Wallace-Reader’s Digest Funds and New York Attorney General Reach Settlement

By JANET L. FIX

New York’s attorney general has announced a settlement with the Wallace-Reader’s Digest Funds that ends a lengthy legal dispute and gives 13 charities direct control of $1.7-billion in assets. The move also raises questions about the future of the company and charitable foundation founded by Lila and DeWitt Wallace.

The agreement, negotiated over the past 11 months, allows the Wallace Funds to put behind it, without any admission of wrongdoing, a controversy that has entangled for nearly a decade a charitable bequest by the founders of Reader’s Digest magazine. That bequest has grown to $3.2-billion.

The settlement ends an investigation begun in 1998. At issue: whether that bequest would have been significantly larger now but for an organizational structure set up to benefit the 13 charities, including the six that are part of New York’s Lincoln Center and the Metropolitan Museum of Art.

The structure, a set of “supporting organizations,” will be dissolved under the deal. Critics and some of the charities contend that the complex structure kept the 13 charities from freely selling Reader’s Digest stock even as it plummeted in value in the past decade while other investments soared.

The agreement could have major ramifications for the Wallace Funds and for the 13 charities. Both have a large part of their assets tied up in Reader’s Digest stock.

The agreement opens up the possibility that the Wallace Funds could eventually sell its 50-percent ownership in the Pleasantville, N.Y., publisher, according to terms of the deal. That could happen once the board changes with new members, term limits, and other alterations outlined in the deal.

In March, the Wallace Funds announced it was expanding its board to include four new board members. Under the deal, all new board members must be free of ties to the publishing company and foundation. By June 2002, when a current director retires and is replaced, five of the nine board members will be new. By 2008, eight of the nine directors will be new.

“Independent decision making is essential to ensure that private foundations are effective stewards of charitable assets,” Eliot L. Spitzer, the New York attorney general, said in a statement.

If the new members choose to sell their control of the company’s stock, ownership of the publishing company could change. The sale could leave the funds with a larger endowment that would allow more gifts to the educational, cultural, and other groups it has supported.

The agreement gives the charities, which had been the beneficiaries of income from several funds, the chance to more easily sell Reader’s Digest stock. As a result, it creates the possibility, for the first time, that the 19-percent share of Reader’s Digest nonvoting common stock the 13 charities will soon directly control may be sold within 12 months.

The charities agreed only to coordinate future sales of the stock to “ensure that they, and other shareholders, receive maximum value for their holdings,” Mr. Spitzer said. The deal “moves the Wallaces’ bequest into the 21st century with a sound investment strategy.”

Christine DeVita, president of the Wallace-Reader’s Digest Funds, said the out-of-court agreement ends the state’s three-year-long investigation by simply outlining “voluntary and evolutionary changes made by the Wallace Funds.”

As a result, she said, the funds’ charitable mission, its operation, and asset size won’t be changed. “We’re delighted that the attorney general thought the changes we made were appropriate,” she said. “This brings two trains running on parallel tracks into the station together. It is a win-win for everybody and a testament to the Wallace legacy.”

‘Flies in Face of Reality’

The attorney general’s office said the changes made by the Wallace Funds and in the operation of the seven foundations that oversee the 13 charities did not come voluntarily.

“That flies in the face of reality,” said Scott Brown, Mr. Spitzer’s spokesman. “You don’t enter into months of negotiation with the state attorney and enter into an out-of-court agreement if what you’re doing is voluntary.”

If the Wallace Funds do not make the changes outlined in the agreement, the state could file suit against the Wallace Funds, according to the attorney general’s office.

The 13 charities do not get new money under the agreement. It does give each charity the chance to reinvest its share of the $1.7-billion endowment into investments that may bring higher returns, and as a result, allow it to increase its endowment more quickly.

Many of the groups, like Macalester College, in St. Paul, which will receive about $303-million — the second-largest share — could quickly sell their Reader’s Digest stock. The college already counts the share it will receive in its $496-million endowment.

“The agreement allows us, along with the 12 other charities, to sell in a coordinated fashion our stock,” said Doug Stone, spokesman for the college. “I don’t know how long that will take, but it’s a matter of months rather than years.”

The goal is to leave the college with a more diversified endowment, he said. In 1992, 65 percent of the college’s total endowment was tied up in Reader’s Digest stock; currently that figure is closer to 13 percent, he said. “I don’t know what our fund managers will take it down to, but we will be diversifying.”

Varying Shares

The charities will receive varying shares of an endowment created in the 1960’s by DeWitt and Lila Wallace, who founded Reader’s Digest magazine in 1922.

The structures that oversaw that endowment were complex and controversial. They allowed executives of the Reader’s Digest company to be directors of the foundation and of the supporting organizations of the charities.

“The arrangement wasn’t good for the public shareholders or the charities,” said Daniel L. Kurtz, a former assistant New York state attorney in the charities bureau who is now a lawyer representing nonprofit groups.

George V. Grune, chairman of the board of the Wallace-Reader’s Digest Funds, said the changes were a “natural evolution.” He added: “It’s the right time and the right decision.”

The largest share of the Wallace money will go to the Metropolitan Museum of Art, which will receive about $424-million.

The six smallest shares will go to the six Lincoln Center groups, including the Chamber Music Society of New York, which will receive about $13-million.

The other charity beneficiaries are: the Colonial Williamsburg Foundation (Va.), Memorial Sloan-Kettering Cancer Center (New York), Open Space Institute (New York), Scenic Hudson (New York), and the Wildlife Conservation Society (New York).

HOW MUCH CHARITIES WILL RECEIVE FROM WALLACE-READER’S DIGEST FUNDS