The Queens Borough Public Library recently announced the selection of Dennis Walcott, the former chancellor of the New York City Department of Education, as its new president and CEO. While an exciting announcement for the library, Walcott faces tremendous challenges as the organization continues to deal with the fallout from the scandal involving its former president, Thomas Galante, and his reported self-indulgent spending habits using library funds.
In early 2014, news outlets picked up on what was perceived to be the excessive compensation of Galante, then president and CEO of Queens Library in New York. Galante had received a base salary of nearly $400,000 in the previous year, and his compensation reportedly also included payment, capped at $37,000, for a car of his choice every three years. Adding fuel to the flame was the fact that $140,000 had also reportedly been spent to renovate Galante’s offices during this same time period, while nearly 130 jobs at the library had been eliminated through layoffs and attrition in the previous five years.
While there is frequently uproar regarding nonprofit executive compensation that is perceived to be excessive (even when such compensation may not in fact be excessive in light of all of the relevant facts and circumstances), there was actually much more to the story here. Later in 2014, the New York Comptroller began an audit of and subsequent investigation into possible misconduct at the library. According to the comptroller’s report on the investigation issued in July 2015, the auditors “observed the absence of key financial controls and identified questionable expenditures and practices engaged in by the library’s senior management that put the library’s finances at risk of abuse.”
The investigation found that Galante and Bridget Quinn-Carey, the former library Chief Operating Officer (who subsequently served as the interim CEO and President), had used their organizational credit cards to make more than $310,000 in prohibited or inappropriate purchases during the 2012 to 2014 fiscal years. Galante was responsible for incurring approximately $260,000 of these charges. The report also concluded that a significant portion of those expenses should have been, but were not, reported by the library as taxable income to those individuals. The prohibited purchases included such things as $23,000 in fuel for personal use, restaurant meals at which only Galante appeared to be present, tickets to Disneyland, four tickets to a Maroon 5 concert purchased for nearly $2,000, Apple TVs for Galante’s home office, satellite radio subscriptions for Galante’s car, parking ticket and towing fees, and $6,500 in purchases on dates when Galante was reportedly on leave from his library role.
The comptroller’s report further focused on the fact that, while serving as the library’s CEO and president, Galante was also simultaneously being paid between $150,000 and $200,000 per year for providing consulting services to a school district. Based on his calendar entries and other records, the comptroller asserted that Galante appeared to have been spending time that should have been devoted to his role at the library on this consulting job.
In June 2014, the New York State legislature enacted legislation allowing the mayor of New York City and the Queens borough president, who appoint the Directors of the Library, to also remove them from office. The following month, eight of the library’s directors (seven of whom had served on the board for more than ten years) were in fact removed. After initiating its own investigation, the library’s reconstituted board terminated Galante’s employment for cause in December 2014. Five additional library executive staff members subsequently resigned from their positions.
Unfortunately, however, the story is likely far from over for the library. The library reported in its Form 990 for the fiscal year ending June 2015 that, “[b]y letter dated August 18, 2015, the Library demanded that…Galante…repay the Library over $330,000 in automatic excess benefits and excess compensation he received from the beginning of 2009 through September 20, 2014,” while serving as president and CEO. Galante responded by filing a lawsuit against the library in federal court in November 2015 seeking a declaratory judgment that he did not actually receive and does not owe the excess benefits that the library has demanded be repaid. His lawsuit further demanded more than $2 million in payments from the library for a claimed breach of his employment contract, which was amended by the library’s board in November 2012 to add a provision providing for $1.9 million in severance payment if Galante were to be terminated without cause.
Last month, the library filed a countersuit seeking repayment of the inappropriate expenses incurred by Galante, as well as legal fees the library paid on behalf of Galante after he received a subpoena from the U.S. Attorney’s Office. It could be a number of years before these suits are resolved, and the potential for additional enforcement actions against Galante remains.
The Legal Implications
While such a scandal has obvious adverse public relations implications for a nonprofit, it also has significant potential legal and tax implications for the organization and the individuals involved. In its 2015 Form 990, the library further reported that it had engaged in an excess benefit transaction during the relevant fiscal year and that it was seeking reimbursement from Galante of the excess compensation and automatic excess benefits he had received from the library. An excess benefit transaction is one in which a disqualified person (generally, a person who is in a position to exercise substantial influence over the affairs of the organization) receives an economic benefit from a 501(c)(3) public charity that is in excess of the value that such individual provided the organization in return.
The Internal Revenue Code (the “Code”) imposes a tax on any disqualified person who is the beneficiary of an excess benefit transaction. The initial tax, which must be paid by the disqualified person herself and not by the organization, is equal to 25 percent of the amount of the excess benefit received, although an additional tax of 200 percent of the excess benefit will be imposed on the individual if the transaction is not corrected before the Internal Revenue Service assesses the tax. Given the amount of the alleged excess benefit that Galante reportedly received here, and therefore the amount of the tax that could be imposed on him personally, he certainly has a strong incentive to dispute that such amounts in fact constituted an excess benefit to him.
The regulations interpreting the Code, however, further provide that, where an economic benefit is provided by an organization to a disqualified person and is not appropriately documented as compensation for services, and where the organization cannot demonstrate that it provided the economic benefit in exchange for consideration other than the performance of services, the benefit will automatically constitute an excess benefit transaction. This means that the relevant taxes discussed above will be imposed regardless of whether the benefit provided to the individual was reasonable or the individual’s total payment from the organization was in fact reasonable. Moreover, where funds are fraudulently taken by a disqualified person from an exempt organization, as is asserted to be the case here, the regulations provide that they may not be treated as consideration for services for purposes of the excess benefit transaction rules, and therefore automatically constitute an excess benefit transaction subject to the taxes.
Of particular concern to nonprofit directors, the excess benefit rules also provide that a tax of 10 percent of the amount of the excess benefit, up to a maximum of $20,000, may be jointly and severally imposed on an organization’s directors personally if they knowingly and willingly participated in an excess benefit transaction. In addition to these potential taxes, the fiduciary duties owed by directors of a nonprofit to the organization under state law also likely require the board to use reasonable effort to recover the funds wrongfully taken from the organization. A written demand for such repayment, as the library’s board issued to Galante, will likely make sense in most such scenarios. However, whether additional steps, such as filing a civil lawsuit, are appropriate and in the best interests of the organization will depend on the facts and circumstances at issue, including the amount taken and the likely cost and potential for success of recovering such funds. If the funds were taken by a disqualified person, the nonprofit will also need to report the event as an excess benefit transaction on its appropriate Form 990 (which is a publicly available document), as the library did here.
The story of Galante’s purported excessive spending habits while serving as the Queens Library’s president and CEO serves as a good reminder of the necessity of strong governance and appropriate oversight within nonprofits. Moreover, it demonstrates the importance of developing, and actually enforcing, appropriate policies related to the organization’s activities, including possibly a spending or credit card policy.