Minnesota Funds Face Call for Return of More Than $450-Million in Fraud Case

When charities find themselves the subject of clawbacks—government calls for the return of illicit gains from financial-fraud cases—it is usually for one of two reasons: Either they had invested charitable assets in what turned out to be a scam or they received donations from people who ran or improperly benefited from a scam.

In both cases, the money the nonprofit groups collected, either as gifts or supposed investment returns, is considered so-called false profits that must be returned and distributed to the victims of the fraud.

But three lawsuits filed in federal bankruptcy court last fall seeking the return of tens of millions of dollars from four Minnesota foundations appear to present a messy mix of both kinds of clawbacks.

The foundations are alleged to have made dozens of investments in the form of high-interest loans over a number of years to businesses related to Tom Petters, a Minnesota businessman convicted in 2009 of running a multibillion-dollar Ponzi scheme.

The loans, with interest rates as high as 42 percent, were issued as promissory notes to cover the purchase of electronics and other goods for resale. But the purchases were never made, according to the complaints, and the foundations were instead paid with money collected from new investors in the scam.

Since the notes were donated to the foundations by entities that were involved in or had benefited from Mr. Petters’s Ponzi deal, the complaints say, both the principal of the investments—in these cases, the gifts—and the interest paid on them must be returned.

A typical investor would be subject to clawbacks only in the amount of the profits received above the initial investment or loan.

Interest Payments

The lawsuits say that the Minneapolis Foundation, a community foundation, owes $6.9-million in principal and roughly $4.1-million in interest payments; the Northwestern Foundation, connected with Northwestern College, in St. Paul, owes $3.2-million in principal and nearly $2-million in interest; and the Sabes Family Foundation, run by a family that individually and through its businesses had dealings with companies related to Mr. Petters, owes $6-million in principal and about $14-million in interest.

The complaint filed against the Fidelis Foundation, a Minneapolis grant maker that supports Christian groups and that has ties to Mr. Petters, says the foundation could be on the hook to repay more than $400-million in principal investments and more than $5-million in profits.

A spokesman for Fidelis says that the foundation has not been asked to return the initial loan amounts and that it did not earn any money above its investments. It has asked the court to dismiss the case.

A lawyer for the Minneapolis Foundation, which also has also sought dismissal of the lawsuit against it, says the loans should not be subject to clawbacks and, in any case, the clawback effort exceeds Minnesota’s six-year statute of limitations.

What’s more, he says, the foundation, which in 2001 received two gifts of promissory notes totaling $6.9-million from the Sabes Family Foundation, two years later, at the request of the donor, gave the entire gift and the interest to another charity.

The Sabes Family Foundation could not be reached for comment. A Northwestern Foundation spokesman declined to comment.

The three lawsuits (Sabes and Minneapolis are included in one, along with other defendants) were filed by Douglas A. Kelley, the court-appointed trustee and receiver in Mr. Petters’s bankruptcy and fraud cases.

The lawsuits are among more than 200 complaints, mostly against businesses and individual investors, seeking the return of about $1.7-billion in so-called phantom profits from Mr. Petters’s illicit operations.