There is a scandal lurking in the database of asset diversions reported by the Washington Post, but it isn’t what many people think. The database covering some 1,000 tax-exempt entities that reported diversions over a four-year period of more than five percent of their asset values doesn’t add up to an indictment of the nonprofit sector for shady operations and mismanagement. Not at all. But it does add up to some important themes that Congress should investigate to protect nonprofits from being victimized by white-collar criminals.
The real scandal exposed by the Washington Post on October 26th is that 501(c)(3) public charities and nonprofits of all sorts—including, by the way, private foundations—have been ripped off by all sorts of investment scams. As writers for the Nonprofit Quarterly have often written, an investment scheme that seems too good to be true is almost always too good to be true. But this is out of hand. This isn’t just nonprofits falling for the imaginary returns of Bernie Madoff, where nonprofit, for-profit, and individual investors operated for years on Madoff’s fraudulent estimates of the values of their holdings, leaving them shocked not only that they didn’t have investments worth anything near what Madoff told them, but that the returns on their investments were nonexistent.
Throughout the Washington Post diversions database one finds nonprofit after nonprofit ripped off by investment advisors of all sorts. These firms were registered and licensed brokers, with the Good Housekeeping seal of approval from necessary state and federal regulators like the Financial Industry Regulatory Authority. Hopefully, nonprofits checked out their choices of investment advisors on the various computerized databases, such as the Central Registration Depository or FINRA’s BrokerCheck website, but lurking in the lists are brokers whose felonious activities were caught only after the fact, after a nonprofit had a trusted broker walk off with investments.
Take, for example, the 3M Employees Welfare Benefits Association Trust III Agreement, a 501(c)(9) that finances the cost of providing life insurance benefits to retired 3M employees. In early 2009, the organization learned that the executives of the WG Trading Company, in which the trust held a limited partnership interest, were facing criminal and civil investigations by the Securities and Exchange Commission, the Commodities Futures Trading Commission, and others. As was reported a year later, one of the managers of WG, one Paul Greenwood, pled guilty to securities fraud, admitting to having used, along with other executives, WG as a personal checking account and replenishing the stolen funds on occasion from other investors’ accounts. In other words, a Ponzi scheme. The indictment was for having defrauded investors of $554 million, though prosecutors claimed that investors lost between $800 and $900 million. WG’s targets? According to the SEC, “large institutional investors, including several public pension funds and educational institutions and endowments.” The Trust reported the diversion to be worth almost $229,000.
The Houston Athletic Association reported a diversion of almost $2.2 million in 2011, which it explained was due to investments in securities held by the J. David Group. The investments, it learned, were fraudulent and nonexistent. Not knowing whether anything might be recouped, it wrote down the value of the investment to zero. The J. David Group was a Houston-based investment firm founded by Joel David Salinas. Salinas, who committed suicide before going to trial, and his associate, Brian Bjork, were charged by the SEC with having raised $39 million from investors who thought they were investing in high-yield corporate bonds with annual yields as high as 9 percent which either didn’t exist or J. David never acquired. Another Salinas/Bjork scheme raised an addition $13 million in other securities and complicated transactions as minimally valuable as the bond scheme.
The Workers Compensation Reinsurance Association and three other nonprofits—including the Minneapolis Foundation—sued Wells Fargo for having breached its fiduciary responsibilities by investing or lending part of the nonprofits’ funds in dubious investment vehicles. Despite a lower court ruling against the bank, Wells appealed and lost, with the courts ordering Wells to pay damages and equitable relief.
In 2009, Westridge Capital Management was charged with $500 million in a fraudulent investment scheme, capturing investment assets of the University of Pittsburgh, Carnegie Mellon, and other institutional investors. Although Westridge’s assets were frozen for potential repayment of investors during the case, the University of Pittsburgh wrote down the value of its holdings in Westridge, roughly $34.9 million, by half. Pitt and Carnegie Mellon didn’t simply stumble onto Westridge. The schools were advised to turn to Westridge by Wilshire Associates, a California-based investment consulting firm that claims to advise 600 organizations in 20 countries controlling $12.5 trillion in assets.
The list of investment fraud by financial and investment advisors is lengthy in the Washington Post database, hardly all schemes concocted by the likes of Bernie Madoff. They weren’t nonprofits investing with corner-shop hustlers like Mouli Cohen, who convinced the donors to the Vanguard Public Foundation to invest in the stock of a firm he wasn’t even associated with that he said, without the slightest evidence, would be purchased by Microsoft. These were legitimate and in many instances quite substantial nonprofits, universities, and pension funds that were investing in investment firms that were probably at the time considered completely legit and clean.
