White Collar Defense and Compliance : New Jersey White Collar Defense Lawyer & Attorney : Fox Rothschild Law Firm : Criminal Defense, Insider Trading, RICO, Consumer Fraud : New Jersey, New York City

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)

• Email This
• Print
• Comments
• Trackbacks

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)

• Email This
• Print
• Comments
• Trackbacks

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)

• Email This
• Print
• Comments
• Trackbacks

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)

• Email This
• Print
• Comments
• Trackbacks

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)
 

• Email This
• Print
• Comments
• Trackbacks

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)

• Email This
• Print
• Comments
• Trackbacks

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)

• Email This
• Print
• Comments
• Trackbacks

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)

• Email This
• Print
• Comments
• Trackbacks

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)

• Email This
• Print
• Comments
• Trackbacks

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)

• Email This
• Print
• Comments
• Trackbacks

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)

• Email This
• Print
• Comments
• Trackbacks