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Michael J. Kline writes:

The Securities Investor Protection Corporation (SIPC) issued a news release that “[n]early $2.5 billion in checks were mailed Wednesday (September 19, 2012) to victims in the liquidation of Bernard L. Madoff Investment Securities LLC (BLMIS).” In doing so, SIPC also applauded Trustee Irving Picard for his efforts in making the distribution possible.  According to SIPC, 

Approximately $17.3 billion in principal is estimated to have been lost in the Ponzi scheme by direct BLMIS customers who filed claims.  When combined with the funds already returned to BLMIS customers, the second interim distribution satisfies more than 50 percent of the total Madoff accounts with allowed claims. 

Previous Installments in this blog series, most recently Installment 82 and Installments referenced therein, discussed the potential impact that such Picard Distributions may have on the diverse and somewhat divergent interests among the Wilpons and how the Wilpons may try to address such impact. (Capitalized terms not otherwise defined herein have the meanings as defined in Installment 82.)  

The earlier Installments focused on possible conflicts and controversies that may be created among the interests of those of the Wilpons who are Allowed Parties holding the aggregate $178 million in Allowed Claims against the Madoff Estate that will not be actually paid out of Picard Distributions but have been or will be offset against the $162 million in aggregate Wilpon Liabilities of the Liable Defendants. 

It would appear that the SIPC news release focused on the 53% of specific accounts of allowed claimants that have been satisfied, not the percentage of total allowed claims that have been paid.  However, Section 2(c) of the Settlement Agreement among the Wilpons and Picard retroactively credited the Allowed Claims of the Wilpons (and required a corresponding offset against Wilpon Liabilities) in the amount of $8,171,451 or 4.602% of the first Picard Distribution that was made on or about October 5, 2011. Therefore, let us assume that, at this point, there has not been a great change over the last year in the total allowed claims of “good faith” customers of BLMIS. In such a case, application of the deemed percentage of 4.602% to the current $2.5 billion Picard Distribution for the Allowed Claims of Allowed Parties among the Wilpons would yield approximately $115,000,000. 

When the two Picard Distributions are added together, the deemed offset against the Wilpon Liabilities would appear to be as much as approximately $123,000,000, with $39,000,000 of the total of $162,000,000 in Wilpon Liabilities remaining. Even if the deemed percentage is considerably less than 4.602%, a substantial portion of the Wilpon Liabilities has already been satisfied. (As an aside, that event provides no satisfaction to the hapless New York Mets baseball fans who suffered through a heart-wrenching three-game home series sweep at the hands of the Philadelphia Phillies, the final straw of which was an ignominious 16-1 defeat last night.)

Installment 82 had suggested that, to minimize conflicts and controversies and with adequate advice of counsel to the involved parties, an Allocation Agreement be entered into among all the Wilpons that are affected by the Settlement Agreement with Picard, in order to provide for Allowed Entities to be compensated for the use of their Allowed Claims for the benefit of the Wilpons as a group and the specific Liable Defendants under the Settlement Agreement. Payments among the Wilpons under such an Allocation Agreement to date could be as much as $123,000,000. While the Wilpons may have successfully limited (and perhaps have already been deemed to have substantially satisfied) their external cash outlays to the Madoff bankruptcy estate under the Settlement Agreement with Picard, resolving rights and obligations among the holders of Allowed Claims and Liable Defendants could be challenging and result in a significant shifting of assets among the Wilpons.

(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.)

 [To be continued in Installment 85]

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Michael J. Kline writes:

There have been recent media reports respecting efforts of Trustee Irving Picard to make a substantial distribution of up to several billion dollars to Madoff victims in the near future. This Installment will discuss a potential impact that such a distribution may have on the diverse and somewhat divergent interests among the Wilpons that are parties to the global Settlement Agreement with Picard and how the Wilpons may address such an impact. 

Installments 75 and 76 in this blog series, which may be read for context with this Installment, discussed concerns about the inclusion of the Wilpons' private charitable Foundations in the Settlement Agreement. (Capitalized terms not otherwise defined herein shall have the meanings assigned to them in Installment 75.)  

Such earlier Installments focused on a possible dichotomy between the interests of the Foundations and the individuals who are their fiduciaries and suggested an analysis of (i) the duty of loyalty of such fiduciaries and (ii) their need to avoid conflicts of interest and prohibited “private benefit and inurement” under U.S. Treasury Regulations. What is clear is that many individual Wilpons beyond the Foundation Fiduciaries should be addressing concerns respecting potential duties of loyalty and the need to avoid conflicts of interest, including fiduciaries (collectively, “Fiduciaries”) of the numerous business entities, family trusts that may even include minors and unborn children as beneficiaries, estates and other entities or multi-party arrangements that are affected by the Settlement Agreement (collectively, the “Entities”). Numerous signatories of the Settlement Agreement were acting not only in their individual capacities, but as partners, officers, trustees, executors or members or in some other fiduciary capacity.

