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Michael J. Kline writes:

There is evidence that some charities may be exercising greater caution in their gift acceptance policies as a result of the dramatic and sometimes devastating consequences that highly respected charities have suffered from involvement in the Ponzi schemes of Bernard L. Madoff (“Bernard”) and others.  It would appear that Fidelity Charitable Gift Fund of Boston, Massachusetts (“Fidelity”) has moved in that direction from actions it has taken respecting grants received from the private foundations formed by Bernard’s sons Andrew and Mark and their respective spouses. This blog series has been following for almost four years the misfortunes of charities flowing from involvement in  Ponzi schemes, and apparently some charities have responded to reduce exposure to potential risks in this area.

The Forms 990-PF for 2010 filed with the IRS and posted on GuideStar by the Deborah and Andrew Madoff Foundation (the “Andrew Foundation”) and the Mark and Stephanie Madoff Foundation (the “Mark Foundation,” and, collectively with the Andrew Foundation, the “Madoff Sons Foundations”) reveals that each of the Madoff Sons Foundations made grants to Fidelity in December 2010  $176,000 by the Andrew Foundation and $79,000 by the Mark Foundation. Andrew serves as a trustee of both of the Madoff Sons Foundations, as did Mark until his tragic death from an apparent suicide on December 11, 2010. The death of Mark was exactly two years to the day after Andrew and Mark turned their father Bernard over to authorities for arrest and was in the same month that the Madoff Sons Foundations made their respective grants to Fidelity. 

Each of the 2010 Forms 990-PF of the Madoff Sons Foundations contains the following “General Explanation Attachment”:

In December 2010, the Foundation made a grant of $ . . . to the Fidelity Charitable Gift Fund in order to satisfy its distribution requirements . . . [under IRS regulations]. In February 2011, such amount was returned to the Foundation by the charitable organization. The Foundation will reflect this amount . . . as a recovery of a qualifying distribution on its 2011 annual return.

Why did Fidelity return the money to the Madoff Sons Foundations in early 2011? Was it to avoid potential adverse publicity that could flow from continued association with the scandal-ridden Madoff name and the recent death of Mark? In this regard, the 2009 Form 990-PF of the Andrew Foundation (but not that of the Mark Foundation) reflected a grant on December 29, 2009 of $207,000 to Fidelity, already more than a year after the arrest of Bernard. However, Fidelity did not return the 2009 grant.

Alternatively, or in addition, could the return of the 2010 grant have resulted from a concern by Fidelity that, even though the funds in the Madoff Sons Foundations had not been invested in the Bernard scheme, the assets of the Madoff Sons Foundations were derived from contributions by Andrew and Mark and could possibly be traced to monies from the Bernard scandal? If that turned out to be the case, the grants may be subject to "clawback” by Irving Picard, the Trustee of the Bernard bankruptcy estate. Picard had already sued Andrew and Mark for millions of dollars that he alleged they received from the Bernard Ponzi scheme. 

This blog series has discussed the unfortunate experience of Malvern Preparatory School with a charitable pledge and grant from a donor/trustee who was later accused of operating a Ponzi scheme. The charitable pledge became worthless, and substantial grants already received by the School were recovered by the trustee in bankruptcy for the former donor/trustee who then was already in prison. 

(As an aside, it is interesting to note that, in contrast to the Madoff Sons Foundations, which did not invest in the Bernard Ponzi scheme, the now-defunct Bernard L. and Ruth Madoff Foundation did invest in the Bernard Ponzi scheme, according to GuideStar Form 990-PF postings.)

In this blog series, we have advocated that every charity should respond pro-actively in the wake of scandals involving the Bernard and other Ponzi schemes. Such actions include heightened transparency in disclosures in Forms 990, examination and upgrading of charitable gift acceptance policies and improvement of governance practices. It appears that Fidelity has already adopted some of these measures.  

(Michael J. Kline, Esq., 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.)

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This is the thirty-seventh in a series of Installments on this blog that is discussing issues that have arisen for charities in the aftermath of the Bernard L. Madoff (“Madoff”) scandal and other smaller Ponzi schemes. Installments 30 and 35 of this series discussed a Ponzi-scheme run by former Trustee Joseph S. Forte (“Forte”) of Malvern Preparatory School (“Malvern” or the “school”). Malvern, among other charities, had claimed that it was a victim of the Ponzi scheme, even though the school had received hundreds of thousands of dollars in donations from Forte.

