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This is the nineteenth in a series of installments on this blog that are discussing some issues arising in the aftermath of the long global Ponzi scheme of Bernard L. Madoff (“Madoff”). Installments 3 through 8, Installment 10 and Installments 14 through 18 of this series focused on the specific concerns of charities that were victims of Madoff and similar schemes. All potential stakeholders should consult professional advisors to have their positions evaluated.

Monday, November 16, 2009 is a critical day for Section 501(c)(3) public charities and private foundations with a calendar fiscal year that invested with Madoff. As a matter of fact, it is a critical day for all Section 501(c)(3) charitable organizations with a calendar fiscal year. It is the final day on which such public charities and private foundations can file their Forms 990 and 990-PF, respectively, with the Internal Revenue Service (the “IRS”) for calendar year 2008 on a timely basis after using both of the two potentially available extension periods. A fling after that date is delinquent and can lead to penalties by the IRS.

While this blog series has strongly advocated filings with the IRS by charitable organizations for 2008 as early as possible, many have delayed their filings until the deadline. A number of factors may have led to this approach, including the following:

1. The new Form 990 for 2008 added probing questions on governance, executive compensation, charitable mission, policies, etc., which required many of the charities to institute or update protocols and procedures.

2. The accounting and auditing firms that assist charities in preparing Forms 990 and 990-PF were under great pressure to deal with the complexities of the new Forms and the financial challenges facing many charities.

3. During 2008 many charities suffered substantial losses in endowment fund values and declines in fundraising that led some of them to delay potentially embarrassing disclosures to the public as long as possible.

4. A number of those charities that invested with Madoff and similar alleged Ponzi schemes had hoped that the IRS would give greater guidance on the uncertainties in treatment of losses and distributions in their filings for 2008 and prior years.

5. Charities that have invested with Madoff or suffered large losses during 2008 may have wanted to see how other Forms 990 and 990-PF filers that filed earlier in the year with the IRS treated the subjects in their financial statements and textual materials.

6. Even charities that did not suffer losses in 2008 may have wanted to see how other Forms 990 and 990-PF filers that filed earlier treated subjects such as description of mission, conflicts of interest and whistleblower policies, executive compensation and other potentially sensitive new areas of disclosure.

Over the course of the next several months it will be interesting and informative to visit Guidestar to review and analyze the 2008 Form 990 and 990-PF filings as they are posted. This blog series will continue to monitor and report on such developments.

[To be continued in Installment 20]
 

(With appreciation to Michael J. Kline, Esq., for contributing this entry and for his on-going analysis of the concerns of Madoff stakeholders)

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This is the eighteenth in a series of installments on this blog that are discussing some issues arising in the aftermath of the long global Ponzi scheme of Bernard L. Madoff (“Madoff”). Installments 3 through 8, Installment 10 and Installments 14 through 17 of this series focused on the specific concerns of charities that were victims of Madoff and similar schemes. All potential stakeholders should consult professional advisors to have their positions evaluated.

On October 27, 2009, Irving Picard, the trustee in the Madoff liquidation proceeding under the Securities Investor Protection Act (the “Madoff Proceeding”), together with Securities Investor Protection Corporation (“SIPC”) President Stephen Harbeck, held a telephone briefing with reporters on progress to date of the Madoff Proceeding. During the course of his prepared remarks, Mr. Picard did not discuss efforts in the Madoff Proceeding to “clawback,” that is, recover assets from Madoff investors who received more in cash distributions than they invested with him.

During the course of the questioning by reporters, the “clawback” issue was raised and the following response was given by Mr. Picard:

At the moment, as I indicated of the accounts that were active at the end of last December, there were 2,568 accounts that received more than was deposited. . . . That’s an area that we are looking at. We’re not going to be suing people who don’t have money. We’re not going to be able to collect. We’re not going to sue people where we become familiar with the fact that they have hardships, medical problems, losing their homes and other things like that. No final decisions have been made; it’s a matter that again, over a period of the next six to eight or nine months, we’re going to be taking a very close look and, quite frankly, those will be looked at virtually on an individual basis before we make some final decisions. . . . if we determine that that’s a matter that we’re going to pursue, then we will pursue them for what we believe is the appropriate amount that we should be seeking from them.

It is noteworthy that Mr. Picard did not address in his response the widely-publicized “profits” from investing with Madoff that have been reported for charities like Hadassah, as discussed in Installment 14 of this series.  

Mr. Picard’s response may be compared to the report by Diana B. Henriques on May 28, 2009 in The New York Times that “[t]here is the widespread fear among some — unfounded, Mr. Picard says — that he will sue struggling charities or people of limited means for money they withdrew in the past but no longer have.”

Has Picard now evidenced by his silence a subtle shift from his earlier position with respect to not pursuing ‘struggling charities” that made profits from investing with Madoff? The October 29,2009 issue of The Chronicle of Philanthropy has disclosed that Hadassah suffered a decline of almost 50% in donations during 2008 to just over $85 million as compared to the 2007 level. Does that loss in revenues qualify Hadassah to be exonerated from clawback as a “struggling charity” under Mr. Picard’s earlier position? A significant portion of the decline in Hadassah donations may be due to the economy generally. However, ironically, some of the decline may be attributable to the adverse publicity for Hadassah from having invested with Madoff. Moreover, a number of its major donors may have incurred heavy losses with Madoff and could not maintain their contributions to Hadassah.

As the Madoff Proceeding continues to unfold, these issues should become clearer.

[To be continued in Installment 19]
 

(With appreciation to Michael J. Kline, Esq., for contributing this entry and for his on-going analysis of the concerns of Madoff stakeholders)

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This is the seventeenth in a series of installments on this blog that are discussing some of the issues arising in the aftermath of the long global Ponzi scheme of Bernard L. Madoff (“Madoff”). Installments 3 through 8, Installment 10 and Installments 14 through 16 of this series focused on the specific concerns of charities that were victims of Madoff and similar schemes. All potential stakeholders should consult professional advisors to have their positions evaluated.

On October 21, 2009, an article in The New York Times by Ken Belson and Richard Sandomir disclosed that a Madoff bankruptcy proceeding report had contradicted earlier information about large losses with Madoff purportedly suffered by the New York Mets and their owners, the Wilpon family. The article states that the report shows that

Mets LP, one of the team’s financial arms, withdrew $570.5 million from two accounts it held with Madoff’s company, $47.8 million more than it put in. The accounts were part of a list of more than 30 in which more money was withdrawn than was deposited with Bernard L. Madoff Investment Securities. As a result, Mets LP and the others were deemed “net winners” ineligible for compensation and potentially liable to being sued by Irving H. Picard, the court-appointed liquidator who is trying to recover money lost in Madoff’s $65 billion Ponzi scheme. A spokesman for Picard declined to comment.

Thus the Mets and the Wilpon family may become the subject of “clawback” by Mr. Picard and end up losers, especially if they have paid now-unrecoverable federal and state income taxes on the illusory Madoff “gains.” This situation can be contrasted to the position stated by Picard with respect to seeking recovery from charities. As reported in Installment 16 of this blog series http://whitecollarcrime.foxrothschild.com/, Diana B. Henriques wrote on May 28, 2009 in The New York Times that “[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.”

Installment 14 of this blog series discussed reports of large profits by Hadassah from its investments with Madoff. Will Picard choose to pursue the Mets and the Wilpon family while passing on Hadassah? All charities, especially those providing social services like Hadassah, are “struggling” with materially reduced contributions because of the economy, increased demands by individuals who are unemployed and suffering financially, losses in endowment funds from the substantial market declines and increased regulatory activity.

While the position earlier stated by Picard as to charities may be humanitarian and emotionally appealing, there is little basis in the law for the disparity in treatment between charities and for-profit entities. This inequality of approach will more likely than not lead to protracted litigation and uncertainty in the Madoff matter.

