Assets on Loan

When Catholic Healthcare West recruited Lloyd H. Dean to be its chief executive four years ago, it made him an offer most nonprofit leaders could only envy.

Besides paying him one of the highest annual salaries in the charity world — $1.2-million in 2001 — Catholic Healthcare West gave Mr. Dean a $2-million interest-free housing loan, due in five years, that helped him acquire a penthouse condominium overlooking San Francisco Bay.

Located in one of the city’s poshest skyscrapers, the condominium came with marble floors, Italian-granite countertops, and designer furnishings, according to a brochure on the building. The loan itself came with something far richer: an agreement to forgive all but $250,000 of Mr. Dean’s debt if he stayed in his job for five years.

Mr. Dean’s mortgage deal is among the sweetest that The Chronicle found in a six-month investigation of thousands of loans made by nonprofit groups to charity officers and directors.

The transactions include at least 140 interest-free loans like Mr. Dean’s, personal loans for investments in stock and real estate, and loans to wealthy donors who borrowed back money they had contributed to nonprofit groups they started.

$142-Million in Debts

The Chronicle reviewed data on 10,700 Form 990 informational tax returns filed by groups that had an annual revenue of $25,000 or more and indicated that they had outstanding debt with officers or directors. Because many charities fill out their returns incorrectly or incompletely, it is impossible to know how much money charities have lent to nonprofit officials in recent years. Some organizations, for example, acknowledged making loans but failed to describe the loans’ sizes, terms, or recipients.

But simply among the 1,002 charities that clearly acknowledged that they had outstanding debt from 1998 through 2001 (the latest year for which data were available) as the result of loans made to officers and directors, loan debts totaled $142-million, The Chronicle found.

Federal law bars private foundations from making loans to their officers and directors, but it does not prevent charities from making such deals. The number of organizations that acknowledged making loans is only a small fraction of the 264,000 charitable groups large enough to file Form 990 federal tax returns.

Still, the practice is prevalent enough that two of the most influential voices in the charity world — one a powerful U.S. senator who chairs a committee that investigates charities, the other the head of the nation’s largest coalition of nonprofit institutions — reacted sharply to the implications of The Chronicle’s findings.

“Families giving to charities want to support good work, not penthouse apartments for executives,” Sen. Charles Grassley, an Iowa Republican who is chairman of the Senate Finance Committee, said in a statement. Mr. Grassley’s committee has been investigating the financial dealings of a number of nonprofit groups for more than two years.

After reviewing the Chronicle’s findings, Mr. Grassley said that Congress should apply to charities some of the principles of the recently enacted Sarbanes-Oxley Act, which outlaws loans to officers and directors by for-profit companies and otherwise requires them to improve their governance and accountability.

Diana Aviv, president of Independent Sector, the nation’s largest coalition of charities and foundations, denounced the practice of using nonprofit assets for loans, whether they are used to recruit executives or for any other reason. “We’re not in the money-lending business,” Ms. Aviv said in an interview. “That’s not our mission.”

State Laws

Last fall, Independent Sector and BoardSource, a Washington group that seeks to improve the effectiveness of nonprofit board members, jointly called on charities to adopt some of the provisions of the Sarbanes-Oxley Act — including its ban on loans to officers and directors.

Curbing loans by nonprofit groups has long been a priority of state regulators — at least on paper — but The Chronicle found little evidence of enforcement. Nineteen states and the District of Columbia prohibit or limit nonprofit groups from making loans to officers or directors, yet 221 organizations in those jurisdictions reported loan debts to such officials totaling $10,000 or more.

Among The Chronicle‘s other findings:

• In the IRS filings, 2,278 nonprofit groups said they were owed at least $10,000 by top executives, other officers, or directors at some point from 1998 through 2001.
• Tax returns filed by another 4,756 groups reported loans to top officials, but failed, as required by the Internal Revenue Service, to say how much the debt totaled.
• More than half of the 2,278 organizations that claimed debts of at least $10,000 failed to stipulate on their tax returns, as required, whether the debts were loans, how much was lent, who received the money, and what the loans’ terms were. Nearly one-third of the 1,002 groups that did provide documentation omitted at least one key piece of information.
• At least two dozen donors created foundation-like entities called supporting organizations with tax-deductible contributions and then borrowed back more than $6.7-million, often investing the money for their personal gain. In at least 12 instances, the loans these donors took accounted for 70 percent or more of the organization’s assets.

