March 6, 2011 | Read Time: 7 minutes
Charities nationwide are facing an alarming demand from state and federal courts handling the clean-up of collapsed investment schemes: Give back donations.
In cases playing out across the country, hundreds of nonprofit organizations have been asked to return anywhere from a couple thousand dollars to millions of dollars each in response to government efforts to take back ill-gotten gains from financial frauds, like Ponzi schemes. A charity becomes a target of such recovery if it has received a gift from a donor who used illicit profits from a fraud scheme to make the charitable contribution.
The legal process, known as a clawback, is not new. But as the economic downturn has sped up the demise of big-time investment scams, more and more charities are learning that the gifts they received in good faith—and innocence—may not be theirs to keep if the donors turn out to be criminals. Some charity officials and legal experts say laws ought to be changed to better protect charitable gifts, but few such efforts are in the works.
“If it’s dirty money, I understand that you will be asked to give it back,” says Barbara-Ann Weinstein, chief executive of Family Central, a social-service provider, in Florida. “It’s just that this is something we never knew could happen and we are disgusted that anyone would take advantage of us and the children we serve by giving us this money. It is hurtful.”
Family Central returned a $25,000 gift it had planned to use to help secure a matching grant to subsidize child-care costs for low-income parents.
The money was a contribution from Scott Rothstein, a South Florida lawyer who pleaded guilty last year to running a $1.4-billion Ponzi scheme. Lawyers sorting out Mr. Rothstein’s case are seeking the return of more than $2-million he contributed to about 30 charities.
One of the biggest beneficiaries, Joe DiMaggio Children’s Hospital, in Hollywood, Fla., returned $800,000 to federal authorities and removed a sign in its emergency room bearing the name of Mr. Rothstein’s foundation, according to local press accounts.
A spokeswoman for the hospital declined to comment to The Chronicle.
Money From Investments
Similar clawback efforts affecting nonprofits are under way in Minnesota, where Tom Petters was found guilty of running a $3.5-billion Ponzi scheme, and in New York, where Hassan Nemazee pleaded guilty to orchestrating a nearly $300-million fraud scheme. In Pennsylvania, Joseph S. Forte was convicted last year of operating a $35-million investment scam since 1995.
In the biggest financial-fraud case of the times, the Bernard Madoff Ponzi scheme, federal authorities are carrying out a different, but more typical, form of a clawback: recouping money from investors—including charities and foundations—that received distributions from investments in the sham enterprise above their original cash deposits.
Protection for Charities
Less well-known, but happening in the other Ponzi-scheme cases, is the version of clawbacks in which authorities go after not just the money that charities may have received in fraudulent investment income but also the money they may have received as donations from the fraud’s perpetrators.
Both kinds of clawbacks can be pursued through federal bankruptcy law and, to a much greater extent, through state fraud laws, which are based on a national model statute called the Uniform Fraudulent Transfer Act.
The laws enable court-appointed receivers, as part of their fiduciary duties, to recover as much money as possible on behalf of creditors and those who were defrauded. The bankruptcy code makes some exceptions for donations, but the state laws do not.
A federal appeals-court judge writing about the recovery of funds following a 1989 fraud case explained the idea behind clawbacks by likening a donation made with illicit gains to a thief rushing into a church and dropping stolen money into a collection plate.
“Does the church obtain good title as against the thief’s victim,” the judge wrote. “It does not.”
Some charity officials and legal experts say that while they understand the intent of the laws, they think fraud legislation ought to be changed to better accommodate nonprofit groups that were not investors in the schemes; had no involvement with or knowledge of the crimes; and spent the gifts they received to advance their charitable causes.
“The laws need to include protections for charities in certain cases where they have acted reasonably and in good faith in accepting and spending the money,” says Michael J. Kline, a New Jersey lawyer who specializes in corporate and securities law. Though, he adds, when cases of fraud include donations made around the country and through the Internet, it is difficult for state laws to prevail.
Jon Pratt, executive director of the Minnesota Council of Nonprofits, agrees that “innocent charities that get burned” need better protections, but he says that going after broad legislative change would be impractical. For now, his association is setting its sights on decreasing to one or two the number of years authorities in Minnesota can reach back to reclaim contributions. Most states’ fraud laws have a statute of limitations of four years. In Minnesota, it is six.
The change, Mr. Pratt says, would serve to shrink the number of donations subject to clawbacks when cases of fraud do occur.
In the absence of other legal protections, Mr. Pratt and other charity officials and observers say that a nonprofit group’s best move is to minimize the risks of accepting what could turn out to be tainted donations. (For suggestions, see box on bottom right.)
Spotless Reputations
But charity and legal experts familiar with clawbacks acknowledge that even organizations that took those kinds of precautions would probably not have been protected from the recently uncovered Ponzi schemes.
It’s unlikely, they say, that even a deep vetting would have revealed the financial wrongdoings that had otherwise escaped authorities. And in many of the cases, the perpetrators who were eventually caught had been respected business leaders and sought-after donors.
“It was not considered irresponsible of us to accept his gift,” says Mike Mullin, president of Cathedral High School, a Catholic institution in St. Cloud, Minn., which received about a third of a $750,000 pledge from Mr. Petters before his financial empire unraveled. “It actually would have been considered irresponsible for any organization not to get in front of Tom in the last few years and give him their proposal.”
Mr. Forte, in Pennsylvania, was well known to Malvern Preparatory School, where he volunteered as a strength and conditioning coach before he pledged $1-million to help the school build a new weight room.
“We knew Joe,” says James H. Stewart, Malvern’s president, “and we could still have done our due diligence, checked résumés, checked references, and not have found anything about him that wasn’t positive.”
That’s what scares David Donell, chief financial officer of the X Prize Foundation, especially since his organization relies on large gifts from a small number of donors. One clawback, he says, would be very financially damaging.
Mr. Donell, who has worked as a certified fraud examiner, says he has looked into the possibility of buying insurance to guard against repayments in a fraud case but can’t find insurers interested in providing such coverage. That may be just as well, he says, noting that donors might resent the idea of insuring against their being criminals—and especially using a portion of their gifts to pay the premiums.
“I’m sure the 99.99 percent of donors who are legitimate wouldn’t be happy,” Mr. Donell says. “Insurance is just not a feasible response. Unfortunately, what it comes down to is: It’s just every recipient beware.”
Avoiding Troubled Gifts: Tips From the Experts
• Adopt a solid and comprehensive policy for accepting gifts that requires criminal checks of donors for gifts of a certain size as well as other efforts to know more about where a donation is coming from.
• Seek feedback from trustees when accepting a sizable gift. “Board members can serve as feelers in a community with respect to donations and donors,” says Heidi Neff Christianson, a lawyer in Minneapolis and a former assistant attorney general in the state’s charities division.
• Be sensible. “Is the donor suddenly driving around in a Ferrari? Is that new wealth?” says David Donell, chief financial officer of the X Prize Foundation, in Playa Vista, Cal. “Ask these questions and be aware if something looks like it’s too good to be true.”