[To be continued in Installment 18]
 

(With appreciation to Michael J. Kline, Esq., for contributing this entry and for his on-going analysis of the concerns of Madoff stakeholders)

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This is the fifteenth in a series of installments on this blog that are discussing some of the issues arising in the aftermath of the long global Ponzi scheme of Bernard L. Madoff (“Bernard”). Installments 3 through 8 and Installments 10 and 14 of this series focused on the specific concerns of charities that were victims of Madoff and similar schemes. All potential stakeholders should consult professional advisors promptly to have their positions evaluated.

A Cliffview Pilot report on September 15, 2009 by Jerry DeMarco reported that U.S. District Judge Stanley Chesler in Newark declined to dismiss a lawsuit brought by two children of, and the private charitable foundation (the “Foundation”) formed by, Senator Frank Lautenberg, who was its President. The claims in the lawsuit include allegations that Peter Madoff violated the Securities Exchange Act of 1934 by failing to disclose to investors that the company of his brother Bernard was engaged in a fraud. The plaintiffs are claiming losses aggregating almost $9 million.

Concerns about the profound financial and other impacts on charities, both public and private, from investments with Bernard were published soon after the Bernard scandal became public in December 2008. See, for example, “Charities Now Seek Bankruptcy Protection,” by Stephanie Strom in The New York Times on February 20, 2009.

The progress of the lawsuit brought by the Foundation raises several interesting points, some of which were discussed in previous Installments of this blog series.

First, it does appear that actions brought against other members of the Madoff family than Bernard may bear some fruit, separate and apart from the much-publicized Bernard bankruptcy proceedings in New York. Query whether the preliminary success of the Foundation will spur other stakeholders to sue members of the Madoff family, thereby exposing them to the potential for very large claims that could precipitate bankruptcy filings for them as well.

Second, as was discussed in an earlier Installment, private foundations such as the Foundation and their managers have potential liability for excise taxes that may be levied by the Internal Revenue Service (“IRS”) for improvident investing. Query whether success in the lawsuit would generate a compelling argument for the Foundation and its managers for avoidance of the excise taxes because of the alleged securities fraud. Alternatively, if the lawsuit is lost by the Foundation, does it increase the potential for success by the IRS in possibly imposing excise taxes on the Foundation and its managers?

Third, a check of the charity information website Guidestar indicates that the Form 990-PF of the Foundation for the 2007 calendar year was filed with the IRS on August 15, 2008. The Form 990-PF for the Foundation for 2008 has not yet been posted on Guidestar. The nature and extent of disclosures that will be made regarding the Foundation in its 2008 Form 990-PF should be illuminating about the litigation, financial status and contingencies respecting the Foundation.

[To be continued in Installment 16]
 

(With appreciation to Michael J. Kline, Esq., for contributing this entry and for his on-going analysis of the concerns of Madoff stakeholders)

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This is the fourteenth in a series of installments on this blog that are discussing some of the issues arising in the aftermath of the long global Ponzi scheme of Bernard L. Madoff. Installments 3 through 8 and Installment 10 of this series focused on the specific concerns of charities that were victims of Madoff and similar schemes. It generally advocated that every charity should respond pro-actively in the wake of the Madoff scandal and the current adverse economic climate. Such action should include a filing of its Form 990 with the Internal Revenue Service (the “IRS”) as promptly as practicable with appropriate disclosures, whether or not it was a Madoff stakeholder itself. All potential stakeholders should consult professional advisors promptly to have their positions evaluated. 

This Installment 14 is designed to compare and contrast the most recent Forms 990 filed with the IRS for fiscal 2008 by two of the most significant and respected charities that invested with Madoff: Hadassah, The Women’s Zionist Organization of America, Inc. (“Hadassah”) and Yeshiva University (“Yeshiva”). While the missions of Hadassah and Yeshiva (collectively, the “Charities”) are different, they provide a basis for comparison, and share as part of their missions the advancement of education and Jewish awareness in the United States and Israel. For disclosure purposes, readers are advised that the spouse of the author of this blog post has been a Life Member of Hadassah for many years.

Concerns about profound financial and other impacts on these Charities from their investments with Madoff were published soon after the Madoff scandal became public in December 2008.  For example, an article by Stewart Ain entitled “Hadassah Reveals $130 Million Windfall from Madoff,” was published in The Jewish Week on January 14, 2009 (the “Ain Article”). A more recent article on Hadassah and its involvement with Madoff that contains some is “Woman Tells of Affair with Madoff in New Book,” by Diana B. Henriques and Stephanie Strom, published in The New York Times on August 13, 2009 (the “Henriques/Strom Article”). An article about the impact of Madoff on Yeshiva entitled “Betrayed by Madoff, Yeshiva U. Adds a Lesson,” by Javier C. Hernandez was published in The New York Times on December, 23, 2008 (the “Hernandez Article”). 

Several weeks ago, the charity information website GuideStar posted the Hadassah Form 990 for the fiscal year ended May 31, 2008 (the “2007 Hadassah Form 990”). This past weekend the Website posted the Yeshiva Form 990 for the fiscal year ended June 30, 2008 (the “2007 Yeshiva Form 990” and collectively with the 2007 Hadassah Form 990, the “2007 Forms 990”).

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This blog series has already covered the newly-designed Form 990 for 2008 (the “2008 Form 990”) that requires 501(c)(3) entities to provide greatly expanded disclosure through answering questions that require “yes” or ‘no” responses about governance and business operations of charities. Questions that are answered “no” require explanation in the 2008 Form 990.

One of the questions for each of the Charities that would have required a response in the 2008 Form 990 (but not the 2007 Forms 990 recently filed with the IRS by the Charities) is whether the respective Board of Trustees and Audit Committee reviewed the 2007 Form 990 prior to its filing with the IRS. Because both Hadassah and Yeshiva have fiscal years other than the calendar year, they were able to use the old Form 990 for 2007. 

Some circumstances differ, and some are similar, for the Charities. As will be shown in the table below, it is my view that the 2007 Yeshiva  Form 990 has significantly greater disclosure and transparency relative to Madoff than the 2007 Hadassah Form 990. Either of the divergent approaches to disclosure chosen by each of the Charities in its 2007 Forms 990 may be compliant and supportable and were reviewed by the same “Big Four” accounting firm. However, this blog series has strongly recommended that early and complete transparency is advisable to maximize the value of utilizing the Form 990 in rebuilding public confidence in a charity that was affected by Madoff. Earlier disclosure will also get the “bad news” out into the open faster and allow the charity to move on. I believe that Yeshiva has been more successful than Hadassah in using its 2007 Form 990 for this purpose. 

The following table will highlight a comparison of some of the relevant factors drawn from the respective 2007 Forms 990 of the Charities that led to the views of the author. 

A COMPARISON OF HADASSAH AND YESHIVA 2007 FORMS 990

(Information in the Hadassah and Yeshiva columns is from their respective 2007 Form 990 unless otherwise noted; readers may access the 2007 Forms 990 by visiting GuideStar and completing a free online registration. Other noted sources in the table have the Internet links designated in the foregoing article.)

[To be continued in Installment 15]

(With appreciation to Michael J. Kline, Esq., for contributing this entry and for his on-going analysis of the concerns of Madoff stakeholders)

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This is the thirteenth in a series of installments on this blog that is discussing issues that face the manifold stakeholders who have been materially affected by the long and worldwide Ponzi scheme scandal of Bernard L. Madoff. All potential stakeholders should consult professional advisors promptly to have their positions evaluated.

Installments 3 through 8 and Installment 10 of this series focused on the specific concerns of charities that were victims of Madoff and similar schemes. This installment is a little different in that it does not relate directly to the Madoff morass but rather addresses a recent court decision on a Ponzi/Madoff scheme operated as a charitable gift annuity (“CGA”) program by a purported charity. The victims and stakeholders in this case were not bona fide charities that were duped but rather well-meaning donors who were misled into purchasing bogus CGAs. It is being included to underscore the endless varieties of investment vehicles that are in reality Ponzi/Madoff schemes.