Objections Raised

Nonprofit officials, government regulators, and legal scholars raise numerous objections to the practice of lending charitable assets to officers and others.

“There’s the question of how that money could have been better spent on programs,” Ms. Aviv said. In addition, she said, a loan could put a nonprofit organization’s assets at risk of being lost should the borrower be unable or unwilling to repay. “Most nonprofits don’t have the ability to do the kinds of checks that a bank can do,” Ms. Aviv said.

A loan may also make it difficult for a board to fire an executive who is not performing well on the job but who owes the charity a considerable sum, she said. A board might be forced to write off the loan as uncollectible, delay removing the executive until it gets the charity’s money back, or sue the borrower, she said. The last option can be especially troublesome, she added, because the cost of a lawsuit could exceed the amount of money owed.

Besides creating the potential for monetary losses, loans also can further sully the image of the nonprofit world at a time when financial scandals already have diminished public confidence in charities, scholars and legal experts said. “If the public sees that their donated dollars are being used in a profligate and inappropriate and self-dealing way, they are going to get angry,” said Peter Dobkin Hall, who teaches nonprofit management at Harvard University’s John F. Kennedy School of Government.

Mortgage Help

Loans to help high-level executives purchase homes represent the most common form of credit extended by nonprofit groups, The Chronicle found. Among the 1,262 loans whose purpose the newspaper could discern from charities’ tax returns, two-thirds, or 846 loans, were for mortgages.

Some nonprofit scholars say that housing loans are defensible when they include a reasonable interest rate and are made available generally to new employees recruited to an organization from another part of the country. Yale University, for example, offers its faculty members loans to buy houses in New Haven, Conn., where the university is located. Mr. Hall, of Harvard, said he purchased his first house under that program when he taught at Yale. The program not only helped employees afford to buy their homes, he said, but also gave economically depressed New Haven a financial lift. Many other colleges offer similar loans.

Nonprofit groups that operate in high-cost cities frequently justify giving loans to officers by noting that they would otherwise not be able to afford housing comparable to what they previously owned. California real-estate prices that are out of reach of many nonprofit executives were a key reason that officials at Catholic Healthcare say they offered the loan to Mr. Dean. Mark Klein, vice president of corporate communications at Catholic Healthcare West, noted that “Catholic Healthcare West needed a CEO in 2000 when San Francisco housing prices were the highest in the country.” The loan, he added, “enabled Mr. Dean to purchase a house in the San Francisco Bay Area roughly equivalent to the home he had in Illinois.”

Before taking the job at Catholic Healthcare West, Mr. Dean was executive vice president of Advocate Health Care, a nonprofit organization that runs hospitals and various other health-care services in and around Chicago. His salary in 2000, the last year he held that job, was $594,866.

Mr. Dean declined to speak with The Chronicle, instead referring all questions to Mr. Klein.

Mr. Klein said that Mr. Dean has engineered a financial turnaround at Catholic Healthcare West that he said more than makes up for the cost of the loan. “When he arrived, the organization was losing about $300-million a year,” Mr. Klein said. For the 2003 fiscal year, he added, “Catholic Healthcare West ended up with a surplus for the first time in six years.”

Ms. Aviv, of Independent Sector, however, questioned whether using loans and other generous perks as recruitment tools is necessary, no matter what the situation.

“I’m hard-pressed to believe that there are only two or three executives for any given position, and the only circumstances under which one can attract them is with lavish benefits,” she said. Noting that only a fraction of nonprofit groups make loans to executives, she added, “How come the other 99.5 percent of organizations are able to attract very-well-qualified candidates without making similar kinds of offers?”