Simply stated, how can the Wilpons as a group fairly treat the Entities and individuals who are signatories to the Settlement Agreement and have been recognized by Picard (the “Allowed Parties”) to have $178 million in aggregate allowed net equity claims against the Madoff Estate (“Allowed Claims”)? The Allowed Parties would receive a pro rata share of future cash distributions to Madoff victims by Picard (“Picard Distributions”) but for the Settlement Agreement, which requires that Picard Distributions on account of the Allowed Claims will not be paid but will serve as offsets against the $162 million in aggregate Wilpon liabilities to the Madoff Estate (“Wilpon Liabilities”) by those of the Wilpons that had received six-year transfers from Madoff in excess of principal (“Wilpon Obligors”).

In reaching their global Settlement Agreement with Picard (which included representations by the Wilpon signatories that they had the right to execute and carry out the Settlement Agreement in their respective individual and fiduciary capacities), the Wilpons should have considered resolving potential duty of loyalty and conflicts of interest issues of the Fiduciaries. Otherwise there can be a myriad of future complaints from beneficiaries of Entities, especially those of the Allowed Entities, that their Picard Distributions should not have been used for the benefit of the Wilpon Obligors to pay for Wilpon Liabilities. Additionally, destruction of numerous Wilpon estate and gifting plans and incurrence of gift tax exposure for certain of the Wilpons could result from the use of Allowed Claims to satisfy Wilpon Liabilities.

One way to have addressed such a complex and diverse situation would appear to be an agreement among all of the Wilpons similar to that of a “tax sharing agreement” (a sample appears here). A tax sharing agreement, as discussed in U.S. Treasury Regulations, allocates the federal income tax liability of individual members of a consolidated group for which a single tax return is filed and a single amount is paid to the Internal Revenue Service. Under a tax sharing agreement, each of the individual members of the consolidated group has its own tax obligation or tax loss calculated as if it were taxed separately and not as a member of the group. A member of the consolidated group that individually would have had a loss for tax purposes is entitled to compensation for the use of the loss to reduce the tax liability for the consolidated group. Conversely, a member of the group that individually would have had taxable income would be required to compensate another member(s) for using such other member’s loss to reduce or eliminate the tax liability of the consolidated group. Under the Treasury Regulations, if one member owes a payment to a second member, the first member is treated as indebted to the second member. If the obligation is not paid, the amount not paid generally is treated as a distribution, contribution, or both, depending on the relationship between the members.

Similarly, to avoid future uncertainties, the Wilpons could forge an agreement ( “Allocation Agreement”), with adequate advice of counsel for the involved parties, to provide a method for Allowed Entities to be compensated for the use of their Allowed Claims for the benefit of the Wilpons and the Wilpon Obligors to offset Wilpon Liabilities under the Settlement Agreement. The Allocation Agreement would reduce potential exposure of Fiduciaries to objections from beneficial holders of Allowed Claims that they were denied their cash Picard Distributions. However, if the Wilpon Obligors cannot or do not make immediate cash payments under an Allocation Agreement to Allowed Entities (and individuals with Allowed Claims) when Picard Distributions are made, the terms as to when and how deferred payments are to be made and provisions for any interest or other consideration for such deferrals can be problematic and complex.  

Payments among the Wilpons under such an Allocation Agreement could prove to be significant. While the Wilpons may have successfully limited their external cash outlays to the Madoff Estate under the Settlement Agreement with Picard, resolving rights and obligations among Allowed Parties and Wilpon Obligors could result in an appreciable shifting of assets among the Wilpons.

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

[To be continued in Installment 83]

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Michael Kline writes:

This Installment raises some questions relating to the inclusion of the Defendant Foundations, which the Trustee had sued for recovery of “fictitious profits” and principal, as parties to the global Settlement Agreement between Picard and the Wilpons. Installment 75 (Part 1) of this blog series, which should be read together with this Installment, discussed the “Schedule 1 Foundations” and concerns about their inclusion in the Settlement Agreement. (Capitalized terms not otherwise defined herein shall have the meanings assigned to them in Installment 75.)   

Unlike the Schedule 1 Foundations, the Defendant Foundations are defendants in the Litigation, and each of them is a signatory to the Settlement Agreement, with Fred Wilpon having signed as Director for the Wilpon Family Foundation and Saul B. Katz having signed as Director for the Katz Family Foundation. Moreover, the Defendant Foundations are listed on Schedule 2 of the Settlement Agreement as recipients of transfers from Madoff in excess of principal, as are the other defendants in the Litigation. 