A CGA is a contract under which a charity, in return for a transfer of cash, marketable securities or other assets by a donor, contracts to pay a fixed amount of money to one or two individuals, usually 60 years of age or older, for their lifetime(s). A person who receives payments is called an “annuitant”. The payments are fixed and unchanged for the term of the contract. The CGA payments are not “income”, because a portion of the payments are considered to be a partial tax-free return of the donor's gift, which are spread over the life expectancy of the annuitant(s).
The contributed property (the gift), given irrevocably, becomes a part of the charity's assets, and the payments are a general obligation of the charity. The CGA is backed by the charity's entire assets, not just by the property contributed. In these uncertain and risky economic times, a number of charities, including some that have invested with Madoff, have declared bankruptcy, which would cause severe economic loss to annuitants.

A CGA should be deemed by the donor to be primarily a gift to the charity, not an investment. The total return on a CGA is significantly less than that which could be earned through an annuity issued by a commercial insurance company. The gift annuity rates recommended by the American Council on Gift Annuities (“ACGA”), which are widely used by bona fide charities, have been computed to produce an average gift to the organization at the expiration of the annuity agreement of approximately 50% of the amount originally donated under the contract.

On June 24, 2009, the United States Court of Appeals for the Ninth Circuit decided the case of Warfield v. Alaniz, wherein the Court held that “CGAs” sold in this case (“Sham CGAs”) were investment contracts illegally sold under federal securities laws. Outside contractors such as financial planners and insurance agents had sold Sham CGAs aggregating $55 million on a commission basis for an organization that was a putative charity but in reality was using funds raised from the Sham CGAs solely to pay contractual returns to earlier annuitants and make payments to the promoters and contractors. Selling materials used by the sellers trumpeted high rates of returns, tax benefits, and superiority to commercial annuities, not a charitable intent for the Sham CGAs.

This type of Ponzi/Madoff scheme unfortunately seeks to prey on senior citizens who have a charitable motivation while seeking to maintain a secure return for their lifetimes. Those who would purchase CGAs should visit the Web site of the ACGA at the link above for explanations on CGAs and how to be aware of risk and dangers in purchasing CGAs.

In addition, points raised in earlier installments of this blog series should be followed by those interested in purchasing a CGA, including the following:

1. Go to websites for Guidestar or Charity Navigator to obtain the most recent Forms 990 filed by the charity with the Internal Revenue Service and read about the charity’s mission, analyze its financial statements, see how much it pays for administrative and fundraising expenses and learn about its governance structure.

2. Contact the charitable registration agency or attorney general of the state in which you live to ascertain whether the charity that is selling the CGA is in good standing in the state.

3. If your state is one that requires registration and annual filings for CGA programs, contact the state office that oversees this process.

4. Buy a CGA directly from the charity that you wish to benefit through an officer, employee, trustee or director of the charity (each a “Charity Representative”). Never purchase a CGA through a third party, whether or not on commission.

5. To the extent possible, meet in person with the Charity Representative - find out how long the CGA program of the charity has been in existence and the number of annuitants that exist.

6. Ask the Charity Representative for the current disclosure statement for the CGA program under the Federal Philanthropy Protection Act of 1995. If the Charity Representative does not have such a statement or does not know what you are talking about, you may be well advised to consider another charity.

7. Take into account your total assets, income and obligations to carefully limit the amount of money you commit to a CGA, as you should for all charitable contributions and investments.

8. Seek advice from a lawyer, accountant, financial planner or other adviser that you trust to advise you on the purchase of the CGA.

9. If the CGA program returns sound too good to be true, they should be suspect.

10. If after doing all of the above, you do not understand how a legitimate CGA works or you have pause on making what should primarily be a charitable donation, your purchase of a CGA may be inadvisable.

[To be continued in Installment 14]
 

(With appreciation to Michael J. Kline, Esq., for contributing this entry and for his on-going analysis of the concerns of Madoff stakeholders)

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This is the twelfth in a series of installments on this blog that is discussing issues that face the manifold stakeholders who have been materially affected by the long and worldwide Ponzi scheme scandal of Bernard L. Madoff. All potential stakeholders should consult professional advisors promptly to have their positions evaluated.

Installments 3 through 8 and Installment 10 of this series focused on the specific concerns of charities that were victims of Madoff and similar schemes. Installments 9 and 11 addressed concerns of an Indirect Individual Investor (“III”) who has been embroiled in the Madoff scandal, but not as a result of a direct investment with him.

This Installment is intended to recognize the noteworthy unrelated events of this week in the Madoff scandal. On Monday, June 30, Federal District Judge Denny Chin in Manhattan sentenced Madoff to 150 years in federal prison for his crimes that were characterized by the Judge as “extraordinarily evil.” The Judge cited three symbolic reasons for the maximum sentence that he imposed on the 71-year-old Madoff. They were retribution, deterrence and justice for the victims. I would add a fourth need arising from the Madoff matter itself: the warning to any potential co-conspirators to come forward and cooperate in order to avoid a harsh sentence if later convicted. Such cooperation could raise the level of assets that can be made available to provide restitution to stakeholders.

There may be finality to the criminal case involving Madoff himself, except for his possible appeals to reduce the length of the sentence, which may be moot in any event in light of his age. However, while this result may give some closure and perhaps even “psychic income” for stakeholders who were victimized by Madoff, it provides no economic benefit to assuage their losses, other than perhaps encouraging collaborators to cooperate. More important for their situation is that on Thursday, July 2, the deadline came for filing claims by victims for recovery under the Securities Investor Protection Corporation (“SIPC”), the federal insurance agency for the securities brokerage industry.

On June 29, 2009, Eric Konigsberg wrote an article in The New York Times entitled “Investors Compete for a Piece of the Madoff Pie,” in which Mr. Konigsberg chronicled the staking out of claims for a portion of the limited funds available for victims with highly diverse and complex factual patterns as to how and how much money they lost with Madoff. Those who are IIIs, for example, have been told by Irving H. Picard, the trustee for Madoff’s assets, that they cannot make a separate SIPC claim. Mr. Konigsberg describes these stakeholders as believing that “they are being treated as members of a lower caste, in that many of them went through feeder funds because they lacked the requisite $1 million or $2 million minimum to go straight to Mr. Madoff.” The article reports that Mr. Picard encouraged such IIIs to file claims in any event for later court cases and that 8,800 claims were already filed of an estimated tens of thousands.

The criminal case against Madoff is finished; other criminal or regulatory actions may be brought against putative collaborators with Madoff in the future. However, those who are economic stakeholders must maintain close contact with the economic developments in the matter as they occur. Because the ultimate “pie” will be far less than the aggregate of slices that are being sought, victims should seek professional interpretations and advice as the inevitably complicated processes and determinations unfold.

[To be continued in Installment 13]

(With appreciation to Michael J. Kline, Esq., for contributing this entry and for his on-going analysis of the concerns of Madoff stakeholders)
 

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This is the eleventh in a series of installments on this blog that is discussing some of the issues that face the manifold stakeholders who have been materially affected by the long and worldwide Ponzi scheme scandal of Bernard L. Madoff. All potential stakeholders should consult professional advisors promptly to have their positions evaluated.

Installments 3 through 8 and Installment 10 of this series focused on the specific concerns of charities that were victims of Madoff and similar schemes. This Installment is continuing the discussion from Installment 9 on the concerns of an Indirect Individual Investor (“III”) who has been embroiled in the Madoff scandal, but not as a result of a direct investment with him.