Installment 35 of this series discussed a September 17, 2010 article by Harold Brubaker, who has written several articles on the subject in The Philadelphia Inquirer.  The Brubaker article reported that Malvern had agreed in a consent order (the “Consent Order”) to return $700,000 received as contributions from Forte of the $900,000 originally sought by the court-appointed receiver.

On the same day as the Brubaker article, the President of Malvern and the Chairman of its Board of Trustees issued a joint statement about the Consent Order entitled “Resolution of Forte Ponzi Scheme Litigation” (the “Malvern Statement”). Included in the Malvern Statement was the avowal that Malvern Prep had no knowledge of Mr. Forte’s Ponzi scheme and accepted his donations under the assumption that he acquired them entirely from legitimate sources. In addition, although Malvern received charitable donations from Mr. Forte, it did not invest any monies with him.

One of the interesting aspects about the Consent Order and the Malvern Statement as to the return of donations by Malvern is the precedent that it may set, not only for other charities that may have innocently received contributions from Forte in the belief that they were from legal sources, but also for charities that received contributions in other Ponzi schemes such as that of Madoff.

Another interesting aspect is the following quotation from the Malvern Statement:

Be assured that none of the money paid to the receiver will be taken from any of the charitable or other funds established by the School’s generous benefactors, and Malvern’s many excellent programmatic and financial aid programs will not be affected.

The meaning of the term “charitable or other funds established by the School’s generous benefactors” is somewhat perplexing. Query whether the general endowment funds of Malvern, which may include not only donations and bequests but also increases from investment earnings and income from operations of the school, fall within the quoted categories. Another potential source for the payment possibly would be current operations.

Installments 30 and 35 of this series pointed out that the Form 990 dated February 9, 2010, filed by Malvern for its fiscal year ended June 30, 2010 with the IRS made no reference (i) to Forte or the fate of his unfulfilled personal pledges and (ii) as to whether the school had written off all or a portion of a Forte outstanding pledge of $500,000.

As stated in Installment 35, it will be interesting to see to what extent Malvern discloses and explains its losses with Forte and the Consent Order in its Form 990 for the fiscal year ended June 30, 2010 to be filed with the IRS. It may provide some guidance for other similarly affected charities.

Installment 30 pointed out that the Form 990 questions and instructions may need some refinement by the IRS to enhance the clarity and consistency of definitions and promote greater and speedier transparency by charities. Further developments in this case may be instructive as to the effectiveness of the current IRS Form 990 and instructions in generating meaningful disclosures.

[To be continued in Installment 38]

(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-fifth in a series of Installments on this blog discussing issues that have arisen for charities in the aftermath of the Bernard L. Madoff scandal and other smaller Ponzi schemes. Installment 30 of this series discussed a Ponzi-scheme run by former Trustee Joseph S. Forte (“Forte”) of Malvern Preparatory School (“Malvern” or the “school”). Malvern, among other charities, had claimed that it was a victim of the Ponzi scheme, even though the school had received hundreds of thousands of dollars in donations from Forte.

Harold Brubaker, who has written several articles on the subject in The Philadelphia Inquirer, published an article on September 17, 2010, entitled “Malvern Prep to return $700,000 received from Ponzi schemer.” The Brubaker article reported that Malvern had agreed in a consent order to return $700,000 received as contributions from Forte of the $900,000 originally sought by Marion A. Hecht, the court-appointed receiver (the “Receiver”). According to Mr. Brubaker, the Receiver is seeking recovery of substantial sums from other charities that also received donations from Forte.
Installment 30 pointed out that the Form 990 dated February 9, 2010, filed by Malvern for its fiscal year ended June 30, 2010 with the IRS (the “Malvern 2009 Form 990”) made no mention of Forte or the fate of his personal pledges, although the Forms 990 filed by the school for the immediately prior two fiscal years had clearly listed him among its Trustees. Moreover, Installment 30 noted that no reference had been made in the Malvern 2009 Form 990 as to whether the school had written off all or a portion of a Forte pledge of $500,000, which may have been a “diversion of assets” requiring a specific explanation if more than $250,000 had been written off.

It will be interesting to see whether, and to what extent, Malvern makes a disclosure and explanation of its losses and settlement with the Receiver respecting Forte in its Form 990 for the fiscal year ended June 30, 2010 to be filed with the IRS. Installment 30 pointed out that the Form 990 questions and instructions may need some refinement by the IRS to enhance the clarity and consistency of definitions and promote greater and speedier transparency by charities. Further developments in this case may be instructive in that regard.

[To be continued in Installment 36]

(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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