the organization’s tax-exempt status.
In addition, no part of an organization’s net earnings may inure to the benefit of a private shareholder or individual. This means that an organization is prohibited from allowing its income or assets to accrue to insiders. An example of prohibited inurement would include payment of unreasonable compensation to an insider. An insider is a person such as an officer, director, or a key employee who has a personal or private interest in the activities of the organization. Any amount of inurement may be grounds for loss of tax-exempt status.
In addition to loss of the organization’s section 501(c)(3) tax-exempt status, activities constituting inurement may result in the imposition of self-dealing excise taxes on individuals benefiting from certain transactions with a private foundation.
The laws regarding duty of loyalty and conflicts of interest of fiduciaries and the IRS rules regarding private benefit and inurement are highly complex. Presumably, each of the Schedule 1 Foundations and its respective Fiduciaries would have been well advised to seek separate guidance and counsel as to their respective rights and obligations under the Settlement Agreement and its impact on a Schedule 1 Foundation Claim and the clawback exposure of the Defendant Fiduciaries.
Query, should Judge Rakoff be inquiring into these Schedule 1 Foundation matters as part of his review and approval of the Settlement Agreement? Should the Schedule 1 Foundations properly be dropped from Schedule 1 of the Settlement Agreement altogether in order to resolve the potential issues? If the Schedule 1 Foundations were to be excluded from involvement in the Settlement Agreement, should the Defendant Fiduciaries be expected to provide substitute funding sources? Whether these questions will be addressed remains to be seen.
(Michael J. Kline, the author of this entry and a co-author of this blog, 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.)
[To be continued in Installment 76]