Such IIIs may have invested with a fund, investment manager or other vehicle, such as a hedge fund that was a “feeder” for Madoff, or even a partnership of family and friends that was formed to aggregate funds sufficient to invest with him. Each of these types of entities will be defined in this series as a Direct Entity Investor (“DEI”), even though some DEIs may have invested their money with a feeder fund for Madoff that in turn invested directly or indirectly with him.

Those that are IIIs and were “fortunate” enough to have secured distributions from the DEI through indirect redemptions from Madoff in the past may believe that they were either lucky or brilliant to have withdrawn money before his arrest on December 11, 2009. However, such IIIs must be concerned about the extent to which the Madoff bankruptcy trustee or federal or state regulators may be intensifying efforts to recover money or seek criminal prosecutions from those who withdrew money from their Madoff investments. While the initial efforts by the trustee can be expected to be focused upon DEIs that received large distributions and were close to Madoff in making direct investments with him, the focus can be expected to go further down the line to IIIs as well.

The word most commonly used for such monetary recovery efforts in the Madoff morass is “clawback.” Distributions from a DEI to an III are potential targets for the bankruptcy trustee because they may be materially disproportionate to the withdrawals of the average investor (“Clawback Targets”). The word clawback actually covers a number of scenarios and theories for recovery by the bankruptcy trustee under the Federal Bankruptcy Code and various state laws that may have varying degrees of likely exposure for the III.

The basis of clawback is that all of the investors who were engaged in a single, unitary, integrated, failed Ponzi enterprise should have a relatively level playing field and that those that received disproportionate distributions should disgorge their excess receipts.

To a certain degree, the energy that will be undertaken by the bankruptcy trustee for Madoff to pursue an III will depend on (i) the absolute amount in dollars of the distribution to such III, especially in relation to the actual hard dollars invested (net of the nonexistent “returns” reported to the III by Madoff), (ii) how recently the redemption(s) took place and/or (iii) the individual factual circumstances that exist relative to the redemptions by the III. The “clawback” process may become highly complex and may be affected by state law, which may differ from state to state. Competent professional advice for IIIs is a necessity in this area.

[To be continued in Installment 12]
 

(With appreciation to Michael J. Kline, Esq., for contributing this entry and for his on-going analysis of the concerns of Madoff stakeholders)

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This is the tenth in a series of installments on this blog that are discussing some of the issues that face the manifold stakeholders that have been materially affected by the long global Ponzi scheme of Bernard L. Madoff. All potential stakeholders should consult professional advisors promptly to have their positions evaluated.

Installments 3 through 8 of this series focused on the specific concerns of charities that were victims of Madoff and similar schemes. It generally advocated that every charity should respond pro-actively in the wake of the Madoff scandal and the current adverse economic climate, including a filing of its Form 990 for 2008 (the “2008 Form 990”) with the IRS as promptly as practicable, whether or not it was a Madoff victim itself. This Installment 10 is designed to extend the discussion in Installment 6 on calendar year filers of the 2008 Form 990 to the many 501(c)(3) entities that have fiscal years other than calendar years (“Fiscal Year Charities”).

This blog series has already pointed out that the 2008 Form 990 contains new questions that require “yes” or ‘no” answers about governance and business operations of 501(c)(3) entities. In some respects it emulates the passive regulatory schemes present in Canada and many European countries to “comply or explain why.” By requiring an explanation if an answer is in the negative, the regulator promotes the desired affirmative behavior.

As has been discussed previously, the 2008 Form 990 includes a series of questions, among others, as to whether the charity has (i) a conflicts of interest policy, (ii) a whistleblower policy, (iii) an audit committee and (iv) a document retention and destruction policy. The 2008 Form 990 also asks whether the audit committee and governing board has reviewed the 2008 Form 990 before it was filed and information about executive compensation and transactions with insiders.

If the charity answers “yes” to a question, it can go on to the next question. If the answer is “no,” the charity must explain why. Obviously the universal availability of the 2008 Form 990 makes it desirable to answer all or almost all of the questions “yes.” Otherwise potential donors and other stakeholders may have questions and draw conclusions of their own about the operating practices of the charity and whether it is worthy of a contribution.

It is further interesting to note that the many Fiscal Year Charities have even longer than May 15, 2009 as their initial due date for filing their 2008 Forms 990 for 2008. Numerous nonprofit colleges and universities, for example, are on fiscal years that begin on June 1 or July 1 of each year.

As an illustration, a Fiscal Year Charity for which its current fiscal year commenced on July 1, 2008, would end such fiscal year on June 30, 2009. Its 2008 Form 990 for the current fiscal year will not be initially due until November 15, 2009. If it were to extend the due date for the 2008 Form 990 by the theoretical maximum of six additional months discussed earlier in Installments 6 and 7, the due date would be May 15, 2010.

A Fiscal Year Charity will have an ample opportunity to acquire samples from the internet of examples of 2008 Forms 990 filed earlier by calendar-year-end charities. Moreover, it has additional time to do what it deems necessary and appropriate to implement “best practices” in order to respond “yes” to the questions and answers posed in the 2008 Form 990. A charity will be well-served to file its 2008 Form 990 as promptly as possible as was recommended in Installment 7 of this blog series.

[To be continued in Installment 11]
 

(With appreciation to Michael J. Kline, Esq., for contributing this entry and for his on-going analysis of the concerns of Madoff stakeholders)

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This is the ninth in a series of installments on this blog that is discussing some of the issues that face the manifold stakeholders that have been materially affected by the long global Ponzi scheme of Bernard L. Madoff. All potential stakeholders should consult professional advisors promptly to have their positions evaluated.

Installments 3 through 8 of this series focused on the specific concerns of charities that were victims of Madoff and similar schemes and advocated that every charity should respond pro-actively in the wake of the Madoff scandal and the current adverse economic climate, whether or not it was a Madoff victim itself.

We will now undertake a discussion of the concerns of an Indirect Individual Investor (“III”) who has been embroiled in the Madoff scandal not as a result of a direct investment with him The III may have invested in an entity that was either (i) a fund, investment manager or other vehicle, such as one of the well-publicized hedge funds that were “feeders” for Madoff, or (ii) an investment vehicle, such as a partnership or limited liability company, that was formed for the express purpose of aggregating sufficient funds from multiple investors to meet the minimum investment thresholds established by Madoff from time to time. There can be other permutations or combinations of these types of entities. Each of these types of entities will be defined in this series as a Direct Entity Investor (“DEI”).

This series will not address in detail the potential tax issues facing the III, as there has been extensive discussion in numerous other publications and internet postings on the tax consequences flowing from losses on investments with Madoff.

As is true of the Direct Individual Investor (“DII”) with Madoff who was discussed in early installments of this blog series, the III should be doing or have already done a number of things. However, the effort by the III must be on two levels: his or her investment in the DEI and the DEI’s investment in turn with Madoff

The III should collect every scrap of hard copy, digital or electronic information and communication that can be located relative to the investment in the DEI and the DEI’s investment with Madoff (collectively, “III Investment”), including statements, financial or otherwise, from the DEI or Madoff, tax statements such as Forms 1099 from the DEI, annual reports, press releases or other media statements by the DEI or Madoff as to the nature of the investments and returns, etc. Such information will prove to be valuable in identifying the scope of the loss by the III and the sequence of events that gave rise to the loss.

The III has many more complex issues, however, that the DII, who only has to deal with the records relating to a direct investment with Madoff. The III must seek out all formation documents filed with state agencies relative to the DEI and any agreements, such as partnership agreements and operating agreements, DEI tax returns, brokerage reports, DEI tax returns, copies of checks or other records of all payments respecting the III to and from the DEI, requests for distributions by the III, records of the DEI regarding its investments with Madoff and distributions from Madoff, if any. The DEI partnership, operating or similar agreement with its IIIs as to the provision of information and other rights of the IIIs and their III interests is of paramount importance.