Take Westridge. Perhaps Pitt should have known that Westridge was concocting a fraudulent investment scheme, but even the Securities and Exchange Commission was taken to task for failing to reveal, report, and take action against Westridge and its executives, who happened to be the same people involved in the WG Trading fraud. As the investigation showed, “the SEC’s Los Angeles Regional Office missed a significant opportunity to uncover the Ponzi scheme and failed to conduct a competent and thorough examination of the investment advisor, Westridge, and did not take the necessary steps to ensure that a follow-up examination of the broker-dealer, WG Trading, was conducted.”
“Nobody can expect every director, or even the directors who serve on a board’s investment committee, to be able to protect the organization against the unscrupulous actions of determined crooks. And it is wrong to hold directors, especially volunteer ones who serve without compensation, to some omniscient standard that no one could pass,” Joe Delano, the money and politics editor of KDKA-TV, wrote about Westridge and WG Trading frauds. “But, if nothing else, the recent experiences of Pitt and CMU are a wake-up call that directors can never ask too much about how their organization’s money is being spent and invested. I know I will ask more questions on the boards on which I serve, and I hope you will, too.”
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Delano is right that boards have to ask tough questions of their investment advisors, but Congress should see the pattern: In the juggernaut for nonprofits to forever increase their investment returns, particularly in recessionary times like the years covered in the Washington Post database, board members are constantly pressured to find investments with better returns, and are hardly prepared, even with their own in-house, on-board financial experts, to suss out the likes of Greenwood, Salinas, and Bjork. If the SEC and other oversight bodies aren’t taking action with alacrity, they should, and Congress should be investing more resources in the SEC and elsewhere to protect nonprofit assets.
Recessions tend to bring out the worst of embezzlers who, like Willie Sutton, try to steal where the money is, aiming at the banking sector and the funds handled by banks and investment firms. Banks and other financial institutions have proven no more able to insulate themselves from fraud than the nonprofits that invest with them. In Virginia, the president of the Bank of the Commonwealth, in the position since 1973, was convicted recently of having participated in a scheme to defraud his own bank of $71 million before it went out of business in 2011. In Missouri, the former president of the Bank of Billings pled guilty recently to bank fraud and money laundering. It happens at the big banks, too; for example, at Citigroup, where one executive embezzled $23 million.
Here’s what might be needed for this category of nonprofit diversions: When tax-exempt monies are involved, particularly funds donated to public charities, there should be an extra layer of oversight and, for the malefactors, an extra layer of penalties. When investment fraud occurs with nonprofit assets, the bad guys are stealing not only from the nonprofits—not only from the people who are the intended clients and beneficiaries of the nonprofits—but from the American taxpayers who have given these funds the benefit of a federal tax deduction.
For inside embezzlers and thieves, what seems notable is the indication that nonprofits in the Washington Post database seem to have pretty consistently taken action against the in-house miscreants, turning them over to the authorities for prosecution, seeking repayment, and strengthening systems. For example:
- When Mercy Medical-Center in Dubuque, Iowa, discovered that an employee had purloined 790 items of equipment and supplies, the hospital terminated the employee, turned the case over to law enforcement, the thief was ordered to pay restitution, and the hospital installed additional locks and cameras to minimize the prospects of future theft.
- Through an internal audit, the University of Miami found an IT supervisor who had managed to purloin computer parts amounting to $471,000. The university terminated the employee, filed a civil suit, and reached an agreement in which the university will receive approximately $500,000 in restitution and attorneys’ fees.
- St. John’s University in Queens found an employee who over a period of several years had falsified credit card statements for non-work items and diverted funds meant for a foreign charitable entity. The University referred the case to the District Attorney who secured an indictment of the former employee and followed with enhancements of internal controls.
- At the Society of St. Paul de Vincent in Buffalo, a bookkeeper embezzled $360,000. According to the executive director, Mark Zimheld, the organization was transparent about what happened, the bookkeeper was arrested and sentenced to jail, and the person now is making restitution on a 10-year repayment schedule.
- Over a four-year period, the treasurer and executive director of the National Coalition of Alternative Community Schools in Ann Arbor, Michigan stole some $33,000 from the organization. The board discovered this and reported the thievery for judicial action.
