Making Philanthropy Accountable

New York’s top regulator pushes for far-reaching changes

The New York State attorney general’s office, one of the nation’s most aggressive charity watchdogs, is

proposing controversial changes in federal law and state regulations that would limit some charitable tax deductions, outlaw the formation of small private foundations, and require many charities to seek multiple bids before signing contracts with professional fund raisers.

The proposals, already under fire by critics, could affect nonprofit groups far beyond the borders of the third-largest state.

The office of Attorney General Eliot Spitzer has asked Congress to:

• Consider banning small private foundations — perhaps organizations with less than $20-million in assets. In defending the proposal, the attorney general’s office cites what it calls serious “abuses” among family and other funds that lack “professional” staff members, grant-review policies, and other safeguards.
• Change federal law so that donors could not deduct the portion of their gifts that wound up in the hands of professional fund raisers. Charities that raise money through professional fund raisers would be required to tell donors through acknowledgments how much of each donation was actually used by the charities and was thus tax-deductible.
• Allow the Internal Revenue Service to share information about charities, foundations, and other tax-exempt organizations with state charity regulators so that the tax agency and states could work together on identifying and investigating nonprofit groups that may be breaking laws. The IRS currently is forbidden from providing a great deal of information to state authorities.
• Provide the IRS with more money to scrutinize tax-exempt groups, and give the tax agency new tools to use against private foundations that give their executives and board members excessive compensation or improper perks.

Back on his home turf, and encouraged by a closely watched U.S. Supreme Court ruling on telemarketing last month, Mr. Spitzer is expected to propose a rule, heavily resisted by charities and professional fund-raising companies, that would require charities and their boards to obtain more than one bid before signing a contract with an outside fund raiser.

The attorney general plans to begin enforcing an existing state law that requires professional fund raisers to file with the state copies of the written “scripts” that telephone solicitors use to seek donations. In addition, he plans to step up the filing of criminal charges against professional fund raisers who violate other New York fund-raising laws.

Wall Street Scandals

Mr. Spitzer, who gained national visibility for his pursuit of corporate corruption in the wake of scandals on Wall Street, said he is bringing a similar zeal to investigating nonprofit malfeasance — especially by boards of directors that fail to exercise oversight of charities and foundations, which he said can lead to high fund-raising costs and corruption.

“My greatest concern is the failure of boards to properly fulfill their fiduciary duty to know what is going on and guide day-to-day management properly,” said Mr. Spitzer in an interview in his New York City office. “To a certain extent it’s the same issue we’ve seen in Enron or other types of organizations, for-profit or not.”

Mr. Spitzer’s plans and recommendations carry great weight, in part because of the size and importance of his state, the experience his office gained in overseeing charities following the September 11 attacks, and his own fast-rising political profile as a possible candidate for New York governor.

New York’s rules on fund raising apply to any charity that raises money in New York, including those based in other states, and Mr. Spitzer’s recommendations to Congress come at a time when lawmakers are already concerned about whether foundations are spending too much on administrative costs and not enough for charity (The Chronicle, May 29).

Already, Mr. Spitzer and two key assistant attorneys general — William Josephson and Karin Kunstler Goldman — are pursuing investigations against more than two dozen private foundations that the office said are examples of governance failures by nonprofit boards.

Part of what is energizing the efforts of the New York attorney general is the Supreme Court’s ruling last month in the telemarketing case. In Madigan v. Telemarketing Associates, the court said that Illinois and other states can prosecute fund raisers for fraud if the fund raisers knowingly mislead donors about how their gifts will be used. At issue was a telemarketer whose contract with a veterans group allowed the company to keep 85 percent of the money it raised.

In its decision, the court stood by three rulings from the 1980s barring states from imposing limits on fund-raising expenses or making charities disclose such costs when seeking gifts.

The court’s new Illinois ruling, Mr. Spitzer said, “creates for us the opportunity to do what we’ve wanted to do for a long time, which is to pursue solicitors who are fast and loose with their claims about how money will be used.”

Last year, Mr. Spitzer proposed new rules that would require charities and their boards to obtain more than one bid before signing a contract. After many charities and professional fund raisers objected to the idea, some claiming that the requirement would be unconstitutional, Mr. Spitzer set aside the idea, at least temporarily.

Although the attorney general did not believe he needed a favorable Supreme Court ruling to revisit the idea of requiring bids, he said the new Supreme Court ruling gives a boost to his position.

