A Risky Mix for Charity

Business-nonprofit deal sours for Arizona charities

Twenty years ago, Benson L. Schaub came up with an idea that he hoped would make philanthropy more practical for people of modest means.

Mr. Schaub established a nonprofit organization in Phoenix through which individuals with as little as $5,000 could set up a family foundation, charitable trust, or other giving tool. The organization, called the American Foundation, was one of the first, in fact, to offer people the ability to set up donor-advised funds, allowing them to deposit money into special investment accounts, take a tax deduction on the donations, then designate which charities they wanted to receive gifts from their assets.

But Mr. Schaub had another objective as well: to make money for himself and his family. “I was looking at how to develop this in a way that would create significant personal profit,” he says.

To accomplish both goals, he set up two for-profit companies. One used donors’ money to make loans to real-estate developers, then divided the interest payments between the company and the donors’ family foundation, donor-advised fund, or charitable trust. The other company charged fees to administer the donors’ charitable funds.

Before halting the arrangement in January 2000 on the advice of their lawyers, Mr. Schaub and his brother, Kenneth, made millions of dollars in profit. Some of the charities, however, have not been so fortunate. Several real-estate deals financed with donors’ money went sour, forcing Mr. Schaub to delay tens of thousands of dollars in payments to the charities. In some cases, donors did not know of the delays until The Chronicle informed them.

No Questions Raised

Despite the controversial nature of Mr. Schaub’s operation — its mix of profit-making and philanthropy, and its investment of donors’ money in the volatile Arizona real-estate market — neither federal nor state regulators ever raised questions about it. That lack of oversight, critics say, points to deep-seated problems in the way authorities monitor a growing breed of enterprises in the United States: for-profit financial companies that seek to make money by handling the charitable assets of their clients.

Mr. Schaub’s approach also raises questions, observers say, about whether his chief intent was to benefit charity or himself — the kind of questions that, in the past, have led to fears that Congress could pass sweeping laws to tighten the rules on charitable donations.

“Whenever there is an appearance of self-dealing, it casts a doubt in the minds of the public upon all charities, whether their money is being effectively invested for the stated objectives of the charity, or whether it’s going into somebody’s pocket, directly or indirectly,” says Stephan Leimberg, a lawyer in Bryn Mawr, Pa., who specializes in tax law. “It’s incentive for the leaders in Congress to say, ‘Let’s cut back on what we are allowing for charities.’ And when Congress gets upset about abuse, it doesn’t come down with a fly swatter. It comes down with a sledgehammer.”

Many observers also argue that neither federal tax laws nor laws in Arizona go far enough to prevent situations similar to those created by Mr. Schaub.

While the Internal Revenue Service bars nonprofit organizations from operating for the express purpose of benefiting their founders, Marc Owens, former director of the service’s Exempt Organizations Division, notes that federal tax law has plenty of gray areas.

For example, he says, the service has permitted charity officials to charge fees for rendering investment and legal advice to donors — fees that could be construed as comparable to those that Mr. Schaub’s company earned for managing donors’ assets.

If charity laws are murky at the federal level, they are all but nonexistent in Arizona, where, in the past three years, two major scandals involving nonprofit groups cost donors and investors an estimated $850-million. In 1999, the Baptist Foundation of Arizona collapsed, owing $750-million to more than 11,000 people who had bought securities from it. And last year the Mid-America Foundation folded, leading the Securities and Exchange Commission to accuse its founder of fleecing elderly donors out of as much as $100-million (The Chronicle, January 10).

“We don’t regulate charities in Arizona,” says Robert Zumoff, chief counsel of the Consumer Protection and Advocacy Section in the Arizona attorney general’s office. “I’m not aware of any state law or regulation covering corporate governance of nonprofits.”

Even a lawyer who advised Mr. Schaub to relinquish his ownership in the for-profit companies says the risk of violating charity regulations in Arizona is minimal. “You have a dearth of laws out there,” says Charles Mooney, a lawyer in New York who specializes in nonprofit and estate-planning issues. “In Arizona, the attorney general only has the power the legislature gives him, which is very little.”

