Ponzi Schemes and Charities: Malvern Preparatory School, its Former Trustee Joseph Forte and New Form 990 Disclosures – Installment 30July 22, 2010 – Articles White Collar Defense & Compliance Blog
This is the thirtieth in a series of Installments on this blog that discusses issues that arose for charities in the aftermath of the Bernard L. Madoff (“Madoff”) scandal. For example, Installment 29 analyzed new disclosure requirements for public charities adopted by the Internal Revenue Service (“IRS”) in 2008 for its new Form 990 (the “New Form 990”) against the backdrop of the Madoff scandal and its relationship to Howard Hughes Medical Institute (“HHMI”). Forms 990 that are filed with the IRS, including the New Form 990 of HHMI and those discussed in this Installment, are universally available on the Internet on Guidestar and other sites.
Madoff, however, was not the only person to have operated an alleged Ponzi scheme that materially and adversely affected charities. The Philadelphia Inquirer published an article by Harold Brubaker on July 7, 2010, entitled “A Workout in Court over Ponzi-scheme Gift.” The Brubaker article reported that Malvern Preparatory School (“Malvern” or the “school”), among other charities, is claiming that it is a victim of a Ponzi-scheme run by its former Trustee Joseph S. Forte (“Forte”), even though the school had received hundreds of thousands of dollars in donations from him. Malvern is a venerable 167-year old independent Catholic middle and high school for boys in Malvern PA. Forte is reported to be serving a 15-year prison term for investment fraud, having pleaded guilty on June 5, 2009.
Mr. Brubaker stated that, unlike other Forte charities that have chosen to negotiate with the receiver for Forte’s estate on donated monies that the receiver is endeavoring to “clawback,” Malvern is suing to retain the money donated by Forte. The Brubaker article explains that the basis of the Malvern claim for victim status is complicated:
The school, known for its sports programs, went into debt constructing a strength-and-conditioning center at Forte's urging and after he pledged $1 million to pay for it. But Forte only paid $500,000 of his pledge, according to the school, leaving Malvern Prep in debt for the rest. The school's June 30 [2010 lawsuit] filing asserted a counterclaim for $630,000, which includes $565,000 for a portion of a term loan needed to pay for the center plus $65,000 in fees and interest.
The facts in the Malvern case are unusual because Malvern was not just a charitable beneficiary of Forte as was the Archdiocese of Philadelphia, which was mentioned in the Brubaker article. Nor was the school simply a direct or indirect investor with Forte as, for example, Hadassah and Yeshiva University were with Madoff, as reported in Installments 22 and 23 of this series.
The discovery of the Forte scandal, his guilty plea and conviction, the Securities and Exchange Commission actions, and the appointment of Marion A. Hecht, CPA, CFE, CIRA, CFF, and MBA, Managing Director of the forensic litigation and valuation division of Goodman & Company, LLP, as receiver for Forte’s assets, all occurred during Malvern’s fiscal year ended June 30, 2009 (“Fiscal 2009”). A review of the balance sheet in the New Form 990 dated February 9, 2010, filed by Malvern for Fiscal 2009 with the IRS (the “Malvern 2009 Form 990”) reveals a decline in the category of “Pledges Receivable” during Fiscal 2009 of approximately $1.2 million from $2,003,004 to $785,992. Because there is no note or explanation by Malvern in the Malvern 2009 Form 990 regarding the category, it is impossible to tell whether all or any portion of the $500,000 Forte pledge was written off by the school during the Fiscal 2009.
Malvern’s financial association with Forte was a complex “hybrid” case in that Malvern not only received direct donations from Forte that were presumably proceeds from his investment scheme; in effect, Malvern also was a type of investor with him. Malvern dedicated the proceeds of Forte’s bounty for the purpose of the strength-and-conditioning center that the school was reluctant to build in the first place and, in doing so, incurred its own new debt in reliance upon the anticipated payment of the remainder of the Forte pledge. Therefore, Malvern has suffered a real investment loss from the failure of Forte to satisfy his $500,000 pledge to pay for the indebtedness incurred by the school to build the project that Forte had induced it to undertake.
It is somewhat perplexing that the Malvern 2009 Form 990 makes no mention of Forte or the fate of his personal pledge, although the Forms 990 filed by the school for the immediately prior two fiscal years clearly listed him among its Trustees.
The matter is further complicated by the fact that, as discussed in Installment 29 of this series, Part VI of New Form 990entitled “Government, Management and Disclosure” has the following question on Line 5 for an answer of “Yes” or “No” by the organization: “Did the organization become aware during the year of a material diversion of the organization’s assets?”
In the Malvern 2009 Form 990, Line 5 was answered “No.”
The instructions for completing the New Form 990 (the “Form 990 Instructions”) provides the following, in part, as to Line 5:
Answer “Yes” if the organization became aware during the organization’s tax year of a material diversion of its assets, whether or not the diversion occurred during the year. If “Yes,” explain the nature of the diversion, amounts or property involved, corrective actions taken to address the matter, and pertinent circumstances in Schedule O, though the person or persons who diverted the assets should not be identified by name.
A diversion of assets includes any unauthorized conversion or use of the organization’s assets other than for the organization’s authorized purposes, including but not limited to an embezzlement or theft. . . .
For this purpose, a diversion is considered material if the gross dollar amount (not taking into account restitution, insurance, or similar recoveries) exceeds the lesser of (1) $250,000 or (2) 5 percent of the lesser of the organization’s gross receipts for its tax year or total assets as of the end of its tax year.
If the decline in the Pledges Receivable in the Malvern 2009 Form 990 was attributable in part to a write-off of at least $250,000 of the outstanding $500,000 Forte pledge because of the repudiation of the Forte pledge by the receiver, the school should have considered making an explanation on Schedule O. If such a write-off of the Forte pledge did actually occur during Fiscal 2009, Malvern and its professional advisers apparently employed a narrow interpretation of the definition of “diversion of assets.”
While such a narrow interpretation may be supportable, I believe that the desirability of Malvern’s having taken a broader view of the term “diversion of assets” was heightened by the fact that Forte had been a Trustee of the school. As a matter of fact the Form 990 Instructions make a specific point that the category Pledges Receivable should include pledges of trustees, after any amounts estimated to be uncollectible:
Line 3. Pledges and grants receivable, Net. Enter the total
of (a) all pledges receivable, less any amounts estimated to be
uncollectible, including pledges made by officers, directors,
trustees, key employees, and highest compensated
employees and (b) all grants receivable.
As a final note, even if no write-off of all or a portion of the Forte receivable occurred during Fiscal 2009, in my view, Malvern should have considered making an explanation in the Malvern 2009 Form 990 as to why it was continuing to carry the Forte pledge in Pledges Receivable at full value.
In summation, the New Form 990 questions and Form 990 Instructions may need some refinement by the IRS to enhance the clarity and consistency of definitions and promote greater transparency by charities, as has been recommended in this and earlier Installments of this series.
[To be continued in Installment 31]