“Getting boards to focus on the fact that this form of fund-raising [telemarketing] has been enormously problematic — and therefore, as almost a prophylactic measure, boards should require some bidding process — seems like a pretty simple, good-practice model to ask people to follow,” said Mr. Spitzer.

In the aftermath of the latest Supreme Court ruling, the attorney general’s office plans to enforce an existing state law requiring that telemarketers file copies of the scripts they use in solicitation campaigns.

“We have not enforced that statute in light of the 1980s Supreme Court cases,” said Mr. Josephson, who heads the state’s Charities Bureau. “But in light of Madigan, we will. The simple act of the filing of the script — there’s no approval of it here in our office — is important, because that enables us to determine whether the fund raiser is saying what he is publicly committed to say.”

Private Foundations

Alleged abuses by small foundations uncovered by Mr. Spitzer’s office led to the drastic step of asking Congress to consider limiting organizations that could qualify as private foundations. “If I had my druthers,” said Mr. Josephson, “the IRS would stop approving exemption applications for small private foundations with, let’s say, $20-million in assets.”

Mr. Josephson wrote members of the House of Representatives that, under the attorney general’s proposal, “the donors to and managers of small private foundations, who want to maintain their philanthropic commitment, would be able to transfer assets to donor-advised funds in community foundations and to other public charities, which are generally sufficiently professional.”

The experience of the New York attorney general’s office reveals that many small foundations “are tremendously abusive” in the way they operate, including providing unreasonable compensation to officials, said Mr. Josephson.

Said Mr. Spitzer: “What we often encounter is a failure on the part of the founder to distinguish between the assets that are his or hers and the assets that are the foundation’s.”

The idea of a threshold for private foundations drew the ire of Douglas K. Mellinger, chief executive officer of Foundation Source, a company that helps donors set up and run small private foundations.

“I’m just sick to my stomach at what these guys are thinking, because they have no clue what they are talking about; it’s mind-boggling,” said Mr. Mellinger. “You can find a couple of bad apples in foundations. But you can’t govern society by the couple of people who are doing everything wrong when you’ve got the majority of people doing it right.”

Loss of Revenue

Mr. Josephson said the attorney general’s office asked Congress to limit tax deductions taken by donors who contribute through professional fund raisers because it was concerned about the loss of revenue to federal and state governments.

Under the proposal, for example, a charity that raised money through a telemarketing company that retained 85 percent of contributions would have to send acknowledgments of gifts that made clear that the allowable charitable tax deduction would be limited to 15 cents on the dollar.

“The extraordinarily high percentage of funds that many charities pay to professional fund raisers should be of great concern from the point of view of revenue loss,” Mr. Josephson wrote congressional committees.

“We thought that since the professional fund-raising community, and indeed parts of the charities community, are so resistant to reform in this area, that rather than try to deal with these issues as a question of fraud or deception, it might be better to persuade the Congress to deal with them from the point of view of the revenue loss that’s involved,” said Mr. Josephson in an interview. “The Madigan case has now given us new tools to deal with fraud and deception that we didn’t clearly have before, but this issue should still be of concern from the point of view of revenue loss.”

Errol Copilevitz, a lawyer for the telemarketing company in the Madigan case who successfully presented the charity’s argument in a 1988 Supreme Court case, said that he had strong concerns about such an approach and that it was an attempt to circumvent current law.

“What they propose as a distinction is no different in most ways from the 1980s and Madigan Supreme Court decisions — it violates the First Amendment,” said Mr. Copilevitz.

“When a person gets a pledge card saying that only 15 percent of the gift is tax-deductible, the person is going to throw the card away and not give the money,” he added. “And that is doing indirectly what time and time again the Supreme Court has said you can’t do directly: equate high costs with some kind of wrongdoing or fraud or misrepresentation.”

Mr. Josephson said that the attorney general’s most urgent request of Congress — that it give the IRS permission to share information about tax-exempt organizations with state attorneys general and work together to enforce laws — is a long-sought and key goal of state charity regulators.

“There are lots of ways in which we and the IRS could share investigations and work jointly, but we are totally unable to do that,” said Ms. Goldman, the assistant attorney general. “It’s very frustrating.”

In the end, Mr. Spitzer said, it’s a mistake to think that “accountability and governance issues” are limited to highly publicized cases involving the worlds of corporations and investment banking.

“We see enough fiduciary violations out there,” Mr. Spitzer declared, “to be aware of the fact that we have a fair bit of work to do to improve the general caliber of governance in the not-for-profits.”