To the extent that the DEI is not fully forthcoming with information requested by III or is unable to locate records regarding the III Investment, the III should contact the managers of the DEI in writing or by other means that will evidence the communication to the DEI and its date. Should the III not receive a meaningful response, he or she should contact an attorney or other competent professional to advise on the matter.

[To be continued in Installment 10]
 

(With appreciation to Michael J. Kline, Esq., for contributing this entry and for his on-going analysis of the concerns of Madoff stakeholders)

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This is the eighth in a series of Installments on this blog that will discuss some issues that face the manifold stakeholders who have been materially affected by the Bernard L. Madoff scandal, allegedly the longest, most widespread and financially devastating Ponzi scheme on record. All potential stakeholders should consult professional advisors promptly to have their positions evaluated.

In this Installment we will complete the current discussion that focuses on charitable organizations and foundations (collectively, “501(c)(3) Entities”) that were affected by the Madoff scandal. Future developments in the Madoff matter respecting 501(c)(3) Entities may lead to additional Installments in this area. Again, we reiterate that the unfortunate experiences of many 501(c)(3) Entities that were directly involved in losses and potential “clawback” from the Madoff morass should be poignant object lessons for all charitable organizations and their fiduciaries and supporters, whether or not victims of Madoff.

Governance Principles Raised in the 2008 Form 990 Filing (the “2008 Filing”)

Installment 7 introduced the new governance disclosures for 501(c)(3) Entities that have been introduced or expanded in the 2008 Filing. Before these changes, matters of corporate governance of 501(c)(3) Entities were generally left to state corporate statutes and case law. The 2008 Filing has broadened the scope of federal scrutiny of the way 501(c)(3) Entities operate. In the 2008 Filing this is done through a series of questions to the 501(c)(3) Entities, together with a request for explanations in certain areas

A number of 501(c)(3) Entities had close ties with Madoff and his associates, including in some cases, their membership on boards. If some of the new inquiries in the 2008 Filing had been in place in earlier years and had been fully and accurately answered, the potentially inappropriate relationship of Madoff and his associates to such 501(c)(3) Entities may have been brought to light. The following questions in the new 2008 Filing fall in this category:

1. Are there any family or business relationships among officers, directors, trustees and key employees of the 501(c)(3) Entity?

2. Is there any “material diversion” of the 501(c)(3) Entity’s assets?

3. Does the 501(c)(3) Entity prepare contemporaneous documentation of all board and committee meetings?

4. Does the 501(c)(3) Entity have a written conflict of interest policy with annual disclosure of related transactions with the 501(c)(3) Entity by officers, directors, trustees and key employees? (New Schedule O to the 2008 Filing asks for information about regular monitoring and enforcement of compliance with this policy.)

5. Was the 2008 Filing provided to the board before it was filed? (New Schedule O to the 2008 Filing asks for the process used by the 501(c)(3) Entity to review the 2008 Filing by the board and its audit committee, if any.)

6. New Schedule O to the 2008 Filing asks how governing documents, conflicts policy, the 2008 Filing and financial statements will be made available to the public.

While the 2008 Filing does not mandate that the 501(c) Entity have all of these and other governance policies in place or the type of policy that is required, the universal availability of the 2008 Filing makes it almost a necessity for a 501(c) Entity to take sufficient preparatory steps to be able to answer all of the questions in the affirmative as a matter of “best practices.” Otherwise potential donors, granting organizations and foundations, and governments may choose not to provide funding to a 501(c) Entity that has less than fully adequate responses.

Moreover, in future years it can be expected that the Form 990 will become even more stringent in its disclosure requirements, perhaps even setting minimum standards for conflicts of interest and other policies.

Conclusions Respecting Governance of 501(c) Entities after Madoff

The unfortunate Madoff scandal, an adverse economy and other events have combined to create challenging times for charities and their stakeholders. A properly prepared Form 990 that reflects recent proactive changes in governance and operations under the leadership of the governing board will go far in repairing the damage to the images of those that invested with Madoff and in enhancing the reputations of those that avoided the Madoff morass.

The next Installment will discuss the impact of the Madoff morass on those that invested with him indirectly through “feeder funds,” other vehicles or even unwittingly.

[To be continued in Installment 9]

(With appreciation to Michael J. Kline, Esq., for contributing this entry and for his on-going analysis of the concerns of Madoff stakeholders)

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This is the seventh in a series of Installments on this blog that will discuss some issues that face the manifold stakeholders who have been materially affected by the Bernard L. Madoff scandal, allegedly the longest, most widespread and financially devastating Ponzi scheme on record. All potential stakeholders should consult professional advisors promptly to have their positions evaluated.

We will continue the discussion of charitable entities and foundations that were affected by the Madoff scandal. Again, we believe that the unfortunate experiences of many charitable organizations and foundations (collectively, “501(c)(3) Entities”) that were directly involved in enormous losses from the Madoff morass should be poignant object lessons for all charitable organizations and their fiduciaries and supporters, whether or not victims of Madoff. This Installment will continue the discussion of the aftermath of the Madoff scandal for 501(c)(3) Entities, against the backdrop of the new Form 990 that has been adopted by the IRS for 501(c)(3) Entities.

Reasons Why a 501(c)(3) Entity Should File its 2008 Form 990 as Early as Possible

We have already discussed in Installment 6 the reasons why a 501(c)(3) Entity may choose or be induced to file its Form 990 for 2008 (the “2008 Filing”) on as late a date as possible in 2009, which may be extended to November 15, 2009. We believe that it is advisable for a charity to make its 2008 Filing as soon as practicable, so that it may commence an initiative for building and repairing bridges with stakeholders as soon as possible.

Many 501(c)(3) Entities will be showing relatively dismal results for 2008. Those charities that invested with Madoff will show losses that are devastating, both from economic and public image points of view. Even a charity that did not invest with Madoff most likely has suffered severe financial losses in its endowment funds since the beginning of 2008. Additionally, the deepening recession during 2008 had a materially negative impact on fundraising revenues. A charity that delays the 2008 Filing until almost 2010 will raise questions among those analysts, foundations and regulatory agencies that review and use Form 2008 Filings. The charity will also highlight late in 2009 a charity’s negative results for 2008. Getting the “bad news” out and in circulation earlier in 2009 will enable a charity to start afresh.

An early filing of the 2008 Filing with positive answers to the new questions and in the new schedules discussed hereafter can disclose a charity’s strong commitment to a defined mission, appropriate governance and investment policies, appropriate engagement by the board and other matters. The new changes to 2008 Filing will allow a charity to use the IRS items as a checklist of “best practices” and tell its positive story in its own words. Additionally, a 501(c) Entity can post its Forms 990 on its own website, together with principal governance documents, that demonstrate its commitment to best practices.

General Outline of New Areas Covered in the 2008 Filings

The new thrust for Form 990 is to emphasize compliance, transparency and accountability for 501(c)(3) Entities. As discussed in earlier Installments, the initiatives by the Senate Finance Committee in the last several years with respect to charities, especially hospitals and colleges and universities, led the IRS to make the changes in the 2008 Filing to appropriately take advantage of its public nature, widespread availability and accountability aspects.

However, the 2008 Filing also affords 501(c)(3) Entities with opportunities to explain and supplement their responses, to define and amplify their mission statements and tell their stories in a place that is universally available.

The principal design of the 2008 Filing changes are outlined below. Not all of them necessarily relate to the Madoff scandal that is the subject of this series, but they are worth mentioning.