However, the fact that the Defendant Foundations are literally “on the same page” as the other defendants in the Litigation, including Fred Wilpon and Saul B. Katz as individuals defendants, should not finish the analysis as to whether the Defendant Foundations are properly parties to the Settlement Agreement. The analysis utilized in Installment 75 for the Schedule 1 Foundations should be considered for the Defendant Foundations as well.

Simply stated, there is a possible dichotomy between the interests of the Defendant Foundations and the individuals who occupy the same status with respect to the Defendant Foundations as the “Fiduciary Defendants” of the Schedule 1 Foundations. (Such individuals will be defined as Fiduciary Defendants with respect to the Defendant Foundations.) While more subtle in the case of the Defendant Foundations, there is a potential divergence of interests that calls for analysis of (i) the duty of loyalty of fiduciaries and (iii) the avoidance of conflicts of interest and prohibited “private benefit and inurement” that was discussed respecting the Schedule 1 Foundations.  To reiterate, as indicated in the IRS Compliance Guide,

A private foundation is prohibited from allowing more than an insubstantial accrual of benefits, including non-monetary benefits, to individuals or organizations. The intent is to ensure that a tax-exempt organization serves a public interest, not a private one. If a private benefit is substantial, it could jeopardize the organization’s tax-exempt status.

Excise taxes for such violations can also be imposed by the IRS on both the non-complying private foundation and its fiduciaries. Basically, the allegation could be made that the inclusion of the Defendant Foundations in the Settlement Agreement benefited on a monetary and/or a non-monetary basis their respective Fiduciary Defendants in settling the Litigation on the most favorable terms on a global basis. 

Query, did the Trustee and the Fiduciary Defendants explore reasonably the question as to whether the Defendant Foundations could have and should have made a better deal by themselves outside of the framework of the global Settlement Agreement? Installment 60 of this blog series (and prior Installments linked therein) give examples of the flexibility and financial accommodations that the Trustee has provided in other cases of charities that realized fictitious profits in the Madoff scheme and would have suffered serious or even irreparable adversity if they were to be fully clawed back.

In conclusion, in the cases of both the Schedule 1 Foundations and the Defendant Foundations, greater scrutiny of their participation in the Settlement Agreement may be called for in order to promote an appearance of propriety for the Settlement Agreement and the Fiduciary Defendants. In addition to the questions at the end of Installment 75, query whether the Trustee, as the party moving for approval of the Settlement Agreement, has a responsibility to be pro-actively bringing the matters of the Involved Foundations to the attention of Judge Rakoff for inclusion in the court’s full and fair review and approval of the Settlement Agreement in this widely-followed Litigation.

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

(To be continued in Installment 77)

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Michael Kline writes:

This Installment addresses some of the effects on, and implications for, certain charitable private foundations (collectively, the “Involved Foundations”) and their respective officers, directors, trustees and foundation managers (collectively, the “Fiduciaries”) under the proposed settlement agreement dated April 13, 2012 (the “Settlement Agreement”), between Madoff Trustee Irving Picard and the numerous defendants, constituting the Wilpon-Katz-Mets individual, business, family trust and charitable interests (collectively, the “Wilpons”). Installment 74 and prior postings in this blog series discussed certain aspects of the Settlement Agreement. 

The Settlement Agreement, which would terminate all existing litigation between the Trustee and the Wilpons (the “Litigation”), is subject to the approval of Federal District Judge Jed S. Rakoff at a hearing scheduled for 4 PM on May 15, 2012.  Further information, including Forms 990-PF filed with the Internal Revenue Service (the “IRS”), respecting each of the Involved Foundations and their Fiduciaries may be found on the GuideStar Web site.

A recurring theme in this blog series has been the relatively inconsistent and sometimes perplexing manner in which the Trustee has dealt with charities that invested with Madoff. Installment 60 and prior Installments discussed some of the differences in the way Picard was dealing with the Judy & Fred Wilpon Family Foundation (the “Wilpon Family Foundation”) and the Iris & Saul Katz Family Foundation (the “Katz Family Foundation” and collectively with the Wilpon Family Foundation, the “Defendant Foundations”), as contrasted to other public charities and charitable private grant-making foundations. 

The Defendant Foundations are listed on Schedule 2 to the Settlement Agreement, which is the “Summary of Six-Year Transfers from BLMIS [Madoff] to Defendants in Excess of Principal,” respecting persons subject to “clawback” efforts by the Trustee of “fictitious profits” and principal. A number of the Fiduciaries of each of the Defendant Foundations also are defendants listed on Schedule 2 for whom the Trustee was seeking clawback. The Defendant Foundations will be discussed more fully in a future Installment in this blog series. 