Real-Estate Deals

Whatever its legal and regulatory implications, Mr. Schaub’s erstwhile mix of business and philanthropy worked well both for him and for the donors he attracted throughout the 1980s and most of the 1990s. But then it fell apart over some troubled real-estate deals, and the foundation began to experience what Mr. Schaub calls “cash-flow problems.”

The approach that Mr. Schaub took to his business and charitable activities was both complex and unusual.

Donors would set up a family foundation, donor-advised fund, or charitable trust with the nonprofit American Foundation. One of Mr. Schaub’s for-profit companies, Foundation Planners of America, earned fees for managing the donors’ assets, making sure checks were sent to charities, filing tax forms, and handling other paperwork.

A separate for-profit company — Investment Planners of America, co-owned by Mr. Schaub and his brother, Kenneth — created partnerships that made mortgage loans to commercial and residential developers in Arizona and elsewhere, sometimes at interest rates as high as 16 percent. The developers were willing to pay such high interest rates because the thriving Arizona real-estate market was generating large profits.

Donors could choose to put a portion of their assets into one or more partnerships, and a share of the interest on the loans made from the partnerships would go to the family foundation, gift fund, or charitable trust the donors had set up through the American Foundation.

$30-Million in Bequests

Through the early 1990s, the American Foundation and the charitable trusts, family foundations, and donor-advised funds affiliated with it had less than $20-million in assets. That changed in 1995, when two of the American Foundation’s original board members died and left about $30-million to the foundation, vastly expanding the amount it had to invest.

As founder, chief executive officer, and a director of the nonprofit group, Mr. Schaub had tremendous influence over how to invest that $30-million and the rest of the foundation’s assets. Sometimes Mr. Schaub used the assets of the American Foundation that he controlled to invest in real-estate partnerships. The two for-profit Schaub companies benefited from his participation, brokering loans to developers and earning fees for administering the charitable funds.

During the 1990s, Investment Planners of America helped the foundation and the trusts, funds, and family foundations affiliated with it to invest nearly $60-million in commercial and residential real-estate deals, producing millions of dollars in interest payments for the nonprofit groups and the company. In fact, the American Foundation and its charitable affiliates invested nearly half of their assets in mortgages.

Bankrupt Projects

The arrangement ran into trouble, however, when the developer of two major real-estate projects ran out of money in 1996 and filed for protection from federal bankruptcy laws.

The foundation and charitable entities affiliated with it had lent more than $20-million for the projects, and when the developer missed numerous interest payments, the nonprofit groups foreclosed on the mortgages. They were forced to take ownership of two huge parcels of undeveloped land in Arizona and Utah.

With such a large portion of its assets locked up in real estate that no longer generated profits, the American Foundation and its charitable affiliates soon faced a cash crunch. Numerous charities — among them the Unity School of Christianity, in Lees Summit, Mo.; the Association of Arizona Food Banks, in Phoenix; and the Institute of Cultural Affairs, also in Phoenix — that had been receiving annual gifts from the trusts set up through the American Foundation went more than a year without receiving payment from donors’ accounts.

The unpaid grants were typically $10,000 or less — not large enough to cause the charities serious financial difficulties, their officials said, but large enough to be noticed.

Delays in Gifts

J.D. Bloom, director of development at the Unity School, which teaches that prayer and belief in Jesus can heal the sick, says the foundation sent $11,900 from 1997 through 2000, but no payments had come since then. The money came from a fund set up with the American Foundation by the wife of one of the foundation’s original board members, Mr. Bloom says.

When he contacted Mr. Schaub in March, Mr. Bloom says, Mr. Schaub told him that the foundation was having financial problems but did not say when any additional money would be sent to the school.

Some donors contacted by The Chronicle said they had no complaints about the way the money was invested, noting that they were given a choice as to whether to invest in real-estate deals and that they were willing to gamble on such transactions in hopes of winning big returns.

But other donors, all of whom refused to be quoted, said they wondered whether Mr. Schaub and his brother had steered them into risky real-estate deals with the lure of large interest payments to maximize the profit of the Schaubs’ companies.

Mr. Schaub denies having any such motive. “These investments were not something we were pushing or recommending,” he says, adding that many donors wanted to put their money into real estate because developers were paying high rates and they saw a way to build their charitable assets quickly.