1. Increased focus on activities, not just the financial results and other metrics respecting the 501(c)(3) Entity

2. A summary page on which a 501(c)(3) Entity can provide highlights of the 2008 Filing

3. A checklist of the comprehensive new schedules that may be required for certain types of 501(c)(3) Entities, e.g., hospitals

4. A governance section relating to the governing board, policies and disclosure items

5. A compensation and insider transactions section

6. A section on foreign activities

7. A description of related organizations, joint ventures, and unrelated business income

8. A description of non-cash contributions and fundraising

Governance Disclosures under the 2008 Filing

A number of new inquiries on the 2008 Filing could have brought to light the dealings by some charities with Madoff, if they had been in existence on Form 990 in earlier years and had been answered completely and accurately,. This is the new part of Form 990 that requires comprehensive disclosures of the governance policies and practice of a 501(c)(3) Entity. Some of the areas that are addressed in the 2008 Filing include explanatory and descriptive schedules if (i) the charity has loans or other transactions with “insiders” including officers and directors and highly paid individuals, (ii) there are “related organizations” and (iii) compensation in excess of defined thresholds is paid to current and former officers, board members and key employees.

The next Installment will continue in greater detail the aftermath of the Madoff scandal for 501(c)(3) Entities and its relationship to the new compliance, transparency and accountability obligations for 501(c)(3) Entities in the 2008 Filing.

[To be continued in Installment 8]

(With appreciation to Michael J. Kline, Esq., for contributing this entry and for his on-going analysis of the concerns of Madoff stakeholders)
 

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This is the sixth in a series of Installments on this blog that will discuss some of the threshold issues that face the manifold stakeholders who have been materially affected by the Bernard L. Madoff scandal, allegedly the longest, most widespread and financially devastating Ponzi scheme on record. All potential stakeholders should consult professional advisors promptly to have their positions evaluated.

We will continue the discussion of charitable entities and foundations that were affected by the Madoff scandal. However, we believe that the unfortunate experiences of many charitable organizations and foundations (collectively, “501(c)(3) Entities”) that were directly involved in enormous losses from the Madoff morass should be poignant object lessons for all charitable organizations and their fiduciaries, whether or not victims of Madoff. This Installment will continue the discussion of the aftermath of the Madoff scandal for 501(c)(3) Entities, with an emphasis on the review and analysis of governance and investment policies that charitable organizations should be conducting to repair and/or enhance their standing among their peers and competitors for contributions.

Installment 5 and prior Installments raised certain problems that exist for private foundations that are 501(c)(3) Entities which invested with Madoff. Such private foundations face the “triple jeopardy” of actual losses of investment value, the possibility of penalty excise taxes for imprudent investments and/or the potential for “clawback” by the trustee for the Madoff assets if the private foundation received substantial and disproportionate payments as compared to the average return for all other investors.

While 501(c)(3) Entities that are public charities and not private foundations do not have the potential for penalty excise taxes, they are subject to loss of investment value and clawback from Madoff investments. Therefore, all 501(c)(3) Entities have similar concerns.

This series of Installments will discuss a number of issues arising from the Madoff scandal in the context of an expanded and more comprehensive Form 990 that 501(c)(3) Entities must file annually with the IRS. The adverse publicity that many charities have suffered from having been involved with Madoff, combined with the substantial losses in market value that charitable endowment and trust funds have incurred over the last year, make it critical that all 501(c)(3) Entities review, analyze and reform their operating policies and procedures. Only by demonstrating their commitment to best practices in governance and operations can they succeed in the increasingly competitive environment for shrinking donor dollars in an adverse economic climate.

Required Filings by 501(c)(3) Entities with the IRS

501(c)(3) Entities that achieve certain minimum sizes as to revenues and/or assets are required to file annual tax returns with the IRS. The filing form for public charities is Form 990 and for private foundations is Form 990-PF. This Installment will focus on Form 990 for public charities because of the dramatic changes that have occurred in the requirements for a 2008 Form 990 filing to be made in 2009 (“2008 Filing”).

It is a coincidence that the uncovering of the Madoff scandal occurred in the year relating to the 2008 Filing and its comprehensive changes to Form 990. However, the Madoff scandal has raised the stakes for a charity to be sufficiently proactive in reviewing, analyzing and revising its compliance, transparency and accountability to enable it to file on a timely basis a complete and accurate 2008 Filing. The changes in the 2008 Filing, which will be hereafter described in greater detail, will require disclosures for a charity that relate directly to the Madoff investments and scandal as to governance and decision-making by their boards. The changes for 2008 Filings may only be the beginning of an evolution in Form 990 that will require even more comprehensive disclosures by charities in the future.

Form 990 as a Financial Reporting Document

For many years Form 990 was viewed as an annual financial report by a 501(c)(3) Entity to the IRS on the charity’s operations for the prior fiscal year. The financial statements track very closely the annual audited financial reports of the 501(c)(3) Entity. The annual financial statements of 501(c)(3) Entities in the 2008 Filing can be expected to be generally dismal because of significant losses in market values of charitable endowment and trust funds during 2008. Both the balance sheet and statement of revenues and expenses in the 2008 Filing will reflect such losses. The financial statements of 501(c)(3) Entities that invested with Madoff will be even more negative to the extent that the Madoff investments may prove to be almost worthless. Such 501(c)(3) Entities will have a need to explain clearly and carefully in the 2008 Filing the steps that they have taken and will take to avoid a repetition of serious mistakes of the past. The changes in the Form 990 for 2008 encourage that approach.

In effect, the changes in Form 990 have converted the Form 990 to much more of a disclosure document for 501(c)(3) Entities akin to the Form 10-K Annual Report filed by public business corporations on an annual basis with the federal Securities and Exchange Commission.

Universal Transparency and Filing Dates for Forms 990

Form 990 is required to be filed with the IRS by the 15th day of the month following the end of a charity’s fiscal year, e.g., May 15, 2009 for the 2008 Filing by a charity with a fiscal year ended on December 31, 2008 (“Calendar Year Filer”). It must be understood that, unlike federal tax returns filed by business corporations, the Form 990 filed by 501(c)(3) Entities can be accessed anonymously by anyone in the world at any time. It becomes a matter of public record after it is filed with the IRS. Web sites, perhaps the most well known of which is www.guidestar.org, publish Forms 990 on line, ordinarily within two months after they are filed. Potential donors, competitors, governmental agencies, beneficiaries and many others easily and routinely access the Forms 990 to analyze operations and other aspects of a 501(c)(3) Entity.

A Calendar Year Filer can have up to two extensions for filing its 2008 Filing that would allow it to delay filing until November 15, 2009. It can be anticipated that many 501(c)(3) Entities will extend their filing dates as long as they can. First of all, those 501(c)(3) Entities that invested with Madoff will most likely require extra time to determine the extent to which the value of the Madoff investment has deteriorated. Such valuation may be closely tied to the prospects for recovery of monies and progress with related civil and criminal cases.

A second reason is that the new requirements for disclosure in 2008 Filings will make it necessary for a 501(c)(3) Entity to generate new material and respond to new questions, perhaps only after the implementation of new policies by its governing board, so that the responses reflect best practices in the Form 990.

Another reason for the likely delays in filing of the 2008 Filings will be that many 501(c)(3) Entities will endeavor to see what types of responses to the new 2008 Filing questions other 501(c)(3) Entities will make. In a number of cases the larger, more seasoned 501(c)(3) Entities may be among the early filers of 2008 Filings. For example, a hospital that is a 501(c)(3) Entity may have obligations under trust indentures for outstanding bond issues that require provision to the trustee of the Form 990 by a specified time based upon the original due date of the Form 990. The early filers of 2008 Filings will, therefore, in some cases be setting some unofficial benchmarks for responses to new questions in the 2008 Filings.

Penalties for Violations of Provisions Covering Form 990 Filings

There are potential serious adverse consequences for a 501(c)(3) Entity that fails to file on a timely basis a complete and correct Form 990. The Internal Revenue Code provides for civil monetary penalties of $20 per day for failure to file a complete and correct Form 990 by its original due date (or permitted extension date for filing). The maximum penalty for any one Form 990 is the lesser of $10,000 or 5% of the gross revenues of such 501(c)(3) Entity. However, for a 501(c)(3) Entity that has gross receipts exceeding $1,000,000 for any year, the penalty for failure to file a complete and correct Form 990 by its required due date is $100 per day up to a maximum of $50,000 for any one Form 990.