Personal Purposes

Home-mortgage loans aren’t the only kind of credit extended to high-level nonprofit executives. In its examination of Forms 990s, The Chronicle found that other types of personal loans to officers and directors accounted for nearly one-fifth, or 226, of the 1,262 loans whose purpose was clearly explained on the tax returns.

For example, a charity in Crossville, Tenn., that helps preschool children with disabilities, lent its executive director $140,000, which he used to start his own restaurant. The official said he thought he was helping the charity because he promised to repay the money at a higher rate of interest than the organization could earn elsewhere. But the arrangement backfired when the local United Fund, a charity similar to the United Way that collects gifts through on-the-job campaigns, and the county government, upset at the loan, stopped supporting the charity.

A religious organization in Irvine, Calif., called Generation of Demonstration, or G.O.D., made a $50,598 loan to its founder, Ruckins McKinley, who is also the charity’s chief executive officer and sole employee. The loan was intended to help compensate him for his work, according to the Rev. Gwen Rollins, a consultant to the group and its spokeswoman.

Mr. McKinley later repaid the money and will never again borrow from the charity, said Ms. Rollins, who became the group’s adviser after the loan had been made.

“I instruct all my clients that making loans to officers, or to people that are closely associated with the organization, is not acceptable,” she said, because it raises questions about whether nonprofit organizations provide insiders with improper benefits. “I can tell you that when these small organizations do make loans, they do it out of ignorance, not malice.”

Giving and Borrowing

Perhaps the most controversial types of loans are those that go to the very donors who start a nonprofit group.

In such cases, wealthy people start and finance foundation-like entities called supporting organizations, deduct the amount of their donations from their federal income-tax returns, and then borrow much of the money for their personal use.

The supporting organizations receive interest payments on the loans, which they use to pay for grants to other charitable groups, while the donor may invest the loan principal in business enterprises or use it for other personal reasons. The donor gets to keep any profits from those enterprises, even though they are financed with tax-exempt money.

That is a route taken by Walter R. Muralt and his father, Gary D. Muralt, owners of a lucrative truck stop in Missoula, Mont. The Muralts set up a charity in 1998 to support a children’s shelter in Missoula. Over the next five years, they donated $1.4-million to the charity, taking what their lawyer described as “appropriate tax deductions” for the donations. During the same period, they and businesses they control borrowed back $758,000 for their personal use. (See article on Page 12.)

Few Explicit Rules

Legal experts say federal law contains no prohibition on loans to officers and directors of charities. Under federal law, and in most states, the term “officers” includes not only people holding titles such as president and vice president, but also those with authority to make key decisions at organizations who hold no special title.

The law prohibits top officials of a nonprofit group from using their relationship with the organization to obtain money or perquisites that benefit them privately but do not help the charity accomplish its mission. A loan could violate that prohibition if its terms are unusually generous — particularly if it carries a below-market interest rate. Federal law, however, allows charities to offer loans and other perquisites when recruiting executives.

Loans to officers — especially for housing — are usually considered part of their compensation package, legal experts said, and nonprofit organizations need only show the federal government that the total amount of compensation is “reasonable,” said Marc Owens, a Washington lawyer who was previously head of the Internal Revenue Service division that oversees tax-exempt organizations. One way a nonprofit group can demonstrate that, he added, is to compare an executive’s total compensation to that paid to executives at three comparably sized organizations — which can include for-profit businesses.

Federal law contains no explicit rules on loans that are not part of an overall compensation package, but legal experts said charities could get in trouble if they offered special conditions on a loan, such as a better rate than available from a commercial lender. However, Stephen Schwarz, a professor at the University of California’s Hastings College of Law, in San Francisco, and co-author of a leading law-school textbook on nonprofit organizations, said the laws covering such transactions are “murky,” and therefore tend not to be very effective in making clear to charities what is appropriate and what is not.