The pattern revealed in the Washington Post database in those cases where nonprofits filed explanations of the diversions is that for the most part, the nonprofits victimized by these crooks took the wrongdoers to the authorities for action, and in many cases argued not only for prosecution, but restitution. Perhaps the groups that failed to take legal and corrective actions didn’t check the diversion box and didn’t explain what happened. We have heard of organizations that turned a blind eye to the purloining efforts of favored staff. We will take these organizations at their word that, for their parts, they have turned to the authorities for action and restitution—even with financial advisors, seeking Securities Investor Protection Corporation (SIPC) compensation and other repayments from recaptured assets—and followed up with improvements in internal controls.
In the for-profit business world, employee pilferage is endemic and increasingly built in as a cost of doing business. The estimates of how much employee theft are huge—25 to 40 percent or perhaps even three-fourths of employees stealing from their employers, costing American business as much as $50 billion a year or even $90 billion, with the calculation of theft of intellectual property taking it as high as $240 billion. One source suggests, “Some small business owners, meanwhile, adopt a remarkably fatalistic attitude toward employee theft. These entrepreneurs do not even bother to study the issue or adopt any but the most rudimentary strategies to control or stop it.”
In this database, it doesn’t appear that the nonprofits checking the diversions box on their 990s looked the other way. If you work for a nonprofit and clip money—and get caught—these nonprofits seemed to be quite willing to turn over the scoundrels to prosecutors and DAs for judicial action. For those of us who have had to encounter and deal with problems of employee financial pilferage, it is easy to imagine the reasons for not taking action. The course of least resistance, if the financial losses can be weathered, is to dismiss the employee and move on with the organization’s business. In the instances reported in the Washington Post database, once the diversions were found, the nonprofits sought legal action. One can only hope that the malefactors received their just deserts and the nonprofits won whatever they could in restitution.
In a number of the diversions, the money was recovered—or the diversion might not have been a diversion, after all. At the Gwinnett Hospital System, a six-figure check was inappropriately cashed on the hospital’s account, but the hospital caught it and worked with the bank to get moneys returned to the hospital. The Wolfsonian in Miami Beach reported as a diversion its transfer of its fixed assets to Florida International University—because it is actually part of FIU. The diversion at Quinlan Arts occurred because of a revaluation of its art collection. The Hallandale Community Council Scholarship Fund reported as diversions its losses in the stock market, a “diversion” that many nonprofits might have reported during the recession.
In Buena Vista, Michigan, the Buena Vista Lions has made a strenuous case that it did not divert nonprofit resources—the reported $6,000 cited on the organization’s 2011 Form 990. Apparently, the organization’s bookkeeper checked the diversions box when he or she meant disbursements for Lions programs, such as taking children Christmas shopping and maintaining the Lions’ facility. Similarly, the Greater Poplar Spring Community Outreach Center in Enterprise, Mississippi, said it didn’t do any fundraising in 2011, and therefore reported as a diversion the spending of $1,020 on food for its food program.
It would appear that plenty of nonprofits, big and small, interpret “diversions” differently. If the nation ever gets to the point of digitizing 990s, we wouldn’t be waiting for the diligent work of the WashingtonPost’s investigative team uncovering 1,000 nonprofits checking the diversions box on their tax forms. There would be a system where the currently beleaguered staff of the IRS’s tax-exempt unit would see these boxes as a flag, warranting, at a minimum, an inquiry and a clarification, and if something more significant is happening, an investigation, perhaps in coordination with state authorities.
If Congress investigates on the basis of the WaPo series, it might be well advised to take a hard look at the investment sector, which has a long history of plundering nonprofit assets under the guise of providing investment advice and placement. It might also work with the nonprofit sector and its leadership organizations, such as the Council of Nonprofits and Independent Sector, among others, to ensure that nonprofits are not only checking the diversion box appropriately, but also adding a full explanation of the reported diversion—which, sadly, too many nonprofits in the database didn’t do.
Additionally, nonprofits of all kinds should be encouraged to report thefts, fraud, and embezzlement. It is best for all concerned that we do not make assumptions that they were at fault before we look at the details. If they had reasonable checks and balances in place, then perhaps they are not at fault because they have been victimized. There are far too many stories in the sector of perpetrators moving from one organization to another because such situations have been kept under wraps.
My next article in this series will concentrate on the smallest of organizations in the Washington Post database.