Additionally, a private IRS ruling released on February 27, 2009 revoked the tax exempt status of a 501(c)(3) Entity that did not observe the conditions for its continued exempt status by failing to file a Form 990 for each of the preceding two fiscal years. Accordingly, the 501(c)(3) Entity was no longer exempt from federal income taxation and contributions by donors were no longer tax deductible.

The civil monetary penalties and revocation of tax-exempt status cover the new disclosure requirements for Form 990.

The next Installment will continue the discussion of the aftermath of the Madoff scandal for 501(c)(3) Entities with an emphasis on its relationship to the 2008 Filings and the related compliance, transparency and accountability obligations of the 501(c)(3) Entities.

[To be continued in Installment 7]
 

(With appreciation to Michael J. Kline, Esq., for contributing this entry and for his on-going analysis of the concerns of Madoff stakeholders)

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This is the fourth in a series of Installments on this blog that will discuss some of the threshold issues that face the manifold stakeholders who have been materially affected by the Bernard L. Madoff scandal, allegedly the longest, most widespread and financially devastating Ponzi scheme on record. All potential stakeholders should consult professional advisors promptly to have their positions evaluated.

We will continue the discussion of charitable entities and foundations that invested with Madoff. This series has already discussed in Installment 3 some generally accepted accounting principles specific to 501(c)(3) Entities that aided Madoff in extending the life and increasing greatly the scope of his operation. Hand in hand with the GAAP principles for 501(c)(3) Entities that assisted Madoff are federal income tax rules that are applicable to 501(c)(3) Entities.

Direct Entity Investors (“DEI”) that are charitable entities and foundations (“501(c)(3) Entities”)

Certain Income Tax Rules Applicable to 501(c)(3) Entities that Inured to the Benefit of Madoff

The most important tax principle for 501(c)(3) Entities that benefited Madoff is that their investment income is exempt from federal and state income taxes. Charities can therefore stay fully invested and roll over investment income into further investments. This was a powerful tool for Madoff. Because of the apparent safety, consistency and stability of his relatively high “returns,” Boards and Investment Committees of 501(c)(3) Entities would be disinclined to redeem either principal or “returns” in accounts with Madoff because they did not even have to pay taxes on their reported returns from Madoff. Such 501(c)(3) Entities would seek to use funds from other areas of their endowment funds to remain as fully invested as practicable with Madoff.

Madoff preyed upon the various business and tax advantages that many 501(c)(3) Entities saw in an investment with him. As a result Madoff was able to count on the fact that charities would be resistant to request redemptions of principal and would even reinvest their reported “returns” for a long period of time. It was only when the rest of the financial markets collapsed that 501(c)(3) Entities began to demand large distributions that Madoff could not meet. Then the 501(c)(3) Entities became subject to the glare of adverse publicity and embarrassing questions as to how and why the staggering losses that they suffered had taken place.

Summary of the benefits for Madoff’s operations of the credibility and stability that he projected to 501(c)(3) Entities
The next discussion in this series will focus on the proactive review and responses that 501(c)(3) Entities should be considering in governance and investment policies to the shocking losses and other harmful aftermath of investing with Madoff. Such a proactive review makes good sense for all 501(c)(3) Entities, irrespective of whether or not they were investors with Madoff. The increased regulatory scrutiny under which charities will be operating in the future makes “best practices” a necessity.

As a prelude to that discussion, it should again be observed that 501(c)(3) Entities have been on the lookout for many years for investment vehicles in which to place their endowment funds that appear to have a high degree of safety and stability and provide a consistent and relatively high rate of return. An investment with Madoff appeared to be ideal to many 501(c)(3) Entities on all of these levels, especially with his track record of 12% average annual returns over decades, combined with the added credibility flowing from the fact that many other highly respected 501(c)(3) Entities were also long time investors. Moreover, for 50 years Madoff had been a leader and innovator in the investment industry and had been Chairman of the NASDAQ Stock Market. This prominence enhanced his stature and trustworthiness as an investment advisor. Therefore, Boards and Investment Committees of many 501(c)(3) Entities felt comfortable with entrusting millions of their endowment dollars with Madoff for extended periods.

Such comfort was heightened by the fact that Madoff appeared to be one with them, that is, he was the epitome of the famous “Three W’s” that are the most desirable attributes for Board members of 501(c)(3) Entities: Wealth, Wisdom and Work. Madoff evidenced personal wealth and largesse in personally contributing large sums to numerous charities; he appeared to unselfishly share his wisdom, experience and business acumen with those 501(c)(3) Entities in which he was interested; and finally he was deeply involved in rising to leadership roles in charities because of his work effort and apparent wealth and wisdom. All of these factors, combined with the apparent business and tax benefits of an investment with Madoff for 501(c)(3) Entities, enhanced the scope and longevity of his enterprise.

The next Installment will continue the discussion of the aftermath of the Madoff scandal for 501(c)(3) Entities with an emphasis on the review and analysis on governance and investment policies that charitable organizations should be conducting to repair and/or enhance their standing among their peers and competitors for contributions.

[To be continued in Installment 5]
 

(With appreciation to Michael J. Kline, Esq., for contributing this entry and for his on-going analysis of the concerns of Madoff stakeholders)

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This is the third in a series of Installments that will discuss some of the threshold issues that face the manifold stakeholders who have been materially affected by the Bernard L. Madoff scandal, allegedly the longest, most widespread and financially devastating Ponzi scheme on record. All potential stakeholders should consult professional advisors promptly to have their positions evaluated.

We will continue by discussing Direct Entity Investors.

Direct Entity Investors (“DEI”) that are charitable entities and foundations (“501(c)(3) Entities”)

General

Perhaps the most perplexing and concerning group of Madoff victims is the long list of charitable organizations that have reportedly lost many millions of dollars in their endowment funds through investments with Madoff. A number of 501(c)(3) Entities have even been forced to abruptly cease their operations.

There are a number of reasons that Madoff may have targeted 501(c)(3) Entities as potential investors, some of which will be discussed in these Installments. The harm that has been inflicted upon many charities, with respect to finances and image, requires discussion beyond the level of other classes of Madoff victims. 501(c)(3) Entities occupy a unique position in society, as tax exempt organizations to which contributions are deductible, thereby imposing on their governing boards a higher standard for operating and investing. These boards have the responsibility for overseeing, protecting and dealing with contributions of others to serve charitable missions that society deems to be of high value. There are important principles on governance and compliance that may be drawn from the Madoff scandal, which should be considered by all 501(c)(3) Entities and their governing boards, whether or not they were direct or indirect investors with Madoff.

In recent years, legislators like Senator Charles Grassley (R-Iowa), the Ranking Member of the Senate Finance Committee, have been questioning whether charities, especially hospitals and colleges and universities are adequately carrying out their charitable missions at a sufficiently high level to warrant their continued favored tax exempt status. One of his principal criticisms is that these institutions are more interested in enhancing their endowment funds than spending such funds on the charitable missions that qualify them for tax-exempt status. The losses to charities with Madoff investments, some of which had appurtenant overtones of conflicts of interest, are almost certain to raise further calls for greater controls on tax exempt organizations and how they use and invest their endowment funds to achieve their charitable missions. The Madoff scandal greatly exacerbated the massive endowment losses in 2008 of 501(c)(3) Entities.
 

Charitable Involvements of Madoff

Madoff enhanced his reputation and standing in the community of wealthy potential investors by being a leader of and heavy contributor to highly visible charitable organizations. Such organizations included those with humanitarian, educational and religious missions. By identifying himself with such charities, Madoff was able to associate with wealthy individuals and leaders involved in foundations, business entities and government. This enabled him to get access to a diverse group of investors, including the charities themselves.