Most of the 19 states that have enacted laws banning or limiting loans by nonprofit corporations to their officers and directors mirror a model law the American Bar Association adopted and recommended to the states in 1987. Lizabeth Moody, dean emeritus of Stetson University College of Law, in Gulfport, Fla., who helped draft the model law, said the reason for banning such loans is that they create at least the appearance of a conflict of interest in which a charity’s funds are used to benefit a top official.

Many states also have a standard that requires trustees to diversify a group’s assets among a range of investments so as not to endanger them. That way, Mr. Schwarz and other legal experts said, if one set of investments performs poorly — for instance, stocks in a bear market — any losses could be at least partially offset by putting other assets into more stable investments like government bonds.

Concentrating a nonprofit organization’s assets in a single loan or set of loans to one individual, they added, might violate the “prudent man” rule. “If all the funds are loaned to one person who’s the original donor, that seems to me a gross violation of state-law standards,” Mr. Schwarz said.

Government’s Role

Although legal experts, regulators, and scholars raise questions about nonprofit loans to executives, the chances of federal or state regulators becoming aware of them are minimal.

The IRS relies mainly on Form 990 informational tax returns to monitor the activities of the hundreds of thousands of nonprofit groups that file them, yet the tax agency annually puts only about 20 percent of that data into its computers — and none of the data include information about loans.

Steven Miller, director of the IRS’s Exempt Organizations office, said the agency lacks adequate resources to review the tax returns. It has only about 60 staff members to review the forms the IRS receives annually — meaning that the IRS receives an average of 6,000 returns a week for each staff member, including those filed by charities and private foundations. “It is a daunting task, when you consider that a form can have as many as 300 attachments,” Mr. Miller said.

State regulators say they, too, lack enough computerized data and staff members to investigate the activities of nonprofit groups. In New York, where 47,000 charities are registered with the state, William Josephson, assistant attorney general in charge of the Charities Bureau in the New York attorney general’s office, said none of the information on the registration forms is computerized. New York law bans loans to officers and directors of nonprofit organizations, except those chartered as educational institutions by the state Board of Regents.

Florida has an even stronger statute, banning loans to officers and directors by any nonprofit group. Yet not only did The Chronicle find that 36 Florida charities reported on tax returns filed from 1998 to 2001 that they had made such loans, but Florida has no state agency that is responsible for enforcing the law on charity loans.

“There’s a risk to the residents of the state of Florida and others who donate to Florida charities that their funds could be used in inappropriate ways if the state is not going to have any regulatory review of their operations,” said Victoria B. Bjorklund, a New York lawyer who sits on an IRS advisory committee on nonprofit groups.

Enforcement in California

California requires charities to gain approval from the state attorney general’s office before making any loans. The state makes an exception for charities issuing mortgages for newly hired officials.

“We’re looking to make sure that the loan is for a proper purpose — something related to the organization, not to help the director start another business — and to know that charitable assets aren’t being wasted,” said Belinda Johns, supervising deputy attorney general for Northern California in the office’s Charitable Trusts section.

Ms. Johns said that in several cases, the state has forced officers or directors to repay loans, and in other instances the state has required charities to reorganize their boards after receiving information about questionable loans.

The Chronicle analysis found that 63 nonprofit organizations in California reported on their federal tax returns that they had made loans unrelated to housing costs to officers or directors. When the state attorney general’s office reviewed a list of those groups, it found that not one had applied for the required permission. Ms. Johns said the registrar of charities, the official in the attorney general’s office who receives charity registration forms, is supposed to review the forms, which include a question about loans.

“It doesn’t appear to me that that occurred,” Ms. Johns said, noting that the person who held the registrar’s job left recently. “I can assure you that it’s going to occur now.”

Regardless of whether regulators strenuously enforce legal restrictions on loans to top officials, some scholars and legal experts say charities should avoid them simply because the public is likely to be upset that charitable assets are being used to make loans to nonprofit executives.

“In issues of accountability, the public expects a higher standard than the strictly legal standard,” said Rikki Abzug, a professor of nonprofit management at New School University’s Milano Graduate School of Management and Urban Policy, in New York City. “If your public demands this, then this is what you should be doing.”