What is more, he says, buyers have come forth for the two foreclosed properties. Mr. Schaub says he expects the sales to close by early next year at a price that will put more assets back into the gift funds, family foundations, and charitable trusts than originally was invested.

Still, Mr. Schaub acknowledges that he and his brother made substantial profits from steering a large portion of the foundation’s assets into real-estate deals, and he says he understands why some donors are upset about his approach of linking nonprofit and for-profit activities.

“I learned that a lot of people don’t like that relationship, because they think you’re benefiting through helping people with charities,” Mr. Schaub says.

That is why he and his brother took their lawyers’ advice and “divorced ourselves from commercial profits,” he says.

Severing Ties

Indeed, Mr. Schaub and his brother gave up their ownership of the two for-profit companies in January 2000. Both brothers made charitable gifts of their shares in Investment Planners of America to an organization affiliated with the American Foundation, making Investment Planners a wholly owned subsidiary of the nonprofit organization.

Mr. Schaub says the gift was valued at more than $1-million, although he says he did not take a tax deduction for his share. Mr. Schaub says Investment Planners of America still employs his brother as its manager, paying Kenneth Schaub a commission based on the value of the mortgages and other investments he generates for the company.

Mr. Schaub also says he transferred ownership of Foundation Planners of America to the same affiliate of the American Foundation that received Investment Planners of America. After an accounting firm determined that Investment Planners was worth $3-million, the foundation paid Mr. Schaub $1.5-million for half its stock. He gave the other half to the foundation as a tax-deductible charitable donation.

Advising Donors

For all his efforts to separate the charitable and for-profit sides of his enterprise in recent months, however, Mr. Schaub insists that his approach was neither illegal nor unethical.

For one thing, Mr. Schaub says, he always told donors about his ownership of Investment Planners of America before they decided whether to invest in one of its mortgage deals.

Moreover, many of the donors in the American Foundation have their money in charitable trusts or family foundations, and those assets were often controlled either by the donor or by an outside trustee chosen by the donor. Because he was not the trustee of those funds, Mr. Schaub says, he could not tell the donors how to invest the assets.

Under federal tax law, Mr. Schaub’s explanations might be satisfactory for the charitable funds still controlled by donors and their trustees and financial advisers, legal experts say. But the answer is not as clear cut, they say, for assets that had been turned over to the American Foundation, either by donors who had died or by donors who expressly asked Mr. Schaub to act as trustee of their money. In those cases, the experts note, Mr. Schaub — as chief executive of the foundation — had tremendous influence over whether the foundation’s funds should be invested through the company that he and his brother owned.

‘Red Flag’

Legal experts also question the heavy investment of charitable assets in real-estate deals — and how the practice escaped the notice of authorities, especially in Arizona. Putting too many assets in real estate creates a disproportionate risk that a development deal will fall through, they say. A nonprofit organization might not only lose the interest payments it is due, but also wind up owning property that can be virtually impossible to sell in a depressed market, the experts say.

In many states, simply the fact that so much of a nonprofit group’s assets were invested in real estate would trigger questions by state officials — especially if the deals were brokered by a company owned by the charity’s chief executive officer, say several lawyers who formerly headed state charity regulatory agencies.

“It would be a red flag,” says Daniel Kurtz, a lawyer in New York who once directed the charities bureau in the state attorney general’s office. “Any attorney general that does anything in the charity area, that has any kind of oversight, would have the same reaction: ‘There’s something here that merits further inquiry.’ Maybe charity officials have a good explanation, but it seems to me it puts the charity seriously at risk.”

Mr. Kurtz emphasized that he was speaking generally about any charity that had so much of its assets tied up in real estate, and not specifically about the American Foundation.

Ronald Badowski, an accountant in Wickenburg, Ariz., who served as a director of the American Support Foundation for 15 years, said that for years he urged the Schaubs to diversify the foundation’s investments.

“I firmly believe in the greater the return, the greater the risk,” Mr. Badowski says. He also says he felt uncomfortable about the foundation’s relationship with Investment Planners of America. “It gave the appearance of conflict,” he says.

After writing letters to Mr. Schaub complaining about the real-estate investment policy and the relationship between the foundation and the for-profit company, Mr. Badowski says, he quit in 1999.

“I’m walking away from this,” he says he decided.