The investment by charitable organization with Madoff held certain advantages for Madoff in furtherance of his alleged Ponzi scheme. These include certain accounting rules and tax laws that are specific to public charities and private foundations.

Certain Accounting Rules Applicable to 501(c)(3) Entities that Inured to the Benefit of Madoff

The first accounting principle that is worthy of note in the Madoff context is the requirement under generally accepted accounting principles for 501(c)(3) Entities (“GAAP”) that 501(c)(3) Entities “mark investments to market.” Therefore, under this GAAP principle, unrealized gains and losses on investments by 501(c)(3) Entities are recognized on the income statement and the current value of investments is reflected on the balance sheet. This principle inured to the benefit of Madoff, because his reporting of consistently high, stable “returns” over years would encourage 501(c)(3) Entities to simply reinvesting and rolling over their Madoff “returns.” It became clear to Madoff than 501(c)(3) Entities would predictably seek to maintain the Madoff investments intact to get the maximum benefit for revenues on their income statements and balance sheet values. To the extent that a 501(c)(3) Entity needed endowment funds or returns, it would be inclined to draw upon assets other than Madoff investments. This in turn enhanced the ability of Madoff to extend the life of his enterprise by avoiding redemptions and even distribution of current “returns.”

Another GAAP principle that would inure to the benefit of Madoff is the requirement that financially credible pledges to 501(c)(3) Entities of multi-year gifts are all recognized as revenues in the year the pledge is first made. To the extent that donors or even Madoff himself expected to use Madoff investments to satisfy such multi-year pledges, the 501(c)(3) Entities would recognize the full amount of the gift in the year of the pledge and then receive interests in Madoff investments over a number of years to satisfy the pledges. Madoff would again benefit by the stability of the investment that would stay in place over years from the donor to the receiving 501(c)(3) Entity, which would be inclined to keep the investment in place for the reasons set forth in the immediately preceding paragraph.

The next Installment will continue the discussion of the aftermath of the Madoff scandal for 501(c)(3) Entities.

[To be continued in Installment 4]
 

(With appreciation to Michael J. Kline, Esq., for contributing this entry and for his on-going analysis of the concerns of Madoff stakeholders)

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This is the second in a series of installments on this blog that will discuss some of the threshold issues that face the manifold stakeholders who have been materially affected by the Bernard L. Madoff scandal, allegedly the longest, most widespread and financially devastating Ponzi scheme on record. All potential stakeholders should consult professional advisors promptly to have their positions evaluated.

We will begin by discussing further Direct Individual Investors (“DII”) and then move on to Direct Entity Investors (“DEI”).

Direct Individual Investors (“DII”) (continued)

Those who are DIIs and were “fortunate” enough to have secured distributions through redemptions from Madoff in the past may believe that they were lucky or brilliant to have withdrawn money before his arrest. However, they may confront efforts by trustees or regulators to “claw back” such distributions to the extent they were materially disproportionate to the withdrawals of the average investor. The likely theory for a “claw back” would be that all of the investors were engaged in a unitary integrated failed enterprise and that no single investor should have fared better proportionately than the average investor, whether wittingly or unwittingly. To a certain degree, the energy that will be undertaken to pursue a DII will depend on (i) the absolute amount in dollars of the disproportionate distribution to such DII, (ii) how long ago the redemption(s) took place and/or (iii) the relative level of disproportion. The “claw back” process may become complex and could even be affected by state law, which may differ from state to state. Competent professional advice for DIIs is a necessity in this area.

There may be some DIIs that have been so adversely affected by the aftermath of the Madoff scandal that they could be considering bankruptcy, selling their residences to raise funds or other precipitous measures. For example, housing prices are deeply depressed in many areas, which can greatly limit the recovery on a sale, especially if there is a mortgage present. Moreover, in some states, there are strong homestead laws that exempt houses from being included in bankruptcy or other insolvency procedures. Again, competent professional advice for DIIs is a necessity in this area.

Direct Entity Investors (“DEI”)

There are many types of potential DEIs that may have invested with Madoff. These include trusts, hedge funds or other investment managers and vehicles, charitable organizations, etc. This blog will endeavor to cover some of the DEIs that have been most prominent in recent publications.

Hedge funds, investment managers and other investment vehicles (“Funds”) have surfaced as major victims of investing with Madoff. While such Funds may be victims, the managers of these Funds may have their own problems in that they charge their own investors a management fee, generally tied to the level of assets under management (1% to 2%) and/or a performance fee that may be as much as 20% of returns or returns above a specified threshold (“Fees”). In cases where such Funds simply turned over substantial assets to Madoff for investment by him and such Funds took their standard Fees on such assets, investors in the Funds may have a legitimate objection that such Fees should be disgorged in light of the fact that the managers of such Funds did not perform investment management services that warranted the Fees. Additionally, depending on the publications by the Funds of their purpose, investment style and other disclosures, there may be a potential cause of action against the managers of such Funds for investing outside of the stated investments for the Funds or even negligence or breach of fiduciary duty in the selection of an investment with Madoff. The issues are complex for both the Funds and their managers and individuals who invested in the Funds and became indirect victims of Madoff.

[To be continued in Installment 3]
 

(With appreciation to Michael J. Kline, Esq., for contributing this entry and for his on-going analysis of the concerns of Madoff stakeholders)

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The Madoff investment scandal was allegedly the longest, most widespread and financially devastating Ponzi scheme on record. On almost a daily basis since the arrest of Bernard L. Madoff on December 11, 2008, there are new disclosures of victims and classes of victims. Over the next few days this blog will discuss some of the threshold issues that face the manifold stakeholders who have been materially affected by the Madoff scandal. In many cases there may be limited time for victims to act to protect themselves to the maximum. Some of the potential self-protective actions will be identified during the course of identifying the stakeholders. All potential stakeholders should consult professional advisors promptly to have their positions evaluated.

Direct Individual Investors (“DII”)

This class of victim may be the largest in numbers, although not necessarily in potential dollar losses. A DII should collect every scrap of hard copy, digital or electronic information and communication that can be located relative to an investment in Madoff (a “Madoff Investment”), including statements, financial or otherwise, from Madoff, tax statements such as Forms 1099, annual reports, statements by Madoff as to the nature of the investments and returns, etc. Such information may prove to be valuable in isolating the scope of the loss and the factual basis that gave rise to the loss. The factual basis may determine whether or not the DII is a potential class plaintiff should any classes be certified in actions against Madoff and/or his controlled business entities.

Other immediate concerns for DII include the mailing on January 2, 2009, by the Securities Investor Protection Corporation (“SIPC”) of formal claims packages to potential claimants of Bernard L. Madoff Investment Securities LLC, a licensed broker-dealer affiliate of Madoff. The liquidation case is set in the Southern District of New York. Claims by customers must be filed with the trustee in the liquidation case, not SIPC, by March 4, 2008. The notice from SIPC relates to claims of customers of the broker-dealer who may have lost money or securities registered in “street name” or in the process of being registered. It does not relate to investors who may have lost money in the alleged Ponzi scheme that was extraneous to the broker-dealer.

Another immediate consideration for DII are potential claims for refunds that may be filed with federal and state taxing authorities. Generally the statute of limitations for the filing of refunds is a three-year period from the filing date of the original income tax return. For example, in the case of a taxpayer who filed his or her federal and state returns on April 15, 2006 for a 2005 calendar year, no claims for refund can be made after April 15, 2009. Since the income reflected on Forms 1099 that were supplied to DII cannot be correct to the extent there was negligible real income earned from the investment with Madoff, taxes paid based on the Forms 1099 were excessive and can be available for refunds.

[To be continued in Installment 2]
 

(With appreciation to Michael J. Kline, Esq. for contributing this entry)

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