The remaining Involved Foundations (the “Schedule 1 Foundations”) appear on Schedule 1 to the Settlement Agreement, which is the “Summary of Allowed Net Equity Claims Against the BLMIS Estate.” Therefore, the Schedule 1 Foundations are not defendants in the Litigation; nor are they signatories to the Settlement Agreement. They are claimants that have been recognized to be entitled to share in the funds recovered by the Trustee in the Madoff bankruptcy.

The Schedule 1 Foundations include, among others, The Dayle H & Michael Katz Foundation Inc. (the “Michael Katz Foundation"). Notably, each of the Schedule 1 Foundations has one or more Fiduciaries who, in one capacity and/or another, is (i) a defendant in the Litigation, (ii) listed on Schedule 2 to the Settlement Agreement and (iii) a signatory to the Settlement Agreement. The Foundation Fiduciaries of each of the Schedule 1 Foundations have an aggregate larger amount of clawback exposure on Schedule 2 than the allowed net equity claim of the related Schedule 1 Foundation (a “Schedule 1 Foundation Claim”). Except for the Michael Katz Foundation, the amount of  the Schedule 1 Foundation Claim of each Schedule 1 Foundation is relatively small, less than $100,000. In the case of the Michael Katz Foundation, however, the Schedule 1 Foundation Claim is $617,000, while the maximum aggregate exposure reflected on Schedule 2 for clawback against the Michael Katz Foundation Fiduciaries exceeds that amount.

In the Settlement Agreement, each Schedule 1 Foundation Claim falls within the definition of a “Defendant Net Equity Claim” under Section 1(c) of the Settlement Agreement. Each of the Fiduciaries who is also a signatory to the Settlement Agreement (a “Fiduciary Defendant”) is defined as a “Defendant” in the Settlement Agreement, who, under Section 2(a) of the Settlement Agreement, has agreed, among other things, to assign all Defendant Net Equity Claims (which would include a Schedule 1 Foundation Claim) to the Trustee.  In addition, each Fiduciary Defendant has represented and warranted under Section 6(b) of the Settlement Agreement that he or she has full power, authority and legal right to assign his or her respective Defendant Net Equity Claim (which would include a Schedule 1 Foundation Claim).

The foregoing acts by the Fiduciary Defendants may be problematic. In effect, each of the Schedule 1 Foundation Claims, which would otherwise be a future unencumbered expectancy to be paid to the respective Schedule 1 Foundation by the Trustee, is being assigned under the Settlement Agreement to the Trustee to fund a portion of the monetary clawback exposure of its respective Fiduciary Defendants.   As stated earlier, the Schedule 1 Foundations are not defendants in the Litigation; nor are they directly signatories to the Settlement Agreement.

This dichotomy between the interests of Schedule 1 Foundations and their respective Fiduciary Defendants sets up a classic divergence of interests that calls for consideration of compliance requirements flowing from the duty of loyalty of fiduciaries and the potential for conflicts of interest. Moreover, the question of potential prohibited “private benefit and inurement” respecting the Schedule 1 Foundations under IRS rules can be raised as indicated in an IRS Compliance Guide:

A private foundation is prohibited from allowing more than an insubstantial accrual of benefits, including non-monetary benefits, to individuals or organizations. The intent is to ensure that a tax-exempt organization serves a public interest, not a private one. If a private benefit is substantial, it could jeopardize the organization’s tax-exempt status.

In addition, no part of an organization’s net earnings may inure to the benefit of a private shareholder or individual. This means that an organization is prohibited from allowing its income or assets to accrue to insiders. An example of prohibited inure­ment would include payment of unreasonable compensation to an insider. An insider is a person such as an officer, director, or a key employee who has a personal or private interest in the activities of the organization. Any amount of inurement may be grounds for loss of tax-exempt status.

In addition to loss of the organization’s section 501(c)(3) tax-exempt status, activities constituting inurement may result in the imposition of self-dealing excise taxes on individuals benefiting from certain transactions with a private foundation.

The laws regarding duty of loyalty and conflicts of interest of fiduciaries and the IRS rules regarding private benefit and inurement are highly complex. Presumably, each of the Schedule 1 Foundations and its respective Fiduciaries would have been well advised to seek separate guidance and counsel as to their respective rights and obligations under the Settlement Agreement and its impact on a Schedule 1 Foundation Claim and the clawback exposure of the Defendant Fiduciaries.

Query, should Judge Rakoff be inquiring into these Schedule 1 Foundation matters as part of his review and approval of the Settlement Agreement?  Should the Schedule 1 Foundations properly be dropped from Schedule 1 of the Settlement Agreement altogether in order to resolve the potential issues? If the Schedule 1 Foundations were to be excluded from involvement in the Settlement Agreement, should the Defendant Fiduciaries be expected to provide substitute funding sources? Whether these questions will be addressed remains to be seen.

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

[To be continued in Installment 76]

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